Capital Budgeting – Ch22 | Complete Test Bank 17e

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Horngren's Cost Accounting: A Managerial Emphasis, 17e, Global Edition by Datar/Rajan

Chapter 22 Capital Budgeting and Cost Analysis

Objective 22.1

1) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

2) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

3) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

4) Which of the following is a stage of the capital budgeting process that forecasts all potential cash flows attributable to the alternative projects?

A) identify projects stage

B) make decisions by choosing among alternatives stage

C) implement the decision, evaluate performance, and learn stage

D) make predictions stage

Diff: 1

Objective: 1

AACSB: Analytical thinking

5) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

6) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

7) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

8) 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

Diff: 1

Objective: 1

AACSB: Analytical thinking

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.

Diff: 1

Objective: 1

AACSB: Analytical thinking

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

Diff: 2

Objective: 1

AACSB: Analytical thinking

11) A capital budget spans only a one-year period.

Diff: 2

Objective: 1

AACSB: Analytical thinking

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

Diff: 1

Objective: 1

AACSB: Analytical thinking

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

Diff: 1

Objective: 1

AACSB: Analytical thinking

14) In the "make decisions by choosing among alternatives" stage of the capital budgeting process, a company determines which investment yields the greatest benefit and the least cost to the organization.

Diff: 1

Objective: 1

AACSB: Analytical thinking

15) In the "make predictions" stage of the capital budgeting process, a company forecasts all potential net income additions those are attributable to the alternative projects.

Diff: 1

Objective: 1

AACSB: Analytical thinking

16) The accrual accounting rate-of-return method is a discounted cash flow approach to analyzing possible capital budget expenditures.

Diff: 1

Objective: 1

AACSB: Analytical thinking

17) Capital budgeting is a decision-making and a control tool.

Diff: 1

Objective: 1

AACSB: Analytical thinking

18) Match each one of the examples below with one of the stages of the capital budgeting decision model.

Stages:

1. Identify Projects

2. Obtain Information

3. Make Predictions

4. Make Decisions by Choosing Among Alternatives

5. Implement the Decision, Evaluate Performance, and Learn

________ a. Issuing corporate stock for the funds to purchase new equipment

________ b. Learning how to effectively operate Machine #8 only takes 15 minutes

________ c. The need to reduce the costs to process the vegetables used in producing goulash

________ d. Monitoring the costs to operate a new machine

________ e. Percentage of defective merchandise considered too high

________ f. Will introducing the new product substantially upgrade our image as

a producer of quality products?

________ g. Estimating yearly cash flows and setting investment budgets accordingly using

a 12-year planning horizon.

________ h. Use of the internal rate of return for each alternative

________ i. Tracking realized cash flows and comparing against estimated numbers.

a. 5. Implement the Decision, Evaluate Performance, and Learn

b. 2. Obtain Information

c. 1. Identify Projects

d. 5. Implement the Decision, Evaluate Performance, and Learn

e. 1. Identify Projects

f. 2. Obtain Information

g. 3. Make Predictions

h. 4. Make Decisions by Choosing Among Alternatives

i. 5. Implement the Decision, Evaluate Performance, and Learn

Diff: 2

Objective: 1

AACSB: Analytical thinking

19) List the capital budgeting methods used to analyze financial information.

Capital budgeting methods include (1) net present value (NPV), (2) internal rate-of-return (IRR), (3) payback, and (4) accrual accounting rate-of-return (AARR). Both the net present value (NPV) and internal rate-of-return (IRR) methods use discounted cash flows.

Diff: 1

Objective: 1

AACSB: Analytical thinking

20) Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting project?

Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which types of capital investments are necessary to accomplish organization objectives and strategies. Stage 2 is the obtain information stage in which a firm gathers information from all parts of the value chain to analyze alternative projects. Stage 3 is the make predictions stage in which the firm forecasts all potential cash flows attributable to the alternative projects. Stage 4 is the make decisions by choosing among alternatives stage in which the firm determines which investment yields the greatest benefit and the least cost to the organization. Stage 5 is the implement the decision, evaluate performance, and learn stage that is further separated into two sub stages: (1) obtain funding and make the investments selected in the stage 4 process, and (2) track the realized cash flows, compare against the forecast numbers, and revise plans if necessary.

Diff: 2

Objective: 1

AACSB: Analytical thinking

21) Use the 5 stages of a capital budgeting project to explain how capital budgeting is a tool that serves both decision making and control.

Diff: 2

Objective: 1

AACSB: Analytical thinking

22) Cast Iron Stove Company wants to buy a molding machine that can be integrated into its computerized manufacturing process. It has received three bids for the machine and related manufacturer's specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual savings of the machines range from $260,000 to $270,000. The payback periods are almost identical and the net present values are all within $8,000 of each other. The president just doesn't know what to do about which vendor to choose since all of the selection criteria are so close together.

