Test Bank - Chapter14 Capital Budgeting

7/17/2019 Test Bank - Chapter14 Capital Budgeting

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Chapter 14

Capital Budgeting Decisions

True/False

1.

F

Medium

The 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

Medium

An increase in the discount rate will result in an increase in

the present value of a given cash flow.

3.

T

Easy

The present value of a cash flow decreases as it moves further

into the future.

4.

F

Medium

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

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

of a project.

5.

F

Medium

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

order to make a proposed investment acceptable.

6.

T

Medium

The net present value method assumes that cash flows from a

project are immediately reinvested at a rate of return equal to

the discount rate.

7.

F

Easy

When using internal rate of return to evaluate investment

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

required rate of return, the project should be accepted.

8.

T

Easy

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

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

9.

T

Medium

In comparing two investment alternatives, the difference between

the net present values of the two alternatives obtained using the

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

10.

T

Easy

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

investment to recoup its own initial cost out of the cash

receipts it generates.

Managerial Accounting, 9/e 5



11.

F

Medium

Projects with shorter payback periods are always more profitable

than projects with longer payback periods.

12.

FEasy

The payback method of making capital budgeting decisions gives

full consideration to the time value of money.

13.

F

Easy

If new equipment is replacing old equipment, any salvage received

from sale of the old equipment should not be considered in

computing the payback period of the new equipment.

14.

F

Easy

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

an investment project.

15.

T

Easy

The preference rule for ranking projects by the profitability

index is: the higher the profitability index, the more desirable

the project.

Multiple Choice

16.

C

Medium

An increase in the discount rate:

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

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.

B

Medium

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

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

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.

B

Medium

CPA adapted

The net present value and internal rate of return methods of

capital budgeting are superior to the payback method in that

they:

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.

Managerial Accounting, 9/e6



19.

C

Medium

CPA

adapted

How are the following used in the calculation of the net

present value of a proposed project? Ignore income tax

considerations.

Depreciation expense Salvage value

a. Include Includeb. Include Exclude

c. Exclude Include

d. Exclude Exclude

20.

D

Medium

CPA

adapted

The net present value method takes into account:

Cash Flow Over Time Value

Life of Project of Money

a. No Yes

b. No No

c. Yes No

d. Yes Yes

21.

C

Easy

CMA

adapted

The net present value method of capital budgeting assumes that

cash flows are reinvested at:

a. the internal rate of return on the project.

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

c. the discount rate used in the analysis.

d. a zero rate of return.

22.

C

Medium

Some investment projects require that a company expand its

working capital to service the greater volume of business that

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.

A

Medium

CMA

adapted

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

handled by the following capital budgeting techniques?

Internal Simple

Rate of Return Rate of Return Payback

a. Excluded Included Excluded

b. Included Excluded Included

c. Excluded Excluded Included

d. Included Included Excluded




24.

B

Easy

CPA

adapted

Which of the following capital budgeting techniques consider(s)

cash flow over the entire life of the project?

Internal rate of return Payback

a. Yes Yes

b. Yes Noc. No Yes

d. No No

25.

C

Medium

CMA

adapted

A weakness of the internal rate of return method for screening

investment projects is that it:

a. does not consider the time value of money.

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

Medium

If the net present value of a project is zero based on a

discount rate of sixteen percent, then the time-adjusted rate

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.

A

Easy

CMA adapted

The payback method measures:

a. how quickly investment dollars may be recovered.

b. the cash flow from an investment.

c. the economic life of an investment.

d. the profitability of an investment.

28.

B

Medium

An investment project that requires a present investment of

$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.




29.

A

Easy

CMA

adapted

Which one of the following statements about the payback method

of capital budgeting is correct?

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

money.

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.

B

Medium

The evaluation of an investment having uneven cash flows using

the payback method:

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.

B

Medium

CMA adapted

The capital budgeting method that divides a project's annual

incremental net income by the initial investment is the:

a. internal rate of return method.

b. the simple ( or accounting) rate of return method.

c. the payback method.

d. the net present value method.

32.

B

Medium

CMA

adapted

When determining a net present value in an inflationary

environment, adjustments should be made to:

a. decrease the discount rate only.

b. increase the estimated cash flows and increase the discount

rate.

c. increase the estimated cash flows only.

d. increase the estimated cash flows and decrease the discount

rate.

33.

B

Hard

CPA

adapted

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

invested in a project that has an eight-year life. It is

expected that the annual cash inflow from the project will be

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

return of 12%, how much was the initial investment in the

project?

a. $160,000

b. $99,360

c. $80,800

d. $64,640




34.

D

Medium

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

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

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.

C

Easy

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

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

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

Hard

(Ignore income taxes in this problem.) Sue Falls is the

president of Sports, Inc. She is considering buying a new

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.

C

Hard

(Ignore income taxes in this problem.) The following

information is available on a new piece of equipment:

Cost of the equipment ...... $21,720

Annual cash inflows ........ $5,000

Internal rate of return ... 16%

Required rate of return ... 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.




38.

C

Hard

CPA adapted

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

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

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.

D

Hard

CPA adapted

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

$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

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.

