Chapter 26 Capital Budgeting and Investment Analysis | Test Bank – 24e

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Fundamental Accounting Principles, 24e (Wild)

Chapter 26 Capital Budgeting and Investment Analysis

1) Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

2) The payback period is the amount of time for the investment to generate enough net cash flow to return the initial cost of investment.

3) Net cash flow can be calculated by adjusting the projected net income from a project for any non-cash revenues and expenses.

4) Projects with shorter payback periods have higher risk, as the company has less time to respond to unanticipated changes.

5) If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be accepted.

6) If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be rejected.

7) Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.

8) An advantage of the break-even time (BET) method over the payback period method is that it recognizes the time value of money.

9) In ranking choices with the break-even time (BET) method, the investment with the longest BET gets the highest rank.

10) In ranking choices with the break-even time (BET) method, the investment with the longest BET gets the lowest rank.

11) When computing payback period, the date the initial capital investment is made is year 1.

12) The payback period method of evaluating an investment ignores cash inflows after the point where an investment's costs are fully recovered.

13) The time value of money is considered when calculating the payback period of an investment.

14) Two investments with exactly the same payback periods are not equally valuable to an investor because the timing of net cash flows may be different.

15) The payback period method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

16) If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

17) A shorter payback period reduces the company's ability to respond to unanticipated changes and increases the risk of having to keep an unprofitable investment.

18) The accounting rate of return (ARR) is computed by dividing a project's after-tax net income by the average annual investment.

19) The accounting rate of return (ARR) is computed by dividing a project's after-tax net income by the amount of the initial investment.

20) If the straight-line depreciation method is used, the annual average investment amount used in calculating the accounting rate of return is calculated as (beginning book value + ending book value)/2.

21) The accounting rate of return is based on cash flows rather than net income in its calculation.

22) When comparing investments with similar lives and risks, a company will prefer the investment with the higher rate of return.

23) If net present values are used to evaluate two investments that have equal costs and equal total cash flows, the one with more cash flows in the early years has the higher net present value.

24) The net present value decision rule is: When an asset's expected cash flows yield a positive net present value when discounted at the required rate of return, the asset should be acquired.

25) The internal rate of return equals the rate that yields a net present value of zero for an investment.

26) The internal rate of return method of evaluating capital investments cannot be used with uneven cash flows.

27) There is only one method of evaluating capital budgeting decisions.

28) Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

29) Capital budgeting decisions are not affected by return on investment considerations.

30) Capital budgeting decisions that relate to investments in technology are not as risky as other types of capital budgeting decisions.

31) The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

32) The time value of money concept works on the principle that a dollar tomorrow is worth more than a dollar today.

33) The process of restating cash flows in terms of their present values is called discounting.

34) All capital investment evaluation methods use the time value of money concept.

35) A hurdle rate is the minimum acceptable rate of return for an investment.

36) For projects financed from borrowed funds, the hurdle rate must exceed the interest rate paid on the borrowed funds.

37) Soft capital rationing is imposed by external factors, such as debt covenants.

38) Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

39) Accounting rate of return gives managers an estimate of how soon they will recover their initial investment.

40) The net present value capital budgeting method considers all estimated cash flows for the project's expected life.

41) In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.

42) Three widely used methods of comparing investment alternatives are payback period, net present value, and rate of return on average investment.

43) The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.

44) Two investments with exactly the same payback periods are always equally valuable to an investor.

45) A disadvantage of an investment with a short payback period is that it will produce revenue for only a short period of time.

46) In calculating the accounting rate of return using the straight-line method of depreciation, the annual average investment is calculated as (beginning book value + ending book value)/2.

47) The accounting rate of return uses cash flows in its calculation.

48) The payback method, unlike the net present value method, ignores cash flows after the point of cost recovery.

49) Using accelerated depreciation for tax reporting increases the net present value of an asset's cash flows because it produces larger net cash inflows in the early years of the asset's life.

50) Using a profitability index allows management to rank projects of similar risks with different investment amounts.