Required:

What suggestions do you have for the president?

Diff: 2

Objective: 1

AACSB: Analytical thinking

Objective 22.2

1) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

2) Which of the following methods utilizes discounted cash flows when analyzing potential capital expenditures?

Methods:

1. Accrual accounting rate-of-return

2. Internal Rate of Return (IRR)

3. Payback Period

4. Net Present Value (NPV)

A) 1 only

B) 1 and 2

C) 1 and 3

D) 2 and 4

Diff: 2

Objective: 2

AACSB: Analytical thinking

3) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

4) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

5) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

6) Assume your goal in life is to retire with $2,500,000. How much would you need to save at the end of each year if interest rates average 8% and you have a 15-year work life? (Round the final answer to the nearest whole dollar.)

A) $13,333

B) $92,074

C) $333,333

D) $788,104

Diff: 2

Objective: 2

AACSB: Application of knowledge

7) Assume your goal in life is to retire with one million dollars. How much would you need to save at the end of each year if interest rates average 8% and you have a 10-year work life?

A) $8,000

B) $463,193

C) $69,027

D) $200,000

Diff: 3

Objective: 2

AACSB: Application of knowledge

8) Assume your goal in life is to retire with 2 million dollars. How much would you need to save at the end of each year if investment rates average 6% and you have a 19-year work life?

A) $6,316

B) $59,242

C) $661,026

D) $210,526

Diff: 3

Objective: 2

AACSB: Application of knowledge

9) Difend Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $120,000. The new machine will cost $400,000 and an additional cash investment in working capital of $180,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $200,000 in additional cash inflows during the first year of acquisition and $280,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

What is the net present value of the investment, assuming the required rate of return is 10%? Would the company want to purchase the new machine?

A) $163,360; yes

B) $210,368; yes

C) $($210,368); no

D) $($163,360); no

Diff: 3

Objective: 2

AACSB: Application of knowledge

10) Difend Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $200,000. The new machine will cost $380,000 and an additional cash investment in working capital of $140,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $190,000 in additional cash inflows during the first year of acquisition and $350,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

What is the net present value of the investment, assuming the required rate of return is 10%? Would the company want to purchase the new machine?

A) $(262,850); yes

B) $(404,660); no

C) $404,660; yes

D) $262,850; no

Diff: 3

Objective: 2

AACSB: Application of knowledge

11) Diemia Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $180,000. The new machine will cost $620,000 and an additional cash investment in working capital of $75,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $130,000 in additional cash inflows during the year of acquisition and $190,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

What is the net present value of the investment, assuming the required rate of return is 10%? Would the hospital want to purchase the new machine?

A) $(150,560); no

B) ($117,990); no

C) $150,560; yes

D) $117,990; yes

Diff: 3

Objective: 2

AACSB: Application of knowledge

12) Diemia Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $150,000. The new machine will cost $640,000 and an additional cash investment in working capital of $75,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $50,000 in additional cash inflows during the year of acquisition and $160,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

What is the net present value of the investment, assuming the required rate of return is 18%? Would the hospital want to purchase the new machine?

A) $42,350, yes

B) ($157,850); no

C) $157,850; yes

D) $69,920; yes

Diff: 3

Objective: 2

AACSB: Application of knowledge

13) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

14) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

15) Which of the following projects is rejected on the basis of net present value method?

A) Project A with an NPV of $7,000

B) Project B with an NPV of $(15,000)

C) Project C with an NPV of $15,000

D) Project D with an NPV of $1,200

Diff: 2

Objective: 2

AACSB: Analytical thinking

16) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

17) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

18) 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 equals 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

19) Concose Park Department is considering a new capital investment. The cost of the machine is $250,000. The annual cost savings if the new machine is acquired will be $95,000. The machine will have a 6-year life and the terminal disposal value is expected to be $40,000. There are no tax consequences related to this decision. If Concose Park Department has a required rate of return of 10%, which of the following is closest to the present value of the project?

A) $194,745

B) $31,020

C) $186,285

D) $163,725

Diff: 3

Objective: 2

AACSB: Application of knowledge

20) Forge Company wants to purchase a new cutting machine for its sewing plant. The investment is expected to generate annual cash inflows of $210,000. The required rate of return is 12% and the current machine is expected to last for four years. Of the following choices, which is the dollar amount the company would be willing to spend for the machine, assuming its life is also four years? Income taxes are not considered.

A) $1,003,590

B) $739,200

C) $745,080

D) $637,770

Diff: 3

Objective: 2

AACSB: Application of knowledge

21) The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $410,000. The investment is expected to generate $175,000 in annual cash flows for a period of four years. The required rate of return is 14%. The old machine can be sold for $20,000. The machine is expected to have zero value at the end of the four-year period. What is the net present value of the investment? Would the company want to purchase the new machine? Income taxes are not considered.

