Cost Accounting, 15e Global Edition (Horngren/Datar/Rajan)
Chapter 21 Capital Budgeting and Cost Analysis
Objective 21.1
1) Which of the following involves the process of making decisions for significant financial investments in
projects to develop new products, expand production capacity, or remodel current production facilities?
A) capital budgeting
B) working capital management
C) master budgeting
D) capitalization
2) Which of the following is a stage of the capital budgeting process that indicates potential capital
investments that agree with an organization’s strategy?
A) identify projects stage
B) make predictions stage
C) obtain information stage
D) implement the decision, evaluate performance, and learn stage
3) Which of the following is a stage of the capital budgeting process during which a plant manager is
queried for assembly time?
A) make decisions by choosing among alternatives stage
B) obtain information stage
C) make predictions stage
D) implement the decision, evaluate performance, and learn stage
4) Which of the following is a stage of the capital budgeting process that forecasts all potential cash flows
attributable to the alternative projects?
A) identify projects stage
B) make decisions by choosing among alternatives stage
C) implement the decision, evaluate performance, and learn stage
D) make predictions stage
5) Which of the following is a stage of the capital budgeting process that determines which investment
yields the greatest benefit and the least cost to an organization?
A) make decisions by choosing among alternatives stage
B) make predictions stage
C) identify projects stage
D) implement the decision, evaluate performance, and learn stage
6) Which of the following is a stage of the capital-budgeting process that tracks realized cash flows and
compares those against estimated numbers?
A) implement the decision, evaluate performance, and learn stage
B) make predictions stage
C) identify projects stage
D) make decisions by choosing among alternatives stage
7) Which of the following is the first stage to the capital budgeting process?
A) forecast all potential cash flows attributable to the alternative projects
B) determine which investment yields the greatest benefit and the least cost to the organization
C) obtain funding and make the investments selected
D) identify potential capital investments that agree with the organization’s strategy
8) Which of the following is a stage of the capital budgeting process in which a firm obtains funding for
the project?
A) make decisions by choosing among alternatives stage
B) identify projects stage
C) obtain information stage
D) implement the decision, evaluate performance, and learn stage
9) Which capital budgeting technique measures all expected future cash inflows and outflows as if they
occurred at a single point in time?
A) net present value method
B) accrual accounting rate-of-return method
C) payback method
D) sensitivity analysis
10) The accounting system that corresponds to the project dimension in capital budgeting is the ________.
A) net present value method
B) internal rate of return
C) accrual accounting rate of return
D) life-cycle costing
11) Capital budgeting is a process of ________.
A) tracing overhead costs to products by focusing on the activities that drive costs
B) assigning identified costs to specific cost objectives or cost centers
C) measuring an organization’s operations, products, and services against those of competitors
recognized as market leaders
D) making long-run planning decisions for investments in projects
12) Capital budgeting is the process of making long-run planning decisions for investments in projects.
13) A capital budget spans only a one-year period.
14) In the “Identify projects” stage of capital budgeting, companies gather information from all parts of
the value chain to evaluate alternative projects.
15) In the “obtain information” stage of capital budgeting, a company gathers information from all parts
of the value chain to evaluate alternative projects.
16) In the “make decisions by choosing among alternatives” stage of the capital budgeting process, a
company determines which investment yields the greatest benefit and the least cost to the organization.
17) In the “make predictions” stage of the capital budgeting process, a company forecasts all potential net
income additions those are attributable to the alternative projects.
18) The final activity in the capital budgeting process is to obtain funding and make the investments
identified in the make decisions by choosing among alternatives stage of the process.
19) Match each one of the examples below with one of the stages of the capital budgeting decision model.
Stages:
1. Identify Projects
2. Obtain Information
3. Make Predictions
4. Make Decisions by Choosing Among Alternatives
5. Implement the Decision, Evaluate Performance, and Learn
________ a. Issuing corporate stock for the funds to purchase new equipment
________ b. Learning how to effectively operate Machine #8 only takes 15 minutes
________ c. The need to reduce the costs to process the vegetables used in producing goulash
________ d. Monitoring the costs to operate a new machine
________ e. Percentage of defective merchandise considered too high
________ f. Will introducing the new product substantially upgrade our image as
a producer of quality products?
________ g. Estimating yearly cash flows and setting investment budgets accordingly using
a 12-year planning horizon.
________ h. Use of the internal rate of return for each alternative
________ i. Tracking realized cash flows and comparing against estimated numbers.
20) List the capital budgeting methods used to analyze financial information.
21) Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting
project?
22) Cast Iron Stove Company wants to buy a molding machine that can be integrated into its
computerized manufacturing process. It has received three bids for the machine and related
manufacturer’s specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual savings
of the machines range from $260,000 to $270,000. The payback periods are almost identical and the net
present values are all within $8,000 of each other. The president just doesn’t know what to do about
which vendor to choose since all of the selection criteria are so close together.
Required:
What suggestions do you have for the president?
Objective 21.2
1) Discounted cash flow methods for capital budgeting focus on ________.
A) cash inflows and required rate of return
B) operating income and required rate of return
C) operating income and cost of capital
D) working capital and cost of capital
2) Net present value is calculated using the ________.
A) internal rate of return
B) discount rate
C) risk-free rate
D) predetermined overhead cost rate
3) Which of the following capital budgeting methods uses discounted cash flows?
A) accrual accounting rate-of-return method
B) net present value method
C) projected income method
D) payback method
4) The capital budgeting method which calculates the expected monetary gain or loss from a project by
discounting all expected future cash inflows and outflows to the present point in time using the required
rate of return is the ________.
A) payback method
B) accrual accounting rate-of-return method
C) sensitivity method
D) net present value method
5) Assume your goal in life is to retire with $2,500,000. How much would you need to save at the end of
each year if interest rates average 7% and you have a 20-year work life?
A) $30,130
B) $60,983
C) $250,205
D) $832,952
6) Assume your goal in life is to retire with two million dollars. How much would you need to save at the
end of each year if interest rates average 6% and you have a 25-year work life?
A) $43,118
B) $55,596
C) $36,453
D) $75,503
7) Assume your goal in life is to retire with 3 million dollars. How much would you need to save at the
end of each year if investment rates average 8% and you have a 14-year work life?
A) $41,159
B) $ 123,891
C) $ 175,706
D) $ 82,582
Answer the following questions using the information below:
Difend Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing
machine is operable for three more years and will have a zero disposal price. If the machine is disposed
now, it may be sold for $100,000. The new machine will cost $350,000 and an additional cash investment
in working capital of $100,000 will be required. The new machine will reduce the average amount of time
required to wash clothing and will decrease labor costs. The investment is expected to net $110,000 in
additional cash inflows during the first year of acquisition and $250,000 each additional year of use. The
new machine has a three-year life, and zero disposal value. These cash flows will generally occur
throughout the year and are recognized at the end of each year. Income taxes are not considered in this
problem. The working capital investment will not be recovered at the end of the asset’s life.
8) What is the net present value of the investment, assuming the required rate of return is 10%? Would
the company want to purchase the new machine?
A) $144,240 ; yes
B) $180,000 ; yes
C) $(180,000); no
D) $(144,240); no
9) What is the net present value of the investment, assuming the required rate of return is 20%? Would
the company want to purchase the new machine?
A) $(62,600); yes
B) $(59,880); no
C) $59,880; yes
D) $62,600; no
Answer the following questions using the information below:
Diemia Hospital has been considering the purchase of a new x-ray machine. The existing machine is
operable for five more years and will have a zero disposal price. If the machine is disposed now, it may
be sold for $80,000. The new machine will cost $600,000 and an additional cash investment in working
capital of $25,000 will be required. The new machine will reduce the average amount of time required to
take the x-rays and will allow an additional amount of business to be done at the hospital. The
investment is expected to net $50,000 in additional cash inflows during the year of acquisition and
$200,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These
cash flows will generally occur throughout the year and are recognized at the end of each year. Income
taxes are not considered in this problem. The working capital investment will not be recovered at the end
of the asset’s life.
10) What is the net present value of the investment, assuming the required rate of return is 11%? Would
the hospital want to purchase the new machine?
A) $(59,050); no
B) $55,430 no
C) $59,050; yes
D) $55,430; yes
11) What is the net present value of the investment, assuming the required rate of return is 18%? Would
the hospital want to purchase the new machine?
A) $33,910; yes
B) $(46,650); no
C) $(46,650); yes
D) $50,800; yes
12) In using the net present value method, only projects with a zero or positive net present value are
acceptable because ________.
A) the return from these projects equals or exceeds the cost of capital
B) a positive net present value on a particular project guarantees company profitability
C) the company will be able to pay the necessary payments on any loans secured to finance the project
D) it results in high payback period
13) Which of the following is also called required rate of return?
