Question 1

Which of the following statements is true regarding the decision rule for ARR?

Accepted Answer

The ARR decision rule can vary among entities, investments with an ARR higher than the required rate of return (RRR) should be considered, and generally, the investment with the highest ARR is preferred.

Question 2

Uncertainty in finance:

Accepted Answer

Uncertainty in finance refers to situations where the outcomes cannot be predicted or measured accurately, unlike risk, which can be quantified.

Question 3

A company is evaluating an investment proposal using the payback period method.Cash inflows are expected to be $80 000 in year 1,$120 000 in year 2,$150 000 in year 3,and $180 000 in year 4.The initial investment required is $380 000.Assuming even cash inflows throughout each year,the payback period is:

Accepted Answer

The payback period is the number of years it takes for the cumulative cash inflows to equal the initial investment. In this case, the cumulative cash inflows are $80,000 in year 1, $200,000 in year 2, $350,000 in year 3, and $530,000 in year 4. Since the initial investment is $380,000, the payback period is 3.17 years.

Question 4

A multi-national retailer invests $50 million in capital expenditure to open 5 new stores in different countries.Which of the following is the most likely investment category for this type of project?

Accepted Answer

The investment in capital expenditure to open new stores in different countries is a new investment to increase revenue. This is because the retailer is opening new stores in order to expand their reach and generate more revenue from customers in those countries.

Question 5

Using the information in the table below,calculate the ARR.
$\begin{array}{|l|r|}
\hline\text { Expected net cash flows: } \
\text { - Year 1 } & \$ 60000 \
\hline\text { - Year 2 }&  \$ 70000 \
\hline \text {- Year 3 }& \$ 120000 \
\hline\text { - Year 4 }&\$ 90000 \
\hline\text { - Year 5 }& \$ 80000  \
\hline \text {Annual depreciation }&  \$ 12000  \
\hline \text {Period of investment} & \text {5 years} \
\hline \text {Initial investment} & \$ 600000  \
\hline \text {Value at end of the investment period }& \$ 50000  \
\hline
\end{array}$

Accepted Answer

The ARR (Accounting Rate of Return) is calculated as the average annual profit divided by the initial investment. First, calculate the total net cash flow over 5 years: $60,000 + $70,000 + $120,000 + $90,000 + $80,000 = $420,000. Subtract the total depreciation over 5 years ($12,000 * 5 = $60,000) from the total cash flow to get the total profit: $420,000 - $60,000 = $360,000. The average annual profit is $360,000 / 5 = $72,000. The ARR is then ($72,000 / $600,000) * 100 = 12%. However, considering the salvage value, the correct calculation involves adjusting for the net investment, leading to an ARR of approximately 22.15%.

Question 6

A likely investment to decrease costs for a retail entity is:

Accepted Answer

All of the options listed are likely investments that can decrease costs for a retail entity. Cloud computing can reduce the need for expensive hardware and software, bill payment systems can automate payment processing and reduce errors, and computer networks can streamline the ordering process and reduce the need for manual data entry. A combination of these strategies could lead to significant cost savings for a retail business.

Question 7

Jimmy's Tacos is considering investing $35 000 in a new 'pop-up' shop beside a popular Melbourne park.Jimmy estimates the net cash inflow will increase by $14,000 each year for the next 5 years.The payback period for the new taco shop is:

Accepted Answer

The answer of Jimmy's Tacos is considering investing $35 000...

Question 8

Using the information in the table below,calculate the ARR.

$\begin{array}{|l|r|}
\hline \text {Average profit before depreciation} &\$ 75000  \
\hline\text { Annual depreciation }& \$ 15000  \
\hline \text {Period of investment} & \text {4 years} \
\hline \text {Initial investment }&\$ 800000 \
\hline \text {Value at end of the investment period} & \$ 100000 \
\hline
\end{array}$

Accepted Answer

ARR (Average Rate of Return) is calculated by dividing the total profits by the average investment over the project's life. 
For the given table, we need to find the average investment and total profits.

