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Chapter 14Capital Budgeting DecisionsTrue/False1.FMediumThe present value of a given sum to be received in five years will be exactly twice as great as the present value of an equal sum to be received in ten years.2. F MediumAn increase in the discount rate will result in an increase in the present ...

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Ch ap t e r1 4 Capi t al Bud get i ngDec i s i ons

True/False 1.

The present value of a given sum to be received in five years

F Medium

will be exactly twice as great as the present value of an equal sum to be received in ten years.

2. F

An increase in the discount rate will result in an increase in the present value of a given cash flow.

Medium 3. T

The present value of a cash flow decreases as it moves further into the future.

Easy 4.

When the net present value method is used, the internal rate of

F

return is the discount rate used to compute the net present value

Medium

of a project.

5.

If net present value is negative, then interpolation is needed in

F

order to make a proposed investment acceptable.

Medium 6.

The net present value method assumes that cash flows from a

T

project are immediately reinvested at a rate of return equal to

Medium

the discount rate.

7.

When using internal rate of return to evaluate investment

F

projects, if the internal rate of return is less than the

Easy

required rate of return, the project should be accepted.

8.

The internal rate of return for a project is the discount rate

T Easy

that makes the net present value of the project equal to zero.

9.

In comparing two investment alternatives, the difference between

T

the net present values of the two alternatives obtained using the

Medium

total cost approach will be the same as the net present value obtained using the incremental cost approach.

10.

The payback period is the length of time it takes for an

T

investment to recoup its own initial cost out of the cash

Easy

receipts it generates.

Managerial Accounting, 9/e

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11.

Projects with shorter payback periods are always more profitable

F

than projects with longer payback periods.

Medium 12.

The payback method of making capital budgeting decisions gives

F Easy

full consideration to the time value of money.

13.

If new equipment is replacing old equipment, any salvage received

F Easy

from sale of the old equipment should not be considered in computing the payback period of the new equipment.

14. F

One strength of the simple rate of return method is that it takes into account the time value of money in computing the return on

Easy

an investment project.

15. T

The preference rule for ranking projects by the profitability index is: the higher the profitability index, the more desirable

Easy

the project.

Multiple Choice 16.

An increase in the discount rate:

C

a. will increase the present value of future cash flows.

Medium

b. will have no effect on net present value. c. will reduce the present value of future cash flows. d. is one method of compensating for reduced risk.

17.

Suppose an investment has cash inflows of R dollars at the end of

B

each year for two years. The present value of these cash inflows

Medium

using a 12% discount rate will be: a. greater than under a 10% discount rate. b. less than under a 10% discount rate. c. equal to that under a 10% discount rate. d. sometimes greater than under a 10% discount rate and sometimes less; it depends on R.

18.

The net present value and internal rate of return methods of

B Medium

capital budgeting are superior to the payback method in that they:

CPA adapted

a. are easier to implement. b. consider the time value of money. c. require less input. d. reflect the effects of depreciation and income taxes.

6

Managerial Accounting, 9/e

19.

How are the following used in the calculation of the net

C

present value of a proposed project? Ignore income tax

Medium CPA

considerations.

adapted



20.

Depreciation expense

Salvage value

a. b.

Include Include

Include Exclude

c.

Exclude

Include

d.

Exclude

Exclude

The net present value method takes into account:

D Medium CPA

 

Cash Flow Over Life of Project

Time Value of Money

adapted

a.

No

Yes

b.

No

No

c. d.

Yes Yes

No Yes

21. C

The net present value method of capital budgeting assumes that cash flows are reinvested at:

Easy

a. the internal rate of return on the project.

CMA

b. the rate of return on the company's debt.

adapted

c. the discount rate used in the analysis. d. a zero rate of return.

22. C

Some investment projects require that a company expand its working capital to service the greater volume of business that

Medium

will be generated. Under the net present value method, the investment of working capital should be treated as: a. an initial cash outflow for which no discounting is necessary. b. a future cash inflow for which discounting is necessary. c. both an initial cash outflow for which no discounting is necessary and a future cash inflow for which discounting is necessary. d. irrelevant to the net present value analysis.

23.

(Ignore income taxes in this problem.) How is depreciation

A

handled by the following capital budgeting techniques?

Medium CMA adapted

 

Internal Rate of Return

Simple Rate of Return

Payback

a.

Excluded

Included

Excluded

b. c.

Included Excluded

Excluded Excluded

Included Included

d.

Included

Included

Excluded

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24.

Which of the following capital budgeting techniques consider(s)

B

cash flow over the entire life of the project?

Easy CPA



adapted

a.

