Chapter 21
Hypore Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $348,400. The annual cost savings if the new machine is acquired will be $80,000. The machine will have a 6-year life, at which time the terminal disposal value is expected to be zero. Hypore Park Department is assuming no tax consequences. What is the internal rate of return for Hypore Park Department? A) 5% B) 10% C) 9% D) 11%
B) 10% Explanation: PV Factor is $348,400 / $80,000 = 4.355. This corresponds to a 10% IRR using the annuity table for a 6-year annuity.
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 five years and the new equipment will cost $99,825 with a five-year life. The expected additional cash inflows are $25,000 per year. What is the internal rate of return? A) 8% B) 12% C) 6% D) 4%
A) 8% Explanation: $99,825 = $25,000F F = 3.993 Chart criteria for 5 years is 3.993 = 8%
AARR indicates the average rate at which ________. A) a dollar of investment generates after-tax operating income B) a dollar of after-tax cash flow generates net income C) a dollar of investment generates a positive cash flow D) a dollar of after-tax non-operating income generates net income
A) a dollar of investment generates after-tax operating income
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? A) capital budgeting B) working capital management C) master budgeting D) capitalization
A) capital budgeting
The net present value method focuses on ________. A) cash flows and required rate of return B) inventory cost and cost of capital C) working capital and cost of capital D) operating income and required rate of return
A) cash flows and required rate of return
) Which of the following methods is described as the method that measures the time it will take to recoup, in the form of future cash inflows, the total dollars invested in a project? A) the accrued accounting rate-of-return method B) the payback method C) the internal rate-of-return method D) the book-value method
B) the payback method
) The net initial investment for a piece of construction equipment is $2,900,000. Annual cash inflows are expected to increase by $500,000 per year. The equipment has an 10-year useful life. What is the payback period? A) 10.00 years B) 7.40 years C) 5.80 years D) 4.80 years
C) 5.80 years
Which of the following is the first stage to the capital budgeting process? A) forecast all potential cash flows attributable to the alternative projects B) determine which investment yields the greatest benefit and the least cost to the organization C) obtain funding and make the investments selected D) identify potential capital investments that agree with the organization's strategy
D) identify potential capital investments that agree with the organization's strategy
Locil Corporation recently purchased a new machine for $307,890 with a eight-year life. The old equipment has a remaining life of eight years and no disposal value at the time of replacement. Net cash flows will be $90,000 per year. What is the internal rate of return? A) 24% B) 29% C) 33% D) 37%
A) 24% Explanation: $307,890 = $90,000F F = 3.421 Chart criteria for 8 years is 3.421 = 24%
Upon which of the following items does discounted cash flow methods for capital budgeting focus? A) cash inflows and required rate of return B) operating income and required rate of return C) operating income and cost of capital D) working capital and cost of capital
A) cash inflows and required rate of return
The relevant terminal disposal price of a machine equals the ________. A) difference between the salvage value of the old machine and the ultimate salvage value of the new machine B) total of the salvage values of the old machine and the new machine C) salvage value of the old machine D) salvage value of the new machine
A) difference between the salvage value of the old machine and the ultimate salvage value of the new machine
A general rule in capital budgeting is that a project is accepted only if the internal rate of return equals or ________. A) exceeds the required rate of return B) exceeds the inflation rate C) exceeds the risk-free rate D) exceeds the accrual accounting rate of return
A) exceeds the required rate of return
) Which of the following is another term for required rate of return? A) hurdle rate B) total cost rate C) variance rate D) predetermined overhead rate
A) hurdle rate
Which of the following is a stage of the capital budgeting process that indicates potential capital investments that agree with an organization's strategy? A) identify projects stage B) make predictions stage C) obtain information stage D) implement the decision, evaluate performance, and learn stage
A) identify projects stage
Which of the following is a stage of the capital-budgeting process that tracks realized cash flows and compares those against estimated numbers? A) implement the decision, evaluate performance, and learn stage B) make predictions stage C) identify projects stage D) make decisions by choosing among alternatives stage
A) implement the decision, evaluate performance, and learn stage
) The internal rate of return method assumes that project cash flows can be reinvested at the project's ________. A) internal rate of return B) required rate of return C) growth rate D) accounting rate of return
A) internal rate of return