C

Hard

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

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

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

Hard

(Ignore income taxes in this problem.) The Baker Company

purchased a piece of equipment with the following expected

results:

Useful life ................... 7 years

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

Salvage value ................. -0-

Internal rate of return ....... 20%

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




42.

B

Hard

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

considering investing in automated equipment with a ten-year

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's10% 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

Hard

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

data:

Present investment required .. $12,000

Net present value ............ $ 430

Annual cost savings .......... $ ?

Discount rate ................ 12%

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

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

Medium

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

pertain to an investment in equipment:

Investment in the project .......... $10,000

Net annual cash inflows ............ 2,400

Working capital required ........... 5,000

Salvage value of the equipment ..... 1,000

Life of the project ................ 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.




45.

A

Medium

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

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

$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.

D

Medium

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

considering an investment proposal in which a working capital

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.

A

Medium


pertain to an investment proposal:

Investment in the project (equipment) .. $14,000

Net annual cash inflows promised ....... 2,800

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




48.

C

Medium

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

contemplating the purchase of a new machine on which the

following information has been gathered:

Cost of the machine ............... $38,900

Annual cash inflows expected ...... $10,000 Salvage value ..................... $ 5,000

Life of the machine ............... 6 years

The company's discount rate is 16%, and the machine will be

depreciated using the straight-line method. Given these data,

the machine has a net present value of:

a. -$26,100.

b. -$23,900.

c. $0.

d. +$26,100.

49.

BHard

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

considering the purchase of a machine that costs $100,000 andhas a useful life of 18 years. The company's required discount

rate is 12%. If the machine's net present value is $5,850, then

the annual cash inflows associated with the machine must be

(round to the nearest whole dollar):

a. $42,413.

b. $14,600.

c. $13,760.

d. it is impossible to determine from the data given.

50.

C

Hard

CPA adapted

(Ignore income taxes in this problem.) Horn Corporation is

considering investing in a four-year project. Cash inflows from

the project are expected to be as follows: Year 1, $2,000; Year

2, $2,200; Year 3, $2,400; Year 4, $2,600. If using a discount

rate of 8%, the project has a positive net present value of

$500, what was the amount of the original investment?

a. $1,411.

b. $2,411.

c. $7,054.

d. $8,054.

51.

B

Medium

(Ignore income taxes in this problem.) The Whitton Company uses

a discount rate of 16%. The company has an opportunity to buy a

machine now for $18,000 that will yield cash inflows of $10,000

per year for each of the next three years. The machine would

have no salvage value. The net present value of this machine to

the nearest whole dollar is:

a. $22,460.

b. $4,460.

c. $(9,980).

d. $12,000.




52.

D

Medium


pertain to an investment:

Cost of the investment ........ $18,955

Life of the project ........... 5 years

Annual cost savings ........... $ 5,000 Estimated salvage value ....... $ 1,000

Discount rate ................. 10%

The net present value of the proposed investment is:

a. $3,355.

b. ($3,430).

c. $-0-.

d. $621.

53.

D

Medium



Cost of the investment .......... $20,000 Annual cost savings ............. $ 5,000

Estimated salvage value ......... $ 1,000

Life of the project ............. 8 years

Discount rate ................... 16%

The net present value of the proposed investment is:

a. $1,720.

b. $6,064.

c. $2,154.

d. $2,025.

54.

C

Hard

(Ignore income taxes in this problem.) Stratford Company

purchased a machine with an estimated useful life of seven

years. The machine will generate cash inflows of $90,000 each

year over the next seven years. If the machine has no salvage

value at the end of seven years, and assuming the company's

discount rate is 10%, what is the purchase price of the machine

if the net present value of the investment is $170,000?

a. $221,950.

b. $170,000.

c. $268,120.

d. $438,120.

55.

C

Medium

(Ignore income taxes in this problem.) Sam Weller is thinking

of investing $70,000 to start a bookstore. Sam plans to

withdraw $15,000 from the business at the end of each year for

the next five years. At the end of the fifth year, Sam plans to

sell the business for $110,000 cash. At a 12% discount rate,

what is the net present value of the investment?

a. $54,075.

b. $62,370.

c. $46,445.

d. $70,000.




56.

D

Hard

(Ignore income taxes in this problem.) Arthur operates a part-

time auto repair service. He estimates that a new diagnostic

computer system will result in increased cash inflows of $2,100

in Year 1, $3,200 in Year 2, and $4,000 in Year 3. If Arthur's

discount rate is 10%, then the most he would be willing to pay

for the new computer system would be:a. $6,652.

b. $6,984.

c. $7,747.

d. $7,556.

57.

C

Medium



Present investment required ........ $26,500

Annual cost savings ................ $ 5,000

Projected life of the investment ... 10 years

Projected salvage value ............ $ -0-

The internal rate of return, interpolated to the nearest tenth

of a percent, would be:

a. 11.6%.

b. 12.8%.

c. 13.6%.

d. 12.4%.

58.

A

Medium

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

available on a proposed investment project:

Initial investment ......... $142,500

Annual cash inflows ........ $30,000

Life of the investment ..... 8 years

Required rate of return .... 10%



a. 13.3%.

b. 12.1%.

c. 15.3%.

d. 12.7%.




59.

