Question 1

An opportunity cost is the benefit foregone by choosing an alternative course of action.

Accepted Answer

This is the definition of opportunity cost.

Question 2

Discounted cash flow methods incorporate compound interest by assuming that companies will reinvest future cash flows when they are received.

Accepted Answer

Discounted cash flow methods use compound interest to calculate the present value of future cash flows by assuming that companies will reinvest those cash flows at a certain interest rate. This allows for the time value of money to be accounted for, as cash flows received in the future are worth less than cash flows received today due to inflation and other factors.

Question 3

You have just won the lottery and have three payout options:
1.$1,000,000 now
2.$150,000 at the end of each year for the next ten years
3.$2,000,000 at the end of ten years.
What is a common basis for comparison that you can use to decide which option to choose? Explain your answer.

Accepted Answer

The answer of You have just won the lottery and...

Question 4

Steve Coleman has just won the state lottery and has the following three payout options for after-tax prize money: 1.$166,000 per year at the end of each of the next six years
2)$304,000 (lump sum)now
3)$504,000 (lump sum)six years from now
The annual discount rate is 9%.Compute the present value of the second option.(Round to nearest whole dollar.)
Present value of $1:
$$\begin{array} { | l | r | r | r | } 
\hline & 8 \% & 9 \% & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 0.857 & 0.842 & 0.826 \
\hline 3 & 0.794 & 0.772 & 0.751 \
\hline 4 & 0.735 & 0.708 & 0.683 \
\hline 5 & 0.681 & 0.650 & 0.621 \
\hline 6 & 0.630 & 0.596 & 0.564 \
\hline 7 & 0.583 & 0.547 & 0.513 \
\hline
\end{array}$$

Accepted Answer

The present value of the second option, which is a lump sum payment of $304,000 now, does not need to be discounted because it is already in present value terms. Therefore, its present value is simply $304,000.

Question 5

Which of the following situations suggests the acceptance of an investment proposal?

Accepted Answer

Acceptance of an investment proposal is typically based on the present value of the net cash inflows exceeding the initial investment, indicating a positive return on investment. The other options suggest limitations or potential challenges in the proposal, such as an IRR lower than the hurdle rate or cash inflows that are less than the initial investment. The presence of a residual value can be a positive factor in the decision-making process, but it is not necessarily a guarantee of acceptance.

Question 6

When a company is evaluating an investment proposal with high risk,a low discount rate should be used.

Accepted Answer

When a company is evaluating an investment proposal with high risk, a high discount rate should be used. This is because the higher the risk, the more return the company will need to justify the investment. A high discount rate reflects this increased risk and accounts for the time value of money.

Question 7

Ken Jones has just won the state lottery.The state offers the following three payout options for after-tax prize money:
1.$50,000 per year at the end of each of the next six years
2.$300,000 (lump sum)now
3.$400,000 (lump sum)six years from now
Calculate the present value of each scenario using an 8% annual discount rate.Round to nearest whole dollar.
Present value of an ordinary annuity of $1:
 $$\begin{array} { | c | r | r | r | } 
\hline & { 7 \% } &  { 8 \% } &{ 9 \% } \
\hline 1 & 0.935 & 0.926 & 0.917 \
\hline 2 & 1.808 & 1.783 & 1.759 \
\hline 3 & 2.624 & 2.577 & 2.531 \
\hline 4 & 3.387 & 3.312 & 3.240 \
\hline 5 & 4.100 & 3.993 & 3.890 \
\hline 6 & 4.767 & 4.623 & 4.486 \
\hline
\end{array}$$ Present value of $1:
 $$\begin{array} { | c | r | r | r | } 
\hline & { 7 \% } & { 8 \% } & { 9 \% } \
\hline 1 & 0.935 & 0.926 & 0.917 \
\hline 2 & 0.873 & 0.857 & 0.842 \
\hline 3 & 0.816 & 0.794 & 0.772 \
\hline 4 & 0.763 & 0.735 & 0.708 \
\hline 5 & 0.713 & 0.681 & 0.650 \
\hline 6 & 0.666 & 0.630 & 0.596 \
\hline
\end{array}$$

Accepted Answer

The answer of Ken Jones has just won the state...