A) $119,775; yes

B) $24,500; no

C) $390,000; yes

D) $183,520; no

Diff: 3

Objective: 2

AACSB: Application of knowledge

22) Forise Water Company drills small commercial water wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below.

Initial investment:

Asset $690,000

Working capital $168,000

Operations (per year for four years):

Cash receipts $450,000

Cash expenditures $210,000

Disinvestment:

Salvage value of drill (existing) $140,000

Discount rate 12%

What is the net present value of the investment? Assume there is no recovery of working capital.

A) ($168,000)

B) $11,120

C) $240,000

D) $179,120

Diff: 3

Objective: 2

AACSB: Application of knowledge

23) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

24) 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 future 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.

Diff: 2

Objective: 2

AACSB: Analytical thinking

25) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

26) The Comil Corporation recently purchased a new machine for its factory operations at a cost of $550,530. The investment is expected to generate $135,000 in annual cash flows for a period of eight years. The required rate of return is 14%. The old machine has a remaining life of eight years. The new machine is expected to have zero value at the end of the eight-year period. The disposal value of the old machine at the time of replacement is zero. What is the internal rate of return?

A) 14%

B) 16%

C) 20%

D) 18%

Diff: 3

Objective: 2

AACSB: Application of knowledge

27) Locil Corporation recently purchased a new machine for $306,425 with a(n) seven-year life. The old equipment has a remaining life of seven years and no disposal value at the time of replacement. Net cash flows will be $85,000 per year. What is the internal rate of return?

A) 20%

B) 24%

C) 22%

D) 26%

Diff: 2

Objective: 2

AACSB: Application of knowledge

28) 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 six years and the new equipment will cost $117,585 with a six-year life. The expected additional cash inflows are $27,000 per year. What is the internal rate of return?

A) 10%

B) 14%

C) 8%

D) 6%

Diff: 2

Objective: 2

AACSB: Application of knowledge

29) 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 five years and the new equipment will cost $94,775 with a(n) five-year life. The expected additional cash inflows are $25,000 per year. What is the internal rate of return?

A) 4%

B) 6%

C) 10%

D) 12%

Diff: 2

Objective: 2

AACSB: Application of knowledge

30) 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(n) eight-year life. The expected additional cash inflows are $16,000 per year. What is the internal rate of return?

A) 18%

B) 20%

C) 22%

D) 24%

Diff: 2

Objective: 2

AACSB: Application of knowledge

31) 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

Diff: 2

Objective: 2

AACSB: Application of knowledge

32) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

33) 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

Diff: 1

Objective: 2

AACSB: Analytical thinking

34) 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)

A) $5,600,000

B) $369,296

C) $1,399,995

D) $4,200,000

Diff: 3

Objective: 2

AACSB: Application of knowledge

35) 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

Diff: 2

Objective: 2

AACSB: Analytical thinking

36) 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 $264,220. The annual cost savings if the new machine is acquired will be $110,000. The machine will have a 3-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) 8%

B) 12%

C) 10%

D) 14%

Diff: 3

Objective: 2

AACSB: Application of knowledge

37) 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.

Diff: 3

Objective: 2

AACSB: Analytical thinking

38) 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

Diff: 3

Objective: 2

AACSB: Analytical thinking

39) 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

Diff: 3

Objective: 2

AACSB: Analytical thinking

40) 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

Diff: 3

Objective: 2

AACSB: Analytical thinking

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

Diff: 2

Objective: 2

AACSB: Analytical thinking

42) Discounted cash flow methods do not consider the present value of the cash flows after the recovery of the initial investment.

Diff: 2

Objective: 2

AACSB: Analytical thinking

43) The three common discounted cash flow methods are net present value, internal rate of return, and payback.

Diff: 2

Objective: 2

AACSB: Analytical thinking

44) 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.

Diff: 2

Objective: 2

AACSB: Analytical thinking

45) The discount rate used to calculate the NPV should be the interest rate that the company could borrow at to finance the proposed capital project.

Diff: 2

Objective: 2

AACSB: Analytical thinking

46) Discounted cash flow methods of evaluating capital expenditures focuses on the operating income as calculated under accrual accounting rules.

Diff: 2

Objective: 2

AACSB: Analytical thinking

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

Diff: 2

Objective: 2

AACSB: Analytical thinking

48) The net present value method accurately assumes that project cash flows can only be reinvested at the company's required rate of return.

Diff: 2

Objective: 2

AACSB: Analytical thinking

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

Diff: 2

Objective: 2

AACSB: Analytical thinking

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

Diff: 2

Objective: 2

AACSB: Analytical thinking

51) The IRR method assumes that cash flows are reinvested at the company's required rate of return.

