Question 1

The cash payback method can be used only when net cash inflows are the same for each period.

Accepted Answer

The cash payback method can be used even when net cash inflows are not the same for each period, by calculating the cumulative cash inflows until the initial investment is recovered. However, it is more accurate to use methods such as net present value or internal rate of return when net cash inflows vary over time.

Question 2

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total operating income generated over the life of the machine is estimated to be $12,000. The machine will generate net cash inflows of $6,000 per year. The average rate of return for the machine is 50%.

Accepted Answer

The average rate of return is calculated as the average annual operating income divided by the initial investment cost. Here, the average annual operating income is $12,000 / 6 years = $2,000. The initial cost of the machine is $24,000. Therefore, the average rate of return is $2,000 / $24,000 = 8.33%, not 50%.

Question 3

If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected net cash inflow and net income of $32,000 and $12,000, respectively, the cash payback period is 4 years.

Accepted Answer

The cash payback period is calculated based on the annual expected net cash inflow, not net income. With an annual expected net cash inflow of $32,000, the cash payback period for the $80,000 expenditure would be $80,000 / $32,000 = 2.5 years.

Question 4

For Years 1-5, a proposed expenditure of $500,000 for a fixed asset with a 5-year life is expected to generate operating income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash inflows of $90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 5 years.

Accepted Answer

The cash payback period is calculated by summing the net cash inflows until the initial investment is recovered. In this case, by the end of Year 4 ($90,000 + $85,000 + $75,000 + $75,000 = $325,000), the initial investment of $500,000 has not been fully recovered. By adding the Year 5 inflow ($75,000), the total inflow reaches $400,000, which still does not recover the initial $500,000 investment, indicating the payback period is longer than 5 years.

Question 5

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 6 years.

Accepted Answer

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Question 6

A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual net cash inflows from the investment are $36,000 (Year 1), $30,000 (Year 2), $18,000 (Year 3), $12,000 (Year 4), and $6,000 (Year 5). The average operating income generated from the investment over its 5-year life is $20,400. The cash payback period is 3.5 years.

Accepted Answer

The average operating income is calculated by dividing the total operating income over the 5-year life of the investment by 5. In this case, the average operating income is $20,400. The cash payback period is calculated by dividing the initial investment by the average annual net cash inflow. In this case, the cash payback period is 3.5 years.

Question 7

If a proposed expenditure of $70,000 for a fixed asset with a 4-year life has an annual expected net cash inflow and net income of $32,000 and $12,000, respectively, the cash payback period is 2.5 years.

Accepted Answer

The cash payback period is calculated by dividing the initial investment by the annual cash inflow. In this case, $70,000 / $32,000 = 2.1875 years, not 2.5 years.

Question 8

The computations involved in the net present value method of analyzing capital investment proposals are less involved than those for the average rate of return method.

Accepted Answer

The net present value method involves more complex computations, including discounting future cash flows back to their present value using a specific discount rate, whereas the average rate of return method typically involves simpler arithmetic calculations based on average annual profits and initial investment costs.

Question 9

A company is considering purchasing a machine for $21,000. The machine will generate operating income of $2,000; annual net cash inflows from the machine will be $3,500. The cash payback period for the new machine is 10.5 years.

Accepted Answer

The cash payback period is calculated by dividing the initial investment by the annual net cash inflows. In this case, $21,000 / $3,500 = 6 years.

Question 10

For Years 1-5, a proposed expenditure of $250,000 for a fixed asset with a 5-year life has expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash inflows of $90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 3 years.

Accepted Answer

The cash payback period is calculated by summing the net cash inflows until the initial investment is recovered. By the end of Year 3, the cumulative cash inflow is $90,000 + $85,000 + $75,000 = $250,000, exactly matching the initial investment, thus confirming a 3-year cash payback period.

Question 11

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 12 years.

Accepted Answer

The payback period for the machine is actually 3 years (48,000 initial cost divided by 16,000 annual net cash inflow). Therefore, the statement is false.

Question 12

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total operating income generated over the life of the machine is estimated to be $12,000. The machine will generate net cash inflows of $6,000 per year. The payback period for the machine is 12 years.

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual net cash inflow. Here, it would be $24,000 / $6,000 = 4 years, not 12 years.

Question 13

The computations involved in the net present value method of analyzing capital investment proposals are more involved than those for the average rate of return method.

Accepted Answer

The net present value method considers the time value of money and involves discounting future cash flows to their present value, while the average rate of return method simply calculates the average profitability of an investment over its life. This makes the computations for net present value more complex and detailed than those for average rate of return.

Question 14

The average rate of return method of analyzing capital investment decisions measures the average rate of return from using the asset over its entire life.

Accepted Answer

The average rate of return method calculates the return on an investment by dividing the average annual profit by the initial investment cost, effectively measuring the profitability of an investment over its entire life.

Question 15

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total operating income generated over the life of the machine is estimated to be $12,000. The machine will generate net cash inflows of $6,000 per year. The average rate of return for the machine is 16.7%.

Accepted Answer

The average rate of return is calculated by dividing the average annual net cash inflows by the initial investment and multiplying by 100. In this case, the average annual net cash inflows are $6,000 and the initial investment is $24,000, so the average rate of return is (6,000 / 24,000) * 100 = 25%.

Question 16

The average rate of return is a measure of profitability computed by dividing the average annual cash inflows from an asset by the average amount invested in the asset.

Accepted Answer

The average rate of return is typically calculated by dividing the average annual profit by the initial investment cost, not by dividing the average annual cash inflows by the average amount invested.

Question 17

The time expected to pass before the net cash inflows from an investment would return its initial cost is called the amortization period.

Accepted Answer

The time expected to pass before the net cash inflows from an investment would return its initial cost is called the payback period, not the amortization period. Amortization typically refers to the process of gradually writing off the initial cost of an intangible asset over its useful life.

Question 18

A company is considering purchasing a machine for $21,000. The machine will generate operating income of $2,000; annual net cash inflows from the machine will be $3,500. The cash payback period for the new machine is 6 years.

Accepted Answer

The cash payback period is calculated by dividing the initial investment by the annual net cash inflows. In this case, the cash payback period is $21,000 / $3,500 = 6 years.

Question 19

In net present value analysis for a proposed capital investment, the expected future net cash flows are averaged and then reduced to their present values.

Accepted Answer

In net present value analysis, the expected future net cash flows are not averaged; instead, each cash flow is individually discounted back to its present value using a specific discount rate before being summed to determine the net present value.

Question 20

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total operating income generated over the life of the machine is estimated to be $12,000. The machine will generate net cash inflows of $6,000 per year. The payback period for the machine is 4 years.

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual net cash inflow. Here, $24,000 / $6,000 = 4 years.

Quiz 26: Capital Investment Analysis