C

Medium



Present investment required ........ $14,000

Annual cost savings ................ $ 2,500

Projected life of the investment ... 8 years Projected salvage value ............ $ -0-

Required rate of return ............ 6%



a. 6.7%.

b. 9.3%.

c. 8.7%.

d. 7.3%.

60.

A

Hard

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

gathered the following data on a proposed investment project:

Investment in depreciable equipment .... $150,000

Annual cash flows ...................... $ 40,000

Life of the equipment .................. 10 years

Salvage value .......................... -0-

Discount rate .......................... 10%

The internal rate of return on this investment is closest to:

a. 23.4%.

b. 25.4%.

c. 22.7%

d. 22.1%

61.

A

Medium

(Ignore income taxes in this problem.) The following

information concerns a proposed investment:

Investment required ........ $14,150

Annual savings ............. $ 2,500

Life of the project ........ 12 years

The internal rate of return is (do not interpolate):

a. 14%.

b. 12%.

c. 10%.

d. 5%.




62.

A

Medium

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

studying a project that would have a ten-year life and would

require a $450,000 investment in equipment that has no salvage

value. The project would provide net income each year as

follows for the life of the project:

Sales ............................ $500,000

Less cash variable expenses ...... 200,000

Contribution margin .............. 300,000

Less fixed expenses:

Fixed cash expenses ............ $150,000

Depreciation expenses .......... 45,000 195,000

Net income ....................... $105,000

The company's required rate of return is 12%. What is the

payback period for this project?

a. 3 years

b. 2 years

c. 4.28 yearsd. 9 years

63.

A

Medium

(Ignore income taxes in this problem.) Buy-Rite Pharmacy has

purchased a small auto for delivering prescriptions. The auto

was purchased for $9,000 and will have a 6-year useful life and

a $3,000 salvage value. Delivering prescriptions (which the

pharmacy has never done before) should increase gross revenues

by at least $5,000 per year. The cost of these prescriptions to

the pharmacy will be about $2,000 per year. The pharmacy

depreciates all assets using the straight-line method. The

payback period for the auto is:

a. 3.0 years.

b. 1.8 years.

c. 2.0 years.

d. 1.2 years.

64.

C

Easy

(Ignore income taxes in this problem.) A company with $800,000

in operating assets is considering the purchase of a machine

that costs $75,000 and which is expected to reduce operating

costs by $20,000 each year. The payback period for this machine

in years is closest to:

a. 0.27 years.

b. 10.7 years.

c. 3.75 years.

d. 40 years.




65.

B

Easy

(Ignore income taxes in this problem.) The Higgins Company has

just purchased a piece of equipment at a cost of $120,000. This

equipment will reduce operating costs by $40,000 each year for

the next eight years. This equipment replaces old equipment

that was sold for $8,000 cash. The new equipment has a payback

period of:a. 8.0 years.

b. 2.8 years.

c. 10.0 years.

d. 3.0 years.

66.

D

Medium

CMA

adapted

(Ignore income taxes in this problem.) The Keego Company is

planning a $200,000 equipment investment that has an estimated

five-year life with no estimated salvage value. The company has

projected the following annual cash flows for the investment.

Year Cash Inflows

1 $120,000

2 60,000 3 40,000

4 40,000

5 40,000

Total $300,000

Assuming that the cash inflows occur evenly over the year, the

payback period for the investment is:

a. 0.75 years.

b. 1.67 years.

c. 4.91 years.

d. 2.50 years.

67.

A

Hard

(Ignore income taxes in this problem.) Denny Corporation is

considering replacing a technologically obsolete machine with a

new state-of-the-art numerically controlled machine. The new

machine would cost $450,000 and would have a ten-year useful

life. Unfortunately, the new machine would have no salvage

value. The new machine would cost $20,000 per year to operate

and maintain, but would save $100,000 per year in labor and

other costs. The old machine can be sold now for scrap for

$50,000. The simple rate of return on the new machine is

closest to:

a. 8.75%.

b. 20.00%.

c. 7.78%.

d. 22.22%.




68.

A

Medium

(Ignore income taxes in this problem.) The Jason Company is

considering the purchase of a machine that will increase

revenues by $32,000 each year. Cash outflows for operating this

machine will be $6,000 each year. The cost of the machine is

$65,000. It is expected to have a useful life of five years

with no salvage value. For this machine, the simple rate ofreturn is:

a. 20%.

b. 40%.

c. 49.2%.

d. 9.2%.

69.

A

Easy

Perkins Company is considering several investment proposals, as

shown below:

Investment Proposal o

A B C D

Investment required ... $80,000 $100,000 $60,000 $75,000

Present value of future

net cash flows ...... 96,000 150,000 84,000 120,000

Rank the proposals in terms of preference using the

profitability index:

a. D, B, C, A.

b. B, D, C, A.

c. B, D, A, C.

d. A, C, B, D.

70.

C

Easy

Information on four investment proposals is given below:

Proposal Investment Net Present Value

1 $50,000 $30,000

2 60,000 24,000

3 30,000 15,000

4 45,000 9,000

Rank the proposals in terms of preference according to the

profitability index:

a. 3, 4, 1, 2.

b. 1, 2, 3, 4.

c. 1, 3, 2, 4.

d. 2, 1, 4, 3.