Diff: 2

Objective: 2

AACSB: Analytical thinking

52) The Enor Machine Company is evaluating a capital expenditure proposal that requires an initial investment of $99,360 and has predicted cash inflows of $20,000 per year for 8 years. It will have no salvage value.

Required:

a. Using a required rate of return of 10%, determine the net present value of the investment proposal.

b. Determine the proposal's internal rate of return.

a.

b. Present value factor of an annuity of $1.00 = $99,360/$20,000 = 4.968

From the annuity table, the 4.968 factor is closest to the 8-year row at the 12% column. Therefore, the IRR is 12%.

Diff: 2

Objective: 2

AACSB: Application of knowledge

53) Network Service Center is considering purchasing a new computer network for $82,000. It will require additional working capital of $13,000. Its anticipated eight-year life will generate additional client revenue of $33,000 annually with operating costs, excluding depreciation, of $15,000. At the end of eight years, it will have a salvage value of $9,500 and return $5,000 in working capital. Taxes are not considered.

Required:

a. If the company has a required rate of return of 14%, what is the net present value of the proposed investment?

b. What is the internal rate of return?

a.

b. Trial and error is necessary. You know it is below 14% because the answer to Part A was negative and, therefore, less than the discount rate. Therefore, let's try 12%.

The (almost) zero net present value indicates an internal rate of return of approximately 12%.

Diff: 3

Objective: 2

AACSB: Application of knowledge

54) EIF Manufacturing Company needs to overhaul its drill press or buy a new one. The facts have been gathered, and they are as follows:

Required:

Which alternative is the most desirable with a current required rate of return of 20%? Show computations, and assume no taxes.

Present value of new system:

Buying the new equipment is the most desirable by $61,336 ($272,096 - $210,760).

Diff: 3

Objective: 2

AACSB: Application of knowledge

55) Flilane Tire Company needs to overhaul its auto lift system or buy a new one. The facts have been gathered, and they are as follows:

Required:

Which alternative is the most desirable with a current required rate of return of 15%? Show computations, and assume no taxes.

Present value of new system:

Overhauling the existing system is the most desirable by $18,481 [$(258,170) - $(276,651)].

Diff: 3

Objective: 2

AACSB: Application of knowledge

56) ABC Boat Company is interested in replacing a molding machine with a new improved model. The old machine has a salvage value of $10,000 now and a predicted salvage value of $4,000 in six years, if rebuilt. If the old machine is kept, it must be rebuilt in one year at a predicted cost of $20,000.

The new machine costs $80,000 and has a predicted salvage value of $12,000 at the end of six years. If purchased, the new machine will allow cash savings of $20,000 for each of the first three years, and $10,000 for each year of its remaining six-year life.

Required:

What is the net present value of purchasing the new machine if the company has a required rate of return of 14%?

Diff: 3

Objective: 2

AACSB: Application of knowledge

57) Retail Outlet is looking for a new location near a shopping mall. It is considering purchasing a building rather than leasing, as it has done in the past. Three retail buildings near a new mall are available but each has its own advantages and disadvantages. The owner of the company has completed an analysis of each location that includes considerations for the time value of money. The information is as follows:

The owner does not understand how the location with the highest percentage return has the lowest net present value.

Required:

Explain to the owner what is (are) the probable cause(s) of the comparable differences.

Diff: 2

Objective: 2

AACSB: Analytical thinking

Objective 22.3

1) 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

Diff: 1

Objective: 3

AACSB: Analytical thinking

2) The net initial investment for a piece of construction equipment is $2,500,000. Annual cash inflows are expected to increase by $600,000 per year. The equipment has a(n) 8-year useful life. What is the payback period?

A) 8.00 years

B) 5.58 years

C) 4.17 years

D) 3.17 years

Diff: 2

Objective: 3

AACSB: Application of knowledge

3) 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

Diff: 2

Objective: 3

AACSB: Analytical thinking

4) The payback method of capital budgeting approach to an investment decision:

A) assigns greater weights to cash flows in the early years

B) does not consider cash flows that occur after the payback period

C) considers time value of money

D) ignores the initial investment

Diff: 2

Objective: 3

AACSB: Analytical thinking

5) Malive Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $219,000. The annual cost savings if the new machine is acquired will be $35,000. The machine will have a 5-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 12% required rate of return. What is the payback period for the investment?

A) 5.3 years

B) 6.3 years

C) 5.0 years

D) 12.5 years

Diff: 2

Objective: 3

AACSB: Application of knowledge

6) 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 seven years and the new equipment has a value of $249,400 with a seven-year life. The expected additional cash inflows are $63,000 per year. What is the payback period for this investment?