Yes

Yes

b. c.

Yes No

No Yes

d.

No

Internal rate of return

Payback

No

25. C

A weakness of the internal rate of return method for screening investment projects is that it:

Medium

a. does not consider the time value of money.

CMA adapted

b. implicitly assumes that the company is able to reinvest cash flows from the project at the company's discount rate. c. implicitly assumes that the company is able to reinvest cash flows from the project at the internal rate of return. d. does not take into account all of the cash flows from a project.

26. A

If the net present value of a project is zero based on a discount rate of sixteen percent, then the time-adjusted rate

Medium

of return: a. is equal to sixteen percent. b. is less than sixteen percent. c. is greater than sixteen percent. d. cannot be determined from the information given.

27.

The payback method measures:

A

a. how quickly investment dollars may be recovered.

Easy

b. the cash flow from an investment.

CMA adapted

c. the economic life of an investment. d. the profitability of an investment.

28.

An investment project that requires a present investment of

B Medium

$210,000 will have cash inflows of "R" dollars each year for the next five years. The project will terminate in five years. Consider the following statements (ignore income tax considerations):  I. If "R" is less than $42,000, the payback period exceeds the life of the project. II. If "R" is greater than $42,000, the payback period exceeds the life of the project. III. If "R" equals $42,000, the payback period equals the life of the project. Which statement(s) is (are) true? a. Only I and II. b. Only I and III. c. Only II and III. d. I, II, and III.

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Managerial Accounting, 9/e

29.

Which one of the following statements about the payback method

A

of capital budgeting is correct?

Easy CMA

a. The payback method does not consider the time value of money.

adapted

b. The payback method considers cash flows after the payback has been reached. c. The payback method uses discounted cash flow techniques. d. The payback method will lead to the same decision as other methods of capital budgeting.

30.

The evaluation of an investment having uneven cash flows using

B

the payback method:

Medium

a. cannot be done. b. can be done only by matching cash inflows and investment outflows on a year-by-year basis. c. will product essentially the same results as those obtained through the use of discounted cash flow techniques. d. requires the use of a sophisticated calculator or computer software.

31.

The capital budgeting method that divides a project's annual

B

incremental net income by the initial investment is the:

Medium

a. internal rate of return method.

CMA adapted

b. the simple ( or accounting) rate of return method. c. the payback method. d. the net present value method.

32.

When determining a net present value in an inflationary

B

environment, adjustments should be made to:

Medium

a. decrease the discount rate only.

CMA

b. increase the estimated cash flows and increase the discount

adapted

rate. c. increase the estimated cash flows only. d. increase the estimated cash flows and decrease the discount rate.

33.

(Ignore income taxes in this problem.) Kipling Company has

B Hard

invested in a project that has an eight-year life. It is expected that the annual cash inflow from the project will be

CPA

$20,000. Assuming that the project has a internal rate of

adapted

return of 12%, how much was the initial investment in the project? a. $160,000 b. $99,360 c. $80,800 d. $64,640

Managerial Accounting, 9/e

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34.

(Ignore income taxes in this problem.) White Company's required

D

rate of return on capital budgeting projects is 12%. The

Medium

company is considering an investment opportunity which would yield a cash flow of $10,000 in five years. What is the most that the company should be willing to invest in this project? a. $36,050. b. $2,774. c. $17,637. d. $5,670.

35.

(Ignore income taxes in this problem.) In order to receive

C

$12,000 at the end of three years and $10,000 at the end of

Easy

five years, how much must be invested now if you can earn 14% rate of return? a. $12,978. b. $8,100. c. $13,290. d. $32,054.

36. C

(Ignore income taxes in this problem.) Sue Falls is the president of Sports, Inc. She is considering buying a new

Hard

machine that would cost $14,125. Sue has determined that the new machine promises a internal rate of return of 12%, but Sue has misplaced the paper which tells the annual cost savings promised by the new machine. She does remember that the machine has a projected life of 10 years. Based on these data, the annual cost savings are: a. it is impossible to determine from the data given. b. $1,412.50. c. $2,500.00. d. $1,695.00.

37.

(Ignore income taxes in this problem.) The following

C

information is available on a new piece of equipment:

Hard 

Cost of the equipment ......

$21,720



Annual cash inflows ........

$5,000

 

Internal rate of return Required rate of return

... ...

16% 10%

The life of the equipment is approximately: a. 6 years. b. 4.3 years. c. 8 years. d. it is impossible to determine from the data given.

10 Managerial Accounting, 9/e

38.

(Ignore income taxes in this problem.) A planned factory

C

expansion project has an estimated initial cost of $800,000.