51) The profitability index is computed by dividing the present value of net cash flows by the initial investment.

52) A positive profitability index indicates a positive net present value.

53) All projects with a profitability index of less than 1 should be accepted.

54) Projects with a profitability index of greater than 1 have a return that is greater than the hurdle rate.

55) The calculation of annual net cash flow from a particular investment project should include all of the following except:

A) Income taxes.

B) Revenues generated by the investment.

C) Cost of products generated by the investment.

D) Depreciation expense.

E) General and administrative expenses.

56) The process of restating future cash flows in today's dollars is known as:

A) Budgeting.

B) Annualization.

C) Discounting.

D) Payback period.

E) Capitalizing.

57) A company's required rate of return, typically its cost of capital is called the:

A) Internal rate of return.

B) Average rate of return.

C) Hurdle rate.

D) Maximum rate.

E) Payback rate.

58) The capital budgeting process involves all of the following except:

A) Having department or plant managers submit new investment proposals.

B) Determining which financial institution to use for financing.

C) Evaluating the submitted proposals.

D) Forming a capital budget committee that includes accounting and finance members.

E) Approving or rejecting new investment proposals.

59) A limitation of the internal rate of return method is that it:

A) Does not consider the time value of money.

B) Measures results in years.

C) Lacks ability to compare dissimilar projects.

D) Ignores varying risks over the life of a project.

E) Measures net income rather than cash flows.

60) The break-even time (BET) method is a variation of the:

A) Payback method.

B) Internal rate of return method.

C) Accounting rate of return method.

D) Net present value method.

E) Present value method.

61) The calculation of the payback period for an investment when net cash flow is even (equal) is:

A) Cost of investment/Annual net cash flow

B) Cost of investment/Total net cash flow

C) Annual net cash flow/Cost of investment

D) Total net cash flow/Cost of investment

E) Total net cash flow/Annual net cash flow

62) Capital budgeting decisions usually involve analysis of:

A) Cash outflows only.

B) Short-term investments only.

C) Long-term investments only.

D) Investments with certain outcomes only.

E) Operating revenues.

63) Capital budgeting decisions are generally based on:

A) Tentative predictions of future outcomes.

B) Perfect predictions of future outcomes.

C) Results from past outcomes only.

D) Results from current outcomes only.

E) Speculation of interest rates and economic performance only.

64) The net cash flow of a particular investment project:

A) Does not take income taxes into consideration.

B) Equals the total of the cash inflows of the project.

C) Equals the total of the cash outflows of the project.

D) Does not include depreciation.

E) Is equal to operating income each period.

65) Which of the following is an objective of capital budgeting?

A) To eliminate all risk.

B) To discount all future and past cash flows.

C) To earn a satisfactory return on investment.

D) To reverse past decisions.

E) To reduce the number of investment activities.

66) The time value of money concept:

A) Means that a dollar today is worth less than a dollar tomorrow.

B) Means that a dollar tomorrow is worth more than a dollar today.

C) Means that a dollar today is worth more than a dollar tomorrow.

D) Means that "Time is money."

E) Does not involve the concept of compound interest.

67) A minimum acceptable rate of return for an investment decision is called the:

A) Internal rate of return.

B) Average rate of return.

C) Hurdle rate of return.

D) Maximum rate of return.

E) Payback rate of return.

68) The rate that yields a net present value of zero for an investment is the:

A) Internal rate of return.

B) Accounting rate of return.

C) Net present value rate of return.

D) Zero rate of return.

E) Payback rate of return.

69) Which methods of evaluating a capital investment project ignore the time value of money?

A) Net present value and accounting rate of return.

B) Accounting rate of return and internal rate of return.

C) Internal rate of return and payback period.

D) Payback period and accounting rate of return.

E) Net present value and payback period.

70) Which methods of evaluating a capital investment project use cash flows as a measurement basis?

A) Net present value, accounting rate of return, and internal rate of return.

B) Internal rate of return, payback period, and accounting rate of return.

C) Accounting rate of return, net present value, and payback period.

D) Payback period, internal rate of return, and net present value.