A) hurdle rate
B) total cost rate
C) variance rate
D) predetermined overhead rate
14) Which of the following projects is rejected on the basis of net present value method?
A) Project A with an NPV of $5,000
B) Project B with an NPV of $(7,000)
C) Project C with an NPV of $15,000
D) Project D with an NPV of $500
15) An annuity is ________.
A) a noncash expense
B) a series of equal cash flows at equal time intervals
C) an investment product whose funds are invested in the stock market
D) a rate at which an investment’s present value of all expected cash inflows equals the present value of
project’s expected cash outflows.
16) The net present value method focuses on ________.
A) cash flows and discount rate
B) inventory cost and cost of capital
C) working capital and cost of capital
D) operating income and required rate of return
17) If the net present value for a project is positive, ________.
A) the project should be accepted
B) its internal rate of return is more than its cost of capital
C) its expected rate of return is below the required rate of return
D) its internal rate of return is less than its cost of capital
18) Concose Park Department is considering a new capital investment. The following information is
available on the investment. The cost of the machine will be $330,000. The annual cost savings if the new
machine is acquired will be $85,000. The machine will have a 5-year life, at which time the terminal
disposal value is expected to be $32,000. Concose Park Department is assuming no tax consequences. If
Concose Park Department has a required rate of return of 11%, which of the following is closest to the
present value of the project?
A) $8,245
B) $24,836
C) $3,136
D) $15,840
19) Forge Company wants to purchase a new cutting machine for its sewing plant. The investment is
expected to generate annual cash inflows of $120,000. The required rate of return is 10% and the current
machine is expected to last for four years. What is the maximum dollar amount the company would be
willing to spend for the machine, assuming its life is also four years? Income taxes are not considered.
A) $273,500
B) $460,800
C) $355,950
D) $380,280
20) The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of
$380,000. The investment is expected to generate $125,000 in annual cash flows for a period of four years.
The required rate of return is 12%. The old machine can be sold for $20,000. The machine is expected to
have zero value at the end of the four-year period. What is the net present value of the investment?
Would the company want to purchase the new machine? Income taxes are not considered.
A) $19,750; yes
B) $35,775; no
C) $360,000; yes
D) $163,005; no
21) Forise Water Company drills small commercial water wells. The company is in the process of
analyzing the purchase of a new drill. Information on the proposal is provided below.
Initial investment:
Asset $600,000
Working capital $ 128,000
Operations (per year for four years):
Cash receipts $450,000
Cash expenditures $ 190,000
Disinvestment:
Salvage value of drill (existing) $ 50,000
Discount rate 18%
What is the net present value of the investment? Assume there is no recovery of working capital.
A) $(124,280)
B) $21,400
C) $82,724
D) $149,400
22) The capital budgeting method that calculates the discount rate at which the present value of expected
cash inflows from a project equals the present value of expected cash outflows is the ________.
A) net present value method
B) accrual accounting rate-of-return method
C) payback method
D) internal rate of return method
23) The internal rate-of-return (IRR) method calculates ________.
A) the discount rate at which an investment’s present value of the total of all expected cash inflows equals
the present value of its expected cash outflows.
B) the discount rate at which an investment’s future value of all expected cash inflows equals the present
value of its expected cash outflows.
C) the discount rate at which an investment’s total of all expected cash inflows equals the present value of
its expected cash outflows.
D) the discount rate at which sum of an investment’s present value of all expected cash inflows equals the
present value of its expected cash outflows.
24) In capital budgeting, a project is accepted only if the internal rate of return equals or ________.
A) exceeds the required rate of return
B) exceeds the inflation rate
C) exceeds the risk-free rate
D) exceeds the accrual accounting rate of return
25) The Comil Corporation recently purchased a new machine for its factory operations at a cost of
$390,875. The investment is expected to generate $125,000 in annual cash flows for a period of five years.
The required rate of return is 12%. The old machine has a remaining life of five years. The new machine is
expected to have zero value at the end of the five-year period. The disposal value of the old machine at
the time of replacement is zero. What is the internal rate of return?
A) 15%
B) 16%
C) 17%
D) 18%
26) Locil Corporation recently purchased a new machine for $415,275 with a nine-year life. The old
equipment has a remaining life of nine years and no disposal value at the time of replacement. Net cash
flows will be $75,000 per year. What is the internal rate of return?
