Deck 11: Capital Budgeting

Question 1

Projects that involve a choice among competing alternatives, where selection of one project implies rejection of all the other alternatives, are:

A) mutually exclusive projects.
B) screening projects.
C) independent projects.
D) preference projects.

Answer 1

A

Question 2

A decision that requires managers to choose from among a set of alternative capital investment opportunities is a(n):

A) preference decision.
B) capital decision.
C) screening decision.
D) incremental decision.

Answer 2

A

Question 3

Preference decisions compare an investment with some minimum criteria

Answer 3

False

Question 4

When deciding between mutually exclusive investments, a manager should choose the option with the lowest depreciation

Question 5

To find the present value of a single amount, you only need to know the amount to be received in the future, the interest rate and the number of periods until the amount will be received

Question 6

The payback period is defined as the average net income divided by the initial investment

Question 7

The payback period method ignores the time value of money

Question 8

An annuity is a series of consecutive payments that are equal in dollar amount, have interest periods of equal length, and earn an equal interest rate each period

Question 9

A decision that occurs when managers evaluate a proposed capital investment to determine whether it meets some minimum criteria is a(n):

A) preference decision.
B) capital decision.
C) screening decision.
D) incremental decision.

Question 10

The accounting rate of return is the only method that focuses on net income rather than cash flow

Question 11

The internal rate of return method uses cash flows rather than net income

Question 12

Independent projects are unrelated to one another, so that investing in one project does not affect the choice about investing in another project

Question 13

The internal rate of return is the rate of return that yields a zero net present value

Question 14

The profitability index is calculated as the present value of future cash flows divided by the initial investment

Question 15

When managers must choose among independent projects, they should prioritize projects according to their net present value

Question 16

Which of the following statements is correct about capital assets?

A) For managerial accounting purposes, "capital assets" are defined more narrowly than for financial accounting purposes.
B) Human capital and research and development are both considered capital assets for financial accounting purposes, but not for managerial accounting purposes.
C) Capital assets are only those that can be depreciated, whether using managerial or financial accounting.
D) For managerial accounting purposes, "capital assets" are defined more broadly than for financial accounting purposes.

Question 17

Projects that are unrelated to one another, so that investing in one project does not preclude or affect the choice about investing in the other alternatives, are:

A) mutually exclusive projects.
B) screening projects.
C) independent projects.
D) preference projects.

Question 18

The net present value method compares a project's future net income to the initial investment

Question 19

An example of a future value of a single amount problem would be finding how much the right to receive a certain amount in the future would be worth today

Question 20

Sensitivity analysis helps determine whether changing the underlying assumptions would affect the decision

Question 21

Addison Corp. is considering the purchase of a new piece of equipment. The equipment will have an initial cost of $900,000, a 6-year life, and no salvage value. If the accounting rate of return for the project is 5%, what is the annual increase in net cash flow? Ignore income taxes.

A) $45,000
B) $105,000
C) $150,000
D) $195,000

Question 22

Which of the following would be included in net income but not in annual cash flows?

A) Sales revenue
B) Depreciation
C) Initial investment
D) Direct labor

Question 23

The method that compares the present value of a project's future cash flows to the initial investment is:

A) accounting rate of return.
B) payback period.
C) net present value.
D) internal rate of return.

Question 24

If cash flows are not equal each year, the payback period:

A) cannot be calculated.
B) is calculated by dividing the initial investment by the average cash flows.
C) is calculated by subtracting each year's cash flows from the initial investment until zero is reached.
D) is calculated by dividing the total years in the project by two.

Question 25

Which of the following capital budgeting methods does not use discounted cash flows?

A) Net present value
B) Internal rate of return
C) Payback period
D) Profitability index

Question 26

The payback method:

A) is a complex method of analysis.
B) is infrequently used.
C) incorporates the time value of money.
D) ignores benefits and costs that occur after the project has paid for itself.

Question 27

Which of the following capital budgeting methods focuses on net income rather than cash flows?

A) Payback period
B) Accounting rate of return
C) Net present value
D) Internal rate of return

Question 28

The accounting rate of return is also called all of the following except:

A) annual rate of return.
B) required rate of return.
C) simple rate of return.
D) unadjusted rate of return.

Question 29

Which of the following statement regarding the payback method is incorrect?

A) The payback period is the amount of time it takes for a capital investment to "pay for itself."
B) In general, projects with longer payback periods are safer investments than those with shorter payback periods.
C) When cash flows are equal each year, the payback period is calculated by dividing the initial investment in the project by its annual cash flow.
D) The payback method is often used as a screening tool for potential investments.