E) Net present value, payback period, accounting rate of return, and internal rate of return.

71) The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

A) The internal rate of return is expressed as a percent rather than the absolute dollar value of present value.

B) The internal rate of return is expressed as an absolute dollar value rather than the percent of net present value.

C) The internal rate of return reflects the time value of money rather than the absolute dollar value of present value.

D) The internal rate of return is expressed as an absolute dollar value rather than the time value of money used in net present value.

E) The internal rate of return is expressed as a percent rather than the accrual income method used in net present value.

72) A project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows:

 Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below:

A) $0.00

B) $21,000.00

C) ($7,461.00)

D) $25,033.32

E) ($4,966.60)

73) A project requires a $28,000 investment and is expected to generate end-of-period annual cash inflows as follows:

Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below.

A) $0.00

B) $2,668.00

C) ($7,461.00)

D) $30,668.00

E) ($4,966.68)

74) A project requires a $28,500 investment and is expected to generate end-of-period annual cash inflows of $12,000 for each of three years. Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below:

A) $0.00

B) $2,668.00

C) ($7,461.00)

D) $1,341.60

E) $29,841.60

75) Restating future cash flows in terms of present values and then determining the payback period using these present values is known as:

A) Break-even time (BET)

B) Internal rate of return method.

C) Accounting rate of return method.

D) Net present value method.

E) Present value method.

76) If Management was not concerned with the time value of money, from which two capital budgeting methods should they choose?

A) IRR or Payback.

B) ARR or Payback.

C) BET or IRR.

D) BET or NPV.

E) NPV or Payback.

77) The calculation of the payback period for an investment when net cash flow is uneven is:

A) Determining when the cumulative total of net cash flows reaches zero.

B) Determining when net income equals the cost of the investment.

C) Determining which depreciation method will shorten the period.

D) Determining the net present value for each cash flow.

E) Determining the applicable hurdle rate.

78) Coffer Co. is analyzing two potential investments.

If the company is using the payback period method and it requires a payback of three years or less, which project(s) should be selected?

A) Project Y.

B) Project X.

C) Both X and Y are acceptable projects.

D) Neither X nor Y is an acceptable project.

E) Project Y because it has a lower initial investment.

79) A company wishes to buy new equipment for $9,000. The equipment is expected to generate an additional $2,800 in cash inflows for six years. All cash flows occur at year-end. A bank will make a $9,000 loan to the company at a 10% interest rate so that the company can purchase the equipment. Use the table below to determine break-even time for this equipment:

A) Break-even time is between two and three years.

B) Break-even time is between three and four years.

C) Break-even time is between four and five years.

D) Break-even time is between five and six years.

E) This project will never break-even.

80) Porter Co. is analyzing two potential investments.

 If the company is using the payback period method and it requires a payback of three years or less, which project(s) should be selected?

A) Project Y.

B) Project X.

C) Both X and Y are acceptable projects.

D) Neither X nor Y is an acceptable project.

E) Project Y because it has a lower initial investment.

81) Porter Co. is analyzing two potential investments.

 The payback period in years for Project X is:

A) 2.00.

B) 3.83.

C) 3.50.

D) 2.83.

E) 4.00.

82) The expected amount of time to recover the initial amount of an investment is called the:

A) Amortization period.

B) Payback period.

C) Interest period.

D) Budgeting period.

E) Discounted cash flow period.

83) A company is considering purchasing a machine for $21,000. The machine will generate an after-tax net income of $2,000 per year. Annual depreciation expense would be $1,500. What is the payback period for the new machine?

A) 4 years.

B) 6 years.

C) 10.5 years.

D) 14 years.

E) 42 years.

84) A company is considering purchasing a machine for $21,000. The machine will generate an after-tax net income of $2,000 per year. Annual depreciation expense would be $1,500. The machine has no salvage value. What is the accounting rate of return?

A) 19%

B) 33%

C) 17%

D) 10%

E) 25%

85) A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual cash inflows from this investment are $36,000 (year 1), $30,000 (year 2), $18,000 (year 3), $12,000 (year 4) and $6,000 (year 5). The payback period is:

A) 4.50 years.