A) 3.0 years

B) 5.0 years

C) 4.0 years

D) 7 years

Diff: 2

Objective: 3

AACSB: Application of knowledge

7) 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 $153,750 with a nine-year life. The expected additional cash inflows are $72,500 per year. What is the payback period for this investment?

A) 1.1 years

B) 2.1 years

C) 9 years

D) 3.1 years

Diff: 2

Objective: 3

AACSB: Analytical thinking

8) If there are non-uniform cash flows (cash flows that differ from year-to-year), payback period is calculated by dividing net initial investment by uniform increase in annual future cash flows.

Diff: 3

Objective: 3

AACSB: Analytical thinking

9) A weaknesses of the payback method is that it does not consider a project's cash flows after the payback period.

Diff: 2

Objective: 3

AACSB: Analytical thinking

10) Supply the missing data for each of the following proposals:

a.

b. Payback period = $339,000/$60,000 = 5.65 years

c.

Annual cash inflow = $60,150/3.020 = $19,917.22

d. Payback = $62,900/$19,917.22 = 3.158

e. Annual net cash inflow = $226,000/5.650 = $40,000

f. PV factor for 10 years = $226,000/$40,000 = 5.650

Look up value 5.650 in PV of annuity table under 10 years in Table 4 and the internal rate of return is 12%.

Diff: 3

Objective: 3

AACSB: Application of knowledge

11) Book & Bible Bookstore desires to buy a new coding machine to help control book inventories. The machine sells for $36,586 and requires working capital of $4,000. Its estimated useful life is five years and will have a salvage value of $4,000. Recovery of working capital will be $4,000 at the end of its useful life. Annual cash savings from the purchase of the machine will be $10,000.

Required:

a. Compute the net present value at a 14% required rate of return.

b. Compute the internal rate of return.

c. Determine the payback period of the investment.

a.

b. Trial and error is required. Because net present value is negative in part a, the internal rate of return is less than 14%. Start by trying 12%.

With a zero net present value, the internal rate of return is 12%.

c. Payback period = ($36,586 + $4,000)/$10,000 = 4.06 years.

Diff: 3

Objective: 2, 3

AACSB: Application of knowledge

12) Sam's Structures desires to buy a new crane and accessories to help move and install modular buildings. The machine sells for $75,000 and requires working capital of $10,000. Its estimated useful life is six years and it will have a salvage value of $17,560. Recovery of working capital will be $10,000 at the end of its useful life. Annual cash savings from the purchase of the machine will be $20,000.

Required:

a. Compute the net present value at a 12% required rate of return.

b. Compute the internal rate of return.

c. Determine the payback period of the investment.

a.

b. Trial and error is required. Because net present value is negative in part a, the internal rate of return is greater than 12%. Start by trying any % above 12% and the solution is listed below:

With a zero net present value, the internal rate of return is 16%.

c. Payback period = ($75,000 + $10,000)/$20,000 = 4.25 years.

Diff: 3

Objective: 2, 3

AACSB: Application of knowledge

13) Griffith Vehicle has received three proposals for its new vehicle-painting machine. Information on each proposal is as follows:

Required:

Determine each proposal's payback.

Proposal Y payback = 3 years plus $12,000/$24,000 or 3.5 years.

Proposal Z payback = ($190,000 + $10,000)/$80,000 = 2.5 years

Diff: 3

Objective: 3

AACSB: Application of knowledge

14) Cedile Trailer Supply has received three proposals for its new trailer assembly line. Information on each proposal is as follows:

Required:

Determine each proposal's payback.

Proposal Y payback = 2 years plus $30,000/$35,000 or 2.86 years.

Proposal Z payback = ($145,000 + $15,000)/$60,000 = 2.67 years

Diff: 3

Objective: 3

AACSB: Application of knowledge

15) A company financial analyst estimates that a project that will cost $150,000 will return the following cash flows:

Year 1 $45,000

Year 2 $55,000

Year 3 $60,000

year 4 $85,000

Year 5 $90,000

Calculate the discounted payback period if required rate of return is 10%

Year 1 .909 × $45,000 = $40,950

Year 2 .826 × $55,000 = $45,430

Year 3 .751 × $60,000 = $45,060

Year 4 .683 × $85,000 = $58,055

Year 5 .621 × $90,000 = $55,890

By the end of year 3, the cumulative discounted cash flows equal $131,395 which means that $18,605 needs to be recovered in year 4.

$18,605/$58,055 = .32 + 3 years = 3.32 years discounted cash flow payback period

Diff: 2

Objective: 3

AACSB: Analytical thinking

Objective 22.4

1) 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

Diff: 1

Objective: 4

AACSB: Analytical thinking

2) 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

Diff: 2

Objective: 4

AACSB: Analytical thinking

3) 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

Diff: 2

Objective: 4

AACSB: Analytical thinking

4) 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

Diff: 2

Objective: 4

AACSB: Analytical thinking

5) 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.