Reference: 14-1

(Ignore income taxes in this problem.) Shields Company has gathered the

following data on a proposed investment project:

Investment required in equipment ..... $400,000

Annual cash inflows .................. $80,000

Salvage value ........................ $-0-

Life of the investment ............... 10 years

Discount rate ........................ 10%




71.

D

Easy

Refer To:

14-1

The payback period for the investment is closest to:

a. 0.2 years.

b. 1.0 years.

c. 3.0 years.

d. 5.0 years.

72.

B

Medium

Refer To:

14-1

The simple rate of return on the investment is closest to:

a. 5%.

b. 10%.

c. 15%.

d. 20%.

73.

C

Medium

Refer To:

14-1

The net present value on this investment is closest to:

a. $400,000.

b. $80,000.

c. $91,600.

d. $76,750.

74.C

Medium

Refer To:

14-1

The internal rate of return on the investment is closest to:a. 11%.

b. 13%.

c. 15%.

d. 17%.

Reference: 14-2

(Ignore income taxes in this problem.) Bugle's Bagel Bakery is investigating

the purchase of a new bagel making machine. This machine would provide an

annual operating cost savings of $3,650 for each of the next 4 years. In

addition, this new machine would allow the production of one new type of

bagel that would result in selling 1,500 dozen more bagels each year. The

company earns a contribution margin of $0.90 on each dozen bagels sold. The

purchase price of this machine is $13,450 and it will have a 4-year useful

life. Bugle's discount rate is 14%.

75.

D

Medium

Refer To:

14-2

The total annual cash inflow from this machine for capital

budgeting purposes is:

a. $3,650.

b. $5,150.

c. $4,750.

d. $5,000.

76.

C

Medium

Refer To:

14-2

The internal rate of return for this investment is closest to:

a. 14%.

b. 16%.

c. 18%.

d. 20%.




77.

A

Medium

Refer To:

14-2

The net present value of this investment is closest to:

a. $1,120.

b. $6,550.

c. $13,450.

d. $20,000.

Reference: 14-3

(Ignore income taxes in this problem.) Treads Corporation is considering the

replacement of an old machine that is currently being used. The old machine

is fully depreciated but can be used by the corporation for five more years.

If Treads decides to replace the old machine, Picco Company has offered to

purchase the old machine for $60,000. The old machine would have no salvage

value in five years.

The new machine would be acquired from Hillcrest Industries for $1,000,000

in cash. The new machine has an expected useful life of five years with no

salvage value. Due to the increased efficiency of the new machine, estimated

annual cash savings of $300,000 would be generated.

Treads Corporation uses a discount rate of 12%.

78.

C

Medium

Refer To:

14-3

The net present value of the project is closest to:

a. $171,000.

b. $136,400.

c. $141,500.

d. $560,000.

79.

C

Medium

Refer To:

14-3

The internal rate of return of the project is closest to:

a. 14%.

b. 16%.

c. 18%.

d. 20%.

Reference: 14-4

(Ignore income taxes in this problem.) Oriental Company has gathered the

following data on a proposed investment project:

Investment in depreciable equipment ..... $200,000

Annual net cash flows ................... $ 50,000

Life of the equipment ................... 10 years

Salvage value ........................... -0-

Discount rate ........................... 10%

The company uses straight-line depreciation on all equipment.

80.

D

Medium

Refer To:

14-4

The payback period for the investment would be:

a. 2.41 years.

b. 0.25 years.

c. 10 years.

d. 4 years.




81.

C

Medium

Refer To:

14-4

The simple rate of return on the investment would be:

a. 10%.

b. 35%.

c. 15%.

d. 25%.

82.

B

Medium

Refer To:

14-4

The net present value of this investment would be:

a. ($14,350).

b. $107,250.

c. $77,200.

d. $200,000.

Reference: 14-5

(Ignore income taxes in this problem.) Apex Corp. is planning to buy

production machinery costing $100,000. This machinery's expected useful life

is five years, with no residual value. Apex uses a discount rate of 10% and

has calculated the following data pertaining to the purchase and operation

of this machinery:

Estimated

annual net

Year cash inflow

1 $ 60,000

2 30,000

3 20,000

4 20,000

5 20,000

83.

A

Medium

CPA

adapted

Refer To:

14-5

The payback period is:

a. 2.50 years.

b. 2.75 years.

c. 3.00 years.

d. 5.00 years.

84.

A

Medium

CPA

adapted

Refer To:

14-5

The net present value is closest to:

a. $20,400.

b. $28,400.

c. $80,000.

d. $50,000.




Reference: 14-6

(Ignore income taxes in this problem.) The Finney Company is reviewing the

possibility of remodeling one of its showrooms and buying some new equipment

to improve sales operations. The remodeling would cost $120,000 now and the

useful life of the project is 10 years. Additional working capital needed

immediately for this project would be $30,000; the working capital would be

released for use elsewhere at the end of the 10-year period. The equipmentand other materials used in the project would have a salvage value of

$10,000 in 10 years. Finney's discount rate is 16%.

85.

B

Easy

Refer To:

14-6

The immediate cash outflow required for this project would be:

a. $(120,000).

b. $(150,000).

c. $(90,000).

d. $(130,000).

86.