The NPV method is the preferred method over IRR for selecting projects because ________. A) its result is expressed in dollars and management can make an assessment as to its financial impact on the value of the business B) it accounts for the time value of money better than IRR C) it assumes that cash flows are reinvested at the internal rate of return for each and every year of the useful life D) it gives a project ranking consistent with that of IRR
A) its result is expressed in dollars and management can make an assessment as to its financial impact on the value of the business
Which of the following is a stage of the capital budgeting process that determines which investment yields the greatest benefit and the least cost to an organization? A) make decisions by choosing among alternatives stage B) make predictions stage C) identify projects stage D) implement the decision, evaluate performance, and learn stage
A) make decisions by choosing among alternatives stage
) 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 ________. A) sensitivity analysis B) net present value analysis C) internal rate-of-return analysis D) adjusted rate-of-return analysis
A) sensitivity analysis
If the net present value for a project is positive, which of the following is true? A) the project should be accepted because its expected rate of return is greater than the cost of capital B) its internal rate of return is more than its cost of capital C) its expected rate of return is below the required rate of return D) its internal rate of return is less than its cost of capital
A) the project should be accepted because its expected rate of return is greater than the cost of capital
) In using the net present value method, only projects with a zero or positive net present value are acceptable because ________. A) the return from these projects equals or exceeds the cost of capital B) a positive net present value on a particular project guarantees company profitability C) the company will be able to pay the necessary payments on any loans secured to finance the project D) it results in high payback period
A) the return from these projects equals or exceeds the cost of capital
Malive Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $179,000. The annual cost savings if the new machine is acquired will be $35,000. The machine will have a 10-year life, at which time the terminal disposal value is expected to be zero. Malive Park is assuming no tax consequences. Malive Park has a 14% required rate of return. What is the payback period for the investment? A) 4.1 years B) 5.1 years C) 10.0 years D) 10.2 years
B) 5.1 years
Assume your goal in life is to retire with $2,800,000. How much would you need to save at the end of each year if interest rates average 10% and you have a 30-year work life? (Round the final answer to the nearest whole dollar.) A) $9333 B) $17,022 C) $186,667 D) $160,464
B) $17,022 Explanation: Savings × (164.49) = $2,800,000 Savings = $17,022.31
Investment A requires a net investment of $604,021 The required rate of return is 12% for the three-year annuity. What are the annual cash inflows if the net present value equals 0? (rounded) A) $2,416,084 B) $251,466 C) $604,016 D) -$1,812,063
B) $251,466 Explanation: 2.402 × annual cash inflows - $604,021 = $0 = $251,466
Ambinu Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van has a value of $133,750 with a six-year life. The expected additional cash inflows are $52,500 per year. What is the payback period for this investment? A) 1.5 years B) 2.5 years C) 6 years D) 3.5 years
B) 2.5 years Explanation: PB = $133,750 / $52,500 = 2.5 years.
Midize Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van will cost $61,392 with a eight-year life. The expected additional cash inflows are $16,000 per year. What is the internal rate of return? A) 17% B) 20% C) 22% D) 27%
B) 20% Explanation: $61,392 = $16,000F F = 3.837 Chart criteria for 8 years is 3.837 = 20%
) Which of the following projects is rejected on the basis of net present value method? A) Project A with an NPV of $10,000 B) Project B with an NPV of $(15,000) C) Project C with an NPV of $21,000 D) Project D with an NPV of $1200
B) Project B with an NPV of $(15,000)
Which of the following statements is true of accrual accounting rate of return (AARR) method and internal rate of return (IRR) method? A) AARR method calculates the return in absolute terms, whereas IRR method calculates the result in terms of percentage. B) 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. C) The AARR method calculates the return considering the time value of money, whereas the IRR method calculates the return ignoring the time value of money. D) The AARR method considers cash flows, whereas the IRR method considers operating income
B) 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.
Which of the following is an advantage of internal rate of return method? A) Sum of IRRs of individual projects gives an IRR of a combination or portfolio of projects. B) The percentage returns computed under the IRR method are easy to understand and compare. C) It can be expressed as a unique number. D) It can be used when the required rate of return varies over the life of a project.
B) The percentage returns computed under the IRR method are easy to understand and compare.