Diff: 3

Objective: 4

AACSB: Analytical thinking

6) 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

Diff: 2

Objective: 4

AACSB: Analytical thinking

7) 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.

Diff: 2

Objective: 4

AACSB: Analytical thinking

8) Relevant annual earned income from a project is divided by capital invested in that project to calculate:

A) accrual accounting rate of return

B) returned working capital

C) IRR increase in expected average annual

D) discounted payback period

Diff: 2

Objective: 4

AACSB: Analytical thinking

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

Diff: 2

Objective: 4

AACSB: Analytical thinking

10) 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.

Diff: 2

Objective: 4

AACSB: Analytical thinking

11) 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.

Diff: 2

Objective: 4

AACSB: Analytical thinking

12) As cash flows and time value of money are central to capital budgeting decisions, the AARR method is regarded as better than the IRR method.

Diff: 2

Objective: 4

AACSB: Analytical thinking

13) Unlike the payback method, which ignores cash flows after the payback period, the AARR method considers income earned throughout a project's expected useful life.

Diff: 1

Objective: 4

AACSB: Analytical thinking

14) Gavin and Alex, baseball consultants, are in need of a microcomputer network for their staff. They have received three proposals, with related facts as follows:

The company uses straight-line depreciation for all capital assets.

Required:

a. Compute the payback period, net present value, and accrual accounting rate of return with initial investment, for each proposal. Use a required rate of return of 14%.

b. Rank each proposal 1, 2, and 3 using each method separately. Which proposal is best? Why?

a.

Payback Method

Net Present Value:

Accrual Accounting Rate of Return:

Proposal A: = 0.167

Proposal B: ($45,000 - $30,000)/$90,000 = 0.167

Proposal C: ($90,000 - $90,000)/$90,000 = 0.0

b. Summary:

Even though Proposal C is Number 1 for payback, it comes in last with the other two methods. Because the net present value method takes into account the time value of money and the other proposals are less comprehensive, Proposal A would be the best alternative.

Diff: 3

Objective: 4

AACSB: Analytical thinking

15) Gibson Manufacturing is considering buying an automated machine that costs $600,000. It requires working capital of $60,000. Annual cash savings are anticipated to be $280,200 for five years. The company uses straight-line depreciation. The salvage value at the end of five years is expected to be $24,000. The working capital will be recovered at the end of the machine's life.

Required:

Compute the accrual accounting rate of return based on the initial investment.

Accrual accounting income = $280,200 - (($600,000 - $24,000)/5)

= $280,200 - $115,200

= $165,000

AARR with initial investment = $165,000 / ($600,000 + $60,000)

= $165,000 / $660,000

= 0.25

Diff: 2

Objective: 4

AACSB: Application of knowledge

16) What are the four alternative methods for evaluating capital budgeting projects? What is an advantage and disadvantage of each method?

Diff: 2

Objective: 4

AACSB: Analytical thinking

17) Bock Construction Company is considering four proposals for the construction of new loading facilities that will include the latest in ship loading/unloading equipment. After careful analysis, the company's accountant has developed the following information about the four proposals:

Required:

How can this information be used in the decision-making process for the new loading facilities? Does it cause any confusion?

Any time that multiple measures are used there may be confusion because very seldom will one proposal appear to be the best with all models. In this case, payback ranks Proposal 1 the best, NPV ranks Proposal 4 the best, IRR ranks Proposal 2 the best, and AARR ranks Proposal 1 the best. The importance of each ranking will depend upon the circumstances of the organization and the managers must be attuned as to what is most favorable.

The net present value and the internal rate-of-return methods are superior because they consider the time value of money.

Diff: 2

Objective: 4

AACSB: Analytical thinking

18) What are the strengths and weaknesses of the accrual accounting rate-of-return (AARR) method for evaluating long-term projects?

Diff: 2

Objective: 4

AACSB: Analytical thinking

Objective 22.5

1) 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

Diff: 2

Objective: 5

AACSB: Analytical thinking

2) The galaxy Corporation disposes a capital asset with an original cost of $220,000 and accumulated depreciation of $111,000 for $50,000. The company's tax rate is 40%. Calculate the after-tax cash inflow from the disposal of the capital asset.

A) $23,600

B) ($23,600)

C) $73,600

D) $109,000

Diff: 3

Objective: 5

AACSB: Application of knowledge

3) The Golden Shades Corporation disposes a capital asset with an original cost of $300,000 and accumulated depreciation of $130,000 for a salvage price of $45,000. Golden Shades's tax rate is 30%. Calculate the after-tax cash inflow from the disposal of the capital asset.

