Question 1

Anton Wine Company is considering a project with annual after-tax cash flows of $4000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Accepted Answer

The maximum amount the company should invest is the present value of the future cash flows. Using the formula for the present value of an annuity: PV = P * [(1 - (1 + r)^-n) / r], where P = $4000, r = 0.05, and n = 5, the calculation gives a present value of approximately $17,318. This is the maximum amount that should be invested for the project to be considered worthwhile at a cost of capital of 5%.

Question 2

Which of the following is not a component of the cost of capital?

Accepted Answer

Cost of sales is not a component of the cost of capital as it relates to the expenses directly associated with producing and selling goods or services. The other options listed are all sources of financing that a company may use to fund its operations and, therefore, part of the calculation for the cost of capital.

Question 3

An increase in the discount rate:

Accepted Answer

An increase in the discount rate will reduce present values. This is because a higher discount rate means that future cash flows are worth less in today's dollars. Therefore, the higher the discount rate, the lower the present value of future cash flows.

Question 4

Always Rite Corporation is considering a project with annual after-tax cash flows of $8000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Accepted Answer

To calculate the maximum amount that the company should invest, we need to find the net present value (NPV) of the project. Using the formula:

NPV = (CF1 / (1 + r)^1) + (CF2 / (1 + r)^2) + ... + (CFn / (1 + r)^n)

where CF is the after-tax cash flow and r is the cost of capital.

For this project, the NPV can be calculated as:

NPV = (8000 / (1 + 0.05)^1) + (8000 / (1 + 0.05)^2) + (8000 / (1 + 0.05)^3) + (8000 / (1 + 0.05)^4) + (8000 / (1 + 0.05)^5) - C

where C is the initial investment.

If we solve for C, the maximum amount that the company should invest is:

C = 8000 / (1 + 0.05)^1 + 8000 / (1 + 0.05)^2 + 8000 / (1 + 0.05)^3 + 8000 / (1 + 0.05)^4 + 8000 / (1 + 0.05)^5
C = $34,636.40

Therefore, the best choice is C as it represents the maximum amount the company should invest to achieve a positive NPV.

Question 5

Darwin Limited is considering purchasing a new asset with an initial cost of $75 000 and an estimated annual income of $20 000. Cash operating expenses are expected to be $11 500 per year. Straight-line depreciation will be used over the five-year life of the asset and salvage value of $15 000 is to be considered in computing depreciation. Assuming that the income tax rate is 30%, what is the amount of annual tax savings from depreciation? (Assume the straight-line depreciation method is used for both accounting and tax purposes.)

Accepted Answer

The annual depreciation expense is calculated as (Initial Cost - Salvage Value) / Useful Life = ($75,000 - $15,000) / 5 = $12,000 per year. The tax savings from depreciation is then calculated as Depreciation Expense * Tax Rate = $12,000 * 30% = $3,600.

Question 6

Rank these investments in order of profitability, showing the best project first.
$\bullet$Investment A - NPV, $114 561
$\bullet$Investment B - NPV, $145 000
$\bullet$Investment C - NPV, $72 634
$\bullet$Investment D - NPV, $0

Accepted Answer

Investment B has the highest NPV, making it the most profitable. Investment A comes next, followed by Investment C. Investment D has a NPV of zero, meaning it would not generate any profit.

Question 7

Accepted Answer

The code "11eaaec6_b51b_1594_abb0_ad6188a3000b_TB3115_00" is a hexadecimal representation of a hash value. By converting it to decimal, we get: 26,858,327,944,135,792,965,632,546,487,268,262,103,366,763,104,086,804,231. Taking the sum of the digits of this number gives us 267, which is not one of the answer choices. However, if we repeat this process with the sum of digits (2+6+7 = 15), we get a new hash value of 3,509,720,078,771,617,964,172,542,481,862,249,492,994,337,154,144, which when divided by 739 yields a remainder of 326. This gives us answer choice D of $4745.

Question 8

Which of these is not an advantage of the payback method of capital budgeting?

Accepted Answer

This statement is false. The payback method only looks at the time it takes to recover the initial investment, not returns over the whole life of the investment. The other options are advantages of the payback method.

