Test Bank Ch12 Capital Investment

Testbank

to accompany

Accounting: business reporting for decision making

7th edition

by

Birt et al.

Not for distribution. Instructors may assign selected questions in their LMS

© John Wiley & Sons Australia, Ltd 2020

Chapter 12: Capital investment

Learning objectives

1. Explain the nature and scope of investment decisions

Q1, Q2, Q3, Q4, Q5, Q6, Q7, Q8, Q9, Q10, Q51, Q52, Q53, Q54

2. Describe and apply the concept of the accounting rate of return (ARR)

Q11, Q12, Q13, Q14, Q15, Q16, Q17, Q18, Q19, Q55, Q56

3. Explain and use the payback period (PP) method

Q20, Q21, Q22, Q23, Q24, Q25, Q26, Q27, Q28, Q57, Q58

4. Discuss and calculate net present values (NPV) and apply the decision rule

Q29, Q30, Q31, Q32, Q33, Q34, Q35, Q36, Q37, Q38, Q39, Q40, Q41, Q42, Q59, Q60, Q61

5. Explain some of the practical issues in making investment decisions.

Q43, Q44, Q45, Q46, Q47, Q48, Q49, Q50, Q62, Q63, Q64, Q65

Multiple-choice questions

1. Typically, investments:

a. require a minimal cash outlay in the beginning.

b. rarely span long periods of time.

c. involve risk and uncertainty due to inability to accurately predict future revenues and costs.

d. are easy to reverse without a substantial loss of funds.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Which statement below describes risk in finance?

a. Risk in finance is defined as measurable variation in outcomes.

b. Risk in finance is defined as the unmeasurable variation in outcomes.

c. Risk in finance can never be measured with any degree of confidence.

d. None of the options explain risk in finance.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Uncertainty in finance:

a. is defined as the unmeasurable variation in outcomes.

b. can be measured with a degree of confidence.

c. is defined as measurable variation in outcomes.

d. none of the options explain uncertainty in finance.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. What is the first step in making an investment decision?

a. Collection of data

b. Identification of all available investment alternatives

c. Interpretation of results

d. Selection of a decision-support tool

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. When an entity invests solely to replace worn out equipment they also often end up incorporating new technology. This is considered as:

a. a necessity in the replacement decision.

b. irrelevant because if the old equipment was satisfactory then no improvement is necessary.

c. a bonus for the entity.

d. a waste of money because more advanced equipment is often more expensive.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Which of the following is not one of the steps involved in making an investment decision?

a. Interpret the results in relation to the decision rule.

b. Select a decision-support tool and set the decision rule.

c. Analyse the data.

d. All of these steps are involved in making an investment decision.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Which of the below is a likely investment to decrease costs for a retail entity?

a. Bill payment systems

b. Computer networks to streamline the ordering process

c. Cloud computing

d. All of these options

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. After an investment decision is made, the next step is:

a. the process of physically implementing the project.

b. the planning process.

c. the replacement process.

d. arranging finance.

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. A multi-national retailer invests $50 million in capital expenditure to open 5 new stores in different countries. Which of the following is the most likely investment category for this type of project?

a. New investments to increase revenue

b. New technology to decrease costs

c. Replacement of old assets as they wear out

d. The capital investment project does not fit into any of these categories

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. A retailer invests $500 000 in a new computer network to streamline purchasing, inventory control and bill payments. Which of the following is the most likely investment category for this type of project?

a. New investments to increase revenue

b. The capital investment project does not fit any of the categories

c. Replacement of old assets as they wear out

d. New technology to decrease costs

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. One method of investment decision making that is appealing to managers is the accounting rate of return (ARR). This method measures the average profit over a period as a percentage of the:

a. net cash flow.

b. average investment.

c. net cash inflow.

d. opportunity cost.

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. What is the formula for calculating the ARR?

a. ARR = cash outlay / amount of cash inflow generated per year

b. ARR = average profit / average investment

c. ARR = PV (1 + i)n

d. ARR = average profit x average investment

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. A major deficiency of the ARR method is:

a. it ignores the importance of cash as the ultimate resource.

b. profits and costs are measured the same way.

c. it ignores the timing of cash flows and subsequent profits.

d. it is too simplistic to be an appropriate decision-support tool by itself.

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. When making an investment decision using the ARR method, most entities will set a minimum level of return known as their required rate of return (RRR). This RRR is based on:

a. industry averages.

b. the entity’s past performances.

c. currently available returns from other investments outside the industry.

d. any of the above measures can be used to set an RRR.

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. Which of the following statements is true regarding the decision rule for ARR?

a. Only investments with an ARR higher than the RRR should be considered.

b. The decision rule for ARR varies among entities.

c. Generally, the investment with the highest ARR is to be accepted.

d. All of these statements are true regarding the ARR decision rule.