D

Hard

Refer To:14-6

What would the annual net cash inflows from this project have

to be in order to justify investing in remodeling?

a. $14,495

b. $35,842c. $16,147

d. $29,158

Reference: 14-7

(Ignore income taxes in this problem.) The Sawyer Company has $80,000 to

invest and is considering two different projects, X and Y. The following

data are available on the projects:

Project X Project Y

Cost of equipment needed now ... $80,000 --

Working capital requirement .... -- $80,000

Annual cash operating inflows .. $23,000 $18,000

Salvage value in 5 years ....... $ 6,000 --

Both projects will have a useful life of 5 years; at the end of 5 years, the

working capital will be released for use elsewhere. Sawyer's discount rate

is 12%.

87.

D

Medium

Refer To:

14-7

The net present value of project X is:

a. $2,915.

b. $(11,708).

c. $5,283.

d. $6,317.

88.

B

Medium

Refer To:

14-7

The net present value of project Y is closest to:

a. $15,110.

b. $30,250.

c. $11,708.

d. $(11,708).




Reference: 14-8

(Ignore income taxes in this problem.) The Becker Company is interested in

buying a piece of equipment that it needs. The following data have been

assembled concerning this equipment:

Cost of required equipment .......... $250,000

Working capital required ............ $100,000 Annual operating cash inflows........ $ 80,000

Cash repair at end of 4 years ....... $ 40,000

Salvage value at end of 6 years ..... $ 90,000

This equipment is expected to have a useful life of 6 years. At the end of

the sixth year the working capital would be released for use elsewhere. The

company's discount rate is 10%.

89.

C

Easy

Refer To:

14-8

The present value of all future operating cash inflows is

closest to:

a. $480,000.

b. $452,300.

c. $348,400.d. $278,700.

90.

B

Easy

Refer To:

14-8

The present value of the net cash flows (all cash inflows less

all cash outflows) occurring during year 4 is:

a. $40,000.

b. $27,320.

c. $54,640.

d. $42,790.

91.

D

Medium

Refer To:

14-8

The present value of the net cash flows (all cash inflows less

all cash outflows) occurring during year 6 is closest to:

a. $270,000.

b. $195,900.

c. $107,200.

d. $152,300.

Reference: 14-9

(Ignore income taxes in this problem.) UR Company is considering rebuilding

and selling used alternators for automobiles. The company estimates that the

net operating cash flows (sales less cash operating expenses) arising from

the rebuilding and sale of the used alternators would be as follows (numbers

in parentheses indicate an outflow):

Years 1 - 10 ... $ 90,000

Year 11 ........ (20,000)

Year 12 ........ 100,000

In addition to the above net operating cash flows, UR Company would purchase

production equipment costing $200,000 now to use in the rebuilding of the

alternators. The equipment would have a 12-year life and a $15,000 salvage

value. The company's discount rate is 10%.




92.

C

Medium

Refer To:

14-9

The present value of the net operating cash flows (sales less

cash operating expenses) arising from the rebuilding and sale

of the alternators (rounded to the nearest dollar) is:

a. $582,735.

b. $596,735.

c. $577,950.d. $591,950.

93.

B

Medium

Refer To:

14-9

The net present value of all cash flows associated with this

investment (rounded to the nearest dollar) is:

a. $377,950.

b. $382,735.

c. $392,950.

d. $362,950.

Reference: 14-10

(Ignore income taxes in this problem.) Westland College has a telephone

system that is in poor condition. The system either can be overhauled orreplaced with a new system. The following data have been gathered concerning

these two alternatives:

Present Proposed New

System System

Purchase cost new ....................... $250,000 $300,000

Accumulated depreciation ................ $240,000 -

Overhaul costs needed now ............... $230,000 -

Annual cash operating costs ............. $180,000 $170,000

Salvage value now ....................... $160,000 -

Salvage value at the end of 8 years ..... $152,000 $165,000

Working capital required ................ - $200,000

Westland College uses a 10% discount rate and the total cost approach to

capital budgeting analysis. Both alternatives are expected to have a useful

life of eight years.

94.

B

Hard

Refer To:

14-10

The net present value of the alternative of overhauling the

present system is:

a. $(1,279,316).

b. $(1,119,316).

c. $801,284.

d. $(1,194,036).

95.

A

Hard

Refer To:

14-10

The net present value of the alternative of purchasing the new

system is:

a. $(1,076,495).

b. $(1,236,495).

c. $(1,169,895).

d. $(969,895).




Reference: 14-11

(Ignore income taxes in this problem.) Lambert Manufacturing has $60,000 to

invest in either Project A or Project B. The following data are available on

these projects:

Project A Project B

Cost of equipment needed now .............. $120,000 $70,000Working capital investment needed now ..... - $50,000

Annual net operating cash inflows ......... $ 50,000 $45,000

Salvage value of equipment in 6 years ..... $ 15,000 -

Both projects have a useful life of 6 years. At the end of 6 years, the

working capital investment will be released for use elsewhere. Lambert's

discount rate is 14%.

96.

D

Medium

Refer To:

14-11

The net present value of Project A is closest to:

a. $82,241.

b. $67,610.

c. $74,450.

d. $81,290.

97.

A

Medium

Refer To:

14-11

The net present value of Project B is closest to:

a. $77,805.

b. $127,805.

c. $55,005.

d. $105,005.

