Question 1

Major weaknesses of the payback method do NOT include which of the following?

Accepted Answer

The payback method can indeed be used as a rough estimate of the riskiness of a project. Shorter payback periods are generally perceived as less risky.

Question 2

Which of the following statements about the payback model is FALSE?

Accepted Answer

The payback model does not measure profitability but rather the length of time it takes for an investment to recoup its initial cost.

Question 3

A disadvantage of the accounting rate of return model is ________.

Accepted Answer

The accounting rate of return model ignores the time value of money, meaning that it does not take into account the fact that money received in the future is worth less than money received in the present. This can lead to inaccurate calculations and decision-making.

Question 4

A plant asset of $180,000 is expected to generate $80,000 in operating cash savings (excluding depreciation expense)annually for three years.Assume straight-line depreciation is used.The useful life is 3 years.The asset has no expected residual value.Ignore income taxes.The accounting rate of return based on the initial investment is ________.

Accepted Answer

The accounting rate of return is calculated by dividing the average annual operating cash savings by the initial investment. In this case, the average annual operating cash savings is $80,000 and the initial investment is $180,000. Therefore, the accounting rate of return is $80,000/$180,000 = 11.11%.

Question 5

The time it will take to recoup in the form of cash inflows the initial dollars invested in an investment project is called the ________.

Accepted Answer

The time it takes for an investment project to recoup its initial costs in the form of cash inflows is called the payback period. It is a simple and widely used measure of investment profitability that helps investors and project managers determine how long it will take to earn back their initial investment, and therefore, how risky the investment is. The shorter the payback period, the better, as it means that the investment is generating cash sooner and has a lower risk of not being profitable.

Question 6

Projects that recoup their investment quickly may be less risky than those that require a longer time.

Accepted Answer

Projects that recoup their investment quickly are generally considered less risky since there is a shorter waiting period to see returns and less exposure to external factors that may affect the investment over a longer period of time.

Question 7

Managers may use the payback period as a rough estimate of the riskiness of a project.

Accepted Answer

The payback period tells how long it will take a project to recoup its initial investment. If the payback period is short, the project is considered less risky compared to other projects with a longer payback period. Therefore, managers can use the payback period as a rough estimate of the riskiness of a project.

Question 8

Reasons for the post-audit of an investment project do NOT include ________.

Accepted Answer

Post-audit of an investment project aims to evaluate the project's performance and provide information for future decision-making. Evaluating manager performance is not the primary objective of a post-audit.

Question 9

A machine that costs $180,000 is expected to generate $40,000 in cost savings annually for five years.The terminal value at the end of five years is $10,000.Assume straight-line depreciation is used.Ignore income taxes.What is the payback period?

Accepted Answer

The answer of A machine that costs $180,000 is expected...

Question 10

The accounting rate of return model ignores the time value of money.

Accepted Answer

The accounting rate of return model, also known as the average rate of return model, is calculated by dividing the average annual profit generated by an investment by the initial investment cost. However, this model ignores the time value of money, which assumes that a dollar received today is worth more than a dollar received in the future due to inflation, interest, and other factors. Therefore, this model may not accurately reflect the profitability or cost-effectiveness of an investment over time.

Question 11

________ is a capital budgeting model that ignores the time value of money and focuses on the profitability of an investment project.

Accepted Answer

The Accounting Rate of Return (ARR) model ignores the time value of money and focuses on the profitability of an investment project by using accounting information.

Question 12

The best way to reconcile any conflict between capital budgeting models and performance evaluation is to use the ________ for both capital budgeting decisions and performance evaluation.

Accepted Answer

The discounted cash flow model is widely accepted as the best capital budgeting model because it takes into account the time value of money and provides a more accurate assessment of a project's profitability. Therefore, using the same model for both capital budgeting decisions and performance evaluation would eliminate any conflict and ensure consistency in decision-making.

Question 13

Managers who are evaluated based on the accounting rate of return model are reluctant to use ________ for capital budgeting decisions.