Question 8

Peter Smith has just won the state lottery and has the following three payout options for after-tax prize money: 1.$50,000 per year at the end of each of the next six years
2)$300,000 (lump sum)now
3)$510,000 (lump sum)six years from now
The annual discount rate is 9%.Compute the present value of the third option.(Round to nearest whole dollar.)
Present value of $1:
$$\begin{array} { | l | r | r | r | } 
\hline & 8 \% & 9 \% & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 0.857 & 0.842 & 0.826 \
\hline 3 & 0.794 & 0.772 & 0.751 \
\hline 4 & 0.735 & 0.708 & 0.683 \
\hline 5 & 0.681 & 0.650 & 0.621 \
\hline 6 & 0.630 & 0.596 & 0.564 \
\hline 7 & 0.583 & 0.547 & 0.513 \
\hline
\end{array}$$

Accepted Answer

To calculate the present value of the third option ($510,000 in six years), we use the present value formula: PV = FV / (1 + r)^n, where FV is the future value, r is the annual discount rate, and n is the number of years. Using the table provided for a 9% discount rate over 6 years, the present value factor is 0.596. Therefore, the present value is $510,000 * 0.596 = $303,960 (rounded to the nearest whole dollar).

Question 9

Zane Set Designs Company has received an award which entitles it to receive annual payments of $10,000 at the end of each year for the next ten years.Which of the following is used to calculate today's value of this award?

Accepted Answer

The present value of an ordinary annuity of $1 is used to calculate the present value of a series of equal payments (in this case, $10,000 per year) made at the end of each year for a specified number of years (in this case, 10 years).

Question 10

When computing the present value,the interest rate will vary depending on the amount of risk.Safer investments,such as FDIC-insured bank deposits,yield lower interest rates.

Accepted Answer

Safer investments with lower risk typically yield lower interest rates.

Question 11

The residual value is discounted as a single lump sum because it will be received only once,when the asset is sold.

Accepted Answer

The residual value is the estimated value of an asset at the end of its useful life. It is discounted as a single lump sum because it represents a one-time cash inflow that will be received when the asset is sold or disposed of.

Question 12

Net present value is defined as the difference between the present value of the investment's net cash inflows and the investment's initial cost.

Accepted Answer

Net present value (NPV) is calculated by subtracting the initial cost of an investment from the present value of its expected future cash inflows. It is a measure used in capital budgeting to evaluate the profitability of an investment.

Question 13

The net present value method of evaluating capital investments suggests that an investment with net cash inflows which exceed the initial cost of the investment is desirable.

Accepted Answer

The net present value (NPV) method determines the present value of all future cash inflows that will be generated by an investment, subtracted by the initial cost of the investment. If the result is positive, then the investment is profitable and desirable as it generates more cash than it costs. Therefore, Option A is correct.

Question 14

Gordon Manufacturing is considering following two investment proposals: $$\begin{array} { | l | r | r | } 
\hline & \text { Proposal X } & \text { Proposal } \mathbf { Y } \
\hline \text { Investment } & \$ 736,000 & \$ 504,000 \
\hline \text { Useful life } & 5 \text { years } & 4 \text { years } \
\hline \text { Estimated annual net cash inflows received } & & \
\text { at the end of each year } & \$ 152,000 & \$ 108,000 \
\hline \text { Residual value } & \$ 64,000 & \$ 0 \
\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \
\hline \text { Annual discount rate } & 10 \% & 9 \% \
\hline
\end{array}$$ Compute the present value of the future cash inflows from Proposal X.
Present value of an ordinary annuity of $1:
$$\begin{array} { | l | r | r | r | } 
\hline &{ 8 \% } & { 9 \% } & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 1.783 & 1.759 & 1.736 \
\hline 3 & 2.577 & 2.531 & 2.487 \
\hline 4 & 3.312 & 3.240 & 3.170 \
\hline 5 & 3.993 & 3.890 & 3.791 \
\hline 6 & 4.623 & 4.486 & 4.355 \
\hline
\end{array}$$ Present value of $1:
$$\begin{array} { | l | r | r | r | } 
\hline &{ 8 \% } &  { 9 \% } & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 0.857 & 0.842 & 0.826 \
\hline 3 & 0.794 & 0.772 & 0.751 \
\hline 4 & 0.735 & 0.708 & 0.683 \
\hline 5 & 0.681 & 0.650 & 0.621 \
\hline 6 & 0.630 & 0.596 & 0.564 \
\hline
\end{array}$$

Accepted Answer

The answer of Gordon Manufacturing is considering following two investment...

