ACC 212 Chapter 26 Smartbook

The capital investment evaluation method that subtracts the initial investment from the discounted future net cash flows from the investment at the required rate of return is the:

net present value

Which of the following is the approximate internal rate of return for an investment that costs $45,880 and has net cash flows of $4,000 for 20 years?

6% (45,880/4000=11.47. Look at Table B.3 in the 20 year row for the present value factor closest to 11.47. You'll see 6%)

A company's required rate of return computed as an average of the rate the company must pay to its lenders and investors is called:

Hurdle Rate

A company has evaluated several projects using net present value. All projects are similar in amount invested and risk. Rank the projects in the order they should be accepted.

NPV = $340, Second choice NPV = ($615), Not an acceptable project NPV = $62, Third choice NPV = $2,067, First choice

A company needs to choose between two investment opportunities. Project 1 has a cost of $500,000 and expected NPV of cash flows of $450,000. Project 2 has a cost of $800,000 and expected NPV of cash flows of $750,000. Using profitability index as the evaluation method, the company should choose:

Project 2 because it has a higher index

Match the capital investment method to its specific characteristic.

-Payback period, Ignores the time value of money -Accounting rate of return, Uses income rather than cash flows -Net present value, Can reflect changes in risk over a project's life -Internal rate of return, Allows comparisons of projects of different sizes

The decision rule for NPV includes: (Check all that apply).

-if an asset's future net cash flows yield a positive net present value, invest. -when comparing projects with similar initial investments and risk, select the one with the highest net present value.

Of the four capital budgeting methods, which ones reflect the time value of money? (Check all that apply).

-net present value -internal rate of return

Characteristics of capital budgeting include: (Check all that apply.)

-outcome is uncertain -large amount of money is involved -long-term investment

A company is considering a capital investment of $16,000 in new equipment which will improve production and increase cash flows for the next five years at the following amounts: Year 1: $8,000; Year 2: $6,000; Year 3: $5,000; Year 4: $6,000; Year 5: $5,000. The payback period is _ years.

2.4 years

Assume straight-line depreciation. A company plans to purchase machinery costing $1,000,000 with salvage value of $200,000 after 4 years. Annual income is expected to be $40,000 during the 4 years. Calculate the accounting rate of return. Round your answer to the nearest tenth of a percent.

6.7% (1,000,000 + 200,000)/2 = 600,000. $40,000/600,000 = 6.7%)

Assume straight-line depreciation and equal cash flows. A company plans to purchase equipment for $25,000. The equipment will have $0 salvage value and increase income by $7,500 annually during its 5-year life. The accounting rate of return is _%.

60%

The discount rate that results in a net present value of $0 is the:

internal rate of return

The formula to calculate the profitability index is:

present value of net cash flows/initial investment

The process of evaluating and planning for long-term investments is called _ budgeting.

Capital

A company is considering an investment opportunity with a cost of $5,000 that will provide future cash flows of $8,000. The cash flows for the investment for the next 4 years are: $1,000, $2,000, $3,000 and $2,000. Assume a required rate of return of 10%. The NPV is $_.

$1,182 (Use PV of annuity table)

An investment that costs $5,000 will produce annual cash flows of $3,000 for 3 years. Using a required return of 8%, the investment will generate a NPV of $_ (rounded to nearest dollar).

$2,731 (3,000 x 2.5771= 7,731.3, 7,731.3 - 5,000 = 2,731.3)

A company is considering an investment opportunity with a cost of $5,000 that will provide future cash flows of $8,000. The cash flows for the investment for the next 4 years are: $1,000, $1,000, $2,000 and $4,000. Assume a required rate of return of 10%. The NPV is $_ (rounded to nearest dollar).

$970 (Multiply each cash flow by their respective period under the rate given all on the Present Value of 1 table, 1,000 x .9091, etc.)

If a company uses straight-line depreciation, the average investment is calculated as: (Check all that apply.)

-(initial investment + salvage value)/2. -sum of individual years' average book values/number of years of planned investment -(beginning book value + salvage value)/2.

Consider the following projects: Project A: cost = $30,000, NPV of cash flows = $10,000; Project B: cost = $45,000, NPV of cash flows = $10,000; Project C: cost = $30,000, NPV of cash flows = $20,000; Project D: cost = $40,000, NPV of cash flows = $5,000. Using profitability index as the evaluation method, rank the projects in order of preference with the best choice on top.

-C -A -B -D

Which of the following are correct statements about the internal rate of return (IRR)? (Check all that apply.)

-The higher the IRR, the better. -IRR uses the time value of money.

List the steps involved in capital budgeting process, with the first step on top.

1. Submit Proposals 2. Evaluate Proposals 3. Approve or Reject Proposals

Which of the following is the approximate internal rate of return for an investment that costs $12,680 and has net cash flows of $4,000 for 4 years?

10% (12,680/4,000=3.17. This is closest to 10% in the annuity table.)

A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment B.

2.25 years

Capital budgeting is used to evaluate the purchase of:

A machine

An investment's _ period is the expected time to recover the initial investment amount.

Payback

The capital budgeting evaluation method that measures the expected amount of time to recover the initial investment amount is the:

Payback Period

The formula to calculate the accounting rate of return is:

annual income/average investment

A capital investment evaluation method that measures the expected time until the present value of the net cash flows equals the initial investment is:

break-even time

An investment that costs $30,000 will produce annual cash flows of $10,000 for 4 years. Using a required return of 8%, the investment will generate (rounded to the nearest dollar) a:

positive NPV of $3,121 ($10,000 x 3.3121=$33,121. $33,121-$30,000=$3,121) *Use PV of annuity table to get 3.3121

A company is considering several investment opportunities. The investments have been evaluated using payback period and break-even time. Only one project will be chosen and time value of money is important. The company should choose the project which the:

shortest break-even time

It is appropriate to use the profitability index to evaluate investment decisions when:

the amounts invested differ substantially