ASP Chapter 12

Which of the following statements is true about a postaudit? a.A postaudit compares the actual benefits with the estimated benefits of a project. b.A postaudit analyzes the project using the accounting rate of return model. c.A postaudit provide useful information for making capital budgeting decisions regarding a new project. d.A postaudit is cheap compared to other analyses

a.A postaudit compares the actual benefits with the estimated benefits of a project. A postaudit compares the actual benefits with the estimated benefits of a project.

Which of the following statements is true about mutually exclusive projects? a.Mutually exclusive projects are those projects that, if accepted, preclude the acceptance of all other competing projects. b.Mutually exclusive projects are projects that, if accepted, have a negative effect on the company's profit. c.Mutually exclusive projects are projects that, if accepted, automatically lead to the acceptance of competing projects. d.Mutually exclusive projects are projects that, if accepted, do not affect the cash flows of other projects.

a.Mutually exclusive projects are those projects that, if accepted, preclude the acceptance of all other competing projects. Mutually exclusive projects are those projects that, if accepted, preclude the acceptance of all other competing projects.

Which of the following equations is used to calculate the present value of future amounts? (P= Present value of a future outlay; F = Future value; i = Interest rate; n = Period of investment) a.P = F / (1 + i)n b.P = F (1 × i)n c.P = F (1 - i2)n d.P = F / (1 - i)n

a.P = F / (1 + i)n

There are four mutually exclusive projects, Project 1, Project 2, Project 3, and Project 4, whose internal rates of return (IRR) are 6%, 18%, 12%, and 16% respectively. A company wants to invest in one of these projects. Based on the given information, which of the following projects should the company invest in? a.Project 2 b.Project 3 c.Project 1 d.Project 4

a.Project 2 Project 2 should be selected as it has the highest IRR at 18%.

Wilson Company is considering replacing an existing piece of capital equipment. Relevant information includes: New equipment cost is $245,000; Expected annual savings is $73,000; Incremental working capital is $27,000. The incremental working capital will be recovered at the end of the project's life. Based on this information, an NPV analysis will show for Year 0 as a: a.$145,000 outflow. b.$272,000 outflow. c.$218,000 outflow. d.$199,000 outflow

b.$272,000 outflow. . In Year 0-, an NPV analysis will consider cash outflows of $272,000 ($245,000 for the equipment plus $27,000 for the incremental working capital).

An investment is expected to produce annual cash flows of $1,300, $2,200, and $2,400. Assuming a discount rate of 12%, the present value of this series of cash flows is _____. (Round your answer to two decimal places.)Period12312%0.892860.797190.71178 a.$3,309.18 b.$4,622.81 c.$2,877.45 d.$3,058.96

b.$4,622.81 P = F × df Correct. Yr CashRcpt Discntfctr PrsntVlu F df P = F × df 1 1 $1,300 0.89286 1,160.72 2 $2,200 0.79719 1,753.82 3 $2,400 0.71178 1,708.27 4,622.81

Suppose that a project requires $390,000 investment and has even cash flows of $65,000 per year. The payback period of the project is: a.4 years. b.6 years. c.8 years. d.7 years

b.6 years. Payback Period = Original Investment / Annual Cash Flow = $390,000 / $65,000 = 6 years

Fly High Inc. intends to invest in a new airplane. Information regarding the investment in the airplane is given below:Project ALife of project5 yearsInitial investment$28,701,400Net annual after-tax cash inflow$7,000,000 The cost of capital for the company is 9%. Calculate the internal rate of return (IRR) for the new airplane. a.9% b.7% c.6% d.11%

b.7% Discount Factor = Investment / Annual Cash Flow = $28,701,400 / $7,000,000 = 4.10020Referring to the present value of an annuity table, the discount factor of 4.10020 for five periods corresponds to a rate of 7%. Therefore, the IRR is equal to 7%.

Which of the following statements is a limitation of a postaudit? a.A postaudit does not ensure that resources are used wisely when evaluating the profitability of a project. b.A postaudit faces the limitation that the assumptions driving the original analysis may often be invalidated by changes in the actual operating environment. c.A postaudit's objective is not achieved if it is done by an independent party. d.A postaudit does not suggest any corrective actions that can be taken if the overall outcome of the investment is negative.

b.A postaudit faces the limitation that the assumptions driving the original analysis may often be invalidated by changes in the actual operating environment. A postaudit faces the limitation that the assumptions driving the original analysis may often be invalidated by changes in the actual operating environment.

Which of the following compounding interest formula is used for computing amounts for n periods into the future? (F= Future value; P= Present value of a future outlay; i = Interest rate) a.F = P(1 × i)n b.F = P(1 + i)n c.F = P(1 - i)n d.F = P(1 / i)n

b.F = P(1 + i)n

Which of the following is a distinguishing characteristic of the accounting rate of return (ARR) method? a.It makes sure that the time value of money is considered while considering cash inflows. b.It ensures that a new investment does not adversely affect debt covenants. c.It evaluates the impact of an investment on liquidity. d.It measures the minimum rate of return of a project

b.It ensures that a new investment does not adversely affect debt covenants. The ARR model ensures that a new investment does not adversely affect debt covenants.

