Deck 11: Capital Budgeting and Investment Analysis

Question 1

In ranking choices with the break-even time (BET) method, the investment with the longest BET gets the highest rank.

Answer 1

False

Question 2

An advantage of the break-even time (BET) method over the payback period method is that it recognizes the time value of money.

Answer 2

True

Question 3

A shorter payback period reduces the company's ability to respond to unanticipated changes and increases the risk of having to keep an unprofitable investment.

Answer 3

False

Question 4

When computing payback period, the date the initial capital investment is made is year 1.

Question 5

The accounting rate of return (ARR) is computed by dividing a project's after-tax net income by the average annual investment.

Question 6

Projects with shorter payback periods have higher risk, as the company has less time to respond to unanticipated changes.

Question 7

The payback period method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

Question 8

In ranking choices with the break-even time (BET) method, the investment with the longest BET gets the lowest rank.

Question 9

If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be accepted.

Question 10

Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.

Question 11

If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

Question 12

If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be rejected.

Question 13

The payback period method of evaluating an investment ignores cash inflows after the point where an investment's costs are fully recovered.

Question 14

Net cash flow can be calculated by adjusting the projected net income from a project for any non-cash revenues and expenses.

Question 15

The payback period is the amount of time for the investment to generate enough net cash flow to return the initial cost of investment.

Question 16

Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

Question 17

The time value of money is considered when calculating the payback period of an investment.

Question 18

If the straight-line depreciation method is used, the annual average investment amount used in calculating the accounting rate of return is calculated as (beginning book value + ending book value)/2.

Question 19

Two investments with exactly the same payback periods are not equally valuable to an investor because the timing of net cash flows may be different.

Question 20

The accounting rate of return (ARR) is computed by dividing a project's after-tax net income by the amount of the initial investment.

Question 21

The accounting rate of return is based on cash flows rather than net income in its calculation.

Question 22

Capital budgeting decisions are not affected by return on investment considerations.

Question 23

Soft capital rationing is imposed by external factors, such as debt covenants.

Question 24

The process of restating cash flows in terms of their present values is called discounting.

Question 25

When comparing investments with similar lives and risks, a company will prefer the investment with the higher rate of return.

Question 26

Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

Question 27

If net present values are used to evaluate two investments that have equal costs and equal total cash flows, the one with more cash flows in the early years has the higher net present value.

Question 28

The net present value capital budgeting method considers all estimated cash flows for the project's expected life.

Question 29

There is only one method of evaluating capital budgeting decisions.

Question 30

Accounting rate of return gives managers an estimate of how soon they will recover their initial investment.

Question 31

The time value of money concept works on the principle that a dollar tomorrow is worth more than a dollar today.

Question 32

The internal rate of return equals the rate that yields a net present value of zero for an investment.

Question 33

Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

Question 34

The internal rate of return method of evaluating capital investments cannot be used with uneven cash flows.

Question 35

The net present value decision rule is: When an asset's expected cash flows yield a positive net present value when discounted at the required rate of return, the asset should be acquired.

Question 36

All capital investment evaluation methods use the time value of money concept.

Question 37

For projects financed from borrowed funds, the hurdle rate must exceed the interest rate paid on the borrowed funds.

Question 38

Capital budgeting decisions that relate to investments in technology are not as risky as other types of capital budgeting decisions.

Question 39

The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

Question 40

A hurdle rate is the minimum acceptable rate of return for an investment.

Question 41

The accounting rate of return uses cash flows in its calculation.

Question 42

A disadvantage of an investment with a short payback period is that it will produce revenue for only a short period of time.

Question 43

In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.

Question 44

Projects with a profitability index of greater than 1 have a return that is greater than the hurdle rate.

Question 45

A company's required rate of return, typically its cost of capital is called the:

A) Internal rate of return.
B) Average rate of return.
C) Hurdle rate.
D) Maximum rate.
E) Payback rate.

Question 46

Two investments with exactly the same payback periods are always equally valuable to an investor.

Question 47

The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.

