Chapter 13 – Capital investment decisions: appraisal methods
MULTIPLE CHOICE
1. Projects that, if accepted, preclude the acceptance of competing projects are
a.
priority projects.
b.
mutually exclusive projects.
c.
independent projects.
d.
equity projects.
2. ____ are capital budgeting models that identify criteria for accepting or rejecting projects without
considering the time value of money.
a.
Net present value models
b.
Nondiscounting models
c.
Discounting models
d.
Capital return models
3. The time required for a project to return its investment is the
a.
accounting rate of return.
b.
interest.
c.
net present value.
d.
payback period.
4. If the annual cash flows are an annuity (equal each period), payback is calculated as
a.
Annual net cash inflows/Capital investment.
b.
Capital investment/Annual net cash inflows.
c.
Annual net cash inflows/Present value factor.
d.
(Annual net cash inflows – Annual depreciation)/Capital investment.
5. If the annual cash flows are not an annuity (equal each period), payback is calculated by
a.
dividing the investment required by the average annual cash inflow.
b.
dividing the average annual cash inflow by the investment required.
c.
accumulating the net cash flows until they equal the initial investment.
d.
Payback cannot be calculated for a project with unequal cash flows.
6. Firms may select projects with short paybacks because
a.
projects with longer paybacks may be riskier.
b.
shorter paybacks may help reduce liquidity problems.
c.
if the risk of obsolescence is high, the firm may want to recover the funds rapidly.
d.
All of the above are correct.
7. What is a weakness of the payback method?
a.
It emphasizes projects with possible liquidity problems.
b.
It ignores the profitability of investments beyond the payback period.
c.
It can be used in conjunction with discounted cash flow methods.
d.
both a and b above
8. Which of the following methods uses income instead of cash flows?
a.
payback
b.
accounting rate of return
c.
internal rate of return
d.
net present value
9. The accounting rate of return is calculated as
a.
Investment/Income.
b.
Income/Debt.
c.
Income/Investment.
d.
Assets/Debt.
10. Why would a company use the accounting rate of return?
a.
to ensure that a new investment will not adversely affect accounting income
b.
because it does not consider the time value of money
c.
because it is a measure of liquidity
d.
all of the above
11. Future cash flows expressed in present value terms are
a.
compounded cash flows.
b.
extended cash flows.
c.
budgeted cash flows.
d.
discounted cash flows.
12. When the discount rate is decreased,
a.
the present value of future cash flows increases.
b.
the present value of future cash flows decreases.
c.
there is no change in the present value.
d.
net present value would equal zero.
13. Which of the following methods assumes a reinvestment rate equal to the discount rate?
a.
payback
b.
accounting rate of return
c.
net present value
d.
internal rate of return
14. A firm is evaluating a project that has a net present value of £0 when a discount rate of 8 per cent is
used. A discount rate of 10 per cent will result in
a.
a negative net present value.
b.
a positive net present value.
c.
a net present value of £0.
d.
The question cannot be answered based upon the information provided.
15. A firm is evaluating a project that has a net present value of £0 when a discount rate of 8 per cent is
used. A discount rate of 6 per cent will result in
a.
a negative net present value.
b.
a positive net present value.
c.
a net present value of £0.
d.
The question cannot be answered based upon the information provided.
16. If a project has a net present value of £0 when a discount rate of 10 per cent is used, what can be
concluded about the rate of return of the project?
a.
The rate of return is greater than 10 per cent.
b.
The rate of return is less than 10 per cent.
c.
The rate of return equals 10 per cent.
d.
The rate of return is 0.
17. A firm is considering two projects with the following cash flows:
Project A
Project B
Year 1
£ 40,000
£140,000
Year 2
60,000
60,000
Year 3
140,000
40,000
Each project requires an investment of £120,000.
Which project will have the higher net present value?
a.
Project A
b.
Project B
c.
Project A and Project B will have the same net present value.
d.
The question cannot be answered from the information provided.
18. Which of the following methods consider the time value of money?
a.
payback and accounting rate of return
b.
payback and internal rate of return
c.
internal rate of return and accounting rate of return
d.
internal rate of return and net present value
19. The internal rate of return is the
a.
rate of return that sets the project’s net present value equal to zero.
b.
hurdle rate.
c.
cost of capital.
d.
required rate of return.
20. If the investment’s internal rate of return is more than the required rate of return, the investment should
be
a.
accepted.
b.
rejected.
c.
put on hold.
d.
None of the above are correct.
21. Why do the NPV method and the IRR method sometimes produce different rankings of mutually
exclusive investment projects?
a.
The NPV method does not assume reinvestment of cash flows, while the IRR method
assumes the cash flows will be reinvested at the internal rate of return.
b.
The NPV method assumes a reinvestment rate equal to the discount rate, while the IRR
method assumes a reinvestment rate equal to the internal rate of return.
c.
The IRR method does not assume reinvestment of the cash flows, while the NPV method
assumes the reinvestment rate is equal to the discount rate.
d.
