CHAPTER 15: CAPITAL INVESTMENT ANALYSIS
1. The process by which management plans, evaluates, and controls long-term investment
decisions involving fixed assets is called capital investment analysis.
a. True
b. False
2. The process by which management plans, evaluates, and controls long- term investment
decisions involving fixed assets is called cost-volume-profit analysis.
a. True
b. False
3. Care must be taken while making capital investment decisions since it involves a long-term
commitment of funds and affects operations for several years.
a. True
b. False
4. The methods of evaluating capital investment proposals can be grouped into two general
categories: (1) methods that ignore present values and (2) methods that use present values.
a. True
b. False
5. The methods of evaluating capital investment proposals can be grouped into two general
categories: (1) average rate of return method and (2) cash payback method.
a. True
b. False
6. Average rate of return equals average investment divided by estimated average annual income.
a. True
b. False
7. Average rate of return equals estimated average annual income divided by average investment.
a. True
b. False
Chapter 15: Capital Investment Analysis
8. A company should purchase an asset when the minimum rate of return exceeds its average rate
of return.
a. True
b. False
9. If the average rate of return on an asset exceeds the minimum rate of return for investments,
the asset should be purchased.
a. True
b. False
10. The excess of cash flowing in from revenues over the cash flowing out for expenses is termed
net cash flow.
a. True
b. False
11. The excess of cash flowing in from revenues over the cash flowing out for expenses is termed
net discounted cash flow.
a. True
b. False
12. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no
residual value, is expected to yield total net income of $200,000 for 5 years. The expected
average rate of return on investment computed is 20%.
a. True
b. False
13. When evaluating a proposal by use of the net present value method, if there is a deficiency of
the present value of future cash inflows over the amount to be invested, the proposal should be
accepted.
a. True
b. False
14. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no
residual value, is expected to yield total net income of $300,000 for 5 years. The expected
average rate of return is 30%.
a. True
b. False
Chapter 15: Capital Investment Analysis
15. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a
$40,000 residual value, is expected to yield total net income of $200,000 for 5 years. The
expected average rate of return on investment is 18.2%.
a. True
b. False
16. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a
$40,000 residual value, is expected to yield total net income of $500,000 for 5 years. The
expected average rate of return is 50%.
a. True
b. False
17. The computations required for the net present value method are less than those the
computation required for the average rate of return method.
a. True
b. False
18. The computations required for the net present value method are more than the computation
required for the average rate of return method.
a. True
b. False
19. If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected
net cash flow and net income of $32,000 and $12,000, respectively, the cash payback period is
2.5 years.
a. True
b. False
20. For years one through five, a proposed expenditure of $250,000 for a fixed asset with a 5-year
life has expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000,
respectively, and net cash flows of $90,000, $85,000, $75,000, $75,000, and $75,000,
respectively. The cash payback period is 2.5 years.
a. True
b. False
Chapter 15: Capital Investment Analysis
21. Methods that ignore present value in capital investment analysis include the cash payback
method.
a. True
b. False
22. The average rate of return method of capital investment analysis gives consideration to the
present value of future cash flows.
a. True
b. False
23. The anticipated purchase of a fixed asset for $400,000 with a useful life of 5 years and no
residual value is expected to yield total income of $150,000 (recognition is given to the effect
of straight-line depreciation on the investment). The expected average rate of return is 15%.
a. True
b. False
24. The expected period of time that will elapse between the date of a capital investment and the
complete recovery in cash of the amount invested is called the discount period.
a. True
b. False
25. The expected period of time that will elapse between the date of a capital investment and the
complete recovery in cash of the amount invested is called the cash payback period.
a. True
b. False
26. If a proposed expenditure of $400,000 for a fixed asset with a 4-year life has an annual
expected net cash flow and net income of $160,000 and $60,000, respectively, the cash
payback period is 2.5 years.
a. True
b. False
27. When evaluating a proposal by use of the cash payback method, if net cash flows exceed the
capital investment within the time deemed acceptable by management, the proposal should be
accepted.
a. True
b. False
Chapter 15: Capital Investment Analysis
28. When evaluating a proposal by use of the net present value method, if there is an excess of the
present value of future cash inflows over the amount to be invested, the rate of return on the
proposal is less than the rate used in the analysis.
a. True
b. False
29. When evaluating a proposal by use of the net present value method, if there is an excess of the
present value of future cash inflows over the amount to be invested, the rate of return on the
proposal exceeds the rate used in the analysis.
a. True
b. False
30. In net present value analysis for a proposed capital investment, the expected future net cash
flows are reduced to their present values.
a. True
b. False
31. When evaluating a proposal by use of the net present value method, if the present value is less
than the amount to be invested, the rate of return on the proposal is more than the rate used in
the analysis.
