Question 1

A postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

Accepted Answer

A postaudit is a review conducted after a project has been completed to determine whether the actual results achieved align with the initial projections made during the planning stage. This review allows for an evaluation of the project's success and the identification of any necessary changes that could be applied to future projects.

Question 2

Sources of cash outflows from capital investments include incremental expenses and installation costs.

Accepted Answer

Sources of cash outflows from capital investments include incremental expenses such as maintenance and operating costs, as well as installation costs such as equipment purchases and construction expenses.

Question 3

The payback method of evaluating capital investments measures the recovery of the investment, but it does not measure profitability.

Accepted Answer

The payback method only looks at how long it takes to recover the investment, not at how profitable the investment is. Other methods, such as net present value or internal rate of return, are better for evaluating profitability.

Question 4

The amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

Accepted Answer

This statement is true. The depreciation tax shield is the amount of money that a company saves on taxes due to the tax-deductible nature of depreciation. It is calculated by multiplying the amount of depreciation expense by the tax rate.

Question 5

When a capital investment is expected to provide unequal annual cash inflows, the payback period can be calculated by accumulating the incremental cash inflows until the sum equals the amount of the original investment.

Accepted Answer

This statement is true. The payback period is the length of time it takes to recover the initial investment through the cash inflows generated by the investment. If the cash inflows are unequal, the payback period can be calculated by summing up the incremental cash inflows until they equal the original investment.

Question 6

The unadjusted rate of return is found by dividing the average incremental increase in annual operating income by the cost of the investment.

Accepted Answer

This statement correctly defines the unadjusted rate of return calculation.

Question 7

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

Accepted Answer

The payback method calculates the time it takes for the cash inflows to equal the initial investment or cost of an asset. It is used to evaluate the profitability of an investment and determine how long it will take to recoup the initial expenditure.

Question 8

Depreciation on a capital investment (such as equipment) has the effect of decreasing the amount of income taxes that the company owning the asset must pay.

Accepted Answer

Depreciation is a tax deduction that allows businesses to recover the cost of a capital investment by deducting the expense over the useful life of the asset. This lowers the taxable income of the business and therefore reduces the amount of income taxes owed.

Question 9

When the effect of income taxes is considered in a capital budgeting analysis, the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

Accepted Answer

Depreciation expense reduces taxable income and therefore reduces income taxes paid. Adding back depreciation expense to after-tax income reflects the additional cash flow available.

Question 10

If the net present value for a capital investment is equal to zero, the internal rate of return for the investment is equal to the required rate of return.

Accepted Answer

When the net present value (NPV) for a capital investment is zero, it means that the expected cash inflows from the investment are equal to the initial investment cost. This also means that the internal rate of return (IRR) for the investment is exactly equal to the discount rate used to calculate the NPV, which is the required rate of return. Therefore, if the NPV is zero, the IRR will be equal to the required rate of return.

Question 11

If a company has to pay a given amount of income taxes over the life of a capital investment, managers of the company should seek to pay the taxes as early as possible in the investment's life.

Accepted Answer

Managers of the company should seek to delay the payment of income taxes as much as possible in order to benefit from the time value of money and the potential returns from reinvesting the cash. Paying taxes early would result in an opportunity cost of the potential return that could have been earned by investing the cash.

Question 12

Generally, the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

Accepted Answer

The unadjusted rate of return is a measure of profitability that calculates the profit or loss generated by an investment. It is best calculated based on the average investment in the asset rather than the original investment amount, as this takes into account any fluctuations in the investment over time. For depreciable assets such as equipment, the average investment can be calculated as the sum of the original cost and the salvage value, divided by two.

Question 13

When a capital investment is expected to provide unequal annual cash inflows, the payback period cannot be calculated.

Accepted Answer

The payback period can still be calculated for investments with unequal annual cash inflows by summing the cash inflows year by year until the initial investment is recovered.

Question 14

A capital investment with an internal rate of return equal to or greater than the required rate of return is considered to be an acceptable investment.

Accepted Answer

If the internal rate of return of a capital investment is equal to or greater than the required rate of return, it means that the investment will generate a return that is at least equal to the cost of capital. Therefore, it is considered an acceptable investment.

Question 15

Generally, a company should use the MACRS method to calculate depreciation on its income tax return, due to the effects of the time value of money.

Accepted Answer

The MACRS method takes into account the time value of money by allowing for higher depreciation deductions in the early years of an asset's life, when the asset is more valuable and has a higher utility. This can help reduce a company's taxable income and provide cash flow benefits. Therefore, it is generally recommended that companies use the MACRS method to calculate depreciation on their income tax return.

Question 16

Cash inflows from a capital investment may include the terminal value of capital assets and increases in revenues.

Accepted Answer

Cash inflows from a capital investment can include the terminal value of capital assets, which is the expected value at the end of the investment's useful life, and also increases in revenues that result from the investment.

Quiz 16: Planning for Capital Investments