An annuity is ________. A) a noncash expense B) a series of equal cash flows at equal time intervals C) an investment product whose funds are invested in the stock market D) a rate at which an investment's present value of all expected cash inflows equals the present value of project's expected cash outflows.
B) a series of equal cash flows at equal time intervals
Accrual accounting rate of return is calculated by dividing ________. A) net initial investment by an increase in expected average annual after-tax operating income B) an increase in expected average annual after-tax operating income by the net initial investment C) an increase in expected average annual cash flow by the net initial investment D) net initial investment by an increase in expected average annual cash flow
B) an increase in expected average annual after-tax operating income by the net initial investment
The payback method of capital budgeting approach to an investment decision ________. A) considers cash flows over the life of the investment B) assumes that cash flows occur uniformly throughout the year C) considers time value of money D) ignores the initial investment
B) assumes that cash flows occur uniformly throughout the year
Depreciation is usually NOT considered an operating cash flow in capital budgeting because ________. A) depreciation is usually a constant amount each year over the life of the capital investment B) deducting depreciation from operating cash flows would be counting the lump-sum amount twice C) depreciation usually does not result in an increase in working capital D) depreciation usually has no effect on the disposal price of the machine
B) deducting depreciation from operating cash flows would be counting the lump-sum amount twice
) The minimum annual acceptable rate of return on an investment is the ________. A) accrual accounting rate of return B) hurdle rate C) internal rate of return D) net present value
B) hurdle rate
Which of the following is the numerator in the mathematical expression for accrual accounting rate-of-return (AARR)? A) increase in expected average investment B) increase in expected average annual after-tax operating income C) increase in expected average cash flow D) increase in expected net initial investment
B) increase in expected average annual after-tax operating income
Which of the following is a component of net-initial-investment cash flows? A) original cost of an old equipment B) initial working capital investment C) depreciation cost D) after-tax cash flow from operations
B) initial working capital investment
Which of the following capital budgeting methods uses discounted cash flows? A) accrual accounting rate-of-return method B) net present value method C) projected income method D) payback method
B) net present value method
Which of the following is a stage of the capital budgeting process during which a plant manager is queried for assembly time? A) make decisions by choosing among alternatives stage B) obtain information stage C) make predictions stage D) implement the decision, evaluate performance, and learn stage
B) obtain information stage
The net present value method assumes that project cash flows can be reinvested at the company's ________. A) internal rate of return B) required rate of return C) growth rate D) accounting rate of return
B) required rate of return
Net present value is calculated using which of the following? A) internal rate of return B) required rate of return as a discount rate C) risk-free rate D) predetermined overhead cost rate
B) required rate of return as a discount rate
Which of the following best explains why the net present value method of capital budgeting is preferred over the internal rate-of-return method? A) the net present value method is expressed as a percentage of initial investment B) the net present values of individual projects can be added to determine the effects of accepting a combination of projects C) the percentage return computed under the net present value method is very easy to compare D) the calculation under the net present value method is easy as it does not use time value of money
B) the net present values of individual projects can be added to determine the effects of accepting a combination of projects
Assume your goal in life is to retire with three million dollars. How much would you need to save at the end of each year if interest rates average 5% and you have a 10-year work life? A) $15,000 B) $1,841,740 C) $238,512 D) $600,000
C) $238,512 Explanation: Look up annuity factor in the table or use function on a calculator or computer. Savings × (12.578) = $3,000,000 Savings = $238,511.69
The galaxy Corporation disposes a capital asset with an original cost of $180,000 and accumulated depreciation of $91,000 for $47,000. The company's tax rate is 40%. Calculate the after-tax cash inflow from the disposal of the capital asset. A) $16,800 B) ($16,800) C) $63,800 D) $89,000
C) $63,800 Explanation: ($180,000 - $91,000) = $89,000; $89,000 - $47,000 = $42,000 loss; $42,000 × 0.4 = $16,800 tax savings from loss plus $47,000 proceeds = $63,800
) 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 six years and the new equipment has a value of $319,400 with a six-year life. The expected additional cash inflows are $113,000 per year. What is the payback period for this investment? A) 1.8 years B) 3.8 years C) 2.8 years D) 6 years
C) 2.8 years Explanation: PB = $319,400 / $113,000 = 2.8 years.