B) 4.25 years.

C) 3.50 years.

D) 3.00 years.

E) 2.50 years.

86) A disadvantage of using the payback period to compare investment alternatives is that:

A) It ignores cash flows beyond the payback period.

B) It includes the time value of money.

C) It cannot be used when cash flows are not uniform.

D) It cannot be used if a company records depreciation.

E) It cannot be used to compare investments with different initial investments.

87) A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $12,000 per year including depreciation of $3,000 per year. Income tax expense is $1,600 per year based on a tax rate of 40%. What is the payback period for the new machine?

A) 20.0 years.

B) 6.0 years.

C) 7.5 years.

D) 12.0 years.

E) 8.9 years.

88) A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus straight-line depreciation of $4,000 per year. The company's after-tax net income, based on a tax rate of 40%, is $2,400. What is the approximate accounting rate of return for the machine?

A) 13%.

B) 17%.

C) 8%.

D) 27%.

E) 10%.

89) A company is planning to purchase a machine that will cost $24,000 with a six-year life and no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine?

A) 24 years.

B) 12 years.

C) 6 years.

D) 4 years.

E) 1 year.

90) A company is planning to purchase a machine that will cost $24,000 with a six-year life and no salvage value. The company uses straight-line depreciation. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the accounting rate of return for this machine?

A) 33.3%.

B) 16.7%.

C) 50.0%.

D) 8.3%.

E) 4%.

91) After-tax net income divided by the average amount invested in a project, is the:

A) Net present value rate.

B) Payback rate.

C) Accounting rate of return.

D) Earnings from investment.

E) Profit rate.

92) A company buys a machine for $60,000 that has an expected life of 9 years and no salvage value. The company uses straight-line depreciation. The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout each year. What is the accounting rate of return?

A) 2.85%.

B) 4.75%.

C) 6.65%.

D) 9.50%.

E) 42.75%.

93) A company buys a machine for $76,000 that has an expected life of 6 years and no salvage value. The company uses straight-line depreciation. The company anticipates a yearly after tax net income of $1,805. What is the accounting rate of return?

A) 2.85%.

B) 4.75%.

C) 6.65%.

D) 9.50%.

E) 42.75%.

94) Carmel Corporation is considering the purchase of a machine costing $36,000 with a 6-year useful life and no salvage value. Carmel uses straight-line depreciation and assumes that the annual cash inflow from the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is Carmel's average investment?

A) $6,000.

B) $7,000.

C) $18,000.

D) $21,000.

E) $36,000.

95) Watson Corporation is considering buying a machine for $25,000. Its estimated useful life is 5 years, with no salvage value. Watson anticipates annual net income after taxes of $1,500 from the new machine. What is the accounting rate of return assuming that Watson uses straight-line depreciation and that income is earned uniformly throughout each year?

A) 6.0%.

B) 8.0%.

C) 8.5%.

D) 10.0%.

E) 12.0%.

96) The accounting rate of return is calculated as:

A) The annual after-tax income divided by the total investment.

B) The annual after-tax income divided by the annual average investment.

C) The annual cash flows divided by the annual average investment.

D) The annual cash flows divided by the total investment.

E) The annual average investment divided by the after-tax income.

97) The following relates to a proposed equipment purchase:

Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is (ignore income taxes):

A) 62.3%.

B) 32.0%.

C) 15.0%.

D) 7.7%.

E) 5.0%.

98) The following relates to a proposed equipment purchase:

The annual average investment amount used to calculate the accounting rate of return is:

A) $72,000

B) $70,000

C) $37,000

D) $74,000

E) $48,950

99) The following relates to a proposed equipment purchase:

Ignoring income taxes, the annual net income amount used to calculate the accounting rate of return is:

A) $46,100

B) $11,100

C) $12,100

D) $74,000

E) $48,950

100) An estimate of an asset's value to the company, calculated by discounting the future cash flows from the investment at the project's required rate of return and then subtracting the initial amount of the investment, is known as:

A) Annual net cash flows.