Question 30

The accounting rate of return is calculated as:

A) initial investment divided by annual net income.
B) initial investment divided by required rate of return.
C) annual net income divided by initial investment.
D) annual net income divided by required rate of return.

Question 31

Homer Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. If the salvage value of the equipment is estimated to be $75,000, what is the annual net cash flow?

A) $25,000
B) $35,000
C) $165,000
D) $175,000

Question 32

Cortland Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net cash flows of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. If the salvage value of the equipment is estimated to be $75,000, what is the annual net income? Ignore income taxes.

A) $25,000
B) $35,000
C) $165,000
D) $175,000

Question 33

When cash flows are equal each year, the payback period is calculated as:

A) Initial investment × Annual net cash flow.
B) Initial investment/Annual net cash flow.
C) Annual net cash flow/Initial investment.
D) Annual net cash flow - Initial investment/Project life.

Question 34

How does the accounting rate of return differ from the return on investment formula?

A) They are not different; both are calculated by dividing net operating income by initial investment.
B) The numerator in each formula differs; accounting rate of return divides net operating income by initial investment, and return on investment divides gross operating income by initial investment.
C) The numerator in each formula differs; accounting rate of return divides net operating income by average invested assets, while return on investment divides gross operating income by average invested assets.
D) The denominator in each formula differs; accounting rate of return divides net operating income by initial investment, while return on investment divides net operating income by average invested assets.

Question 35

Which of the following is not a limitation of using the accounting rate of return method for capital budgeting?

A) The accounting rate of return method does not incorporate time value of money.
B) The accounting rate of return method is based on accounting income, rather than cash flow.
C) Net income-on which the accounting rate of return method is based-is more objective than cash flow.
D) The accounting rate of return method is subject to potential manipulation based on accounting choices made by management (e.g., the method used to depreciate a capital asset).

Question 36

Which of the following statements is correct about the net present value method?

A) It is a discounted cash flow method based on net income.
B) It is a non-discounted method based on net income.
C) It is a discounted cash flow method based on cash flow.
D) It is a non-discounted method based on cash flow.

Question 37

The total time to recover an original investment is the:

A) net present value.
B) internal rate of return.
C) accounting rate of return.
D) payback perioD.
The payback period is the amount of time needed for a capital investment to pay for itself.

Question 38

Which of the following is the formula for accounting rate of return?

A) Initial investment/net income
B) Annual net cash flow/Initial investment
C) Initial investment/Annual net cash flow
D) Annual net income/Initial investment

Question 39

Which of the following methods is calculated as annual net income as a percentage of the original investment in assets?

A) Accounting rate of return
B) Payback period
C) Net present value
D) Internal rate of return

Question 40

Fletcher Corp. is considering the purchase of a new piece of equipment. The equipment will have an initial cost of $400,000, a 5-year life, and a salvage value of $75,000. If the accounting rate of return for the project is 10%, what is the annual increase in net cash flow? Ignore income taxes.

A) $25,000
B) $40,000
C) $65,000
D) $105,000

Question 41

Lawrence Corp. is considering the purchase of a new piece of equipment. When discounted at a hurdle rate of 8%, the project has a net present value of $24,580. When discounted at a hurdle rate of 10%, the project has a net present value of ($28,940). The internal rate of return of the project is:

A) zero.
B) between zero and 8%.
C) between 8% and 10%.
D) greater than 10%.

Question 42

The minimum required rate of return for a project is the:

A) annual rate of return.
B) accounting rate of return.
C) hurdle rate.
D) internal rate of return.

Question 43

When comparing mutually exclusive capital investments, managers should:

A) choose the option with the lowest cost on a net present value basis.
B) choose the option with the lowest undiscounted cost.
C) not use net present value because it cannot be used to compare investments.
D) not use sensitivity analysis.

Question 44

Newport Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $900,000 and have a 6-year life. There is no salvage value for the equipment. If the hurdle rate is 8%, what is the approximate net present value? Ignore income taxes.

A) $924,580
B) $24,580
C) $900,000
D) $300,000

Question 45

Olive Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $250,000. The equipment will have an initial cost of $1,300,000 and have an 8-year life. There is no salvage value for the equipment. If the hurdle rate is 10%, what is the internal rate of return? Ignore income taxes.

A) Between 6% and 8%
B) Between 8% and 10%
C) Greater than 10%
D) Less than zero

Question 46

When making screening decisions using the net present value method, a project is acceptable if:

A) the NPV is greater than the hurdle rate.
B) the NPV is greater than the IRR.
C) the NPV is positive.
D) the NPV is negative.

Question 47

A profitability index greater than ____________ means that a project has a positive NPV.