98.

C

Medium

Refer To:

14-11

Which of the following statements is (are) correct?

I. Project A is acceptable according to the net present value

method.

II. Project A has an internal rate of return greater than 14%.

a. Only I.

b. Only II.

c. Both I and II.

d. Neither I nor II.

Reference: 14-12

(Ignore income taxes in this problem.) Fast Food, Inc., has purchased a new

donut maker. It cost $16,000 and has an estimated life of 10 years. The

following annual donut sales and expenses are projected:

Sales ..................... $22,000

Expenses:

Flour, etc., required

in making donuts ... $10,000

Salaries ............... 6,000

Depreciation ........... 1,600 17,600

Net income ................ $ 4,400




99.

B

Medium

Refer To:

14-12

The payback period on the new machine is closest to:

a. 5 years.

b. 2.7 years.

c. 3.6 years.

d. 1.4 years.

100.

C

Easy

Refer To:

14-12

The simple rate of return for the new machine is closest to:

a. 20%.

b. 37.5%.

c. 27.5%.

d. 80.0%.

Reference: 14-13

(Ignore income taxes in this problem.) Purvell Company has just acquired a

new machine. Data on the machine follow:

Purchase cost ............ $50,000

Annual cost savings ...... 15,000 Life of the machine ...... 8 years

The company uses straight-line depreciation and a $5,000 salvage value. (The

company considers salvage value in making depreciation deductions.) Assume

cash flows occur uniformly throughout a year.

101.

A

Easy

Refer To:

14-13

The payback period would be closest to:

a. 3.33 years.

b. 3.0 years.

c. 8.0 years.

d. 2.9 years.

102.

C

Medium

Refer To:

14-13

The simple rate of return would be closest to:

a. 30.0%.

b. 17.5%.

c. 18.75%.

d. 12.5%.

Reference: 14-14

(Ignore income taxes in this problem.) Hanley Company purchased a machine

for $125,000 that will be depreciated on the straight-line basis over a

five-year period with no salvage value. The related cash flow from

operations is expected to be $45,000 a year. These cash flows from

operations occur uniformly throughout the year.

103.

C

Easy

CPA

adapted

Refer To:

14-14

What is the payback period?

a. 2.1 years.

b. 2.3 years.

c. 2.8 years.

d. 4.2 years.




104.

A

Easy

CPA

adapted

Refer To:14-14

What is the simple rate of return on the initial investment?

a. 16%.

b. 24%.

c. 28%.

d. 36%.

Essay

105.

Medium

(Ignore income taxes in this problem.) Prince Company’s

required rate of return is 10%. The company is considering the

purchase of three machines, as indicated below. Consider each

machine independently.

Required:

a. Machine A will cost $25,00 and have a life of 15 years. Its

salvage value will be $1,000, and cost savings are projected

at $3,500 per year. Compute the machine’s net present value.

b. How much will Prince Company be willing to pay for Machine B

if the machine promises annual cash inflows of $5,000 per

year for 8 years?

c. Machine C has a projected life of 10 years. What is the

machine's internal rate of return if it costs $30,000 and

will save $6,000 annually in cash operating costs?

Interpolate to the nearest tenth of a percent. Would you

recommend purchase? Explain.

Answer:

a. 10% Present

Year Amount Factor Value

Investment required now ($25,000) 1.000 ($25,000)

Annual cost savings 1-15 3,500 7.606 26,621

Salvage value ..... 15 1,000 0.239 239

Net present value $ 1,860

b. 10% Present

Year Amount Factor Value

Annual cash inflows 1-8 $ 5,000 5.335 $26,675

Since the present value of the cash inflows is $26,675, the

company should be willing to pay up to this amount to acquire

the machine.




c. Investment required ÷ Net annual cash flow = Factor of the

internal rate of return

$30,000 ÷ %6,000 = 5.000

14% factor ............ 5.216 5.216 True factor ........... 5.000

16% factor ............ 4.833

0.216 0.383

14% + 2%(0.216 ÷ 0.383) = 15.1%

The machine should be purchased, since the internal rate of

return is greater than the required rate of return.

106.

Medium

Ignore income taxes in this problem.) Ursus, Inc., is

considering a project that would have a ten-year life and would

require a $1,000,000 investment in equipment. At the end of ten

years, the project would terminate and the equipment would haveno salvage value. The project would provide net income each

year as follows:

Sales ................................ $2,000,000

Less variable expenses ............... 1,400,000

Contribution margin .................. 600,000

Less fixed expenses .................. 400,000

Net income ........................... $ 200,000

All of the above items, except for depreciation of $100,000 a

year, represent cash flows. The depreciation is included in the

fixed expenses. The company's required rate of return is 12%.

Required:

a. Compute the project's net present value.

b. Compute the project's internal rate of return, interpolating

to the nearest tenth of a percent.

c. Compute the project's payback period.

d. Compute the project's simple rate of return.

Answer:

a. Since depreciation is the only noncash item on the income

statement, the net annual cash flow can be computed by adding

back depreciation to net income.