The NPV method assumes a reinvestment rate equal to the bank loan interest rate, while
the IRR method assumes a reinvestment rate equal to the discount rate.
22. If NPV and IRR produce different rankings, which method should be used in choosing investment
projects?
a.
payback
b.
accounting rate of return
c.
net present value
d.
internal rate of return
23. How is working capital needed in the operations of investments treated in discounted cash flow
analysis?
a.
added to cost of the investment
b.
added to cash inflows when recovery occurs
c.
both a and b
d.
none of the above
24. Which of the following is NOT included in the calculation of net present value of a proposed project?
(Ignore income taxes.)
a.
salvage value
b.
working capital
c.
discount rate
d.
depreciation expense
25. The Bradshaw Company is considering purchasing equipment for £78,000. This equipment will save
the company £22,000 in operating costs annually. The payback period for this equipment is
a.
3.5 years.
b.
4 years.
c.
2.2 years.
d.
0.3 years.
26. Ducky Pizza Restaurant purchases a van to deliver pizzas to their customers. The van costs £28,000
and is projected to increase revenues by £10,000 a year and to increase costs by £4,500. The payback
period for this van is
a.
2.8 years.
b.
6.2 years.
c.
5.1 years.
d.
0.4 years.
27. Lewis Manufacturing Company is planning to invest in equipment costing £240,000. The estimated
cash flows from this equipment are expected to be as follows:
Year
1
2
3
4
5
Total
Assume that the cash inflows occur evenly over the year. The payback period for this investment is
a.
3.75 years.
b.
3.25 years.
c.
2.4 years.
d.
1.3 years.
28. Kaylin Company purchased a piece of equipment for £100,000 that had a useful life of 5 years. The
equipment had no salvage value. It saves the company £40,000 a year and costs the company £5,000 a
year to operate. What is the accounting rate of return on the equipment?
a.
30%
b.
15%
c.
40%
d.
35%
29. The present value of £8,000 to be received each year for ten years and earning a 16 per cent return is
a.
£1,655.
b.
£1,816.
c.
£35,242.
d.
£38,664.
30. The present value of £10,000 to be received five years from now and earning a 12 per cent return is
a.
£2,774.
b.
£5,670.
c.
£17,637.
d.
£36,050.
31. The present value of £2,000 to be received three years from now and earning a 12 per cent return is
a.
£1,424.
b.
£1,760.
c.
£2,440.
d.
£2,720.
32. The present value of £2,000 to be received each year for three years and earning a 10 per cent return is
a.
£5,560.
b.
£4,974.
c.
£4,922.
d.
£4,600.
33. A firm is considering a project with annual cash flows of £75,000. The project would have a 7-year
life, and the company uses a discount rate of 10 per cent. What is the maximum amount the company
could invest in the project and the project still be acceptable?
a.
£525,000
b.
£365,100
c.
£269,325
d.
none of the above
34. A firm is considering a project with annual cash flows of £40,000. The project would have a 10-year
life, and the company uses a discount rate of 8 per cent. What is the maximum amount the company
could invest in the project and the project still be acceptable?
a.
£400,000
b.
£268,400
c.
£203,200
d.
£363,600
35. A firm is considering a project with annual cash flows of £120,000. The project would have an 8-year
life, and the company uses a discount rate of 12 per cent. What is the maximum amount the company
could invest in the project and the project still be acceptable?
a.
£488,740
b.
£562,614
c.
£580,291
d.
£596,160
36. A firm is considering a project requiring an investment of £100,000. The project would generate
annual cash inflows of £26,380 per year for the next five years. The approximate internal rate of return
for the project is
a.
8%.
b.
10%.
c.
12%.
d.
16%.
37. A firm is considering a project requiring an investment of £14,150. The project would generate annual
cash inflows of £3,300 per year for the next seven years. The approximate internal rate of return for the
project is
a.
6%.
b.
8%.
c.
12%.
d.
14%.
38. Brooks Company invested in a project that is expected to have an annual cash flow of £10,000. The
project’s life is five years and has an IRR of 14 per cent. How much was the initial investment in the
project?
a.
£34,330
b.
£50,000
c.
£36,050
d.
£29,140
39. Lake Kariba Company is considering buying a new boat that would cost £120,000. The accountant
determined that the boat promises an internal rate of return of 10 per cent and has a life of four years.
The accountant resigned and the president wanted to check her calculations. What were the
approximate annual net cash inflows from the project?
a.
£20,490
b.
£30,000
c.
£37,855
d.
Net cash inflows cannot be determined from the information given.
40. Matusadona Company plans to invest £450,000 in a new factory. With a discount rate of 14 per cent,
the present value from the factory is £483,000. To yield a 14 per cent internal rate of return, the actual
investment cost cannot exceed the £450,000 estimate by more than
a.
£63,000.
b.
£33,000.
c.
£16,500.
d.
This cannot be determined from the information given.
Figure 13-1
A project requires an investment of £90,000 in equipment. Annual cash inflows of £15,000 are
expected to occur for the next ten years. No salvage value is expected.
41. Refer to Figure 13-1. If the annual cash inflows occur throughout the year, payback for the project
would be
a.
