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Exam 11: Capital Budgeting and Investment Analysis

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Question 81

Multiple Choice

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

A) $6,000.
B) $7,000.
C) $18,000.
D) $21,000.
E) $36,000.

F) A) and B)
G) All of the above

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Question 82

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Presented below are terms preceded by letters a through g and followed by a list of definitions 1 through 7. Match the letter of the term with the definition

Premises

Responses

Initial cost of an investment subtracted from discounted future cash flows from the investment.

Net present value

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

Net cash flow

Equals the discount rate that results in a net present value of zero.

Hurdle rate

The required rate of return.

Payback period

Annual after-tax net income divided by annual average investment.

Capital budgeting

Cash inflows minus cash outflows for the period.

Internal rate of return

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

Accounting rate of return

Premises

Initial cost of an investment subtracted from discounted future cash flows from the investment.

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

Equals the discount rate that results in a net present value of zero.

The required rate of return.

Annual after-tax net income divided by annual average investment.

Cash inflows minus cash outflows for the period.

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

Responses

Net present value

Net cash flow

Hurdle rate

Payback period

Capital budgeting

Internal rate of return

Accounting rate of return

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Correct Answer

Premises

Responses

Initial cost of an investment subtracted from discounted future cash flows from the investment.

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

Equals the discount rate that results in a net present value of zero.

The required rate of return.

Annual after-tax net income divided by annual average investment.

Cash inflows minus cash outflows for the period.

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

Premises

Initial cost of an investment subtracted from discounted future cash flows from the investment.

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

Equals the discount rate that results in a net present value of zero.

The required rate of return.

Annual after-tax net income divided by annual average investment.

Cash inflows minus cash outflows for the period.

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

Responses

Question 83

Multiple Choice

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The following relates to a proposed equipment purchase: Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is (ignore income taxes) :

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

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

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

The following relates to a proposed equipment purchase: Ignoring income taxes, the annual net income amount used to calculate the accounting rate of return is:

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

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

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

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

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

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

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

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

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

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