B) Rate of return on investment.

C) Net present value.

D) Payback period.

E) Unamortized carrying value.

101) Which of the following cash flows is not considered when using the net present value method?

A) Future cash inflows.

B) Future cash outflows.

C) Past cash outflows.

D) Non-uniform cash inflows.

E) Future year-end cash flows.

102) Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?

A) Accounting rate of return.

B) Net present value.

C) Payback period.

D) Cash flow method.

E) Return on average investment.

103) The hurdle rate is often set at:

A) The rate the company could earn if the investment were placed in the bank.

B) The company's cost of capital.

C) 10% above the IRR of current projects.

D) 10% above the ARR of current projects.

E) The rate at which the company is taxed on income.

104) Butler Corporation is considering the purchase of new equipment costing $30,000. The projected annual after-tax net income from the equipment is $1,200, after deducting $10,000 for depreciation. The revenue is to be received at the end of each year. The machine has a useful life of 3 years and no salvage value. Butler requires a 12% return on its investments. The present value of an annuity of $1 for different periods follows:

What is the net present value of the machine?

A) $24,018.

B) $(3,100).

C) $30,000.

D) $26,900.

E) $(29,520).

105) Vextra Corporation is considering the purchase of new equipment costing $35,000. The projected annual cash inflow is $11,000, to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Vextra requires a 12% return on its investments. The present value of an annuity of $1 for different periods follows:

What is the net present value of the machine?

A) $(33,410).

B) $(3,100).

C) $35,000.

D) $3,410.

E) $(1,590).

106) The following present value factors are provided for use in this problem.

Cliff Co. wants to purchase a machine for $40,000, but needs to earn a return of 8%. The expected year-end net cash flows are $12,000 in each of the first three years, and $16,000 in the fourth year. What is the machine's net present value?

A) $(9,075).

B) $2,685.

C) $42,685.

D) $(28,240).

E) $52,000.

107) The following present value factors are provided for use in this problem.

Xavier Co. wants to purchase a machine for $37,000 with a four year life and a $1,000 salvage value. Xavier requires an 8% return on investment. The expected year-end net cash flows are $12,000 in each of the four years. What is the machine's net present value?

A) $3,480.

B) $2,745.

C) $40,480.

D) ($3,480).

E) ($2,745).

108) Turk Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows:

Turk Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Turk purchase?

A) Only Machine A is acceptable.

B) Only Machine B is acceptable.

C) Both machines are acceptable, but A should be selected because it has the greater net present value.

D) Both machines are acceptable, but B should be selected because it has the greater net present value.

E) Neither machine is acceptable.

109) Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows:

The present value factors of $1 each year at 15% are:

The present value of an annuity of $1 for 3 years at 15% is 2.2832

Which investment should Alfarsi choose?

A) Only Investment A is acceptable.

B) Only Investment B is acceptable.

C) Both investments are acceptable, but A should be selected because it has the greater net present value.

D) Both investments are acceptable, but B should be selected because it has the greater net present value.

E) Neither machine is acceptable.

110) Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows:

The present value factors of $1 each year at 15% are:

The present value of an annuity of $1 for 3 years at 15% is 2.2832.

The net present value of Investment A is:

A) $18,266.

B) $(15,000).

C) $9,000.

D) $(20,549).

E) $3,266.

111) Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows:

The present value factors of $1 each year at 15% are:

The present value of an annuity of $1 for 3 years at 15% is 2.2832

The net present value of Investment B is:

A) $780.

B) $(15,780).

C) $9,000.

D) $39,797.

E) $(5,918).

112) A company is considering the purchase of new equipment for $45,000. The projected annual net cash flows are $19,000. The machine has a useful life of 3 years and no salvage value. Management of the company requires a 12% return on investment. The present value of an annuity of $1 for various periods follows:

What is the net present value of this machine assuming all cash flows occur at year-end?

