Question 1

Apex Co. has $100,000 available for long-term investment. Which projects should be selected from the list below? $\begin{array}{ccccc}
\text { Proiect } & \text { Cost } & \text { IRR } & \text { NPV } & \text { Profitability Index }\
\hline1 & \$ 60,000 & 16 \% & \$ 3,413 & 1.057 \
2 & 40,000 & 20 \% & 7,563 & 1.190 \
3 & 40,000 & 24 \% & 8,036 & 1.201 \
4 & 20,000 & 14 \% & 1,313 & 1.066 \
5 & 60,000 & 18 \% & 14,583 & 1.243
\end{array}$
 .243

Accepted Answer

Projects 3 and 5 have the highest NPVs and profitability indexes, so they should be selected.

Question 2

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the total tax savings from the amortization tax shield is:

Accepted Answer

The total tax savings from the amortization tax shield is calculated by taking the annual depreciation expense, multiplying it by the tax rate, and then finding the present value of these tax savings over the life of the asset. The annual depreciation expense for the new machine is the cost of the machine ($100,000) minus the terminal value ($8,000), divided by the life of the machine (5 years), which equals $18,400 per year. The annual tax savings is then $18,400 * 30% = $5,520. The present value of these annual tax savings over 5 years at a 12% discount rate is approximately $19,899.60.

Question 3

If the internal rate of return exceeds the discount rate, the net present value is:

Accepted Answer

If the internal rate of return exceeds the discount rate, it means that the project is generating a rate of return higher than the cost of capital. As a result, the net present value of the project will be positive, indicating that the project is potentially profitable. Therefore, the best choice is C.

Question 4

A negative net present value means that the:

Accepted Answer

A negative net present value indicates that the present value of the outflows exceeds the present value of the inflows, meaning the project is not expected to generate enough cash flow to cover its costs and earn a return greater than the required rate of return. Therefore, the internal rate of return is less than the required rate of return.

Question 5

Capital budgeting decisions typically fall into which of the following major categories?
I. Developing or expanding products or services
II. Allocating costs to products or services
III. Replacing or reorganizing assets or services

Accepted Answer

Developing or expanding products or services (I) and replacing or reorganizing assets or services (III) are both typical categories of capital budgeting decisions. Allocating costs to products or services (II) may be a part of the decision-making process, but it is not typically considered a major category of capital budgeting decisions. Therefore, the correct choice is C.

Question 6

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the cash flows for year 4, excluding the maintenance, is:

Accepted Answer

The answer of Arnold Company is acquiring a new machine...

Question 7

Which of the following capital budgeting methods ignores the time value of money?

Accepted Answer

Payback period only considers the amount of time it will take to recover the initial investment without considering the time value of money.

Question 8

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the cash flows from the sale of the old machine is:

Accepted Answer

The answer of Arnold Company is acquiring a new machine...

Question 9

The rate of return that results in a zero net present value for a project is called the:

Accepted Answer

The internal rate of return (IRR) is the rate at which the net present value (NPV) of a project equals zero. This means that the cash inflows from the project will be equal to the cash outflows when discounted at the IRR. The IRR is a useful measure of a project's profitability and is often used as a benchmark for comparing different investment opportunities.

Question 10

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}
\text { Cost of new machine } & \$ 100,000 \
\text { Annual cost savings in cash expenses } &&45,000 \
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } &5,000  \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the total savings (excluding the maintenance in year 4) in annual cash operating costs is:

Accepted Answer

The answer of Arnold Company is acquiring a new machine...

Question 11

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the terminal cash flows is:

Accepted Answer

The present value of the terminal cash flow is calculated by discounting the terminal value of $8,000 at the discount rate of 12% for 5 years: $ PV = \frac{8,000}{(1+0.12)^5} = 4,536 $.

Question 12

The process that managers use when they evaluate multi-year investments is called

Accepted Answer

Capital budgeting is the process of evaluating and selecting long-term investments that are expected to generate returns over a period of multiple years. It involves analyzing the expected cash inflows and outflows associated with different investment options and selecting the most profitable one. Activity-based budgeting is a different process that focuses on the costs and resources required to carry out specific activities within an organization. Short-term decision making and breakeven analysis are also different concepts that do not directly relate to evaluating multi-year investments.