Net income ............. $200,000

Depreciation ........... 100,000

Net annual cash flow ... $300,000

12% Present

Years Amount Factor Value

Initial investment .. Now $(1,000,000) 1.000 $(1,000,000)

Net annual cash

flows ............. 1-10 300,000 5.650 1,695,000








b. The formula for computing the factor of the internal rate of

return (IRR) is:

Investment required ÷ Net annual cash inflow = Factor of the

IRR

$1,000,000÷ $300,000 = 3.333

26% factor ........ 3.465 3.465

True factor ....... 3.333

28% factor ........ 3.269

0.132 0.196

26% + 2%(0.132 ÷0.196) = 27.3%

c. The formula for the payback period is:

Investment required ÷ Net annual cash inflow = Payback

period

$1,000,000 ÷ $300,000 = 3.33 years

d. The formula for the simple rate of return is:

Net income ÷ Initial investment = Simple rate of return

$200,000 ÷ $1,000,000 = 20.0%

107.

Medium


concern an investment project:

Investment in equipment ........... $16,000

Net annual cash inflows ........... $ 3,600

Working capital required .......... $ 4,500

Salvage value of the equipment .... $ 2,000

Life of the project ............... 12 years

Discount rate ..................... 14%

The working capital will be released for use elsewhere at the

conclusion of the project.

Required:

Compute the project's net present value.

Answer:

14% Present

Item Years Amount Factor Value

Investment now ($16,000) 1.000 ($16,000)

Annual cash

inflows ............... 1-12 3,600 5.660 20,376

Working capital

required .............. now (4,500) 1.000 (4,500)

Working capital

released .............. 12 4,500 0.208 936

Salvage value

equipment ............. 12 2,000 0.208 416

Net present value ....... $ 1,228







108.

Medium

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

required rate of return is 14%. The company has an opportunity

to be the exclusive distributor of a very popular consumer

item. No new equipment would be needed, but the company would

have to use one-fourth of the space in a warehouse it owns. The

warehouse cost $200,000 new. The warehouse is currently half-empty and there are no other plans to use the empty space. In

addition, the company would have to invest $100,000 in working

capital to carry inventories and accounts receivable for the

new product line. The company would have the distributorship

for only 5 years. The distributorship would generate a $17,000

net annual cash inflow.

Required:

What is the net present value of the project at a discount rate

of 14%? Should the project be accepted?

Answer: 14% Present

Years Amount Factor Value

Working capital investment Now $(100,000) 1.000 $(100,000)

Annual cash inflows ...... 1-5 17,000 3.433 58,361

Working capital released 5 100,000 0.519 51,900

Net present value ........ $ 10,261

Yes, the distributorship should be accepted since the project

has a positive net present value.

109.

Medium

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

considering three investment opportunities with cash flows as

described below:

Project A: Cash investment now ..................... $15,000

Cash inflow at the end of 5 years ....... $21,000

Cash inflow at the end of 8 years ....... $21,000

Project B: Cash investment now ..................... $11,000

Annual cash outflow for 5 years ......... $ 3,000

Additional cash inflow at the end

of 5 years ............................ $21,000

Project C: Cash investment now ..................... $21,000

Annual cash inflow for 4 years .......... $11,000

Cash outflow at the end of 3 years ...... $ 5,000

Additional cash inflow at the end

of 4 years ............................ $15,000

Required:

Compute the net present value of each project assuming Monson

Company uses a 12% discount rate.




Answer:

Project A:

12% Present

Amount Factor Value

Cash investment now.............. ($15,000) 1.000 ($15,000)Cash inflow at the end of 5 years $21,000 0.567 $11,907

Cash inflow at the end of 8 years $21,000 0.404 $ 8,484

Net present value................ $ 5,391

Project B:

12% Present

Amount Factor Value

Cash investment now.............. ($11,000) 1.000 ($11,000)

Annual cash outflow for 5 years.. ($ 3,000) 3.605 ($10,815)

Additional cash inflow at the

end of 5 years............... $21,000 0.567 $11,907

Net present value................ ($ 9,908)

Project C:

12% Present

Amount Factor Value

Cash investment now.............. ($21,000) 1.000 ($21,000)

Annual cash inflow for 4 years... $11,000 3.037 $33,407

Cash outflow at the end of

3 years........................ ($ 5,000) 0.712 ($ 3,560)

Additional cash inflow at the

end of 4 years................. $15,000 0.636 $ 9,540

Net present value................ $18,387

110.

Medium

(Ignore income taxes in this problem.) Jim Bingham is

considering starting a small catering business. He would need

to purchase a delivery van and various equipment costing

$125,000 to equip the business and another $60,000 for

inventories and other working capital needs. Rent for the

building used by the business will be $35,000 per year. Jim's

marketing studies indicate that the annual cash inflow from the

business will amount to $120,000. In addition to the building

rent, annual cash outflow for operating costs will amount to

$40,000. Jim wants to operate the catering business for only

six years. He estimates that the equipment could be sold at

that time for 4% of its original cost. Jim uses a 16% discount

rate.

Required:

Would you advise Jim to make this investment?