A) $(1,768)

B) $3,000

C) $634

D) $19,000

E) $45,634

113) A company can buy a machine that is expected to have a three-year life and a $30,000 salvage value. The machine will cost $1,800,000 and is expected to produce a $200,000 after-tax net income to be received at the end of each year. If a table of present values of $1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and 0.7118 for three years, what is the net present value of the cash flows from the investment, discounted at 12%?

A) $118,855

B) $583,676

C) $629,788

D) $705,391

E) $1,918,855

114) A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of $1 for five years are shown below:

A) The project should be accepted.

B) The project should be rejected because it earns less than 10%.

C) The project earns more than 10% but less than 12%. At a hurdle rate of 12%, the project should be rejected.

D) Only 9% is acceptable.

E) Only 10% is acceptable.

115) Tressor Company is considering a 5-year project. The company plans to invest $90,000 now and it forecasts cash flows for each year of $27,000. The company requires that investments yield a discount rate of at least 14%. Selected factors for a present value of an annuity of $1 for five years are shown below:

  Calculate the internal rate of return to determine whether it should accept this project.

A) The project should be accepted because it will earn more than 14%.

B) The project should be accepted because it will earn more than 10%.

C) The project will earn more than 12% but less than 14%. At a hurdle rate of 14%, the project should be rejected.

D) The project should be rejected because it will earn less than 14%.

E) The project should be rejected because it will not earn exactly 14%.

116) A new manufacturing machine is expected to cost $278,000, have an eight-year life, and a $30,000 salvage value. The machine will yield an annual incremental after-tax income of $35,000 after deducting the straight-line depreciation. Compute the payback period for the purchase.

A) 8.7 years.

B) 3.8 years.

C) 4.2 years.

D) 7.3 years.

E) 5.4 years.

117) A new manufacturing machine is expected to cost $278,000, have an eight-year life, and a $30,000 salvage value. The machine will yield an annual incremental after-tax income of $35,000 after deducting the straight-line depreciation. Compute the accounting rate of return for the investment.

A) 22.7%.

B) 23.4%.

C) 46.9%.

D) 12.2%.

E) 24.5%.

118) Nestor Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year.

Compute the payback period for this investment.

A) 2.85 years.

B) 2.57 years.

C) 3.00 years.

D) 2.50 years.

E) 3.62 years.

119) A machine costs $180,000 and will have an eight-year life, a $20,000 salvage value, and straight-line depreciation is used. Management estimates the machine will yield an after-tax net income of $12,500 each year. Compute the accounting rate of return for the investment.

A) 12.5%.

B) 26.8%.

C) 11.8%.

D) 10.8%.

E) 22.5%.

120) Poe Company is considering the purchase of new equipment costing $80,000. The projected annual cash inflows are $30,200, to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine.

A) $(15,731).

B) $(4,896).

C) $15,731.

D) $4,896.

E) $32,334.

121) Poe Company is considering the purchase of new equipment costing $80,000. The projected net cash flows are $35,000 for the first two years and $30,000 for years three and four. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine.

A) $(15,731).

B) $(4,896).

C) $15,731.

D) $4,896.

E) $23,775.

122) Nestor Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the break-even time (BET) period for this investment.

A) 2.85 years.

B) 2.57 years.

C) 3.17 years.

D) 2.98 years.

E) 3.62 years.

123) A postaudit is:

A) An evaluation of the effectiveness of the budgeting committee.

B) An analysis of the capital budgeting method used.

C) An evaluation of a project's actual results versus its projected results.

D) A review by outside auditors to assess efficiency.

E) An analysis of risk changes over the life of an investment.

124) The process of analyzing alternative long-term investments and deciding which assets to acquire or sell is known as:

A) Planning and control.

B) Capital budgeting.

C) Variance analysis.

D) Master budgeting.

E) Managerial accounting.

125) Capital budgeting decisions are risky because all of the following are true except:

A) The outcome is uncertain.

B) Large amounts of money are usually involved.

C) The investment involves a long-term commitment.

D) The decision could be difficult or impossible to reverse.