A) $37,500

B) $125,000

C) $45,000

D) $82,500

Diff: 3

Objective: 5

AACSB: Application of knowledge

4) The Ambitz Corporation has an annual cash inflow from operations from its investment in a capital asset of $38,000 (excluding the deprecation) each year for seven years. The corporation's income tax rate is 40%. Calculate the total after-tax cash inflow from operations for seven years.

A) $266,000

B) $266,003

C) $159,600

D) $38,000

Diff: 3

Objective: 5

AACSB: Application of knowledge

5) The Venoid Corporation has an annual cash inflow from operations from its investment in a capital asset of $18,000 (excluding depreciation) each year for eight years. The corporation's income tax rate is 40%. Calculate the total after-tax cash inflow from operations for eight years.

A) $144,000

B) $86,400

C) $57,600

D) $18,000

Diff: 3

Objective: 5

AACSB: Application of knowledge

6) A company is looking to purchase and replace a fixed asset for $220,000. It will sell the asset that will be replaced for $41,000 but will incur a $10,000 gain upon that sale. It must also commit $30,000 of working-capital to the investment. The firm's tax rate is 30%. What is the amount of the relevant initial investment?

A) $220,000

B) $212,000

C) $179,000

D) $182,000

Diff: 2

Objective: 5

AACSB: Analytical thinking

7) The focus in capital budgeting should be on:

A) favorable and unfavorable variance

B) expenses under accrual accounting

C) expected future cash flows that differ between alternatives

D) allocation of overheads

Diff: 2

Objective: 5

AACSB: Analytical thinking

8) An example of a sunk cost in a capital budgeting decision for new equipment is:

A) the initial investment in working capital

B) the original price of an old equipment

C) the necessary transportation costs on a new equipment

D) the initial investment in a new equipment

Diff: 2

Objective: 5

AACSB: Analytical thinking

9) 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

Diff: 2

Objective: 5

AACSB: Analytical thinking

10) 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

Diff: 3

Objective: 5

AACSB: Analytical thinking

11) 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

Diff: 3

Objective: 5

AACSB: Analytical thinking

12) The income taxes saved as a result of depreciation deductions are irrelevant because they decrease cash outflows.

Diff: 2

Objective: 5

AACSB: Analytical thinking

13) Depreciation has no impact on a capital project's cash flows because depreciation is a noncash expense.

Diff: 2

Objective: 5

AACSB: Analytical thinking

14) The use of an accelerated method of depreciation for tax purposes would usually decrease the present value of the investment.

Diff: 3

Objective: 5

AACSB: Analytical thinking

15) Net initial investment in the project includes the acquisition of assets and any associated additions to working capital, minus the after-tax cash flow from the disposal of existing assets.

Diff: 2

Objective: 5

AACSB: Analytical thinking

16) Relevant cash flows are expected future cash flows that differ among the alternative uses of investment funds.

Diff: 2

Objective: 5

AACSB: Analytical thinking

17) Cash flows from the terminal disposal of the investment include the pre-tax cash flow from terminal disposal of assets and the pre-tax cash flow from terminal recovery of working-capital investment.

Diff: 2

Objective: 5

AACSB: Analytical thinking

18) In determining whether to keep a machine or replace it, the original cost of the machine is a sunk cost and is NOT a relevant factor.

Diff: 1

Objective: 5

AACSB: Analytical thinking

19) In the net present value (NPV) method, pre-tax cash flows should be used instead of after-tax cash flows.

Diff: 2

Objective: 5

AACSB: Analytical thinking

20) In calculating the net initial investment cash flows, any increase in working capital required for the project should be included.

Diff: 1

Objective: 5

AACSB: Analytical thinking

21) A loss on the disposal of a replacement asset is an irrelevant fact when estimating relevant cash flows of a capital asset decision.

Diff: 2

Objective: 5

AACSB: Analytical thinking

22) A commitment to a new capital project will always result in an increase in net working capital.

Diff: 2

Objective: 5

AACSB: Analytical thinking

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

Diff: 2

Objective: 5

AACSB: Analytical thinking

24) Depreciation results in income tax cash savings that are equal to the depreciation expense multiplied by the company's income tax rate.

Diff: 2

Objective: 5

AACSB: Analytical thinking

25) Explain why the term tax shield is used in conjunction with depreciation.

Diff: 2

Objective: 5

AACSB: Analytical thinking

26) What are the relevant cash inflows and outflows for capital budgeting decisions?

Diff: 2

Objective: 5

AACSB: Analytical thinking

Objective 22.6

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

A) It encourages managers to overstate the expected cash inflows from projects and accept projects they should reject.

B) It helps managers avoid optimistic estimate errors.

C) It does not help senior management to recognize problems in the implementation of the project.

