Question 1

How does the calculation of break-even time (BET)differ from the calculation of payback period (PBP)?

Accepted Answer

The answer of How does the calculation of break-even time...

Question 2

There are two basic steps in calculating the internal rate of return.Which of the following represents those two steps?

Accepted Answer

The two basic steps in calculating the internal rate of return are (1) computing the present value factor for the project and (2) identifying the discount rate that makes the net present value equal to zero. Therefore, option B, which states these two steps correctly, is the best choice. Option A is incorrect because it mentions comparing the PV factor to the hurdle rate instead of identifying the discount rate. Option C is incorrect because it states that the discount rate needs to be identified first, which is not correct. Option D is incorrect because accepting or rejecting the project is not a step in calculating the IRR. Option E is incorrect because selecting the hurdle rate is not one of the steps in calculating the IRR, although the hurdle rate may be used as a benchmark to compare the IRR.

Question 3

The rate that yields a net present value of zero for an investment is the:

Accepted Answer

The rate that yields a net present value of zero for an investment is called the internal rate of return (IRR). It is the rate that makes the present value of cash inflows equal to the initial investment. It is a widely used technique for evaluating the profitability of an investment and is considered to be a better measure of investment attractiveness than the accounting rate of return or the payback period because it takes into account the time value of money.

Question 4

Holder Manufacturing is considering purchasing two machines.Each machine costs $8,000 and will produce cash flows as follows:
$$\begin{array} { c c } 
\begin{array}{l}
\text {End of}\
 \text {Year}\
1\
2\
3
\end{array}
\begin{array} { }
& \text { Machine }  \
&\begin{array} { }
&\text { A } &  \text { B }  \
&\$ 5,000 & \$ 1,000 \
&4,000 & 2,000 \
&2,000 & 11,000
\end{array}
\end{array}

\end{array}$$
Holder Manufacturing uses the net present value method to make the decision,and it requires a 15% annual return on its investments.The present value factors of 1 at 15% are: 1 year,0.8696; 2 years,0.7561; 3 years,0.6575.Which machine should Holder purchase?

Accepted Answer

Machine A .8696($5,000) + .7561($4,000) + .6575($2,000) = $8,687
Machine B .8696($1,000) + .7561($2,000) + .6575($11,000) = $9,614
Saxon should purchase Machine B

Question 5

A company is considering the purchase of new equipment costing $91,000.The machine has a useful life of four years and no salvage value.The company requires a 12% return on its investments.The factors for the present value of an annuity of 1 for different periods follow:

$$\begin{array} { lr } 
\underline{\text { Periods }} &\underline{12 \text { Percert }} \
1 &0.8929 \
2 &1.6901 \
3 &2.4018 \
4 & 3.0373
\end{array}$$
Assuming all revenue is to be received at the end of each year,what are the net cash flows for this investment if net present value equals ($11,790)?

Accepted Answer

Present value of annual net cash flows:
PV of net cash flows - $90,000 = ($11,790)
PV of net cash flows = $78,210
Net cash flows x 3.0373 = $78,210
Net cash flows = $25,750

Question 6

Scott Corporation is considering the purchase of new equipment costing $30,000.The projected annual after-tax net income from the equipment is $1,200,after deducting $10,000 for depreciation.The revenue is to be received at the end of each year.The machine has a useful life of three years and a $4,000 salvage value.Scott requires a 12% return on its investments.The factors for the present value of $1 for different periods follow:
$$\begin{array} { l r } 
\underline{\text { Periods }} & \underline{12 \text { Percent }} \
1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$
What is the net present value of the machine and what is the maximum Scott would have been willing to pay for it?

Accepted Answer

(.8929+.7972+.7118)($11,200) + (.7118)(4,000) = $29,748.48 - $30,000 = ($251.52)
Maximum price to pay would be equal to the PV of $29,748.48

Question 7

In using the internal rate of return method,management must consider a hurdle rate in making its decisions.What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

Accepted Answer

The answer of In using the internal rate of return...

Question 8

The following present value factors are provided for use in this problem:

$\begin{array} { cc } 
&\text{Present}&\
&\text{Value}& \text{Present Value of an}\
\text{Periods}& \text{of 1 at 8 \%}& \text{Annutity of 1 at 8 \%}\
1 & 0.9259 & 0.9259 \ 
2 & 0.8573 & 1.7833 \ 
3 & 0.7938 & 2.5771 \ 
4 & 07350 & 3.3121
 \end{array}$
Norman Co.wants to purchase a machine for $40,000 but needs to earn an 8% return.The expected year-end net cash flows are $12,000 in each of the first three years and $16,000 in the fourth year.What is the machine's net present value (rounded to the nearest whole dollar)?

Accepted Answer

2.5771($12,000) + .7350($16,000) - $40,000 = $2,685

Question 9

What is capital budgeting? Why are capital budgeting decisions often difficult and risky?

Accepted Answer

The answer of What is capital budgeting? Why are capital...

Question 10

Presented below are terms preceded by letters (a)through (g)and followed by a list of definitions (1)through (7).Match the letter of the term with the definition.Use the space provided preceding each definition.
(a)Net present value
(b)Capital budgeting
(c)Accounting rate of return
(d)Net cash flow
(e)Internal rate of return
(f)Payback period
(g)Hurdle rate
__________ (1) A discount rate that results in a net present value of zero.
__________ (2) Cash inflows minus cash outflows for the period.
__________ (3) A minimum acceptable rate of return.
__________ (4) The time expected to pass before the net cash flows from an investment equals its initial cost.
__________ (5) Annual after-tax net income divided by annual average investment.
__________ (6) A process of analyzing alternative long-term investments.
__________ (7) Initial cost of an investment subtracted from discounted future cash flows from the investment.