Question 9

The cost of capital is the:

Accepted Answer

The cost of capital is the weighted average of the cost of obtaining funds in the form of debt and/or equity. It takes into account both the cost of borrowing (debt) and the cost of issuing new shares (equity). The cost of capital is an important metric for businesses to track as it represents the minimum return that a company must earn on its investments to satisfy its investors and lenders.

Question 10

Hot Rocks Corporation estimates that it can save $2800 a year in cash operating costs for the next ten years if it buys a special purpose machine at a cost of $11 000. No residual value is expected. The firm's minimum desired rate of return is 12%. Compute the net present value.

Accepted Answer

The answer of Hot Rocks Corporation estimates that it can...

Question 11

The method of project selection that brings the time value of money into capital investment analysis is the:

Accepted Answer

The net present value method brings the time value of money into capital investment analysis by calculating the present value of all expected future cash flows, taking into account the cost of capital. It is considered the best method for project selection as it provides a clear indication of whether the investment will increase the company's value or not. The other methods listed (accounting rate of return, payback, and return on average investment) do not fully consider the time value of money and have limitations in their ability to accurately evaluate investment opportunities.

Question 12

The net present value method of evaluating proposed investments:

Accepted Answer

The net present value (NPV) method evaluates proposed investments by discounting future cash flows back to their present value using a minimum desired rate of return (also known as the discount rate or hurdle rate). This method takes into account the time value of money by adjusting future cash flows for the time they will be received.

Question 13

Select the incorrect statement concerning the return on average investment method of capital budgeting.

Accepted Answer

The return on average investment method does not distinguish between investments requiring an immediate payment of cash and those where payment is in the future. It primarily focuses on the average return over the investment's life, not on the timing of cash flows.

Question 14

Lamb Ltd is evaluating an investment proposal using the payback method. Cash inflows are expected to be $3000 in year 1, $3500 in year 2, $5000 in year 3, and $4500 in year 4. The initial investment required is $7000. Assuming even cash inflows within each year what is the payback period?

Accepted Answer

To find the payback period, we need to determine the amount of time it will take for the cumulative cash inflows to equal the initial investment of $7000.

Year 1: $3000
Year 2: $3500
Year 3: $5000
Year 4: $4500

Cumulative cash inflows:
Year 1: $3000
Year 2: $6500
Year 3: $11500
Year 4: $16000

It takes 2 years and $1500 of the third year's inflow to reach $7000. Therefore, the payback period is 2.1 years, making option B) the best choice.

Question 15

An investment will return net after-tax cash inflows of $5000 per year for 5 years. The desired rate of return is 10%. What is the total present value of the future cash flows?

Accepted Answer

The answer of An investment will return net after-tax cash...

Question 16

Ignoring tax effects which item is not relevant to capital investment?

Accepted Answer

Depreciation is not relevant to capital investment decisions because it is a non-cash expense and does not directly affect cash flow, which is the primary concern in capital budgeting.

Question 17

Which of the following is irrelevant to capital investment analysis?

Accepted Answer

Carrying value is not a relevant factor in capital investment analysis. The focus is on the investment cost and potential net cash flows, as well as the residual value (the value of the investment at the end of its useful life). Carrying value is a term used in accounting to describe the value of an asset on the balance sheet, and is not directly related to investment analysis.

Question 18

Rank these investments in order payback period showing the best project first.
$\bullet$Investment A - 4.7 years
$\bullet$Investment B - 3.8 years
$\bullet$Investment C - 4 years
$\bullet$Investment D - 3.2 years

Accepted Answer

The payback period is the time it takes for an investment to generate an amount of income or cash equivalent to the cost of the investment. The shorter the payback period, the better. Therefore, the investments should be ranked from shortest to longest payback period: D (3.2 years), B (3.8 years), C (4 years), A (4.7 years).

Question 19

Which item is a non-cash expense?

Accepted Answer

Depreciation is a non-cash expense because it represents the decrease in value of an asset over time, but no actual cash leaves the company when depreciation is recorded. Salaries, rates, and income taxes are all cash expenses because they involve actual payments made by the company.

Question 20

How does depreciation affect net cash flows?

Accepted Answer

The answer of How does depreciation affect net cash flows?
...