Question 15

Bill Jones has just won the state lottery and has the following three payout options for after-tax prize money: 1.$150,000 per year at the end of each of the next six years
2)$304,000 (lump sum)now
3)$500,000 (lump sum)six years from now
The annual discount rate is 9%.Compute the present value of the first option.(Round your answer to the nearest whole dollar.)
Present value of an ordinary annuity of $1:
$$\begin{array} { | r | r | r | r | } 
\hline & 8 \% & 9 \% & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 1.783 & 1.759 & 1.736 \
\hline 3 & 2.577 & 2.531 & 2.487 \
\hline 4 & 3.312 & 3.240 & 3.170 \
\hline 5 & 3.993 & 3.890 & 3.791 \
\hline 6 & 4.623 & 4.486 & 4.355 \
\hline 7 & 5.206 & 5.033 & 4.868 \
\hline
\end{array}$$ Present value of $1:
$$\begin{array} { | l | r | r | r | } 
\hline & 8 \% & 9 \% & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 0.857 & 0.842 & 0.826 \
\hline 3 & 0.794 & 0.772 & 0.751 \
\hline 4 & 0.735 & 0.708 & 0.683 \
\hline 5 & 0.681 & 0.650 & 0.621 \
\hline 6 & 0.630 & 0.596 & 0.564 \
\hline 7 & 0.583 & 0.547 & 0.513 \
\hline
\end{array}$$

Accepted Answer

The present value of the annuity is calculated using the present value factor for 9% over 6 years: $150,000 * 4.486 = $672,900.

Question 16

The net present value of future cash inflows received in earlier years is higher than future cash inflows received in later years.

Accepted Answer

This is true because the net present value (NPV) calculation discounts the value of future cash inflows to reflect the time value of money. The longer the time horizon for the cash inflows, the more they are discounted, resulting in a lower NPV. Therefore, cash inflows received earlier in time have a higher present value and contribute more to the NPV calculation.

Question 17

Norton Manufacturing is considering the following two investment proposals: $$\begin{array} { | l | r | r | } 
\hline & \text { Proposal X } & \text { Proposal } \mathbf { Y } \
\hline \text { Investment } & \$ 732,000 & \$ 500,000 \
\hline \text { Useful life } & 5 \text { years } & 4 \text { years } \
\hline \text { Estimated annual net cash inflows received } & & \
\text { at the end of each year } & \$ 152,000 & \$ 108,000 \
\hline \text { Residual value } & \$ 60,000 & \$ 0 \
\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \
\hline \text { Annual discount rate } & 10 \% & 9 \% \
\hline
\end{array}$$ Compute the present value of the future cash inflows from Proposal Y.
Present value of an ordinary annuity of $1:
$$\begin{array} { | l | r | r | r | } 
\hline &  { 8 \% } &{ 9 \% } & 10 \% \
\hline 1 & 0.926 & 0.917 & 0.909 \
\hline 2 & 1.783 & 1.759 & 1.736 \
\hline 3 & 2.577 & 2.531 & 2.487 \
\hline 4 & 3.312 & 3.240 & 3.170 \
\hline 5 & 3.993 & 3.809 & 3.791 \
\hline 6 & 4.623 & 4.486 & 4.355 \
\hline
\end{array}$$

Accepted Answer

The present value of the future cash inflows from Proposal Y is calculated using the present value of an ordinary annuity formula. Given the annual discount rate for Proposal Y is 9% and the useful life is 4 years, we use the 9% row and the value for 4 years from the table, which is 3.240. The estimated annual net cash inflows received at the end of each year for Proposal Y is $108,000. Therefore, the present value of the future cash inflows is $108,000 * 3.240 = $349,920.

Question 18

When computing the present value,the interest rate will vary depending on the amount of risk.Riskier investments,such as FDIC-insured bank deposits,command higher interest rates.

Accepted Answer

Riskier investments such as stock investments command higher interest rates.

Question 19

Management's minimum desired rate of return on a capital investment is known as the return on investment.

Accepted Answer

Management's minimum desired rate of return on a capital investment is known as the hurdle rate or required rate of return, not the return on investment (ROI). ROI is a measure of the profitability of an investment.

Question 20

Discounted cash flow methods typically ________.

Accepted Answer

Discounted cash flow methods, such as net present value and internal rate of return, assume that cash flows will be reinvested when received in order to calculate the present value of future cash flows. This is because the goal of discounted cash flow analysis is to determine the current value of an investment based on its expected future cash flows. Simple interest calculations are not typically used. Focusing on the payback period alone is not a discounted cash flow method. While discounted cash flow methods are commonly used in financial analysis, they are not a requirement of GAAP (Generally Accepted Accounting Principles).

Quiz 26: Capital Investment Decisions