A) negative one
B) zero
C) one
D) the hurdle rate

Question 48

The internal rate of return is a measure of:

A) the rate actually earned by the project, considering the time value of money.
B) the rate actually earned by the project, based on accounting income.
C) the rate used to discount the future cash flows to reflect the time value of money.
D) the firm's cost of capital.

Question 49

Newport Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $900,000 and have a 6-year life. There is no salvage value for the equipment. If the hurdle rate is 10%, what is the approximate net present value? Ignore income taxes.

A) Negative $28,940
B) Positive $28,940
C) Zero
D) Positive $300,000

Question 50

Byron Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. The salvage value of the equipment is estimated to be $75,000. If the hurdle rate is 15%, what is the approximate net present value? Ignore income taxes.

A) Negative $27,490
B) Zero
C) Positive $400,000
D) Positive $75,000

Question 51

Byron Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. The salvage value of the equipment is estimated to be $75,000. If the hurdle rate is 10%, what is the approximate net present value? Ignore income taxes.

A) $25,648
B) $100,000
C) $175,000
D) ($20,291)

Question 52

Wilson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The salvage value of the equipment is estimated to be $100,000. If the hurdle rate is 10%, what is the internal rate of return?

A) Less than zero
B) Between zero and 10%
C) Between 10% and 15%
D) More than 15%

Question 53

If the hurdle rate is greater than the internal rate of return, the net present value will be:

A) positive.
B) negative.
C) zero.
D) equal to the hurdle rate.

Question 54

Newport Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $900,000 and have a 6-year life. There is no salvage value for the equipment. If the hurdle rate is 10%, what is the internal rate of return? Ignore income taxes.

A) Between 6% and 8%
B) Between 8% and 10%
C) Between 10% and 12%
D) Less than zero

Question 55

Grace Corp., whose required rate of return is10%, is considering the purchase of a new piece of equipment. The internal rate of return of the project, which has a life of 8 years, is 12%. The project would have:

A) an accounting rate of return greater than 10%.
B) a payback period more than 8 years.
C) a net present value of zero.
D) a net present value greater than zero.

Question 56

Byron Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. The salvage value of the equipment is estimated to be $75,000. If the hurdle rate is 10%, what is the internal rate of return?

A) Between 6% and 8%
B) Between 8% and 10%
C) Between 10% and 12%
D) Between 12% and 14%

Question 57

If a project has a positive net present value, it means the project is expected to provide returns that are ___________ the cost of capital.

A) greater than
B) less than
C) equal to
D) not connected to

Question 58

The discount rate that would return a net present value equal to zero is the:

A) annual rate of return.
B) accounting rate of return.
C) hurdle rate.
D) internal rate of return.

Question 59

A positive net present value indicates that a project will:

A) generate a return in excess of the firm's cost of capital.
B) generate more cash than is initially invested.
C) generate more cash than alternative projects.
D) generate a return in excess of alternative projects.

Question 60

Wilson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The salvage value of the equipment is estimated to be $100,000. If the hurdle rate is 10%, what is the approximate net present value?

A) Less than zero
B) $100,000
C) $500,000
D) $46,826

Question 61

Frank Inc. is trying to decide whether to lease or purchase a piece of equipment needed for the next ten years. The equipment would cost $45,000 to purchase, and maintenance costs would be $5,000 per year. After ten years, Frank estimates it could sell the equipment for $20,000. If Frank leased the equipment, it would pay a set annual fee that would include all maintenance costs. Frank has determined after a net present value analysis that at its hurdle rate of 10%, it would be better off by $5,700 if it buys the equipment. What would the approximate annual cost be if Frank were to lease the equipment?

A) $9,000
B) $7,000
C) $12,000
D) $13,250

Question 62

Independent projects should be prioritized according to their:

A) profitability index.
B) net present value.
C) payback period.
D) total cash flows.

Question 63

A problem in which you must calculate how much money you will have in the future as a result of investing a certain amount in the present is a:

A) future value of a single amount problem.
B) present value of a single amount problem.
C) future value of an annuity problem.
D) present value of an annuity problem.

Question 64

An analysis that reveals whether changing the underlying assumptions would affect the decision is a:

A) net present value analysis.
B) internal rate of return analysis.
C) payback period analysis.
D) sensitivity analysis.

Question 65

Randall Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $100,000 to purchase, and maintenance costs would be $10,000 per year. After five years, Randall estimates it could sell the equipment for $30,000. If Randall leases the equipment, it would pay $30,000 each year, which would include all maintenance costs. If the hurdle rate for Randall is 12%, Randall should:

A) lease the equipment, as net present value of cost is about $11,000 less.
B) buy the equipment, as net present value of cost is about $11,000 less.
C) lease the equipment, as net present value of cost is about $30,000 less.
D) buy the equipment, as net present value of cost is about $30,000 less.