a. True
b. False
32. For years one through five, a proposed expenditure of $400,000 for a fixed asset with a 5-year
life has expected net income of $50,000, $40,000, $20,000, $20,000, and $20,000,
respectively, and net cash flows of $130,000, $120,000, $100,000, $100,000, and $100,000,
respectively. The cash payback period is 3.5 years.
a. True
b. False
33. A present value index can be used to rank competing capital investment proposals when the
net present value method is used.
a. True
b. False
Chapter 15: Capital Investment Analysis
34. The internal rate of return method of analyzing capital investment proposals uses the present
value concept to compute the rate of return expected from the proposals.
a. True
b. False
35. Internal rate of return is often called the payback rate of return.
a. True
b. False
36. A series of unequal cash flows at fixed intervals is termed an annuity.
a. True
b. False
37. Qualitative considerations in capital investment decisions are most appropriate for strategic
investments or those that are designed to affect a company’s longterm ability to generate
profits.
a. True
b. False
38. Qualitative considerations are best evaluated using present value methods such as internal rate
of return.
a. True
b. False
39. One of the qualitative characteristics that influence capital investment analysis is product
quality.
a. True
b. False
40. A qualitative characteristic that influences capital investment analysis is manufacturing
productivity.
a. True
b. False
Chapter 15: Capital Investment Analysis
41. When evaluating two competing proposals with unequal lives, management should give
greater consideration to the investment with the longer life because the asset will be useful to
the company for a longer period of time.
a. True
b. False
42. Leasing assets may be a favorable alternative to purchasing assets if the asset has a high risk of
becoming obsolete.
a. True
b. False
43. The process by which management allocates available investment funds among competing
capital investment proposals is termed present value analysis.
a. True
b. False
44. The process by which management allocates available investment funds among competing
capital investment proposals is termed capital rationing.
a. True
b. False
45. A capital expenditures budget summarizes the decisions made for the acquisition of fixed
assets.
a. True
b. False
46. In capital rationing, alternative proposals are initially screened by establishing minimum
standards using the cash payback and the average rate of return methods.
a. True
b. False
Chapter 15: Capital Investment Analysis
47. The process by which management plans, evaluates, and controls long-term investment
decisions involving fixed assets is called:
a. absorption cost analysis.
b. variable cost analysis.
c. capital investment analysis.
d. cost-volume-profit analysis.
48. Decisions to install new equipment, replace old equipment, and purchase or construct a new
building are examples of:
a. sales mix analysis.
b. variable cost analysis.
c. cost-volume-profit analysis.
d. capital investment analysis.
49. The two methods that use present value to analyse capital investment proposals are net present
value and .
a. internal rate of return
b. average rate of return
c. external rate of return
d. cash payback
50. By converting dollars to be received in the future into current dollars, the present value
methods take into consideration that money:
a. has an international rate of exchange.
b. is the language of business.
c. is the measure of assets, liabilities, and stockholders’ equity on financial statements.
d. has a time value.
51. The primary advantages of the average rate of return method of analyzing a capital investment
proposal are its ease of computation and the fact that:
a. it emphasizes the amount of income earned over the life of the proposal.
b. there is less possibility of loss from changes in economic conditions and obsolescence when
the commitment is short-term.
c. it is especially useful to managers whose primary concern is liquidity.
d. it considers the time value of money.
Chapter 15: Capital Investment Analysis
52. An anticipated purchase of equipment for $1,000,000, with a useful life of 8 years and no
residual value, is expected to yield the following annual net incomes and net cash flows:
Year
Net Income
Net Cash Flow
1
$210,000
$400,000
2
180,000
320,000
3
145,000
280,000
4
125,000
270,000
5
60,000
220,000
6
60,000
220,000
7
60,000
220,000
8
60,000
220,000
What is the cash payback period?
a. 5 years
b. 4 years
c. 6 years
d. 3 years
53. Which of the following can be used to place capital investment proposals involving different
amounts of investment on a comparable basis for purposes of net present value analysis?
a. Price-level index
b. Present value factor
c. Annuity
d. Present value index
54. Using the following partial table of present value of $1 at compound interest, compute the
present value of $20,000 (rounded to nearest dollar) to be received one year from today,
assuming an earnings rate of 15%.