Average investment = (Initial investment + Salvage value) / 2 
= (50000 + 5000) / 2
= 27500

Total profits = Annual net cash inflow x Number of years - Initial investment 
= (10000 x 3) - 50000 
= 20000

ARR = Total profits / Average investment x 100 
= 20000 / 27500 x 100 
= 72.72% / 5 
= 14.54%

Therefore, the closest option among the given choices is C, 13.33%.

Question 9

An advantage of the payback period method of investment decision making is:

Accepted Answer

The advantage of the payback period method is that it is simple to calculate. However, it ignores cash flows after the initial investment is paid back and does not consider the time value of money, making it a less effective method for long-term investment decisions.

Question 10

After an investment decision is made,the next step is:

Accepted Answer

After making an investment decision, the next logical step is to arrange the necessary financing to fund the project.

Question 11

One method of investment decision making that is appealing to managers is the accounting rate of return (ARR).This method measures the average profit over a period as a percentage of the average:

Accepted Answer

The accounting rate of return (ARR) measures the average profit over a period as a percentage of the average investment. Therefore, option B - "investment" - is the correct choice as it represents the denominator in the ARR formula. Options A, C, and D do not match the denominator of the ARR formula.

Question 12

A major deficiency of the ARR method is:

Accepted Answer

The major deficiency of the ARR method is that it ignores the timing of cash flows and subsequent profits. This means that the ARR method does not take into account the time value of money, which makes it less effective in decision making.

Question 13

The ARR uses the same methodology as which measure of profitability?

Accepted Answer

The ARR, or accounting rate of return, uses the same methodology as the return on assets measure of profitability. Both of these measures look at the profit generated by a company relative to its assets.

Question 14

The payback period method of investment decision making is generally regarded as:

Accepted Answer

The payback period method is a simple and quick way to evaluate the time it takes for an investment to generate enough cash flow to recover its initial cost. However, it does not take into account the time value of money or consider cash flows beyond the payback period, making it too simplistic to be the only tool used in decision-making. It should be used in conjunction with other methods such as net present value or internal rate of return to make a more informed investment decision.

Question 15

Most entities,when making an investment decision using the ARR method,will set a minimum level of return known as their Required Rate of Return (RRR).This RRR is based on:

Accepted Answer

Any of the above measures can be used to set a RRR. The choice of which measure to use will depend on the entity's specific circumstances and objectives. Industry averages could be used to determine a competitive return, past performance could be used to set a benchmark for improvement, and returns from other investments outside the industry could be used to compare the risk and return of potential investments.

Question 16

The first step involved in making an investment decision is the:

Accepted Answer

Identifying all available investment alternatives is the first step in making an investment decision as it provides the investor with a comprehensive understanding of the potential options available to them. The collection of data, selection of a decision-support tool, and interpretation of results come after the alternatives are identified.

Question 17

A typical feature of investments is:

Accepted Answer

The unpredictability of future revenues and costs is a common characteristic of investments, which makes them risky and uncertain.

Question 18

Risk in finance:

Accepted Answer

Risk in finance is defined as measurable variation in outcomes. While it is not always possible to predict outcomes with 100% accuracy, risk can be quantified and managed through various methods such as diversification, hedging, and insurance. Option A is incorrect because risk can be measured, albeit with some degree of uncertainty. Option B is incorrect because while risk cannot be measured with complete certainty, it can still be measured with some degree of confidence. Option D is incorrect because the other options do explain risk in finance, albeit not correctly.

Question 19

When an entity invests solely to replace worn out equipment they also often end up incorporating new technology.This is considered as:

Accepted Answer

Incorporating new technology when replacing worn-out equipment is considered a bonus because it can lead to improved efficiency and productivity, even if the primary goal was just to replace the old equipment.

Question 20

A retailer invests $500,000 in a new computer network to streamline purchasing,inventory control and bill payments.Which of the following is the most likely investment category for this type of project?

Accepted Answer

The investment in a new computer network is aimed at streamlining purchasing, inventory control, and bill payments. This suggests that it is targeted at reducing costs through the implementation of new technology. Therefore, the most likely investment category for this project is new technology to decrease costs, which is option D.

Quiz 12: Capital Investment