E) They rarely produce net cash flows.

126) Presented below are terms preceded by letters a through g and followed by a list of definitions 1 through 7. Match the letter of the term with the definition. Use the space provided preceding each definition.

(a) Internal rate of return

(b) Hurdle rate

(c) Accounting rate of return

(d) Net cash flow

(e) Capital budgeting

(f) Payback period

(g) Net present value

______ (1) Equals the discount rate that results in a net present value of zero.

______ (2) Cash inflows minus cash outflows for the period.

______ (3) The required rate of return.

______ (4) The time expected to pass before the net cash flows from an investment equals its initial cost.

______ (5) Annual after-tax net income divided by annual average investment.

______ (6) A process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

______ (7) Initial cost of an investment subtracted from discounted future cash flows from the investment.

127) Presented below are terms preceded by letters a through f and followed by a list of definitions 1 through 6. Match the letter of the terms with the definitions. Use the space provided preceding each definition.

(a) Postaudit

(b) Capital rationing

(c) Profitability index

(d) Net present value

(e) Cost of capital

(f) Annuity

______ (1) Used to compare projects when a company cannot fund all positive net present value projects calculated by dividing present value of net cash flows by the initial investment.

______ (2) A series of cash flows of equal dollar amount over equal time periods.

______ (3) An estimate of an asset's value to the company; computed by discounting the future net cash flows using the company's required rate of return and then subtracting the initial amount invested.

______ (4) An evaluation of a project's actual results versus its projected results.

______ (5) An average of the rate the company must pay to its lenders and investors.

______ (6) Finance constraints that limit a company from accepting all positive net present value investments.

128) What is capital budgeting? Why are capital budgeting decisions often difficult and risky?

129) Briefly describe the time value of money. Why is the time value of money important in capital budgeting?

130) In using a capital budgeting method that takes the time value of money into consideration, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

131) How does the calculation of break-even time (BET) differ from the calculation of payback period (PBP)?

132) Briefly describe both the payback period method and the net present value method of comparing investment alternatives.

133) When making capital budgeting decisions, companies usually prefer shorter payback periods. Explain why shorter payback periods are desirable.

134) What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

135) You have evaluated three projects of similar investment amount and risk using the net present value (NPV) method. How would you decide which one of the projects to select?

136) When the amount invested differs substantially across projects, NPV is of limited value for comparison purposes. You have evaluated three projects of substantially different investment amounts using the net present value (NPV) method. How would you decide which one of the projects to select?

137) Identify at least three reasons for managers to favor the internal rate of return (IRR) over other capital budgeting approaches.

138) For each of the capital budgeting methods listed below, place an X in the correct column, indicating the measurement basis of each, the ability to make comparison among projects, and whether each method reflects or ignores the time value of money.

139) Nebraska Co. is reviewing a capital investment of $100,000. This project's projected cash flows over a five-year period are estimated at $35,000 each year.

Required:

(a) Calculate the payback period.

(b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below:

Present Value

Periods of 1 at 12%

1…… 0.8929

2…… 0.7972

3…… 0.7118

4…… 0.6355

5…… 0.5674

(c) Using the results in (a) and (b), make a recommendation for the project.

140) A company is considering purchasing a machine for $85,000. The machine is expected to generate a net after-tax income of $11,250 per year. Depreciation expense would be $8,500. What is the payback period for this machine?

141) A company is trying to decide which of two new product lines to introduce in the coming year. The predicted revenue and cost data for each product line follows:

The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that cash flows will be spread evenly throughout each year. Calculate each product's payback period. If the company requires a payback period of three years or less, which, if either, product should be chosen?

142) A company is considering a proposal to invest $40,000 in a project that would provide the following net cash flows:

Year 1 $ 6,500

Year 2 12,700

Year 3 15,000

Year 4 12,800

Compute the project's payback period.

143) A company produces two boat models, Flyer and Skimmer. Both products are being considered for major investment projects next year. Relevant data follow:

Flyer Skimmer

New investment $424,000 $380,000

Expected net cash flows:

Year 1 150,000 130,000

Year 2 160,000 130,000

Year 3 170,000 130,000

Required:

Use the payback period to evaluate these two investment projects.

