Question 1

Which capital budgeting technique defines returns in terms of income instead of cash flows?

Accepted Answer

The unadjusted rate of return method calculates returns in terms of the income generated by the investment rather than the cash flows. It is calculated by dividing the average annual income by the initial investment. However, this method does not consider the time value of money or the cash flows generated over the life of the project. Therefore, it is not considered the best capital budgeting technique.

Question 2

Which of the following does not represent an advantage of the unadjusted rate of return over the payback method for evaluating capital projects?

Accepted Answer

The payback method and the unadjusted rate of return method both ignore the time value of money.

Question 3

Findell Corporation is considering two projects,A and B,and it has gathered the following estimates for the projects: $\begin{array}{|l|l|l|}
\hline & \text { Project A } & \text { Project B } \
\hline \text { Useful life } & 5 \text { years } & 5 \text { years } \
\hline \text { Present value of cash inflows } & \$ 84,360 & \$ 55,100 \
\hline \text { Present value of cash outflows } & \$ 77,000 & \$ 49,000 \
\hline & & \
\hline
\end{array}$ What is the net present value of cash flows for project B?

Accepted Answer

The answer of Findell Corporation is considering two projects,A and...

Question 4

Mr.J's Bagels invested in a new oven for $14,000.The oven reduced the amount of time for baking which increased production and sales for five years by the following amounts of cash inflows: $\begin{array}{|l|l|l|l|l|}
\hline  \underline {\text { Year 1 }} & \underline {\text { Year 2 }} & \underline {\text { Year 3 }} & \underline {\text { Year 4 }} & \underline {\text { Year 5 }}  \
\hline  \$ 8,000 &\$ 6 ,000&\$  5,000&\$ 6 ,000&\$5  ,000\
\hline
\end{array}$ Using the averaging method,the payback period for the investment in the oven would be:

Accepted Answer

The total cash inflow over 5 years is $30,000. The average annual cash inflow is $6,000. The payback period is $14,000 / $6,000 = 2.33 years, which rounds to 2.3 years.

Question 5

Saget Company is considering the purchase of equipment that would cost $35,000 and offer annual cash inflows of $10,500 over its useful life of 5 years.Assuming a required rate of return of 8%,what is the net present value of this investment opportunity?

Accepted Answer

Revised estimate:
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
Net present value = ($10,500 x 3.992710)- $35,000 = $6,923 (rounded)
PV factor from Appendix Table 2 (n = 5,i = 8)

Question 6

Grayson Company is considering purchase of equipment that costs $49,000 and is expected to offer annual cash inflows of $13,000.Grayson's minimum required rate of return is 10%.How many years must the cash flows last for the investment to be acceptable? (Do not round your intermediate calculations.Round to nearest whole year. )

Accepted Answer

Recall that a present value of zero suggests the investment will earn a rate of return equal to the desired rate.As such,we can set the net present value to zero to determine the minimum expected annual cash flow.
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
$0 = ($13,000 x PV factor)- $49,000
$13,000 x PV factor = $49,000
PV factor = $49,000 ÷ $13,000 = 3.769231 (rounded)
Referring to Appendix Table 2 with i = 10,this factor is closest to the 3.790787factor that relates to 5 years.
Proof that cash flows of at least 5 years will generate a small positive net present value:
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
Net present value = ($13,000 x 3.790787)- $49,000 = $280 (rounded)

Question 7

Paul Company is considering purchasing a capital investment that is expected to provide annual cash inflows of $12,000 per year for 3 years.Assuming that the required rate of return is 10%,what is the present value of these cash inflows? (Do not round PV factors and intermediate calculations.Round your final answer to the nearest dollar. )

Accepted Answer

Revised estimate:
Net present value = (Expected cash flows x PV factor)
Net present value = $12,000 x 2.486852 = $29,842 (rounded)
PV factor from Appendix Table 2 (n = 3,i = 10)

Question 8

Benson Corporation is considering an investment in equipment that would cost $50,000 and provide annual cash inflows of $14,000.The company's required rate of return is 12%;the internal rate of return for the investment is 10.5%.Should the company make this investment?

Accepted Answer

The internal rate of return is the rate at which the present value of cash inflows equals the cash outflows.It is the rate that will produce a zero net present value.An internal rate of return below the desired rate suggests management should reject a particular proposal.

Question 9

The purposes of the postaudit for capital investments include all of the following except:

Accepted Answer

The goal of a postaudit is to provide feedback that will help managers improve the accuracy of future cash flow projections,maximizing the quality of the firm's capital investments.

