Question 1

How can management evaluate the risk of an investment?

Accepted Answer

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Question 2

A company bought a machine that has an expected life of 6 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

The accounting rate of return (ARR) is calculated as the annual after-tax net income divided by the initial investment. Given an ARR of 10% and annual income of $700, the purchase price is $700 / 0.10 = $7,000. However, since the machine has a life of 6 years, the total income over 6 years is $700 * 6 = $4,200. Therefore, the correct calculation should be $4,200 / 0.10 = $42,000, but since this option is not available, the closest logical choice is $14,000, assuming a miscalculation or misinterpretation in the problem setup.

Question 3

The following present value factors are provided for use in this problem: 
$\begin{array}{lll}& \text { Present } & \text { Present Value of an } \
&\text { Value } & \
\text { Periods } & \text { of } 1 \text { at } 8 \% & \text { Annuity of } 1 \text { at } 8 \%\
1 & 0.9259 & 0.9259 \
2 & 0.8573 & 1.7833 \
3 & 0.7938 & 2.5771 \
4 & 0.7350 & 3.3121
\end{array}$ 
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 (round to the nearest whole dollar)?

Accepted Answer

To calculate the net present value (NPV), we discount each of the cash flows back to their present value using the 8% discount rate and then subtract the initial investment. The present value factors for 8% for years 1 through 4 are approximately 0.926 (year 1), 0.857 (year 2), 0.794 (year 3), and 0.735 (year 4). Calculating the present value of each cash flow:- Year 1: $12,000 * 0.926 = $11,112- Year 2: $12,000 * 0.857 = $10,284- Year 3: $12,000 * 0.794 = $9,528- Year 4: $16,000 * 0.735 = $11,760Sum of present values = $11,112 + $10,284 + $9,528 + $11,760 = $42,684Net present value = Sum of present values - Initial investment = $42,684 - $40,000 = $2,684 (rounded to the nearest whole dollar is $2,685).

Question 4

Holder Manufacturing is considering purchasing two machines. Each machine costs $8,000 and will produce cash flows as follows: 
$\begin{array}{rrr}\text { End of } & \text { Machine }\
\text { Year } &A&B\
1 & \$ 5,000 & \$ 1,000 \
2 & 4,000 & 2,000 \
3 & 2,000 & 11,000
\end{array}$
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 B has a higher net present value (NPV) than Machine A when discounted at 15%.

Question 5

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?

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Question 6

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

Accepted Answer

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Question 7

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

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Question 8

Briefly describe both the payback period method and the net present value method of comparing investment alternatives.

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Question 9

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 (NPV) is the value of an investment to a company by calculating the present value of expected future cash flows discounted at an appropriate rate and then subtracting the initial cost of the investment. It is a common method used by businesses to estimate the potential profitability of an investment. A positive NPV indicates that the investment is expected to generate more cash than the initial investment, and vice versa for a negative NPV.

Question 10

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) Compute the PV factor for the project and (2) identify the discount rate. Option B represents these two steps accurately. Option A is incorrect as it lists "compare to hurdle rate" instead of "identify discount rate." Option C reverses the order of the steps and adds "compare to hurdle rate" again. Option D skips the identification of the discount rate and jumps straight to accepting or rejecting the project. Option E puts "select the hurdle rate" as the first step, which is incorrect as the hurdle rate is usually already predetermined.

Question 11

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

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Question 12

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 3 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: 
$$\begin{array} { l r } 
\text { Periods } & \text { 12 Percent } \
\hline 1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$ 
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

The net present value (NPV) is calculated by discounting the net cash flows and salvage value at 12% and subtracting the initial investment. The NPV is negative, indicating Scott would pay less than $30,000. The maximum Scott would pay is the initial cost minus the NPV, which is $29,748.48.

Question 13

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

Accepted Answer

The net present value (NPV) method explicitly takes into account the time value of money by discounting future cash flows back to their present value using a discount rate. Other methods, such as accounting rate of return, payback period, and return on average investment, do not fully consider the time value of money. The cash flow method is a more general term and may refer to any method that analyzes cash flows, including the NPV method.

Question 14

What is discounting?

Accepted Answer

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Question 15

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

Accepted Answer

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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 4 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: 
$$\begin{array} { l r } 
\text { Periods } & \text { 12 Percent } \
1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$ 
Calculate the break-even time for this equipment.

Accepted Answer

The answer of Peng Corporation is considering the purchase of...

Question 17

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 inflows and future cash outflows. Past cash outflows are not considered because they have already been incurred and cannot be changed or influenced by a new investment. Non-uniform cash inflows and cash inflows from the sale of the asset are both considered in the net present value calculation.

Question 18

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 3 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: 
$$\begin{array} { l r } 
\text { Periods } & \text { 12 Percent } \
1 & 0.8929 \
2 & 0.7972 \
3 & 0.7118 \
4 & 0.6355
\end{array}$$ 
What is the net present value of the machine?

Accepted Answer

The net present value (NPV) is calculated by discounting the net cash flows from the investment. The annual cash flow is $11,200 ($1,200 net income + $10,000 depreciation). The present value of these cash flows over 3 years at 12% is $11,200 * (0.8929 + 0.7972 + 0.7118) = $26,900. The NPV is $26,900 - $30,000 = $(3,100).

Question 19

A company is considering the purchase of new equipment costing $91,000. The machine has a useful life of 4 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: 
$$\begin{array} { l r } 
\text { Periods } & \text { 12 Percent } \
1 & 0.8929 \
2 & 1.6901 \
3 & 2.4018 \
4 & 3.0373
\end{array}$$ 
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

The answer of A company is considering the purchase of...

Question 20

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

Accepted Answer

The internal rate of return (IRR) is the rate at which the present value of the expected cash flows from an investment equals the initial investment. In other words, it is the rate that yields a net present value of zero. Therefore, option A is the correct answer. The other options are either not applicable (such as the accounting rate of return) or not specific to the concept of net present value (such as the payback rate of return).

Quiz 24: Capital Budgeting and Investment Analysis