Hard CPA adapted

Using a discount rate of 20%, the present value of future cost savings from the expansion is $843,000. To yield exactly a 20% internal rate of return, the actual investment cost cannot exceed the $800,000 estimate by more than: a. $160,000. b. $20,000. c. $43,000. d. $1,075.

39.

(Ignore income taxes in this problem.) Hilltop Company invested

D Hard

$100,000 in a two-year project. The cash flow was $40,000 for the first year. Assuming that the internal rate of return was

CPA adapted

exactly 12%, what was the cash flow for the second year of the project? a. $51,247. b. $60,000. c. $64,284. d. $80,652.

40.

(Ignore income taxes in this problem.) Joe Flubup is the

C

president of Flubup, Inc. He is considering buying a new

Hard

machine that would cost $25,470. Joe has determined that the new machine promises a internal rate of return of 14%, but Joe has misplaced the paper which tells the annual cost savings promised by the new machine. He does remember that the machine has a projected life of 12 years. Based on these data, the annual cost savings are: a. impossible to determine from the data given. b. $2,122.50. c. $4,500.00. d. $4,650.00.

41. B

(Ignore income taxes in this problem.) The Baker Company purchased a piece of equipment with the following expected

Hard

results:  Useful life ................... 7 years 

Yearly net cash inflow ........ $50,000



Salvage value .................

-0-

 

Internal rate of return ....... Discount rate .................

20% 16%

The initial cost of the equipment was: a. $300,100. b. $180,250 c. $190,600. d. Cannot be determined from the information given.

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42.

(Ignore income taxes in this problem.) Highpoint, Inc., is

B

considering investing in automated equipment with a ten-year

Hard

useful life. Managers at Highpoint have estimated the cash flows associated with the tangible costs and benefits of automation, but have been unable to estimate the cash flows associated with the intangible benefits. Using the company's 10% discount rate, the net present value of the cash flows associated with just the tangible costs and benefits is a negative $184,350. How large would the annual net cash inflows from the intangible benefits have to be to make this a financially acceptable investment? a. $18,435. b. $30,000. c. $35,000. d. $37,236.

43. B

(Ignore income taxes in this problem.) Given the following data:

Hard  

Present investment required .. Net present value ............

$12,000 $ 430



Annual cost savings ..........

$



Discount rate ................



Life of the project .......... 10 years

? 12%

Based on the data given, the annual cost savings would be: a. $1,630.00. b. $2,200.00. c. $2,123.89. d. $2,553.89. 44. A

(Ignore income taxes in this problem.) The following data pertain to an investment in equipment:

Medium  

Investment in the project .......... Net annual cash inflows ............

$10,000 2,400



Working capital required ...........

5,000

 

Salvage value of the equipment ..... Life of the project ................

1,000 8 years

At the completion of the project, the working capital will be released for use elsewhere. Compute the net present value of the project, using a discount rate of 10%: a. $606. b. $8,271. c. ($1,729). d. $1,729.

12 Managerial Accounting, 9/e

45.

(Ignore income taxes in this problem.) A piece of equipment has

A

a cost of $20,000. The equipment will provide cost savings of

Medium

$3,500 each year for ten years, after which time it will have a salvage value of $2,500. If the company's discount rate is 12%, the equipment's net present value is: a. $580. b. ($225). c. $17,500. d. $2,275.

46.

(Ignore income taxes in this problem.) Parks Company is

D

considering an investment proposal in which a working capital

Medium

investment of $10,000 would be required. The investment would provide cash inflows of $2,000 per year for six years. The working capital would be released for use elsewhere when the project is completed. If the company's discount rate is 10%, the investment's net present value is: a. $1,290. b. ($1,290). c. $2,000. d. $4,350.

47.

(Ignore income taxes in this problem.) The following data

A Medium

pertain to an investment proposal: 

Investment in the project (equipment) ..

$14,000

 

Net annual cash inflows promised ....... Working capital required ...............

2,800 5,000



Salvage value of the equipment .........

1,000



Life of the project .................... 10 years

The working capital would be released for use elsewhere when the project is completed. What is the net present value of the project, using a discount rate of 8%? a. $2,566. b. ($251). c. $251. d. $5,251.

Managerial Accounting, 9/e

13

48.

(Ignore income taxes in this problem.) Boston Company is

C

contemplating the purchase of a new machine on which the

Medium

following information has been gathered: 

Cost of the machine ...............

$38,900

 

Annual cash inflows expected ...... Salvage value .....................

$10,000 $ 5,000



Life of the machine ...............

6 years

The company's discount rate is 16%, and the machin...