Question 66

You are saving for a car that costs $28,000 that you hope to purchase in five years. How much will you need to deposit today in a savings account that earns 8%, compounded annually, to withdraw enough for the purchase?

A) $16,800
B) $19,057
C) $25,760
D) $41,140

Question 67

Devon Corp. is trying to decide whether to lease or purchase a piece of equipment. The total cost lease the equipment will be $150,000 over its estimated life, while the total cost to buy the equipment will be $120,000 over its estimated life. At Devon's required rate of return, the net present value of the cost of leasing the equipment is $108,000 and the net present value of the cost of buying the equipment is $119,000. Based on financial factors, Devon should:

A) lease the equipment, saving $30,000 over buying.
B) buy the equipment, saving $30,000 over leasing.
C) lease the equipment, saving $11,000 over buying.
D) buy the equipment, saving $11,000 over leasing.

Question 68

A problem in which you must calculate the worth to you today of receiving a certain amount at some time in the future is a:

A) future value of a single amount problem.
B) present value of a single amount problem.
C) future value of an annuity problem.
D) present value of an annuity problem.

Question 69

If you invest $10,000 today in a savings account that earns 5% interest, compounded annually, how much would be in the account at the end of ten years?

A) $6,139
B) $16,289
C) $77,217
D) $125,779

Question 70

Norwood, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, net present value, and profitability index for each of the projects are as follows: In what order should Norwood prioritize investment in the projects?

A) A, B, C
B) C, B, A
C) A, C, B
D) C, A, B

Question 71

You have $10,000 that you can invest in a savings account that earns 7% interest, compounded annually. If you want to withdraw at least $18,000 at some point in the future, how long will you need to keep the money invested?

A) 9 years
B) 10 years
C) 11 years
D) 12 years

Question 72

Heidi Inc. is considering whether to lease or purchase a piece of equipment. The total cost to lease the equipment will be $120,000 over its estimated life, while the total cost to buy the equipment will be $75,000 over its estimated life. At Heidi's required rate of return, the net present value of the cost of leasing the equipment is $73,700 and the net present value of the cost of buying the equipment is $68,000. Based on financial factors, Heidi should:

A) lease the equipment, saving $45,000 over buying.
B) buy the equipment, saving $45,000 over leasing.
C) lease the equipment, saving $5,700 over buying.
D) buy the equipment, saving $5,700 over leasing.

Question 73

Foster Inc. is trying to decide whether to lease or purchase a piece of equipment needed for the next ten years. The equipment would cost $45,000 to purchase, and maintenance costs would be $5,000 per year. After ten years, Foster estimates it could sell the equipment for $20,000. If Foster leases the equipment, it would pay $12,000 each year, which would include all maintenance costs. If the hurdle rate for Foster is 10%, Foster should:

A) lease the equipment, as net present value of cost is about $5,700 less.
B) buy the equipment, as net present value of cost is about $5,700 less.
C) lease the equipment, as net present value of cost is about $2,000 less.
D) buy the equipment, as net present value of cost is about $45,000 less.

Question 74

Carmen, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, net present value, and profitability index for each of the projects are as follows: In what order should Carmen prioritize investment in the projects?

A) A, C, B
B) B, C, A
C) A, B, C
D) B, A, C

Question 75

The value today of cash flow to be received in the future is called:

A) present value.
B) cash value.
C) future value.
D) accounting value.

Question 76

You purchase a home for $200,000 that you expect to appreciate 6% in value on an annual basis. How much will the home be worth in ten years?

A) $111,680
B) $358,120
C) $1,472,020
D) $2,636,160

Question 77

Dallas Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $100,000 to purchase, and maintenance costs would be $10,000 per year. After five years, Dallas estimates it could sell the equipment for $30,000. If Dallas leased the equipment, it would pay a set annual fee that would include all maintenance costs. Dallas has determined after a net present value analysis that at its hurdle rate of 12% it would be better off by $11,000 if it leases the equipment. What would the approximate annual cost be if Dallas were to lease the equipment?

A) $21,800
B) $27,800
C) $30,000
D) $34,700

Question 78

When a project has a positive net present value, it has a profitability index:

A) greater than zero.
B) less than zero.
C) greater than one.
D) less than one.

Question 79

How much would you need to deposit in a savings account that earns 7%, compounded annually, to withdraw $20,000 eight years from now?

A) $11,640
B) $18,600
C) $18,692
D) $34,364

Question 80

Boxwood, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, and net present value for each of the projects are as follows: In what order should Boxwood prioritize investment in the projects?

A) A, B, C
B) C, B, A
C) A, C, B
D) C, A, B