Question 48

Using accelerated depreciation for tax reporting increases the net present value of an asset's cash flows because it produces larger net cash inflows in the early years of the asset's life.

Question 49

The break-even time (BET) method is a variation of the:

A) Payback method.
B) Internal rate of return method.
C) Accounting rate of return method.
D) Net present value method.
E) Present value method.

Question 50

In calculating the accounting rate of return using the straight-line method of depreciation, the annual average investment is calculated as (beginning book value + ending book value)/2.

Question 51

A limitation of the internal rate of return method is that it:

A) Does not consider the time value of money.
B) Measures results in years.
C) Lacks ability to compare dissimilar projects.
D) Ignores varying risks over the life of a project.
E) Measures net income rather than cash flows.

Question 52

The calculation of annual net cash flow from a particular investment project should include all of the following except:

A) Income taxes.
B) Revenues generated by the investment.
C) Cost of products generated by the investment.
D) Depreciation expense.
E) General and administrative expenses.

Question 53

The profitability index is computed by dividing the present value of net cash flows by the initial investment.

Question 54

All projects with a profitability index of less than 1 should be accepted.

Question 55

Three widely used methods of comparing investment alternatives are payback period, net present value, and rate of return on average investment.

Question 56

A positive profitability index indicates a positive net present value.

Question 57

Using a profitability index allows management to rank projects of similar risks with different investment amounts.

Question 58

The process of restating future cash flows in today's dollars is known as:

A) Budgeting.
B) Annualization.
C) Discounting.
D) Payback period.
E) Capitalizing.

Question 59

The payback method, unlike the net present value method, ignores cash flows after the point of cost recovery.

Question 60

The capital budgeting process involves all of the following except:

A) Having department or plant managers submit new investment proposals.
B) Determining which financial institution to use for financing.
C) Evaluating the submitted proposals.
D) Forming a capital budget committee that includes accounting and finance members.
E) Approving or rejecting new investment proposals.

Question 61

The net cash flow of a particular investment project:

A) Does not take income taxes into consideration.
B) Equals the total of the cash inflows of the project.
C) Equals the total of the cash outflows of the project.
D) Does not include depreciation.
E) Is equal to operating income each period.

Question 62

The time value of money concept:

A) Means that a dollar today is worth less than a dollar tomorrow.
B) Means that a dollar tomorrow is worth more than a dollar today.
C) Means that a dollar today is worth more than a dollar tomorrow.
D) Means that "Time is money."
E) Does not involve the concept of compound interest.

Question 63

A project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows: $$\begin{array} { l c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\$ 12,000 & \$ 8,000 & \$ 10,000 & \$ 30,000\end{array}$$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below:
$$\begin{array} { c c c } = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\0.9091 & 0.8264 & 0.7513\end{array}$$

A) $0.00
B) $21,000.00
C) ($7,461.00)
D) $25,033.32
E) ($4,966.60)

Question 64

Which methods of evaluating a capital investment project ignore the time value of money?

A) Net present value and accounting rate of return.
B) Accounting rate of return and internal rate of return.
C) Internal rate of return and payback period.
D) Payback period and accounting rate of return.
E) Net present value and payback period.

Question 65

If Management was not concerned with the time value of money, from which two capital budgeting methods should they choose?

A) IRR or Payback.
B) ARR or Payback.
C) BET or IRR.
D) BET or NPV.
E) NPV or Payback.

Question 66

The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

A) The internal rate of return is expressed as a percent rather than the absolute dollar value of present value.
B) The internal rate of return is expressed as an absolute dollar value rather than the percent of net present value.
C) The internal rate of return reflects the time value of money rather than the absolute dollar value of present value.
D) The internal rate of return is expressed as an absolute dollar value rather than the time value of money used in net present value.
E) The internal rate of return is expressed as a percent rather than the accrual income method used in net present value.

Question 67

Which methods of evaluating a capital investment project use cash flows as a measurement basis?

