Question 1

Why is the time value of money often taken into account in analyzing a capital investment?

Accepted Answer

The answer of Why is the time value of money...

Question 2

When the effect of income taxes is considered in a capital budgeting analysis, the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

Accepted Answer

When income taxes are considered, the amount of depreciation expense must be added back to after-tax income because depreciation is a non-cash expense that reduces taxable income. Therefore, adding it back provides a more accurate calculation of the cash inflows that the project will generate.

Question 3

When a capital investment is expected to provide unequal annual cash inflows, the payback period cannot be calculated.

Accepted Answer

The payback period can still be calculated, although it may not be as easy to determine as it would be with equal annual cash inflows. Various methods can be used, such as calculating the cumulative cash inflows or using a discounted cash flow analysis.

Question 4

Generally, the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

Accepted Answer

The unadjusted rate of return should be based on the average investment over the life of the asset, rather than the amount of the original investment. This is because the asset's value will decrease over time as it is depreciated, so using the original investment amount would not accurately reflect the asset's value over its useful life.

Question 5

Generally, a company should use the MACRS method to calculate depreciation on its income tax return, due to the effects of the time value of money.

Accepted Answer

The MACRS method allows for accelerated depreciation, meaning more depreciation is taken in the earlier years of an asset's life and less in the later years. This results in a larger tax deduction in the earlier years when the company may have a higher tax liability. Additionally, because the company can deduct more depreciation earlier, it can also reduce its taxable income sooner, providing a cash flow benefit due to the time value of money. Therefore, it is generally advantageous for a company to use the MACRS method for tax purposes.

Question 6

Sources of cash inflows from capital investments include incremental expenses and installation costs.

Accepted Answer

The answer of Sources of cash inflows from capital investments...

Question 7

When a capital investment is expected to provide unequal annual cash inflows, the payback period can be calculated by accumulating the incremental cash inflows until the sum equals the amount of the original investment.

Accepted Answer

This statement accurately describes the concept of calculating payback period for an investment with unequal annual cash flows. The payback period is the amount of time it takes for the cumulative cash inflows from the investment to equal the original investment amount.

Question 8

A postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

Accepted Answer

A postaudit is a review conducted after a capital investment project has been completed to evaluate whether the expected outcomes were achieved. This helps to assess the effectiveness of the investment and to identify areas for improvement in future projects.

Question 9

Cash inflows from a capital investment may include the terminal value of capital assets and increases in revenues.

Accepted Answer

Cash inflows from a capital investment can include the terminal value of capital assets, such as selling them at the end of their useful life, as well as increases in revenues resulting from the investment.

Question 10

If the net present value for a capital investment is equal to zero, the internal rate of return for the investment is equal to the required rate of return.

Accepted Answer

When the NPV is zero, it means the investment is expected to earn the required rate of return. Therefore, the IRR must also be equal to the required rate of return for the investment to break even.

Question 11

Depreciation on a capital investment (such as equipment) has the effect of decreasing the amount of income taxes that the company owning the asset must pay.

Accepted Answer

Depreciation is a non-cash expense that allows for the gradual reduction in the value of an asset over time, reflecting its anticipated useful life. As a tax deduction, it reduces the taxable income of the company and hence decreases the amount of income taxes that must be paid.

Question 12

The payback method of evaluating capital investments measures the recovery of the investment, but it does not measure profitability.

Accepted Answer

The payback method only calculates the time it takes to recover the initial investment, not the profitability of the investment.

Question 13

Describe what is meant by the time value of money.

Accepted Answer

The answer of Describe what is meant by the time...

Question 14

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

Accepted Answer

The payback method is a financial analysis technique that helps calculate the period required to recover an investment. It is one of the commonly used methods by businesses to evaluate the potential profitability of capital projects or new investments.

Question 15

What is the reinvestment assumption, and how does the assumption affect capital investment analyses?

Accepted Answer

The answer of What is the reinvestment assumption, and how...

Question 16

The amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

Accepted Answer

This is correct. The depreciation tax shield is the amount of tax savings a company receives due to the tax deductibility of the depreciation expense. It is calculated by multiplying the amount of depreciation expense by the company's tax rate.

Question 17

Why does a company use its cost of capital as the minimum required rate of return for its capital investment decisions?

Accepted Answer

The answer of Why does a company use its cost...

Question 18

A capital investment with an internal rate of return equal to or greater than the required rate of return is considered to be an acceptable investment.

Accepted Answer

This is because the internal rate of return, or IRR, is a measure of the profitability of an investment and represents the rate of return that makes the net present value of all cash flows from the investment equal to zero. If the IRR is equal to or greater than the required rate of return, it means that the investment is generating a return that matches or exceeds what is expected, and is therefore deemed acceptable.

Question 19

If a company has to pay a given amount of income taxes over the life of a capital investment, managers of the company should seek to pay the taxes as early as possible in the investment's life.

Accepted Answer

Managers should aim to delay paying income taxes on capital investments as long as possible, as this can provide a cash flow advantage and increase the net present value of the investment. By delaying taxes, the company can potentially reinvest the money they would have paid in taxes elsewhere, earning a return on the money until they have to pay taxes.

Question 20

The unadjusted rate of return is found by dividing the average incremental increase in annual operating income by the cost of the investment.

Accepted Answer

This is the correct formula for calculating the unadjusted rate of return.

Quiz 10: Planning for Capital Investments