4.5 years.
b.
4.8 years.
c.
5 years.
d.
6 years.
42. Refer to Figure 13-1. Using the initial capital investment, the accounting rate of return for the project
would be
a.
6.25%.
b.
6.67%.
c.
16.67%.
d.
26.67%.
Figure 13-2
Investment
£80,000
Annual revenues
£50,000
Annual variable costs
£15,000
Annual fixed out-of-pocket costs
£10,000
Salvage value
£5,000
Discount rate
12%
Expected life of project
8 years
43. Refer to Figure 13-2. The present value of the annual net cash inflows from operations is
a.
£77,740.
b.
£86,669.
c.
£116,411.
d.
£124,200.
44. Refer to Figure 13-2. The net present value of the project is
a.
£24,500.
b.
£36,411.
c.
£44,200.
d.
£46,220.
Figure 13-3
Glady, Inc., is considering the purchase of production equipment that costs £800,000. The equipment
is expected to generate annual cash inflows of £250,000. The equipment is expected to have a useful
life of five years with no salvage value. The firm’s cost of capital is 14 per cent.
45. Refer to Figure 13-3. Payback for Glady’s project is
a.
5 years.
b.
3.2 years.
c.
4 years.
d.
3.125 years.
46. Refer to Figure 13-3. If depreciation is £190,000 per year, Glady’s accounting rate of return based on
the average investment would be
a.
15.0%.
b.
7.5%.
c.
6.25%.
d.
5.5%.
47. Refer to Figure 13-3. Excluding the effect of income taxes, Glady’s net present value of the project is
a.
£165,200.
b.
£450,000.
c.
£58,250.
d.
£233,550.
48. Refer to Figure 13-3. The approximate internal rate of return of Glady’s project is
a.
16%.
b.
20%.
c.
24%.
d.
25%.
Figure 13-4
A capital investment project requires an investment of £60,000 and has an expected life of four years.
Annual cash flows, which occur evenly throughout the year, are expected to be as follows:
Year
Amount
1
£20,000
2
£34,000
3
£24,000
4
£40,000
49. Refer to Figure 13-4. Payback for the project is
a.
2.25 years.
b.
2.5 years.
c.
3 years.
d.
2 years.
50. Refer to Figure 13-4. The net present value of the project using a 6 per cent discount rate is
a.
£40,960.
b.
£43,950.
c.
£53,160.
d.
£35,040.
Investment
Present value of cash inflows:
Year 1 (£20,000 0.943)
Year 2 (£34,000 0.890)
Year 3 (£24,000 0.840)
Year 4 (£40,000 0.792)
Net present value
Figure 13-5
Investment
£120,000
Annual revenues
£70,000
Annual variable costs
£15,000
Annual fixed out-of-pocket costs
£11,000
Salvage value
£27,000
Discount rate
14%
Expected life of project
3 years
51. Refer to Figure 13-5. The present value of the annual net cash inflows from operations is
a.
£101,416.
b.
£101,897.
c.
£102,168.
d.
£104,618.
Cumulative Cash Flows
Year 1
£20,000
Year 2
34,000
Year 3
£60,000
52. Refer to Figure 13-5. The net present value of the project is
a.
(£3,215).
b.
£393.
c.
£6,102.
d.
£6,412.
Figure 13-6
JD, Inc., is considering the purchase of production equipment that costs £400,000. The equipment is
expected to generate annual cash inflows of £125,000. The equipment is expected to have a useful life
of five years with no salvage value. The firm’s cost of capital is 12 per cent.
53. Refer to Figure 13-6. JD’s payback for the project is
a.
2.9 years.
b.
3.2 years.
c.
3.25 years.
d.
4.2 years.
54. Refer to Figure 13-6. If depreciation is £90,000 per year, JD’s accounting rate of return based on the
average investment would be
a.
12.0%.
b.
14.5%.
c.
17.0%.
d.
17.5%.
55. Refer to Figure 13-6. JD’s net present value of the project is
a.
£40,480.
b.
£48,625.
c.
£50,625.
d.
£54,450.
56. Refer to Figure 13-6. JD’s approximate internal rate of return of the project is
a.
17%.
b.
15%.
c.
13%.
d.
12%.
57. Refer to Figure 13-6. Based on quantitative factors, should JD accept, reject, or wait on the project?
a.
accept
b.
reject
c.
wait
58. A firm is considering a project with an annual cash flow of £200,000. The project would have a 7-year
life, and the company uses a discount rate of 10 per cent. Ignoring income taxes, what is the maximum
amount the company could invest in the project and have the project still be acceptable?
a.
£718,200
b.
£1,400,000
c.
£973,600
d.
£200,000
59. A firm is considering a project with an annual cash flow of £240,000. The project would have an
8-year life, and the company uses a discount rate of 12 per cent. Ignoring income taxes, what is the
maximum amount the company could invest in the project and have the project still be acceptable
(rounded)?
a.
£977,480
b.
£1,125,228
c.
£1,160,582
d.
£1,192,320