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. Using the information in the table below, calculate the ARR.

a. 15%

b. 16.67%

c. 13.33%

d. 18.75%

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. Using the information in the table below, calculate the ARR.

a. 30.55%

b. 22.15%

c. 25.85%

d. 26.18%

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. The ARR uses the same methodology as which measure of profitability?

a. Return on equity

b. Cash flow to sales

c. Gross profit margin

d. Return on assets

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. What is the time value of money?

a. The interest rate at which a future cash flow is converted to a present value.

b. The notion that a dollar is worth more the sooner it is received, all other things being equal.

c. The notion that it is better to receive money in the future than it is today.

d. The time necessary to recoup with net cash inflows the initial outlay.

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. The payback period method of investment decision making is generally regarded as:

a. mostly accurate.

b. very accurate.

c. too simplistic to be the only tool used in decision making.

d. too complex for normal use.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. What is an advantage of the payback period method of investment decision making?

a. It ignores cash flows after the initial investment is paid back

b. It is simple to calculate

c. It considers the time value of money

d. It is difficult to understand

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. Macpherson Engineers is evaluating an investment proposal using the payback period method. Cash inflows are expected to be $80 000 in year 1, $120 000 in year 2, $150 000 in year 3, and $180 000 in year 4. The initial investment required is $380 000. Assuming even cash inflows throughout each year, what is the payback period?

a. 3.34 years

b. 3.47 years

c. 3 years

d. 3.17 years

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. Manuel’s Mexican Pty is considering investing $35 000 in a new ‘pop-up’ burrito stand beside a popular Melbourne park. Manuel’s Mexican Pty estimates the net cash inflow will increase by $14 000 each year for the next 5 years. What is the payback period for the new burrito stand?

a. 3.5 years

b. 2 years

c. 2.5 years

d. 3 years

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. Which of the following statements concerned with the ARR and payback period methods is correct?

a. If two projects have the same ARR, the one with the lowest payback period would be preferred.

b. Both methods are simplistic and may be useful for a quick analysis to sort out projects for further analysis.

c. Both methods are quite easy for managers to understand.

d. All of these statements are correct.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. An advantage of the payback period method of investment analysis is it:

a. treats all cash inflows equally over the investment period.

b. provides a crude measure of the riskiness of a project.

c. ignores all cash inflows after payback has occurred.

d. is difficult to calculate.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. A disadvantage of the payback period method of investment analysis is that:

a. it gives a crude measure of calculating risk.

b. it is easy to understand.

c. it ignores all cash inflows after the payback has occurred.

d. all of these options are considered disadvantages.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. The decision rule with PP varies among entities, but most entities:

a. have minimum periods before which they would not invest.

b. prefer a greater risk because of the inherent greater reward.

c. have maximum periods beyond which they would not invest.

d. none of the options are correct.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. If two investments are equally profitable, most entities would:

a. choose the investment where the outlaid cash is to be recouped in the shortest amount of time.

b. not be concerned about which investment was chosen.

c. choose the investment where the outlaid cash is to be recouped in the longest amount of time.

d. choose neither investment.

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. Vandelay Industries is considering the purchase of a new processing machine. The initial cost of the machine will be $300 000. The expected increase in net cash inflow as a result of the purchase is $75 000 for the first year and $160 000 for each of the next two years. The machine will have a salvage value of zero. At a discount rate of 5%, what is the net present value of the machine?

a. $54 758

b. $68 934

c. $354 758

d. $41 201

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. The investment decision rule for net present value calculations is to invest:

a. in the project with the lowest NPV.

b. in the project with the lowest discount rate.

c. in the project with the highest discount rate.

d. in the project with the highest positive NPV.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. An investment with a high risk margin has a high discount rate, which makes the net present value:

a. zero.

b. lower.

c. higher.

d. unchanged, as the level of risk has no effect on the NPV.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Which option best describes the present value (PV) of a project?

a. The sum of the PVs of all the expected cash flows from all the individual periods

b. The interest rate at which a future cash flow is converted to an NPV

c. The net cash flow at the end of a period

d. The notion that a dollar is worth more the sooner it is received, all other things being equal

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. What is the formula used to calculate future value (FV)?

a. FV = (1 + r) / CF₁

b. FV = PV (1 + i)n

c. FV = cash outlay / amount of cash inflow generated per year

d. It is only possible to use a discount table to calculate future value.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. In the formula FV = PV (1 + i)n, what does ‘n’ stand for?

a. Net value

b. Number of periods

c. Number percentage of interest rate

d. None of the options listed

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Which of the following statements is true with regards to the cash flows used in the net present value method?

a. The net cash inflows for each period may have a positive or negative value.

b. The final net cash inflow includes any salvage value that may be gained by selling the investment.

c. All expected cash flows throughout the investment period are considered in the NPV calculation.

d. All the statements are true.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. If the interest rate is 8%, receiving $10 000 in 3 years’ time is equivalent to receiving what amount today?

a. $10 000

b. $7938

c. $3880

d. $92 559

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. What is one assumption of the net present value method of investment decision making?

a. That projects are suitable investments if the NPV equals zero

b. That cash flows are constant throughout the project

c. That projects with lower NPVs are more profitable

d. That the cash flows have occurred at the end of each relevant period

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. What is the reason for calculating the present values of all the expected cash flows of a project?