Accepted Answer

The answer of Presented below are terms preceded by letters...

Question 11

Saxon Manufacturing is considering purchasing two machines.Each machine costs $9,000 and will produce cash flows as follows:
$$\begin{array} { c c } 
\begin{array}{l}
\text {End of}\
 \text {Year}\
1\
2\
3
\end{array}
\begin{array} { }
& \text { Machine }  \
&\begin{array} { }
&\text { A } &  \text { B }  \
&\$ 5,000 & \$ 1,000 \
&4,000 & 2,000 \
&2,000 & 11,000
\end{array}
\end{array}

\end{array}$$
Saxon Manufacturing uses the net present value method to make the decision,and it requires a 15% annual return on its investments.The present value factors of 1 at 15% are: 1 year,0.8696; 2 years,0.7561; 3 years,0.6575.Which machine should Saxon purchase?

Accepted Answer

Machine A .8696($5,000) + .7561($4,000) + .6575($2,000) = $8,687
Machine B .8696($1,000) + .7561($2,000) + .6575($11,000) = $9,614
Saxon should purchase Machine B

Question 12

What is discounting?

Accepted Answer

The answer of What is discounting?...

Question 13

Daniels Corporation is considering the purchase of new equipment costing $30,000.The projected annual after-tax net income from the equipment is $1,200,after deducting $10,000 for depreciation.The revenue is to be received at the end of each year.The machine has a useful life of three years and no salvage value.Daniels requires a 12% return on its investments.The factors for the present value of $1 for different periods follow:
$$\begin{array} { l r } 
\underline{\text { Periods }} & \underline{12 \text { Percent }} \
1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$
What is the net present value of the machine?

Accepted Answer

(.8929+.7972+.7118)($11,200) = $26,900 - $30,000 = ($3,100)

Question 14

How can management evaluate the risk of an investment?

Accepted Answer

The answer of How can management evaluate the risk of...

Question 15

Which of the following cash flows is not considered when using the net present value method?

Accepted Answer

The net present value method only considers future cash flows, not past cash outflows. The focus is on determining the current value of future cash flows in relation to the initial investment.

Question 16

Peng Corporation is considering the purchase of new equipment costing $30,000.The projected annual after-tax net income from the equipment is $1,200,after deducting $10,000 for depreciation.The revenue is to be received at the end of each year.The machine has a useful life of four years and no salvage value.Peng requires a 12% return on its investments.The factors for the present value of $1 for different periods follow:
$$\begin{array} { l r } 
\underline{\text { Periods }} & \underline{12 \text { Percent }} \
1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$
Calculate the break-even time for this equipment.

Accepted Answer

11ea8897_ddf7_4331_a96f_a52469de8ed2_TB6312_00_TB6312_00_TB6312_00 BET is between 3 and 4 years

Question 17

A company bought a machine that has an expected life of six years and no salvage value.Management estimates that this machine will generate annual after-tax net income of $700.If the accounting rate of return is 10%,what was the purchase price of the machine?

Accepted Answer

Accounting rate of return = $700/ [(Purchase price + 0)/2] = 10%
Annual average investment = $700/.10 = $7,000
(Purchase price + 0)/2 = $7,000
Purchase price = 7,000 x 2 = $14,000

Question 18

An estimate of an asset's value to the company,calculated by discounting the future cash flows from the investment at an appropriate rate and then subtracting the initial cost of the investment,is known as:

Accepted Answer

Net present value is the estimate of an asset's value to the company by discounting future cash flows at an appropriate rate and subtracting the initial cost of the investment. This method takes into account the time value of money and provides a more accurate reflection of the asset's value than just looking at annual net cash flows or payback period. Rate of return on investment is a different calculation that measures the profitability of an investment. Unamortized carrying value refers to the portion of an asset's cost that has not yet been depreciated, which is not relevant to this calculation.

Question 19

Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?

Accepted Answer

Net present value considers the time value of money by discounting future cash flows to their present value using a discount rate that reflects the cost of capital. The other methods, such as accounting rate of return and payback period, do not explicitly consider the time value of money.

Question 20

Presented below are terms preceded by letters (a)through (f)and followed by a list of definitions (1)through (6).Match the letter of the terms with the definitions.Use the space provided preceding each definition.
(a)Discounting
(b)Break-even time
(c)Return on average investment
(d)Net present value
(e)Uneven cash flows
(f)Accounting rate of return
__________ (1) Annual after-tax net income divided by annual average investment.
__________ (2) A rate used to evaluate the acceptability of an investment; equals the after-tax periodic income divided by the average investment in the asset.
__________ (3) An estimate of an asset's value to the company; calculated by discounting the future cash flows from the investment at a satisfactory rate and then subtracting the initial cost of the investment.
__________ (4) Cash flows that are not all equal in amount.
__________ (5) The process of restating future cash flows in terms of their present value.
__________ (6) A measure of the amount of time needed for the present value of the net cash flows to equal the initial cost of an investment.

Accepted Answer