Accepted Answer

Managers who are evaluated based on accounting rate of return model prefer models that use accounting measures, such as payback period or return on investment. They may be reluctant to use discounted cash flow models, such as net present value or internal rate of return, which require estimating future cash flows and discounting them to present value. Real options model is also based on future uncertainties and may not be preferred by managers who are evaluated based on accounting measures.

Question 14

Woods Company is considering the purchase of some equipment.The initial investment will be $100,000.The estimated useful life of the equipment will be 5 years,at which point it will have a zero terminal salvage value.The annual savings in cash operating costs at the end of each year,for five years,is $29,000.The company has a minimum desired rate of return of 12%.The company uses straight-line depreciation for financial reporting.Ignore income taxes.The cash operating savings of $29,000 do not include depreciation expense.
Given:
The present value of ordinary annuity of one at 12% and 5 periods is 3.6048.
The present value of one at 12% and 5 periods is 0.5674.
Required:
Compute:
A) Net present value
B) Payback period
C) Accounting rate of return using the average investment

Accepted Answer

The answer of Woods Company is considering the purchase of...

Question 15

Tomlin Company spends $12,000 for a forklift with an estimated useful life of four years.The company expects annual savings of $4,000 per year for four years,and a salvage value of $5,000 at the end of 4 years.What is the payback period?

Accepted Answer

The answer of Tomlin Company spends $12,000 for a forklift...

Question 16

An investment of $42,000 is expected to generate the following annual cash flows:
$\begin{array}{ll}
\text { Year 1 } & \$ 10,000 \
\text { Year 2 } & \$ 15,000 \
\text { Year 3 } & \$ 15,000 \
\text { Year 4 } & \$ 12,000
\end{array}$
Assume straight-line depreciation is used.Ignore income taxes.What is the payback period?

Accepted Answer

The payback period is the time it takes for the investment to generate cash flows to recover the initial investment. By adding the annual cash flows, we find that by the end of Year 3, the total cash flow is $40,000 ($10,000 + $15,000 + $15,000), which is short of the initial investment of $42,000. In Year 4, the cash flow is $12,000, but only $2,000 is needed to reach the initial investment. Therefore, the payback period extends into Year 4. To find the exact time into Year 4, divide the remaining amount ($2,000) by the Year 4 cash flow ($12,000), resulting in 1/6 of a year or approximately 0.17 years. Thus, the payback period is 3 years plus approximately 0.17 years, totaling 3.17 years.

Question 17

Bryant Company has obtained the following data about a possible planned investment:
 $\begin{array}{ll}
\text { Cost } & \$ 270,000 \
\text { Terminal salvage value in } 8 \text { years } & \$ 10,000 \
\text { Annual cash operating savings for } 8 \text { years (end of year) } & \$ 50,000 \
\text { Estimated useful life in years } & 8 \
\text { Minimum desired rate of return } & 10 \% \
\text { Present value of ordinary annuity of one, } 10 \%, 8 \text { periods } & 5.3349 \
\text { Present value of one, } 10 \%, 8 \text { periods } & 0.4665
\end{array}$ 
The company uses straight-line depreciation method for financial reporting.Ignore income taxes.The cash operating savings of $50,000 do not include depreciation expense.
Required: 
A) Compute the net present value of the investment.
B) Compute the payback period.
C) Compute the accounting rate of return using the initial required investment.

Accepted Answer

The answer of Bryant Company has obtained the following data...

Question 18

A plant asset of $270,000 is expected to generate $180,000 in operating cash savings (excluding depreciation expense)annually for three years.Assume straight-line depreciation is used.The useful life is three years.The asset has no expected residual value.Ignore income taxes.The accounting rate of return based on the average investment is ________.

Accepted Answer

The answer of A plant asset of $270,000 is expected...

Question 19

The payback model measures profitability as well as how quickly investment dollars are recouped.

Accepted Answer

The payback model primarily measures how quickly investment dollars are recouped, not profitability.

Question 20

A follow-up evaluation of capital-budgeting decisions is called a post-audit.

Accepted Answer

A post-audit is a follow-up evaluation of capital-budgeting decisions. It involves comparing actual results to the projected results used to make the decision to determine the accuracy of the original assumptions and decision-making process.

Quiz 11: Capital Budgeting