Question 13

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x8. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The net cash flow associated with selling the old machine in January 20x5 (i.e., the value of the sale and any tax consequences) would be:

Accepted Answer

The net cash flow associated with selling the old machine in January 20x5 would be:
Sale value of the old machine: $25,000
Taxable gain: $25,000 - $10,000 – $5,000 = $10,000
Tax on gain: $10,000 × 40% = $4,000
Net cash flow: $25,000 – $4,000 = $21,000
However, the question asks for the net cash flow associated with selling the old machine in January 20x5, after amortization for the year 20x4. 
Therefore, net cash flow = $21,000 – $5,000 = $16,000
So, the best choice is D: $11,000.

Question 14

Valley Hospital is considering the purchase of new medical equipment for $25,000. The old equipment has zero salvage value. The costs associated with operating the equipment are: $\begin{array}{lrr} 
& \underline{\text { Old Equipment}}& \underline{\text { New Equipment}}\
& \$ 9,000 & \$ 4,500 \
\text { Mabour } & 2,000 & 1,200 \
\text { Miscellaneous } & 1,500 & 1,300 \
\text { Amortization } & 8,000 & 4,750
\end{array}$
 If the new machine is purchased and ignoring income taxes, the payback period is:

Accepted Answer

The answer of Valley Hospital is considering the purchase of...

Question 15

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x48. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The tax effect of selling the new machine in 20x8 would be:

Accepted Answer

The tax effect of selling the new machine in 20x8 is zero because the book value of the new machine will be zero at the end of its useful life. This is because the machine will be fully amortized by the end of 20x8. Therefore, there will be no gain or loss on the sale, and no tax effect. The best choice would be to purchase the new machine and dispose of the old machine as it will increase the net income and the cash flows for Bailey Corporation.

Question 16

The payback period is deficient as a decision criterion for capital projects because it:
I. Disregards relative profitability
II. Ignores income beyond the payback period
III. Does not take into account the time value of money

Accepted Answer

The payback period is deficient because it disregards relative profitability (I), ignores income beyond the payback period (II), and does not take into account the time value of money (III).

Question 17

Which of the following is not a step in the process for addressing capital budgeting decisions?

Accepted Answer

While financial statement effects are important to consider, they are not a step in the process for addressing capital budgeting decisions. The correct steps are: identify decision alternatives, apply quantitative analysis techniques, perform sensitivity analysis, and make the decision.

Question 18

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x8. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The relevant annual pretax cash operating cost associated with Bailey's decision will be:

Accepted Answer

The answer of Bailey Corporation is considering modernizing its production...

Question 19

Which of the following is the best example of a capital budgeting decision?

Accepted Answer

Capital budgeting involves making long-term investment decisions related to the acquisition or expansion of assets with the expectation of generating future cash flows. Purchasing a piece of equipment with an expected life of eight years is a capital budgeting decision as it involves a long-term investment that is expected to generate future cash flows. Options A, B, and D do not involve long-term investments in assets with potential future cash flows.

Question 20

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the maintenance cost in year 4 is:

Accepted Answer

To calculate the present value of the maintenance cost in year 4, you use the formula for present value: $$PV = \frac{FV}{(1 + r)^n}$$ where $FV$ is the future value ($5,000), $r$ is the discount rate (0.12), and $n$ is the number of years (4). Plugging in the values: $$PV = \frac{5,000}{(1 + 0.12)^4} = \frac{5,000}{1.5748} = 3,177.62$$ which rounds to approximately $3,180.

Quiz 13: Pricing Decisions

If the internal rate of return exceeds the discount rate, the net present value is:

A negative net present value means that the:

Capital budgeting decisions typically fall into which of the following major categories? I. Developing or expanding products or services II. Allocating costs to products or services III. Replacing or reorganizing assets or services

Which of the following capital budgeting methods ignores the time value of money?

The rate of return that results in a zero net present value for a project is called the:

The process that managers use when they evaluate multi-year investments is called

The payback period is deficient as a decision criterion for capital projects because it: I. Disregards relative profitability II. Ignores income beyond the payback period III. Does not take into account the time value of money

Which of the following is not a step in the process for addressing capital budgeting decisions?

Which of the following is the best example of a capital budgeting decision?