A) Net present value, accounting rate of return, and internal rate of return.
B) Internal rate of return, payback period, and accounting rate of return.
C) Accounting rate of return, net present value, and payback period.
D) Payback period, internal rate of return, and net present value.
E) Net present value, payback period, accounting rate of return, and internal rate of return.

Question 68

A project requires a $28,500 investment and is expected to generate end-of-period annual cash inflows of $12,000 for each of three years. Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $$\begin{array} { c c c } = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\0.9091 & 0.8264 & 0.7513\end{array}$$

A) $0.00
B) $2,668.00
C) ($7,461.00)
D) $1,341.60
E) $29,841.60

Question 69

The calculation of the payback period for an investment when net cash flow is uneven is:

A) Determining when the cumulative total of net cash flows reaches zero.
B) Determining when net income equals the cost of the investment.
C) Determining which depreciation method will shorten the period.
D) Determining the net present value for each cash flow.
E) Determining the applicable hurdle rate.

Question 70

Capital budgeting decisions usually involve analysis of:

A) Cash outflows only.
B) Short-term investments only.
C) Long-term investments only.
D) Investments with certain outcomes only.
E) Operating revenues.

Question 71

Restating future cash flows in terms of present values and then determining the payback period using these present values is known as:

A) Break-even time (BET)
B) Internal rate of return method.
C) Accounting rate of return method.
D) Net present value method.
E) Present value method.

Question 72

A minimum acceptable rate of return for an investment decision is called the:

A) Internal rate of return.
B) Average rate of return.
C) Hurdle rate of return.
D) Maximum rate of return.
E) Payback rate of return.

Question 73

The calculation of the payback period for an investment when net cash flow is even (equal) is:

A) Cost of investment/Annual net cash flow
B) Cost of investment/Total net cash flow
C) Annual net cash flow/Cost of investment
D) Total net cash flow/Cost of investment
E) Total net cash flow/Annual net cash flow

Question 74

Coffer Co. is analyzing two potential investments. If the company is using the payback period method and it requires a payback of three years or less, which project(s) should be selected?

A) Project Y.
B) Project X.
C) Both X and Y are acceptable projects.
D) Neither X nor Y is an acceptable project.
E) Project Y because it has a lower initial investment.

Question 75

Capital budgeting decisions are generally based on:

A) Tentative predictions of future outcomes.
B) Perfect predictions of future outcomes.
C) Results from past outcomes only.
D) Results from current outcomes only.
E) Speculation of interest rates and economic performance only.

Question 76

A company wishes to buy new equipment for $9,000. The equipment is expected to generate an additional $2,800 in cash inflows for six years. All cash flows occur at year-end. A bank will make a $9,000 loan to the company at a 10% interest rate so that the company can purchase the equipment. Use the table below to determine break-even time for this equipment:

A) Break-even time is between two and three years.
B) Break-even time is between three and four years.
C) Break-even time is between four and five years.
D) Break-even time is between five and six years.
E) This project will never break-even.

Question 77

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

A) Internal rate of return.
B) Accounting rate of return.
C) Net present value rate of return.
D) Zero rate of return.
E) Payback rate of return.

Question 78

Which of the following is an objective of capital budgeting?

A) To eliminate all risk.
B) To discount all future and past cash flows.
C) To earn a satisfactory return on investment.
D) To reverse past decisions.
E) To reduce the number of investment activities.

Question 79

Porter Co. is analyzing two potential investments. If the company is using the payback period method and it requires a payback of three years or less, which project(s) should be selected?

A) Project Y.
B) Project X.
C) Both X and Y are acceptable projects.
D) Neither X nor Y is an acceptable project.
E) Project Y because it has a lower initial investment.

Question 80

A project requires a $28,000 investment and is expected to generate end-of-period annual cash inflows as follows: $$\begin{array} { l c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \\\$ 12,000 & \$ 13,000 & \$ 12,000\end{array}$$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below.
$$\begin{array} { c c c } = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\0.9091 & 0.8264 & 0.7513\end{array}$$

A) $0.00
B) $2,668.00
C) ($7,461.00)
D) $30,668.00
E) ($4,966.68)