Answer:

16% Present

Description Years Amount Factor Value

Van & equipment ..... 0 ($125,000) 1.000 ($125,000)

Working capital ..... 0 ($ 60,000) 1.000 ($ 60,000)

Building rent ....... 1-6 ($ 35,000) 3.685 ($128,975)Net annual cash

inflow ............ 1-6 $ 80,000 3.685 $294,800

Salvage value,

equipment ......... 6 $ 5,000 0.410 $ 2,050

Release of working

capital ........... 6 $ 60,000 0.410 $ 24,600


111.

Medium

(Ignore income taxes in this problem.) General Manufacturing

Company consists of several divisions, one of which is the

Transportation Division. The company has decided to dispose of

this division since it no longer fits the company's long-term

strategy. An offer of $9,000,000 has been received from aprospective buyer. If General retained the division, the

company would operate the division for only nine years, after

which the division would no longer be needed and would be sold

for $600,000. If the company retains the division, an immediate

investment of $500,000 would need to be made to update

equipment to current standards. Annual net operating cash flows

would be $1,805,000 if the division is retained. The company’s

discount rate is 12%.

Required:

Using the net present value method, determine whether General

Manufacturing should accept or reject the offer made by the

potential buyer.

Answer:

12% Present

Year Explanation Amount Factor Value o

0 Investment to update assets $ (500,000) 1.000 $ (500,000)

1-9 Annual cash inflows ....... 1,805,000 5.328 9,617,040

9 Selling price for

the division ............ 600,000 0.361 216,600

Net present value ......... $9,333,640

The sales price of $9,000,000 is less than the present value of

the cash flows resulting from retaining the division. General

thus should not accept the offer.




112.

Medium

(Ignore income taxes in this problem.) Mark Stevens is

considering opening a hobby and craft store. He would need

$100,000 to equip the business and another $40,000 for

inventories and other working capital needs. Rent on the

building used by the business will be $24,000 per year. Mark

estimates that the annual cash inflow from the business willamount to $90,000. In addition to building rent, annual cash

outflow for operating costs will amount to $30,000. Mark plans

to operate the business for only six years. He estimates that

the equipment and furnishings could be sold at that time for

10% of their original cost. Mark uses a discount rate of 16%.

Required:

Would you advise Mark to make this investment? Use the net

present value method.

Answer:

16% Present

Description Years Amount Factor Value oEquipment ........... 0 ($100,000) 1.000 ($100,000)

Working capital ..... 0 ($ 40,000) 1.000 ($ 40,000)

Building rent ....... 1-6 ($ 24,000) 3.685 ($ 88,440)

Net annual cash

inflow ............ 1-6 $ 60,000 3.685 $221,100

Salvage value,

equipment ......... 6 $ 10,000 0.410 $ 4,100

Release of working

capital ........... 6 $ 40,000 0.410 $ 16,400


113.

Medium

(Ignore income taxes in this problem.) Vernon Company has been

offered a 7-year contract to supply a part for the military.

After careful study, the company has developed the following

estimated data relating to the contract:

Cost of equipment needed ............................. $300,000

Working capital needed ............................... $ 50,000

Annual cash receipts from the delivery of parts,

less cash operating costs .......................... $ 70,000

Salvage value of equipment at termination of

the contract ....................................... $ 5,000

It is not expected that the contract would be extended beyond

the initial contract period. The company's discount rate is

10%.

Required:

Use the net present value method to determine if the contract

should be accepted. Round all computations to the nearest

dollar.




Answer:

10% Present

Description Years Amount Factor Value o

Equipment ........... 0 ($300,000) 1.000 ($300,000)

Working capital ..... 0 ($ 50,000) 1.000 ($ 50,000)

Net annual cash inflow ............ 1-7 $ 70,000 4.868 $340,760

Salvage value,

equipment ......... 7 $ 5,000 0.513 $ 2,565

Release of working

capital ........... 7 $ 50,000 0.513 $ 25,650


114.

Hard

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

considering the purchase of a machine that promises to reduce

operating costs by the same amount for every year of its 6-year

useful life. The machine will cost $83,150 and has no salvage

value. The machine has a 20% internal rate of return.

Required:

What is the annual cost savings promised by the machine?

Answer:

Investment required ÷ Net annual cash inflow =

Factor of the internal rate of return

$83,150 ÷ Net annual cash inflow = 3.326

$83,150 ÷ 3.326 = Net annual cash inflow

= $25,000

115.

Easy

(Ignore income taxes in this problem.) Ferris Company has an

old machine that is fully depreciated but has a current salvage

value of $5,000. The company wants to purchase a new machine

that would cost $60,000 and have a 5-year useful life and zero

salvage value. Expected changes in annual revenues and expenses

if the new machine is purchased are:

Increased revenues ............... $63,000

Increased expenses:

Salary of additional operator .. $20,000

Supplies ....................... 9,000

Depreciation ................... 12,000

Maintenance .................... 4,000 45,000

Increased net income .............. $18,000

Required:

a. Compute the payback period on the new equipment.

b. Compute the simple rate of return on the new equipment.

Answer:

a. Investment required ÷ Net annual cash inflow = Payback period

$60,000 - $5,000) ÷ ($18,000 + $12,000) = 1.83 years (rounded)

b. Incremental net income ÷ Investment = Simple rate of return




$18,000 ÷ $55,000 = 32.7% (rounded)

Date post:	06-Jan-2016
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Test Bank - Chapter14 Capital Budgeting

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