Question 1

The payback method of capital budgeting approach to an investment decision ________.

Accepted Answer

The payback method of capital budgeting approach only considers the length of time it would take to recover the initial investment, ignoring cash flows beyond that point, the time value of money, and any potential profitability of the investment. It's used primarily to assess the liquidity of the investment, making option B the best choice.

Question 2

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 3

The NPV method is the preferred method over IRR for selecting projects because ________.

Accepted Answer

The NPV method is preferred because it directly measures the increase in value to the firm and aligns with the goal of maximizing shareholder wealth.

Question 4

Discounted cash flow methods focus on operating income.

Accepted Answer

Discounted cash flow methods focus on cash flows, not operating income, as they aim to determine the present value of future cash flows.

Question 5

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

Accepted Answer

A capital budgeting project is accepted if the internal rate of return (IRR) equals or exceeds the required rate of return, not the other way around.

Question 6

The Required Rate of Return (RRR)is set externally by creditors as the interest rate on long term liabilities.

Accepted Answer

The Required Rate of Return (RRR) is usually set internally by companies as the minimum return they require on investments to justify the risk they undertake. It is not set by creditors. The interest rate on long-term liabilities is determined by market forces and may exceed or fall below a company's RRR.

Question 7

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:
 $$\begin{array} { | l | c | c | c | } 
\hline & \text { Location A } & \text { Location B } & \text { Location C } \
\hline \text { Internal rate of return } & 13 \% & 17 \% & 20 \% \
\hline \text { Net present value } & \$ 25,000 & \$ 40,000 & \$ 20,000 \
\hline
\end{array}$$ 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 8

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 why it is considered an accurate method for evaluating project profitability.

Question 9

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 net present value method takes into consideration the time value of money by discounting future cash flows back to their present value using a required rate of return. This required rate of return can be adjusted or varied based on the risk profile or changing market conditions of the project over its life.

Question 10

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 11

Flilane Tire Company needs to overhaul its auto lift system or buy a new one.The facts have been gathered,and they are as follows:
 $$\begin{array} { | l | r | r | } 
\hline & \text { Current Machine } & \text { New Machine } \
\hline \text { Purchase Price, New } & \$ 123,750 & \$ 162,800 \
\hline \text { Current book value } & 36,850 & \
\hline \text { Overhaul needed now } & 30,250 & \
\hline \text { Annual cash operating costs } & 69,300 & 52,800 \
\hline \text { Current salvage value } & 44,000 & \
\hline \text { Salvage value in five years } & 8,800 & 38,500 \
\hline
\end{array}$$ 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 Flilane Tire Company needs to overhaul its...

Question 12

The net initial investment for a piece of construction equipment is $3,000,000.Annual cash inflows are expected to increase by $500,000 per year.The equipment has an 8-year useful life.What is the payback period?

Accepted Answer

Payback period is calculated by dividing the net initial investment by the expected annual cash inflows.
Payback period = Net initial investment / Annual cash inflows
In this case, 
Payback period = $3,000,000 / $500,000 per year
Payback period = 6 years 
Therefore, the best choice is C, which is 6 years.

Question 13

The three common discounted cash flow methods are net present value,internal rate of return,and payback.

Accepted Answer

The two common discounted cash flow methods are net present value and internal rate of return. The traditional payback method is not a discounted cash flow method.

Question 14

The net present value (NPV)method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return.

Accepted Answer

This is a correct description of the NPV method.

Question 15

Managers prefer projects with higher IRRs to projects with lower IRRs,if all other things are equal.

Accepted Answer

Managers prefer projects with higher IRRs because it indicates a higher rate of return on investment compared to projects with lower IRRs. However, other factors such as project size, risk, and cash flow must also be considered before making a final decision.

Question 16

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 internal rate of return (IRR) is a metric used to estimate the profitability of potential investments, calculated as the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero, not the expected net monetary gain or loss.

Question 17

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, which measures the time it takes for a project to recoup its initial investment. The other options listed (accrued accounting rate-of-return method, internal rate-of-return method, book-value method) do not specifically measure the time it takes to recoup an investment in this way.

Question 18

If internal rate of return is less than required rate of return,the net present value is positive.

Accepted Answer

If the internal rate of return is less than the required rate of return, it means the investment is not generating enough return to meet expectations. In this case, the net present value would be negative, indicating that the investment is not worthwhile. A positive net present value occurs when the internal rate of return is greater than the required rate of return.

Question 19

The Enor Machine Company is evaluating a capital expenditure proposal that requires an initial investment of $99,360 and has predicted cash inflows of $20,000 per year for 8 years.It will have no salvage value.
Required:
a.Using a required rate of return of 10%,determine the net present value of the investment proposal.
b.Determine the proposal's internal rate of return.

Accepted Answer

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

Question 20

EIF Manufacturing Company needs to overhaul its drill press or buy a new one.The facts have been gathered,and they are as follows:
 $$\begin{array} { | l | r | r | } 
\hline & \text { Current Machine } & \text { New Machine } \
\hline \text { Purchase Price, New } & \$ 88,000 & \$ 110,000 \
\hline \text { Current book value } & 33,000 & \
\hline \text { Overhaul needed now } & 44,000 & \
\hline \text { Annual cash operating costs } & 77,000 & 44,000 \
\hline \text { Current salvage value } & 22,000 & \
\hline \text { Salvage value in five years } & 5,500 & 22,000 \
\hline
\end{array}$$ 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...

Quiz 21: Capital Budgeting and Cost Analysis