144) A company is evaluating the purchase of a machine for $750,000 with a six-year useful life and no salvage value. The company uses straight-line depreciation and it assumes that the annual net cash flow from using the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is the company's average investment?

145) A company purchases a machine for $800,000. The machine has an expected life of 9 years and no salvage value. The company anticipates a yearly after-tax net income of $60,000 to be received uniformly throughout each year. What is the accounting rate of return?

146) A company is considering two projects, Project A and Project B. The following information is available for each project:

Project A Project B

Investment $500,000 $2,000,000

Net present value of cash flows $600,000 $800,000

Calculate the profitability index for each project. Based on the profitability index, which project, if any, should the company pursue and why?

147) A company is considering the purchase of new equipment for $42,000. The projected annual cash inflow is $18,000. The machine has a useful life of 3 years and no salvage value. Management of the company requires a 12% return on investment. The present value of an annuity of $1 for various periods follows:

What is the net present value of this machine assuming all cash flows occur at year-end?

148) A company is trying to decide which of two new product lines to introduce in the coming year. The company requires a 12% return on investment. The predicted revenue and cost data for each product line follows:

The company has a 30% tax rate and it uses the straight-line depreciation method. The present value of an annuity of 1 for 5 years at 12% is 3.6048. Compute the net present value for each piece of equipment under each of the two product lines. Which, if either of these two investments is acceptable?

149) A company is considering two alternative investment opportunities, each of which requires an initial cash outlay of $110,000. The expected net cash flows from the two projects follow:

Project A Project Z

Year 1 ……………… $ 30,000 $ 44,000

Year 2 ……………… 44,000 70,000

Year 3……………… 70,000 30,000

Totals ……………… $144,000 $144,000

Based on a comparison of their net present values, and assuming the same discount rate of 12% is required for both projects, which project is the better investment? Use the table values below to compute the net present value of each project's cash flows.

Periods Present value of 1 at 12%

1………………. 0.8929

2………………. 0.7972

3………………. 0.7118

150) A company has a decision to make between two investment alternatives. The company requires a 10% return on investment. Predicted data is provided below:

Investment A Investment Z

Projected after-tax net income $ 40,000 $ 42,000

Investment costs $600,000 $675,000

Estimated life 6 years 6 years

The present value of an annuity for 6 years at 10% is 4.3553. This company uses straight-line depreciation.

Required:

(a) Calculate the net present value for each investment.

(b) Which investment should this company select? Explain.

151) A company is considering a 5-year project. It plans to invest $62,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of 1 for five years are shown below:

152) Dracor Company is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $280,000 with a 7-year life, no salvage value, and will be depreciated using straight-line depreciation. The expected annual income related to this equipment follows. Compute the (a) payback period and (b) accounting rate of return for this equipment.

153) Trevoline Company is deciding between two projects. Each project requires an initial investment of $350,000. The projected net cash flows for the two projects are listed below. The revenue is to be received at the end of each year. Trevoline requires a 10% return on its investments. The present value of an annuity of 1 and present value of an annuity factors for 10% are presented below. Use net present value to determine which project should be pursued and explain why.

154) ________ is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

155) The minimum acceptable rate of return on an investment, often the company's cost of capital, is called the ________.

156) A capital budgeting method that considers how quickly a project recovers costs is known as ________. An enhancement to this method that also considers the time value of money is called ________.

157) In evaluating capital budgeting alternatives, there are two primary methods that do not consider the time value of money. These methods are ________ and ________. There are also two primary methods that consider the time value of money; these are ________ and ________.

158) The ________ is computed by dividing a project's annual after-tax net income by the annual average amount invested.

159) The ________ is computed by discounting the future net cash flows from the investment at the project's required rate of return and then subtracting the initial amount invested.

160) The net present value decision rule requires that when an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the project should be ________.

161) The ________ is the rate that yields a net present value of zero for an investment.