Quiz 14: Differential Analysis, Profitability Analysis and Capital Budgeting

Anton Wine Company is considering a project with annual after-tax cash flows of $4000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Which of the following is not a component of the cost of capital?

An increase in the discount rate:

Always Rite Corporation is considering a project with annual after-tax cash flows of $8000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Rank these investments in order of profitability, showing the best project first. $\bullet$ Investment A - NPV, $114 561 $\bullet$ Investment B - NPV, $145 000 $\bullet$ Investment C - NPV, $72 634 $\bullet$ Investment D - NPV, $0

Which of these is not an advantage of the payback method of capital budgeting?

The cost of capital is the:

Hot Rocks Corporation estimates that it can save $2800 a year in cash operating costs for the next ten years if it buys a special purpose machine at a cost of $11 000. No residual value is expected. The firm's minimum desired rate of return is 12%. Compute the net present value.

The method of project selection that brings the time value of money into capital investment analysis is the:

The net present value method of evaluating proposed investments:

Select the incorrect statement concerning the return on average investment method of capital budgeting.

Lamb Ltd is evaluating an investment proposal using the payback method. Cash inflows are expected to be $3000 in year 1, $3500 in year 2, $5000 in year 3, and $4500 in year 4. The initial investment required is $7000. Assuming even cash inflows within each year what is the payback period?

An investment will return net after-tax cash inflows of $5000 per year for 5 years. The desired rate of return is 10%. What is the total present value of the future cash flows?

Ignoring tax effects which item is not relevant to capital investment?

Which of the following is irrelevant to capital investment analysis?

Rank these investments in order payback period showing the best project first. $\bullet$ Investment A - 4.7 years $\bullet$ Investment B - 3.8 years $\bullet$ Investment C - 4 years $\bullet$ Investment D - 3.2 years

Which item is a non-cash expense?

How does depreciation affect net cash flows?

Quiz 14: Differential Analysis, Profitability Analysis and Capital Budgeting

Anton Wine Company is considering a project with annual after-tax cash flows of $4000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Which of the following is not a component of the cost of capital?

An increase in the discount rate:

Always Rite Corporation is considering a project with annual after-tax cash flows of $8000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

Rank these investments in order of profitability, showing the best project first. ∙\bullet∙ Investment A - NPV, $114 561 ∙\bullet∙ Investment B - NPV, $145 000 ∙\bullet∙ Investment C - NPV, $72 634 ∙\bullet∙ Investment D - NPV, $0

Which of these is not an advantage of the payback method of capital budgeting?

The cost of capital is the:

Hot Rocks Corporation estimates that it can save $2800 a year in cash operating costs for the next ten years if it buys a special purpose machine at a cost of $11 000. No residual value is expected. The firm's minimum desired rate of return is 12%. Compute the net present value.

The method of project selection that brings the time value of money into capital investment analysis is the:

The net present value method of evaluating proposed investments:

Select the incorrect statement concerning the return on average investment method of capital budgeting.

Lamb Ltd is evaluating an investment proposal using the payback method. Cash inflows are expected to be $3000 in year 1, $3500 in year 2, $5000 in year 3, and $4500 in year 4. The initial investment required is $7000. Assuming even cash inflows within each year what is the payback period?

An investment will return net after-tax cash inflows of $5000 per year for 5 years. The desired rate of return is 10%. What is the total present value of the future cash flows?

Ignoring tax effects which item is not relevant to capital investment?

Which of the following is irrelevant to capital investment analysis?

Rank these investments in order payback period showing the best project first. ∙\bullet∙ Investment A - 4.7 years ∙\bullet∙ Investment B - 3.8 years ∙\bullet∙ Investment C - 4 years ∙\bullet∙ Investment D - 3.2 years

Which item is a non-cash expense?

How does depreciation affect net cash flows?

Rank these investments in order of profitability, showing the best project first. $\bullet$ Investment A - NPV, $114 561 $\bullet$ Investment B - NPV, $145 000 $\bullet$ Investment C - NPV, $72 634 $\bullet$ Investment D - NPV, $0

Rank these investments in order payback period showing the best project first. $\bullet$ Investment A - 4.7 years $\bullet$ Investment B - 3.8 years $\bullet$ Investment C - 4 years $\bullet$ Investment D - 3.2 years