ch 21

Investment A requires a net investment of $1,400,000 The required rate of return is 10% for the five-year annuity. What are the annual cash inflows if the net present value equals 0? (rounded)

$369,296 Present Value of an Ordinary Annuity of $1 table 10% & 5yr= 3.791 1400000/3.791

Assume your goal in life is to retire with 4 million dollars. How much would you need to save at the end of each year if investment rates average 9% and you have a 20-year work life?

$78,186 Future Value of an Ordinary Annuity of $1 table 9% & 20 yr = 51.160 4Mil/51.160= 78,186

Diamond Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of six years and the new equipment has a value of $110,997 with a six-year life. The expected additional cash inflows are $27,000 per year. What is the internal rate of return?

12% 110997/27000= 4.111 look at Present Value of an Ordinary Annuity of $1 table uder 6 years and find 4.1111

Soda Manufacturing Company provides vending machines for soft-drink manufacturers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of eight years and the new equipment has a value of $160,728 with a eight-year life. The expected additional cash inflows are $37,000 per year. What is the internal rate of return?

16% (160728/37000= 4.344 look at table for PV on year 8 = 16%)

Pearl Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of eight years and the new equipment has a value of $269,400 with a eight-year life. The expected additional cash inflows are $83,000 per year. What is the payback period for this investment?

3.2 years (269400/83000)

The net initial investment for a piece of construction equipment is $2,700,000. Annual cash inflows are expected to increase by $700,000 per year. The equipment has an 8-year useful life. What is the payback period?

4 years (2700000/7000000)

Depreciation results in income tax cash savings which are not relevant in capital budgeting decisions.

False

Discounted cash flow methods focus on operating income.

False

In the "Identify projects" stage of capital budgeting, companies gather information from all parts of the value chain to evaluate alternative projects.

False

In the net present value (NPV) method, pre-tax cash flows should be used instead of after-tax cash flows when taxes are a consideration.

False

Internal rate of return is a method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.

False

The Required Rate of Return (RRR) is set externally by creditors as the interest rate on long term liabilities.

False

Unlike the net present value method and the internal rate-of-return method, the payback method does NOT distinguish between the origins of the cash flows.

False

Using capital budgeting techniques to track and (based on success to date) modify resource levels committed to staged R&D investments is called timed options.

False

Which of the following statements is true of a post-investment audit?

It provides managers with feedback about the performance of a project so they can compare the actual results to the costs and benefits expected at the time the project was selected.

Which of the following statements is true of accrual accounting rate of return (AARR) method and internal rate of return (IRR) method?

The AARR method calculates the return using operating-income numbers after considering accruals and taxes, whereas the IRR method calculates the return using after-tax cash flows and the time value of money.

Accrual accounting rate of return is calculated by dividing an increase in expected average annual after-tax operating income by the net initial or average investment.

True

As a discounted cash flow method does not report good operating income results in the project's early years, managers are tempted to not use discounted cash flow methods even though the decisions based on them would be in the best interests of the company as a whole over the long run.

True

Capital budgeting is the process of making long-run planning decisions for investments in projects.

True

Deducting depreciation from operating cash flows would result in counting the initial investment twice in a discounted cash flow analysis.

True

If there are uniform cash flows, payback period is calculated by dividing net initial investment by uniform increase in annual future cash flows.

True

In the "obtain information" stage of capital budgeting, a company gathers information from all parts of the value chain to evaluate alternative projects.

True

Managers prefer projects with higher IRRs to projects with lower IRRs, if all other things are equal.

True

Post-investment audits prevent managers from overstating the expected cash inflows from projects and accepting projects they should reject.

True

Tax deductions for depreciation result in tax savings that partially offset the cost of acquiring the capital asset.

True

The accrual accounting rate-of-return method has a significant weakness for use in making capital budgeting decisions because it does NOT track cash flows and it ignores the time value of money.

True

The net present value (NPV) method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return.

True

The net present value method can be used in situations where the required rate of return varies over the life of the project.

True

While calculating terminal recovery of working capital there are no tax consequences as there is no gain or loss on working capital.

True

Which of the following is a component of net-initial-investment cash flows?

X (after-tax cash flow from operations)

A "what-if" technique that examines how a result will change if the original predicted data are NOT achieved or if an underlying assumption changes is called ________.

X (net present value analysis)

The internal rate-of-return (IRR) method calculates ________.

X (the discount rate at which an investment's present value of the total of all expected cash inflows equals the present value of its expected cash outflows.)

Which of the following is the numerator in the mathematical expression for accrual accounting rate-of-return (AARR)?

X(increase in expected net initial investment)

AARR indicates the average rate at which ________.

a dollar of investment generates after-tax operating income

Accrual accounting rate of return is calculated by dividing ________.

an increase in expected average annual after-tax operating income by the net initial investment

The AARR method is similar to the IRR method as ________.

both calculate the result in terms of percentage

Which of the following involves the process of making decisions for significant financial investments in projects to develop new products, expand production capacity, or remodel current production facilities?

capital budgeting

Net initial investment includes ________.

cash outflow to purchase new equipment, cash outflow for working capital, and after-tax cash inflow from disposal of the old equipment

Depreciation is usually NOT considered an operating cash flow in capital budgeting because ________.

deducting depreciation from operating cash flows would be counting the lump-sum amount twice

The relevant terminal disposal price of a machine equals the ________.

difference between the salvage value of the old machine and the ultimate salvage value of the new machine

The focus in capital budgeting should be on ________.

expected future cash flows that differ between alternatives

If internal rate of return is less than required rate of return, the net present value is positive.

false

Which of the following is the first stage to the capital budgeting process?

identify potential capital investments that agree with the organization's strategy

Which of the following is a stage of the capital budgeting process that indicates potential capital investments that agree with an organization's strategy?

identify projects stage

Which of the following is a stage of the capital budgeting process in which a firm obtains funding for the project?

implement the decision, evaluate performance, and learn stage

Which of the following is the numerator in the mathematical expression for accrual accounting rate-of-return (AARR)?

increase in expected average annual after-tax operating income

The accounting system that corresponds to the project dimension in capital budgeting is the ________.

life-cycle costing

Capital budgeting is a process of ________.

making long-run planning decisions for investments in projects

A "what-if" technique that examines how a result will change if the original predicted data are NOT achieved or if an underlying assumption changes is called ________.

sensitivity analysis

A capital budgeting tool that management can use to summarize the difference in the future net cash inflows from an intangible asset at two different points in time is referred to as:

the net present value method

The net present value method of capital budgeting is preferred over the internal rate-of-return method because ________.

the net present values of individual projects can be added to determine the effects of accepting a combination of projects

In using the net present value method, only projects with a zero or positive net present value are acceptable because ________.

the return from these projects equals or exceeds the cost of capital

The reason to have a post-investment audit is ________.

they help alert senior management to problems in the implementation of projects