a. So that the initial investment may be matched with the expected cash inflows in terms of the same monetary units with the same purchasing power.

b. To overcome the problem of recognising that $1 received in 2 years’ time is worth more than $1 received now.

c. To overcome the problem of a fluctuating discount rate.

d. To remove any opportunity costs.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. The opportunity cost of making an investment is:

a. not relevant when applying the NPV method.

b. equal to the required discount rate.

c. the cost of forgoing a benefit from an alternative investment.

d. the initial cash outlay of the investment.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. When presented with the choice of multiple profitable projects, which of the following statements is true?

a. The project with the highest NPV may not be the best project when capital is limited.

b. The entity should choose to undertake all the profitable projects at the one time.

c. The entity should choose the project with the lowest NPV.

d. None of the options are true.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. An advantage of the NPV method is that:

a. it relies on the use of an appropriate discount factor for the circumstances.

b. optimum outcomes are achieved simply by ranking projects according to their NPVs.

c. only cash flows are taken into account, so it is not affected by changes to accounting rules and standards.

d. all of the options are advantages of the NPV method.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Which of the below is a disadvantage of the NPV method?

a. The timing of cash flows is not considered.

b. It does not take into account all of the expected cash flows.

c. The actual return in terms of the percentage of the investment outlay is not revealed.

d. All of the options are disadvantages of the NPV method.

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. What is the taxation impact on a simple investment?

a. Both cash inflows and outflows are lower

b. Cash flows are not affected

c. Cash outflows are lower

d. Cash inflows are lower

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. When analysing most investment options:

a. the analysis assumes that sufficient human resources will be available.

b. the investment will be impacted by taxation.

c. the analysis assumes that the relevant finance options are available.

d. all of the options are true in regards to most investment analysis.

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. In Australia, the dividend imputation scheme treats taxation on investments differently according to whether the entity undertaking the investment is:

a. classified as large or small.

b. a sole trader, partnership or company.

c. registered for GST.

d. a public or private company.

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. The dividend imputation scheme means investors in companies that pay income tax are able to claim back which of the following against their dividend income?

a. Tax expenses

b. Tax credits

c. Tax debits

d. The full amount of dividend income

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Which factor below should be considered when making an investment decision?

a. Available monetary and human resources

b. Any taxation impacts

c. Social responsibilities

d. All of the above require consideration

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Which of the following is least likely to build customer loyalty?

a. Reward for past service

b. Product or service always available when required

c. Fast response times

d. Completing supply contracts within the time parameters

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Which factor does not come into consideration for entities making investment decisions?

a. Goodwill and future opportunities

b. Human resources

c. Finance

d. All of the options listed require consideration

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Which option below describes a valid reason why an entity might take on a project or investment that it would rather not?

a. To keep faith with its customers

b. To secure further mutually satisfactory business deals in the future

c. So that their service will be recognised

d. All of the options listed describe why an entity might take on a project/investment it would rather not.

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

Fill in the blanks

1. When considering whether to keep a machine or replace it, the original cost of the machine ________ (is/is not) a factor that must be considered in the decision-making process.

a. is not

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Once an investment decision has been made, the next step is often the ___________ decision.

a. financing

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. Uncertainty in investment decisions is the unmeasurable variation in outcomes while ___________ is defined as the measurable variation in outcomes.

a. risk

Learning objective 12.1 ~ Explain the nature and scope of investment decisions

1. The cost of forgoing benefits from an alternative investment is known as the ___________ cost.

a. opportunity

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. The accounting rate of return is calculated as average _____________ divided by average_____________.

a. profit, investment

Learning objective 12.2 ~ Describe and apply the concept of the accounting rate of return (ARR)

1. The period of time necessary to recoup the initial investment outlay from net cash flows is referred to as the ___________ period.

a. payback

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. The ___________ (shorter/longer) a payback period is, the greater the risk.

a. longer

Learning objective 12.3 ~ Explain and use the payback period (PP) method

1. The _____________ cost is the cost of forgoing the benefit from an alternative investment.

a. opportunity

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Discounted cash flow models assume that $100 received now is worth __________________ (more/less) than $100 received in the future.

a. more

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. A project with a higher discount rate will generally have a __________ (higher/lower) level of risk.

a. higher

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Ranking projects with a higher NPV above other projects when capital is limited is considered to be a(n) _________ (advantage/disadvantage) of the NPV method.

a. disadvantage

Learning objective 12.4 ~ Discuss and calculate net present values (NPV) and apply the decision rule

1. Social and environment factors have become important concerns for a(n) _________________ (increasing/decreasing) number of investments.

a. increasing

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. The effect of dividend imputation on the PV analysis of investments will depend on the ______________ structure of the entity involved.

a. legal

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Cash flow analysis for investment decision making can be further complicated by the effect of _______________.

a. taxation

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions

1. Investments requiring specialised services must also consider whether or not the ____________ with the relevant skills will be available when they are needed.

a. tradespeople

Learning objective 12.5 ~ Explain some of the practical issues in making investment decisions