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Chapter 11 Capital Budgeting Decisions Answer Key

True / False Questions

1.

In the payback method, depreciation is deducted from net operating income when

computing the annual net cash flow.

2.

In calculating the payback period where new equipment is replacing old equipment, any

salvage value to be received on disposal of the old equipment should be added to the cost

of the new equipment.

3.

One criticism of the payback method is that it ignores cash flows that occur after the

payback point has been reached.

4.

The payback method of making capital budgeting decisions does not give full

consideration to the time value of money.

5.

The basic premise of the payback method is that the more quickly the cost of an

investment is recovered the more desirable is the investment.

6.

When considering a number of investment projects, the project that has the shortest

payback period does not necessarily have the highest net present value.

7.

When discounted cash flow methods of capital budgeting are used, the working capital

required for a project is ordinarily counted as a cash inflow at the beginning of the project

and as a cash outflow at the end of the project.

8.

Discounted cash flow techniques do not take into account recovery of initial investment.

9.

The required rate of return is the minimum rate of return that an investment project must

yield to the acceptable.

10.

For capital budgeting decisions, the simple rate of return method is superior to the net

present value method.

11.

In preference decision situations, a project with a lower net present value may be

preferable to a project with a higher net present value.

12.

Preference decisions follow screening decisions and seek to rank investment proposals in

order of their desirability.

13.

The project profitability index is used to compare the net present values of two

investments that require different amounts of investment funds.

14.

The project profitability index is computed by dividing the present value of the cash

inflows of the project by present value of the cash outflows of the project.

15.

An investment project with a project profitability index of less than one should ordinarily

be rejected.

16.

If a project does not have constant incremental revenues and expenses over its useful life,

the simple rate of return will fluctuate from year to year.

17.

The simple rate of return method does not take into account the time value of money.

Multiple Choice Questions

18.

Which of the following will have the largest dollar effect on the net present value of a 10

year investment project?

19.

If taxes are ignored, all of the following items are included in a discounted cash flow

analysis except:

20.

In capital budgeting computations, discounted cash flow methods:

21.

The best capital budgeting method for ranking investment projects of different dollar

amounts is the:

22.

The investment required for the project profitability index should:

23.

Harrison Corporation is studying a project that would have an eight-year life and would

require a $300,000 investment in equipment which has no salvage value. The project

would provide net operating 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

37,500

187,500

Net operating income

$112,500

The company's required rate of return is 10%. The payback period for this project is

closest to:

24.

Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The auto was

purchased for $28,000 and will have a 6-year useful life and a $4,000 salvage value.

Delivering prescriptions (which the pharmacy has never done before) should increase

gross revenues by at least $32,000 per year. The cost of these prescriptions to the

pharmacy will be about $25,000 per year. The pharmacy depreciates all assets using the

straight-line method. The payback period for the auto is closest to:

25.

A company with $600,000 in operating assets is considering the purchase of a machine

that costs $72,000 and which is expected to reduce operating costs by $18,000 each year.

These reductions in cost occur evenly throughout the year. The payback period for this

machine in years is closest to:

26.

The Zinger Corporation is considering an investment that has the following data:

Year

1

Year

2

Year

3

Year

4

Year

5

Investment

$8,000

$3,000

Cash

inflow

$2,000

$2,000

$5,000

$4,000

$4,000

Cash inflows occur evenly throughout the year. The payback period for this investment is:

27.

The management of Helberg Corporation is considering a project that would require an

investment of $203,000 and would last for 6 years. The annual net operating income from

the project would be $103,000, which includes depreciation of $30,000. The scrap value of

the project's assets at the end of the project would be $23,000. The cash inflows occur

evenly throughout the year. The payback period of the project is closest to:

28.

Neighbors Corporation is considering a project that would require an investment of

$279,000 and would last for 8 years. The incremental annual revenues and expenses

generated by the project during those 8 years would be as follows:

Sales

$224,000

Variable expenses

22,000

Contribution margin

202,000

Fixed expenses:

Salaries

25,000

Rents

38,000

Depreciation

33,000

Total fixed expenses

96,000

Net operating income

$106,000

The scrap value of the project's assets at the end of the project would be $15,000. The

cash inflows occur evenly throughout the year. The payback period of the project is

closest to:

29.

Jason Corporation has invested in a machine that cost $80,000, that has a useful life of

eight years, and that has no salvage value at the end of its useful life. The machine is

being depreciated by the straight-line method, based on its useful life. It will have a

payback period of five years. Given these data, the simple rate of return on the machine is

closest to:

30.

Fimbrez Corporation has provided the following data concerning an investment project

that it is considering:

Initial investment

$360,000

Annual cash flow

$118,000

per

year

Expected life of the

project

4

years

Discount rate

12%

The net present value of the project is closest to:

31.

Beaver Corporation is investigating the purchase of a new threading machine that costs

$18,000. The machine would save about $4,000 per year over the present method of

threading component parts, and would have a salvage value of about $3,000 in 6 years

when the machine would be replaced. The company's required rate of return is 12%. The

machine's net present value is closest to:

32.

Frick Road Paving Corporation is considering an investment in a curb-forming machine.

The machine will cost $180,000, will last 10 years, and will have a $30,000 salvage value at

the end of 10 years. The machine is expected to generate net cash inflows of $40,000 per

year in each of the 10 years. Frick's discount rate is 10%. The net present value of the

proposed investment is closest to:

33.

Czlapinski Corporation is considering a capital budgeting project that would require an

initial investment of $440,000 and working capital of $32,000. The working capital would

be released for use elsewhere at the end of the project in 4 years. The investment would

generate annual cash inflows of $147,000 for the life of the project. At the end of the

project, equipment that had been used in the project could be sold for $11,000. The

company's discount rate is 7%. The net present value of the project is closest to:

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