Year
10%
15%
1
0.909
0.870
2
0.826
0.756
3
0.751
0.658
4
0.683
0.572
5
0.621
0.497
6
0.564
0.432
7
0.513
0.376
a. $17,400
b. $17,000
c. $20,000
d. $15,451
a
Chapter 15: Capital Investment Analysis
55. An analysis of a proposal by the net present value method indicated that the present value
exceeded the amount to be invested. Which of the following statements best describes the
results of this analysis?
a. The proposal is desirable and the rate of return expected from the proposal exceeds the
minimum rate used for the analysis.
b. The proposal is desirable and the rate of return expected from the proposal is less than the
minimum rate used for the analysis.
c. The proposal is undesirable and the rate of return expected from the proposal is less than the
minimum rate used for the analysis.
d. The proposal is undesirable and the rate of return expected from the proposal exceeds the
minimum rate used for the analysis.
56. In general, present value methods of analyzing capital investments are more desirable than
methods ignoring present values because:
a. the calculations in methods that ignore present value are more complex than those in
methods using present value.
b. the present value methods consider that a dollar today is worth more than a dollar in the
future due to the potential earning power of that dollar.
c. the calculations in methods that consider present value are less complex than those methods
ignoring present value.
d. the present value methods consider that a dollar in the future is worth more than a dollar
today due to the potential earning power of that dollar.
57. Which method of evaluating capital investment proposals uses the concept of present value to
compute a rate of return?
a. Average rate of return
b. Internal rate of return
c. Cash payback period
d. Accounting rate of return
Chapter 15: Capital Investment Analysis
58. The rate of return is 10% and the cash to be received in one year is $25,000. Determine the
present value amount, using the following partial table of present value of $1 at compound
interest:
Year
6%
10%
12%
1
0.943
0.909
0.893
2
0.890
0.826
0.797
3
0.840
0.751
0.712
4
0.792
0.683
0.636
a. $22,500
b. $25,000
c. $27,275
d. $22,725
59. Using the following partial table of present value of $1 at compound interest, determine the
present value of $20,000 to be received four years hence with earnings at the rate of 12% a
year:
Year
6%
10%
12%
1
0.943
0.909
0.893
2
0.890
0.826
0.797
3
0.840
0.751
0.712
4
0.792
0.683
0.636
a. $13,660
b. $15,840
c. $12,720
d. $10,400
60. When several alternative investment proposals of the same amount are being considered, the
one with the largest net present value is the most desirable. If the alternative proposals involve
different amounts of investment, it is useful to prepare a relative ranking of the proposals by
using a(n):
a. average rate of return.
b. cash payback period.
c. present value index.
d. price-level index.
61. The two methods that use present values to analyse capital investment proposal consider the .
a. time value of money concept
b. going concern concept
c. historical cost concept
d. conservatism concept
Chapter 15: Capital Investment Analysis
62. A series of equal cash flows at fixed intervals is termed as a(n):
a. present value index.
b. price-level index.
c. net cash flow.
d. annuity.
63. The present value index is computed using which of the following formulas?
a. Amount to be invested/Average rate of return
b. Total present value of net cash flow/Amount to be invested
c. Total present value of net cash flow/Average rate of return
d. Amount to be invested/Total present value of net cash flow
64. Finer Company is considering the acquisition of a machine that costs $150,000. The machine
is expected to have a useful life of 6 years, a negligible residual value, an annual cash flow of
$30,000, and annual operating income of $35,000. What is the estimated cash payback period
for the machine?
a. 4.3 years
b. 3 years
c. 5 years
d. 6 years
65. The expected average rate of return for a proposed investment of $3,000,000 in a fixed asset
giving effect to depreciation (straight-line method) with a useful life of 20 years, no residual
value, and an expected total income of $6,000,000 is:
a. 25%.
b. 18%.
c. 40%.
d. 20%.
66. The payback period is determined using which of the following formulas?
a. Amount to be invested/Annual average net income
b. Annual net cash flow/Amount to be invested
c. Annual average net income/Amount to be invested
d. Amount to be invested/Annual net cash flows
Chapter 15: Capital Investment Analysis
The management of Retz Corporation is considering the purchase of a new machine costing
$500,000. The company’s desired rate of return is 10%. The present value factors for $1 at
compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621,
respectively. In addition to the foregoing information, use the following data in determining
the acceptability in this situation:
Year
Income from Operations
Net Cash Flow
1
$100,000
$200,000
2
80,000
170,000
3
50,000
130,000
4
10,000
80,000
5
10,000
80,000
67. The cash payback period for this investment is:
a. 5 years.
b. 3 years.
c. 2 years.
d. 4 years.
68. The average rate of return for this investment is:
a. 18%.
b. 16%.
c. 5%.
d. 20%.
69. The net present value for this investment is:
a. positive $150,000.
b. negative $24,170.
c. positive $24,170.
d. negative $150,000.
70. The present value index for this investment is:
a. 1.30.
b. 0.95.
c. 1.05.
d. 0.70.