Question 10

Langdon Company is considering purchasing a capital investment that is expected to provide annual cash inflows of $10,000 per year for 3 years.Assuming that Langdon's required rate of return is 8%,what is the present value of these cash inflows? (Do not round your intermediate calculations.Round your final answer to the nearest dollar. )

Accepted Answer

Revised estimate:
Net present value = (Expected cash flows x PV factor)
Net present value = $10,000 x 2.577097= $25,771 (rounded)
PV factor from Appendix Table 2 (n = 3,i = 8)

Question 11

Six years ago,Neighborhood Hardware paid a contractor $45,000 to expand the store.At that time,the company calculated a net present value of about $6,000 for the expansion.Now,the company believes that the investment increased annual cash inflows by $8,000 per year for each of the six years.The company has a desired rate of return of 10%.Ignoring income tax considerations,what was the net present value actually achieved for this capital investment? (Do not round your intermediate calculations.Round your answer to the nearest dollar. )

Accepted Answer

Revised estimate:
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
Net present value = ($8,000 x 4.355261)- $45,000 = $34,842.09 - $45,000 = $(10,158)(rounded)
PV factor from Appendix Table 2 (n = 6,i = 10)

Question 12

Generro Company is considering the purchase of equipment that would cost $36,000 and offer annual cash inflows of $10,500 over its useful life of 5 years.Assuming a desired rate of return of 12%,is the project acceptable?

Accepted Answer

Revised estimate:
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
Net present value = ($10,500 x 3.604776)- $36,000 = $1,850 (rounded)
PV factor from Appendix Table 2 (n = 5,i = 12)
The positive net present value suggests the investment will earn a rate of return in excess of 12 percent (if cash flows are indeed $10,500 each year).Because the projected rate of return is higher than the desired rate of return,this analysis suggests the company should accept the investment opportunity.

Question 13

Select the incorrect statement regarding postaudits of capital investment decisions.

Accepted Answer

A postaudit is conducted at the completion of a capital investment project,using the same analytical technique that was used to justify the original investment.

Question 14

Finnegan Company plans to invest in a new operating plant that is expected to cost $500,000.The projected incremental income from the investment is as follows: $\begin{array}{|l|c|}
\hline & \text { Net Income } \
\hline \text { Year } & \text { After Tax } \
\hline 1 & \$ 30,000 \
\hline 2 & \$ 45,000 \
\hline 3 & \$ 50,000 \
\hline 4 & \$ 55,000 \
\hline 5 & \$ 40,000 \
\hline 6 & \$ 20,000 \
\hline
\end{array}$ The unadjusted rate of return on the initial investment would be approximately:

Accepted Answer

The unadjusted rate of return is calculated by dividing the average annual net income by the initial investment. The average annual net income is ($30,000 + $45,000 + $50,000 + $55,000 + $40,000 + $20,000) / 6 = $40,000. The unadjusted rate of return is $40,000 / $500,000 = 8.0%.

Question 15

Cash outflows generated by capital investments include all of the following except:

Accepted Answer

Cash outflows fall into three primary categories.One category consists of outflows for the initial investment.A second category of cash outflows may result from increases in operating expenses.Third,increases in working capital commitments result in cash outflows.Cash is paid when assets are purchased,not when depreciation is recognized.As such,because depreciation expense does not require a cash payment,it must be added back to after-tax income to determine the annual cash inflow.

Question 16

The review of a capital budgeting decision to determine whether a project was accepted that should have been rejected is referred to as:

Accepted Answer

A postaudit is a review of a capital budgeting decision after the project has been completed to determine whether the decision was correct or not. Option A, an audit, refers to a general review of financial records and is too broad for the given scenario. Option B, a preaudit, refers to a review of financial controls before a transaction takes place and is not relevant to the scenario given. Option D, a capital review, is too vague of a term and doesn't indicate whether it is pre or post decision-making.

Question 17

Kerwin Company is considering purchase of equipment that costs $50,000.If the useful life is expected to be 5 years and Crown's required rate of return is 12%,what is the minimum annual cash inflow that the equipment must offer for the investment to be acceptable? (Do not round your intermediate calculations.Round your final answer to the nearest dollar. )

Accepted Answer

Recall that a present value of zero suggests the investment will earn a rate of return equal to the desired rate.As such,we will set the net present value to zero to determine the minimum expected annual cash flow.
Net present value = (Expected annual cash flows x PV factor)- Cost of investment
$0 = Expected cash flows x 3.604776)- $50,000
Expected cash flows x 3.604776 = $50,000
Expected cash flows = $50,000 ÷ 3.604776 = $13,870 (rounded)
PV factor from Appendix Table 2 (n = 5,i = 12)

Question 18

Which of the following statements concerning payback analysis is

Accepted Answer

The payback method is preferred for shorter paybacks, ignores the time value of money, and differs from the unadjusted rate of return, making all statements correct.

Question 19

Nguyen Company has an opportunity to purchase an asset that will cost the company $36,000.The asset is expected to add $12,000 per year to the company's net income.Assuming the asset has a five-year useful life and zero salvage value,the unadjusted rate of return based on the average investment will be:

Accepted Answer

Unadjusted rate of return = Average incremental increase in annual net income ÷ Net cost of original investment
Unadjusted rate of return = (Original investment - Recovery of investment)÷ Net cost of original investment
Unadjusted rate of return = ($12,000 - $0)÷ $36,000 = 0.33 = 33%

Question 20

Fenwick Company is considering purchase of equipment that costs $60,000 and is expected to offer annual cash inflows of $16,645 for 5 years.Fenwick Company's required rate of return is 10%.The internal rate of return of this investment project is closest to:

Accepted Answer

The answer of Fenwick Company is considering purchase of equipment...

Quiz 10: Planning for Capital Investments