Chapter 26- Pre-Test Practice

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The following table is for the present value of $1 at compound interest: Year 6% 10% 12% Y1 0.943 0.909 0.893 Y2 0.890 0.826 0.797 Y3 0.840 0.751 0.712 Y4 0.792 0.683 0.636 Y5 0.747 0.621 0.567 The following table is for the present value of an annuity of $1 at compound interest: Year 6% 10% 12% Y1 0.943 0.909 0.893 Y2 1.833 1.736 1.690 Y3 2.673 2.487 2.402 Y4 3.465 3.170 3.037 Y5 4.212 3.791 3.605 Using these tables, what is the present value of $22,000 to be received 5 years from today, assuming an earnings rate of 6%?

$16,434 $22,000 × 0.747 = $16,434

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The following table is for the present value of $1 at compound interest: Year 6% 10% 12% Y1 0.943 0.909 0.893 Y2 0.890 0.826 0.797 Y3 0.840 0.751 0.712 Y4 0.792 0.683 0.636 Y5 0.747 0.621 0.567 The following table is for the present value of an annuity of $1 at compound interest: Year 6% 10% 12% Y1 0.943 0.909 0.893 Y2 1.833 1.736 1.690 Y3 2.673 2.487 2.402 Y4 3.465 3.170 3.037 Y5 4.212 3.791 3.605 Using these tables, what is the present value of $21,000 to be received 3 years from today, assuming an earnings rate of 6%?

$17,640 $21,000 × 0.840 = $17,640

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The management of Arnold Corporation is considering the purchase of a new machine costing $470,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to this information, use the following data in determining the acceptability in this situation: Year Income from Operations Net Cash Flow Y1 $120,000 $240,000 Y2 60,000 180,000 Y3 30,000 150,000 Y4 15,000 135,000 Y5 15,000 135,000

$185,530. The total present value of the net cash flows is as follows: $240,000 × 0.909 = $218,160 180,000 × 0.826 =148,680 150,000 × 0.751 =112,650 135,000 × 0.683 =92,205 135,000 × 0.621 =83,835 $655,530 Net Present Value = Total Present Value of Net Cash Flow - Amount to Be Invested = $655,530 - $470,000 = $185,530

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods Using the following partial table of present value of $1 at compound interest, determine the present value of $32,000 to be received 3 years hence, with earnings at the rate of 10% a year: Year 6% 10% 12% Y1 0.943 0.909 0.893 Y2 0.890 0.826 0.797 Y3 0.840 0.751 0.712 Y4 0.792 0.683 0.636

$24,032 The present value is computed by using the discount factor for 10% for 3 years, which is 0.751. $32,000 × 0.751 = $24,032

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods Which of the following is NOT an advantage of the internal rate of return method?

It assumes that the cash received from a proposal can be reinvested at the internal rate of return.

4. List and describe additional factors in capital investment analysis Which of the following is NOT an advantage of leasing a fixed asset?

Leasing a fixed asset is normally less costly than purchasing the asset.

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods The expected average rate of return for a proposed investment of $725,000 in a fixed asset with a useful life of 5 years, straight-line depreciation, no residual value, and an expected total net income of $300,000 is

16.55%. Estimated Average Annual Income = $300,000 ÷ 5 = $60,000; Average Investment = $725,000 ÷ 2 = $362,500; Average Rate of Return = Estimated Average Annual Income ÷ Average Investment = $60,000 ÷ $362,500 = 0.1655, or 16.55%

4. List and describe additional factors in capital investment analysis Which of the following considerations may impact capital investment analysis?

Market opportunities Employee morale Product quality

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods An anticipated purchase of equipment for $760,000 with a useful life of 8 years and no residual value is expected to yield the following annual net incomes and net cash flows: Year Net Income Net Cash Flow Y1 $105,000 $210,000 Y2 95,000 200,000 Y3 95,000 180,000 Y4 85,000 170,000 Y5 85,000 180,000 Y6 85,000 180,000 Y7 85,000 180,000 Y8 85,000 180,000 What is the cash payback period?

4 years Because the annual net cash flow is unequal, add up the yearly amounts until the purchase price is reached: $210,000 + $200,000 + $180,000 + $170,000 = $760,000. The purchase price is reached in 4 years, so the cash payback period is 4 years.

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods An anticipated purchase of equipment for $1,160,000 with a useful life of 8 years and no residual value is expected to yield the following annual net incomes and net cash flows: YearNet IncomeNet Cash Flow Y1 $155,000 $310,000 Y2 145,000 300,000 Y3 145,000 280,000 Y4 135,000 270,000 Y5 135,000 280,000 Y6 135,000 280,000 Y7 135,000 280,000 Y8 135,000 280,000 What is the cash payback period?

4 years Because the annual net cash flow is unequal, add up the yearly amounts until the purchase price is reached: $310,000 + $300,000 + $280,000 + $270,000 = $1,160,000. The purchase price is reached in 4 years, so the cash payback period is 4 years.

4. List and describe additional factors in capital investment analysis Assume in analyzing alternative proposals that Proposal A has a useful life of 5 years and Proposal B has a useful life of 8 years. What is one widely used method that makes the proposals comparable?

Adjust the life of Proposal A to a time period that is equal to that of Proposal B by estimating a residual value at the end of Year 5.

4. List and describe additional factors in capital investment analysis Which of the following is NOT a qualitative consideration impacting capital investment analysis?

Average rate of return of the project

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods Which of the following is a method of analyzing capital investment proposals that ignores present value?

Cash payback

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods Which of the following is a present value method of analyzing capital investment proposals?

Internal rate of return

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods Which of the following is an advantage of the cash payback method?

It analyzes cash flows.

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods Which of the following is a disadvantage of using the average rate of return?

The average rate of return method does not consider the timing of the expected cash flows.

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The correct formula for the present value index is

Total Present Value of Net Cash Flow ÷ Amount to Be Invested.

1. Explain the nature and importance of capital investment analysis Decisions to install new equipment, purchase other businesses, and purchase a new building are examples of

capital investment analysis.

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods The __________ is the expected period of time between the date of an investment and the recovery in cash of the amount invested.

cash payback period

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The process of interest earning interest is called

compounding

1. Explain the nature and importance of capital investment analysis Capital investment evaluation methods can be grouped into methods that __________ and methods that __________.

do not use present values; use present values

5. Diagram the capital rationing process At the end of the capital rationing process, proposals that are selected for funding are

included in the capital expenditures budget.

2. Evaluate capital investment proposals, using the average rate of return and cash payback methods All of the following are advantages of the average rate of return EXCEPT

it uses present values.

5. Diagram the capital rationing process When using capital rationing, unfunded proposals

may be reconsidered if funds later become available.

3. Evaluate capital investment proposals, using the net present value and internal rate of return methods The __________ is the amount of cash needed today to yield a series of equal net cash flows at fixed intervals in the future.

present value of an annuity

1. Explain the nature and importance of capital investment analysis The __________ recognizes that a dollar today is worth more than a dollar tomorrow because today's dollar can earn interest.

time value of money concept