Question 1

The net initial investment for a piece of construction equipment is $2,000,000. Annual cash inflows are expected to increase by $400,000 per year. The equipment has an 8-year useful life. What is the payback period?

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual cash inflow. $2,000,000 / $400,000 = 5 years.

Question 2

Network Service Center is considering purchasing a new computer network for $82,000. It will require additional working capital of $13,000. Its anticipated eight-year life will generate additional client revenue of $33,000 annually with operating costs, excluding depreciation, of $15,000. At the end of eight years, it will have a salvage value of $9,500 and return $5,000 in working capital. Taxes are not considered.
Required:
a. If the company has a required rate of return of 14%, what is the net present value of the proposed investment?
b. What is the internal rate of return?

Accepted Answer

The answer of Network Service Center is considering purchasing a...

Question 3

The method that measures the time it will take to recoup, in the form of future cash inflows, the total dollars invested in a project is called:

Accepted Answer

The method described in the question is the payback method. It calculates the amount of time it will take to recover the initial investment in a project by adding up the expected cash inflows until they equal the initial investment. The payback period is a simple method that is widely used due to its simplicity and ease of use. The other methods mentioned in the answers are different techniques for evaluating investment projects, but they are not specifically designed to measure the payback period.

Question 4

Retail Outlet is looking for a new location near a shopping mall. It is considering purchasing a building rather than leasing, as it has done in the past. Three retail buildings near a new mall are available but each has its own advantages and disadvantages. The owner of the company has completed an analysis of each location that includes considerations for the time value of money. The information is as follows:
  The owner does not understand how the location with the highest percentage return has the lowest net present value.
Required:
Explain to the owner what is (are)the probable cause(s)of the comparable differences.

Accepted Answer

The answer of Retail Outlet is looking for a new...

Question 5

A weaknesses of the payback method is that it does not consider a project's cash flows after the payback period.

Accepted Answer

The payback method only looks at the amount of time it takes to recoup an initial investment and does not take into account any cash flows that occur after that point.

Question 6

Upper Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $72,096. The annual cost savings if the new machine is acquired will be $20,000. The machine will have a 5-year life, at which time the terminal disposal value is expected to be zero. Upper Darby Park is assuming no tax consequences. Upper Darby Park has a 10% required rate of return. What is the payback period on this investment?

Accepted Answer

Payback period is the time that it takes for an investment to recover its initial cost. To calculate the payback period, we need to determine how many years it will take to recover the initial investment of $72,096.

To determine the payback period, we need to divide the initial investment by the annual cost savings.

Payback Period = Initial Investment / Annual Cost Savings

Payback Period = $72,096 / $20,000

Payback Period = 3.6 years

Therefore, the payback period for this investment is 3.6 years. As the payback period is within the machine's life, it could be a good investment opportunity for Upper Darby Park Department.

Question 7

Unlike the net present value method and the internal rate-of-return method, the payback method does NOT distinguish between the origins of the cash flows.

Accepted Answer

None of the three capital budgeting methods distinguish between the origins of the cash flows.

Question 8

ABC Boat Company is interested in replacing a molding machine with a new improved model. The old machine has a salvage value of $10,000 now and a predicted salvage value of $4,000 in six years, if rebuilt. If the old machine is kept, it must be rebuilt in one year at a predicted cost of $20,000.
The new machine costs $80,000 and has a predicted salvage value of $12,000 at the end of six years. If purchased, the new machine will allow cash savings of $20,000 for each of the first three years, and $10,000 for each year of its remaining six-year life.
Required:
What is the net present value of purchasing the new machine if the company has a required rate of return of 14%?

Accepted Answer

The answer of ABC Boat Company is interested in replacing...

Question 9

A capital budgeting project is accepted if the required rate of return equals or exceeds the internal rate of return.

Accepted Answer

The answer of A capital budgeting project is accepted if...

Question 10

Internal rate of return is a method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.

Accepted Answer

The answer of Internal rate of return is a method...

Question 11

The net present value method can be used in situations where the required rate of return varies over the life of the project.

Accepted Answer

The NPV method takes into account the required rate of return for each period of cash flow, so it can be used when the required rate of return varies over the life of the project.

Question 12

The net present value method accurately assumes that project cash flows can only be reinvested at the company's required rate of return.

Accepted Answer

The net present value method assumes that project cash flows can only be reinvested at the company's required rate of return, which is one of the key assumptions of the method. This assumption is based on the idea that if the project generates excess cash flows, the company can use them to invest in other projects with the same required rate of return, thereby maximizing shareholder wealth. Consequently, the net present value method is considered to be a more accurate and reliable measure of a project's profitability in comparison to other methods, such as the internal rate of return or the payback period.

Question 13

The Zero Machine Company is evaluating a capital expenditure proposal that requires an initial investment of $41,920 and has predicted cash inflows of $10,000 per year for 10 years. It will have no salvage value.
Required:
a. Using a required rate of return of 16%, determine the net present value of the investment proposal.
b. Determine the proposal's internal rate of return.

Accepted Answer

The answer of The Zero Machine Company is evaluating a...

Question 14

The payback method is only useful when the expected cash flows in the later years of the project are highly uncertain.

Accepted Answer

The payback method is useful when cash flows are certain and can be predicted with some accuracy. It is a simple method that calculates the time it takes for a project to generate enough cash flows to recover its initial investment. However, it does not take into account the time value of money, and it ignores cash flows that occur after the payback period. Therefore, it may not be the best method to use when cash flows in later years are uncertain, as it does not provide a complete picture of a project's profitability over time.

Question 15

The payback method of capital budgeting approach to the investment decision highlights:

Accepted Answer

The payback method focuses on how quickly an investment can recover its initial cost, emphasizing the liquidity aspect by determining how fast the cash inflows will cover the initial outlay.

Question 16

EIF Manufacturing Company needs to overhaul its drill press or buy a new one. The facts have been gathered, and they are as follows:
  Required:
Which alternative is the most desirable with a current required rate of return of 20%? Show computations, and assume no taxes.

Accepted Answer

The answer of EIF Manufacturing Company needs to overhaul its...

Question 17

Springtime Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van has a value of $123,750 with a seven-year life. The expected additional cash inflows are $27,500 per year. What is the payback period on this investment?

Accepted Answer

To calculate the payback period, we need to determine how long it will take to recover the initial investment. 
Payback Period = Initial Investment ÷ Annual Cash Inflows 
Payback Period = $123,750 ÷ $27,500 = 4.5 years. Therefore, the payback period on this investment is 4.5 years.

Question 18

Crystal Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of five years and the new equipment has a value of $231,000 with a five-year life. The expected additional cash inflows are $70,000 per year. What is the payback period on this investment?

Accepted Answer

The answer of Crystal Manufacturing Company provides glassware machines for...

Question 19

Maremount Tire Company needs to overhaul its auto lift system or buy a new one. The facts have been gathered, and they are as follows:
  Required:
Which alternative is the most desirable with a current required rate of return of 15%? Show computations, and assume no taxes.

Accepted Answer

The answer of Maremount Tire Company needs to overhaul its...

Question 20

Supply the missing data for each of the following proposals:

Accepted Answer

The answer of Supply the missing data for each of...

Quiz 21: Capital Budgeting and Cost Analysis