Assume that the cash flows of a project are an equal amount each period. Which of the following formulas computes the payback period of the project? a.Payback Period = Net Income / Annual Cash Flows b.Payback Period = Original Investment / Annual Cash Flows c.Payback Period = Annual Cash Flows / Original Investment d.Payback Period = Initial Investment / Average Income

b.Payback Period = Original Investment / Annual Cash Flows

Due to which of the following reasons is the net present value (NPV) method preferred over the internal rate of return (IRR) method when choosing among mutually exclusive alternatives? a.The NPV method measures profitability in relative terms, whereas the IRR method measures it in absolute terms. b.The NPV method assumes that each cash inflow received is reinvested at the required rate of return, whereas the IRR method assumes that each cash inflow is reinvested at the computed IRR. c.The NPV method measures the return in terms of income, whereas the IRR method measures the return in terms of a project's cash flows. d.The NPV method considers the time value of money while making a capital investment decision, whereas the IRR method considers the accounting rate of return while making a capital investment decision.

b.The NPV method assumes that each cash inflow received is reinvested at the required rate of return, whereas the IRR method assumes that each cash inflow is reinvested at the computed IRR. The NPV method assumes that each cash inflow received is reinvested at the required rate of return, whereas the IRR method assumes that each cash inflow is reinvested at the computed IRR.

A project provides a reasonable return if: a.it provides a return equal to initial cost of the project. b.it covers the opportunity cost of funds invested. c.it receives a cash flow equal to the original investment in the first year of investment. d.it provides return lower than the initial investment in the project. Feedback Area

b.it covers the opportunity cost of funds invested.

Which of the following statements is true about the internal rate of return (IRR)? a.If the IRR is less than the required rate of return, the firm is indifferent between accepting or rejecting the investment proposal. b.If the IRR is less than the required rate of return, the project is deemed acceptable. c.If the IRR is greater than the required rate, the project is deemed acceptable. d.If the IRR is greater than the required rate of return, the firm is indifferent between accepting or rejecting the investment proposal.

c.If the IRR is greater than the required rate, the project is deemed acceptable. If the IRR is greater than the required rate of return, the project is deemed acceptable.

Which of the following statements is a limitation of the net present value (NPV) model while making a capital investment decision? a.The NPV model ignores the time value of money while making a capital investment decision. b.The NPV model assumes that each cash inflow received is reinvested at the internal rate of return, which is not a realistic assumption. c.The NPV model allows firms to use a higher discount rate than its cost of capital because of uncertain future cash flows. d.The NPV method measures profitability in relative terms, and in the final analysis, what counts are the total dollars earned—the absolute profit— not the relative profits.

c.The NPV model allows firms to use a higher discount rate than its cost of capital because of uncertain future cash flows. Firms may use a higher discount rate than its cost of capital because of uncertain future cash flows, making it hard for a project to achieve a positive NPV.

Which of the following capital investment decision-making models is generally preferred by managers over the internal rate of return (IRR) model? a.The accounting rate of return b.The payback period c.The net present value d.The average rate of return

c.The net present value The capital investment decision-making model that is generally preferred by managers over the internal rate of return (IRR) model.

Which of the following statements is true when choosing among mutually exclusive projects? a.The accounting rate of return model is preferred to the payback period model. b.The payback period model is preferred to the accounting rate of return model. c.The net present value model is preferred to the internal rate of return model. d.The internal rate of return model is preferred to the net present value model.

c.The net present value model is preferred to the internal rate of return model. The net present value model is preferred to the internal rate of return model when choosing among mutually exclusive projects.

Which of the following statements is true about independent projects? a.Independent projects are projects that, if accepted, have to accept one small project to assist other independent projects. b.Independent projects are projects that, if accepted or rejected, affect the net profit of other projects. c.Independent projects are projects that, if accepted, have a negative effect on the company's profit. d.Independent projects are projects that, if accepted or rejected, do not affect the cash flows of other projects

d.Independent projects are projects that, if accepted or rejected, do not affect the cash flows of other projects

Which of the following is a limitation of using the payback period model for making capital budgeting decisions? a.The payback period model is dependent upon net income, which is something that can be easily manipulated by managers. b.The payback period model evaluates the profitability of an investment by considering the time value of cash flows from a project. c.The payback period model is dependent upon required rate of return of investment. d.The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment.

d.The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment. The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment.

Which of the following is a limitation of using the payback period model for making capital budgeting decisions? a.The payback period model is dependent upon net income, which is something that can be easily manipulated by managers. b.The payback period model is dependent upon required rate of return of investment. c.The payback period model evaluates the profitability of an investment by considering the time value of cash flows from a project. d.The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment.

d.The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment. The payback period model ignores the cash flow performance of investments beyond the recovery of the original investment.

_____ is the minimum acceptable rate of return for a project. a.The accounting rate of return b.The average rate of return c.The ordinary rate of return d.The required rate of return

d.The required rate of return The required rate of return is the minimum acceptable rate of return for a project.

To make a capital investment decision, a manager must: a.evaluate the amount of dividend to be declared in the coming financial year. b.consider the profits earned in the earlier years before making investments. c.look into the before-tax cash flows before making investments. d.estimate the quantity and the timing of cash flows.

d.estimate the quantity and the timing of cash flows. A manager must estimate the quantity and the timing of cash flows.