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 eight years and the new equipment will cost $141,969 with a eight-year life. The expected additional cash inflows are $37,000 per year. What is the internal rate of return? A) 13% B) 15% C) 20% D) 23%
C) 20% Explanation: $141,969 = $37,000F F = 3.837 Chart criteria for 8 years is 3.837 = 20%
The AARR method is similar to the IRR method as ________. A) both calculate the return using after-tax cash flows B) both calculate the return using operating-income numbers after considering accruals and taxes C) both calculate the result in terms of percentage D) both consider the time value of money
C) both calculate the result in terms of percentage
Net initial investment includes ________. A) depreciation on new equipment, cash outflow for working capital, and after-tax cash inflow from disposal of the old equipment B) cash outflow to purchase new equipment, depreciation on new equipment, and after-tax cash inflow from disposal of the old equipment C) cash outflow to purchase new equipment, cash outflow for working capital, and after-tax cash inflow from disposal of the old equipment D) cash outflow to purchase new equipment, cash outflow for working capital, and depreciation on new equipment
C) cash outflow to purchase new equipment, cash outflow for working capital, and after-tax cash inflow from disposal of the old equipment
In situations where the required rate of return is not constant for each year of the project, it is advantageous to use ________. A) the nominal rate-of-return method B) the internal rate-of-return method C) the net present value method D) the projected income method
C) the net present value method
The Golden Shades Corporation disposes a capital asset with an original cost of $320,000 and accumulated depreciation of $140,000 for a salvage price of $42,000. Golden Shades's tax rate is 35%. Calculate the after-tax cash inflow from the disposal of the capital asset. A) $48,300 B) $138,000 C) $42,000 D) $90,300
D) $90,300 Explanation: ($320,000 - $140,000) = $180,000; $180,000 - $42,000 = $138,000 loss; $138,000 × 0.35 = $48,300 tax savings from loss plus $42,000 proceeds = $90,300
9) Capital budgeting is both a decision making and control tool. Which of the following is an example of capital budgeting as a control tool? A) A company uses capital budgeting techniques to evaluate a group of prospective alternative projects. B) A large manufacturer sets up a "capital relief" fund to help supplement sustainability projects that would not meet targeted rates of returns without the capital relief fund assistance. C) When considering capital expenditures, a company looks at a minimum of six potential (alternative) projects. D) A company's capital project is not meeting the level of profitability expected, will not meet the targeted NPV, and is abandoned.
D) A company's capital project is not meeting the level of profitability expected, will not meet the targeted NPV, and is abandoned.
Which of the following is a limitation of AARR method? A) It is difficult to compare projects as its result is expressed in dollars and not in percentage terms. B) It does not consider income earned throughout a project's expected useful life. C) It does not track initial investment. D) It does not consider time value of money
D) It does not consider time value of money.
Which of the following methods of capital budgeting divides the average annual accrual accounting income of a project by a measure of the investment in it? A) net present value B) internal rate of return C) payback method D) accrual accounting rate of return
D) accrual accounting rate of return
Which of the following is a stage of the capital budgeting process in which a firm obtains funding for the project? A) make decisions by choosing among alternatives stage B) identify projects stage C) obtain information stage D) implement the decision, evaluate performance, and learn stage
D) implement the decision, evaluate performance, and learn stage
The capital budgeting method that calculates the discount rate at which the present value of expected cash inflows from a project equals the present value of expected cash outflows is the ________. A) net present value method B) accrual accounting rate-of-return method C) payback method D) internal rate of return method
D) internal rate of return method
Which of the following best describes the internal rate-of-return (IRR) method? A) it calculates 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. B) it calculates the discount rate at which an investment's future value of all expected cash inflows equals the present value of its expected cash outflows. C) it calculates the discount rate at which an investment's total of all expected cash inflows equals the present value of its expected cash outflows. D) it calculates the discount rate at which sum of an investment's present value of all expected cash inflows equals the present value of its expected cash outflows.
D) it calculates the discount rate at which sum of an investment's present value of all expected cash inflows equals the present value of its expected cash outflows.
Which of the following methods is described as follows: "It calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time using the required rate of return"? A) payback method B) accrual accounting rate-of-return method C) internal rate of return D) net present value method
D) net present value method