D) It provides managers with feedback about the performance of a project to determine if any variance from expectations were the result of the overly optimistic estimates of because of implementation issues.

Diff: 3

Objective: 6

AACSB: Analytical thinking

2) Comparison of the actual results for a project to the costs and benefits expected at the time the project was selected is referred to as:

A) the audit trail

B) management control

C) a post-investment audit

D) a cost-benefit analysis

Diff: 2

Objective: 6

AACSB: Analytical thinking

3) Post-investment audits:

A) result in managers to overstate the expected cash inflows from projects and accept projects they should reject

B) provide management with feedback about the performance of a project

C) include obtaining appropriation requests so that the funding will be authorized to purchase the equipment

D) are usually not feasible in a large project because the cost accounting system does not collect actual costs at the same level of detail as the initial plans had

Diff: 3

Objective: 6

AACSB: Analytical thinking

4) The reason to have a post-investment audit is:

A) they encourage mid-level managers to make overly optimistic estimates during the early stages of the capital budgeting process

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

C) they analyze by calculating contribution-margin

D) they help in calculating present value

Diff: 3

Objective: 6

AACSB: Analytical thinking

5) 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.

Diff: 2

Objective: 6

AACSB: Analytical thinking

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

Diff: 2

Objective: 6

AACSB: Analytical thinking

7) What conflicts can arise between using discounted cash flow methods for capital budgeting decisions and accrual accounting for performance evaluation? How can these conflicts be reduced?

Diff: 3

Objective: 6

AACSB: Analytical thinking

Objective 22.7

1) Decisions are made with regard to capital budgeting should always:

A) result in an actual annual rate of return exceed the cost of capital for common equity

B) advance the strategic goals of the company

C) increase the working capital of the business

D) accomplish the marketing plan

Diff: 2

Objective: 7

AACSB: Analytical thinking

2) NPV methods can be used to estimate the present value of a customer to a business so that strategic decisions can be made to retain customers and lower churn rates.

Diff: 2

Objective: 7

AACSB: Analytical thinking

3) The higher the probability of customer churn, the higher the NPV of a customer.

Diff: 2

Objective: 7

AACSB: Application of knowledge

4) Strategic capital investment decisions require consideration of a broad range of factors that must be precisely estimated.

Diff: 2

Objective: 7

AACSB: Application of knowledge

5) Discuss a range of factors that managers may have to consider when making capital budgeting decisions that are strategic in nature.

Diff: 2

Objective: 7

AACSB: Analytical thinking

Objective 22.A

1) The real approach to incorporating inflation into the net present value method predicts:

A) cash inflows and outflows in real monetary units and uses a real rate as the required rate of return

B) cash inflows and outflows in real monetary units and uses a nominal rate as the required rate of return

C) cash inflows and outflows in nominal monetary units and uses a real rate as the required rate of return

D) cash inflows and outflows in monetary units that are adjusted for inflation and uses a real rate as the required rate of return

Diff: 2

Objective: A

AACSB: Analytical thinking

2) Real rate of return is the rate of return that:

A) is demanded to cover investment risk if there is no inflation

B) equals a risk-free rate of return such as the current interest rate on U.S. treasury bills

C) is equal to the pure rate of return on risk-free long-term government bonds

D) is demanded by invested as a risk premium for bearing risk

Diff: 2

Objective: A

AACSB: Analytical thinking

3) The nominal approach to incorporating inflation into the net present value method predicts cash inflows in real monetary units and uses a real rate as the required rate of return.

Diff: 2

Objective: A

AACSB: Analytical thinking

4) In nominal rate of return, the inflation element is the premium above the real rate.

Diff: 2

Objective: A

AACSB: Analytical thinking

5) The nominal rate of return is made up of a risk-free element when there is no expected inflation, a business-risk element, and an inflation element.

Diff: 2

Objective: A

AACSB: Analytical thinking

6) What is the difference between nominal approach and real approach to incorporating inflation into the net present value method?

Diff: 3

Objective: A

AACSB: Analytical thinking

7) How is inflation related to capital budgeting? Discuss.

When using the net present value method (the definitive method for evaluating alternative options in capital budgeting), it is important to understand what elements are included in the rate of return percentage. In general, it is expected that there will always be a decline in the general purchasing power of whatever monetary units are in use (dollar, etc.). The real rate of return consists of a risk free element as well as a business risk element but excludes the inflation element. The nominal rate of return includes all three components: the risk free element, business risk element, and inflation element.

It is acceptable to use either the real rate of return or the nominal rate of return when performing capital budgeting analysis using the net present value concepts. The main caveat is to understand which one is being used and to make sure that there is internal consistency within the analysis such that all cash flows (in and out) are using the same approach

Diff: 2

Objective: A

AACSB: Analytical thinking