A) 11%
B) 16%
C) 20%
D) 24%
27) Soda Manufacturing Company provides vending machines for soft-drink manufacturers. The
company has been investigating a new piece of machinery for its production department. The old
equipment has a remaining life of four years and the new equipment has a value of $91,110 with a four-
year life. The expected additional cash inflows are $30,000 per year. What is the internal rate of return?
A) 12%
B) 16%
C) 10%
D) 8%
28) Diamond Manufacturing Company provides glassware machines for major department store
retailers. The company has been investigating a new piece of machinery for its production department.
The old equipment has a remaining life of four years and the new equipment has a value of $87,776 with
a four-year life. The expected additional cash inflows are $32,000 per year. What is the internal rate of
return?
A) 10%
B) 12%
C) 17%
D) 20%
29) Midize Flower Company provides flowers and other nursery products for decorative purposes in
medium to large sized restaurants and businesses. The company has been investigating the purchase of a
new specially equipped van for deliveries. The van has a value of $66,645 with a seven-year life. The
expected additional cash inflows are $15,000 per year. What is the internal rate of return?
A) 10%
B) 13%
C) 15%
D) 20%
30) The net present value method of capital budgeting is preferred over the internal rate-of-return
method because ________.
A) the net present value method is expressed as a percentage of initial investment
B) the net present values of individual projects can be added to determine the effects of accepting a
combination of projects
C) the percentage return computed under the net present value method is very easy to compare
D) the calculation under the net present value method is easy as it does not use time value of money
31) In situations where the required rate of return is not constant for each year of the project, it is
advantageous to use ________.
A) the nominal rate-of-return method
B) the internal rate-of-return method
C) the net present value method
D) the projected income method
32) A “what-if” technique that examines how a result will change if the original predicted data are NOT
achieved or if an underlying assumption changes is called ________.
A) sensitivity analysis
B) net present value analysis
C) internal rate-of-return analysis
D) adjusted rate-of-return analysis
33) Investment A requires a net investment of $1,400,000. The required rate of return is 10% for the five-
year annuity. What are the annual cash inflows if the net present value equals 0? (rounded)
A) $378,966
B) $369,296
C) $345,696
D) $251,466
34) The minimum annual acceptable rate of return on an investment is the ________.
A) accrual accounting rate of return
B) hurdle rate
C) internal rate of return
D) net present value
35) Hypore Darby Park Department is considering a new capital investment. The following information
is available on the investment. The cost of the machine will be $251,130. The annual cost savings if the
new machine is acquired will be $110,000. The machine will have a 3-year life, at which time the terminal
disposal value is expected to be zero. Hypore Park Department is assuming no tax consequences. What is
the internal rate of return for Hypore Park Department?
A) 10%
B) 15%
C) 14%
D) 16%
36) Which of the following is an advantage of internal rate of return method?
A) Sum of IRRs of individual projects gives an IRR of a combination or portfolio of projects.
B) The percentage returns computed under the IRR method are easy to understand and compare.
C) It can be expressed as a unique number.
D) It can be used when the required rate of return varies over the life of a project.
37) The net present value method assumes that project cash flows can be reinvested at the company’s
________.
A) internal rate of return
B) required rate of return
C) growth rate
D) accounting rate of return
38) The internal rate of return method assumes that project cash flows can be reinvested at the project’s
________.
A) internal rate of return
B) required rate of return
C) growth rate
D) accounting rate of return
39) The NPV method is the preferred method over IRR for selecting projects because ________.
A) its use leads to shareholder value maximization
B) it accounts for the time value of money
C) it assumes that cash flows are reinvested at the internal rate of return
D) it gives a project ranking consistent with that of IRR
40) The Required Rate of Return (RRR) is set externally by creditors as the interest rate on long term
liabilities.
41) Discounted cash flow methods focus on operating income.
42) The three common discounted cash flow methods are net present value, internal rate of return, and
payback.
43) The net present value (NPV) method calculates the expected monetary gain or loss from a project by
discounting all expected future cash inflows and outflows back to the present point in time using the
required rate of return.
44) Internal rate of return is a method of calculating the expected net monetary gain or loss from a project
by discounting all expected future cash inflows and outflows to the present point in time.
45) A capital budgeting project is accepted if the required rate of return equals or exceeds the internal rate
of return.
46) The net present value method can be used in situations where the required rate of return varies over
the life of the project.
47) The net present value method accurately assumes that project cash flows can only be reinvested at the
company’s required rate of return.