Financial and Managerial Accounting, 8e (Wild)
Chapter 24 Capital Budgeting and Investment Analysis
1) Capital budgeting is the process of analyzing alternative long-term investments and deciding
which assets to acquire or sell.
2) The payback period is the amount of time for the investment to generate enough net cash flow
to return the initial cost of investment.
3) Net cash flow can be calculated by adjusting the projected net income from a project for any
non-cash revenues and expenses.
4) Projects with shorter payback periods have higher risk, as the company has less time to
respond to unanticipated changes.
5) If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project
should be accepted.
6) If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project
should be rejected.
7) Neither the payback period nor the accounting rate of return methods of evaluating
investments considers the time value of money.
8) An advantage of the break-even time (BET) method over the payback period method is that it
recognizes the time value of money.
9) In ranking choices with the break-even time (BET) method, the investment with the longest
BET gets the highest rank.
10) In ranking choices with the break-even time (BET) method, the investment with the longest
BET gets the lowest rank.
11) When computing payback period, the date the initial capital investment is made is year 1.
12) The payback period method of evaluating an investment ignores cash inflows after the point
where an investment’s costs are fully recovered.
13) The time value of money is considered when calculating the payback period of an
investment.
14) Two investments with exactly the same payback periods are not equally valuable to an
investor because the timing of net cash flows may be different.
15) The payback period method, unlike the net present value method, does not ignore cash flows
after the point of cost recovery.
16) If two projects have the same risks, the same payback periods, and the same initial
investments, they are equally attractive.
17) A shorter payback period reduces the company’s ability to respond to unanticipated changes
and increases the risk of having to keep an unprofitable investment.
18) The accounting rate of return (ARR) is computed by dividing a project’s after-tax net income
by the average annual investment.
19) The accounting rate of return (ARR) is computed by dividing a project’s after-tax net income
by the amount of the initial investment.
20) If the straight-line depreciation method is used, the annual average investment amount used
in calculating the accounting rate of return is calculated as (beginning book value + ending book
value)/2.
21) The accounting rate of return is based on cash flows rather than net income in its calculation.
22) When comparing investments with similar lives and risks, a company will prefer the
investment with the higher rate of return.
23) If net present values are used to evaluate two investments that have equal costs and equal
total cash flows, the one with more cash flows in the early years has the higher net present value.
24) The net present value decision rule is: When an asset’s expected cash flows yield a positive
net present value when discounted at the required rate of return, the asset should be acquired.
25) The internal rate of return equals the rate that yields a net present value of zero for an
investment.
26) The internal rate of return method of evaluating capital investments cannot be used with
uneven cash flows.
27) There is only one method of evaluating capital budgeting decisions.
28) Capital budgeting decisions are risky because the outcome is uncertain, large amounts are
usually involved, the investment involves a long-term commitment, and the decision could be
difficult or impossible to reverse.
29) Capital budgeting decisions are not affected by return on investment considerations.
30) Capital budgeting decisions that relate to investments in technology are not as risky as other
types of capital budgeting decisions.
31) The time value of money concept works on the principle that a dollar today is worth more
than a dollar tomorrow.
32) The time value of money concept works on the principle that a dollar tomorrow is worth
more than a dollar today.
33) The process of restating cash flows in terms of their present values is called discounting.
34) All capital investment evaluation methods use the time value of money concept.
35) A hurdle rate is the minimum acceptable rate of return for an investment.
36) For projects financed from borrowed funds, the hurdle rate must exceed the interest rate paid
on the borrowed funds.
37) Soft capital rationing is imposed by external factors, such as debt covenants.
38) Neither the net present value nor the internal rate of return methods of evaluating
investments consider the time value of money.
39) Accounting rate of return gives managers an estimate of how soon they will recover their
initial investment.
40) The net present value capital budgeting method considers all estimated cash flows for the
project’s expected life.
41) In ranking choices with the break-even time (BET) method, the investment with the highest
BET measure gets the highest rank.
42) Three widely used methods of comparing investment alternatives are payback period, net
present value, and rate of return on average investment.
43) The payback method of evaluating an investment fails to consider how long the investment
will generate cash inflows beyond the payback period.
44) Two investments with exactly the same payback periods are always equally valuable to an
investor.
45) A disadvantage of an investment with a short payback period is that it will produce revenue
for only a short period of time.
46) In calculating the accounting rate of return using the straight-line method of depreciation, the
annual average investment is calculated as (beginning book value + ending book value)/2.
47) The accounting rate of return uses cash flows in its calculation.
48) The payback method, unlike the net present value method, ignores cash flows after the point
of cost recovery.
49) Using accelerated depreciation for tax reporting increases the net present value of an asset’s
cash flows because it produces larger net cash inflows in the early years of the asset’s life.
50) Using a profitability index allows management to rank projects of similar risks with different
investment amounts.
51) The profitability index is computed by dividing the present value of net cash flows by the
initial investment.
52) A positive profitability index indicates a positive net present value.
53) All projects with a profitability index of less than 1 should be accepted.
54) Projects with a profitability index of greater than 1 have a return that is greater than the
hurdle rate.
55) The calculation of annual net cash flow from a particular investment project should include
all of the following except:
A) Income taxes.
B) Revenues generated by the investment.
C) Cost of products generated by the investment.
D) Depreciation expense.
E) General and administrative expenses.
56) The process of restating future cash flows in today’s dollars is known as:
A) Budgeting.
B) Annualization.
C) Discounting.
D) Payback period.
E) Capitalizing.
57) A company’s required rate of return, typically its cost of capital is called the:
A) Internal rate of return.
B) Average rate of return.
C) Hurdle rate.
D) Maximum rate.
E) Payback rate.
58) The capital budgeting process involves all of the following except:
A) Having department or plant managers submit new investment proposals.
B) Determining which financial institution to use for financing.
C) Evaluating the submitted proposals.
D) Forming a capital budget committee that includes accounting and finance members.
E) Approving or rejecting new investment proposals.
59) A limitation of the internal rate of return method is that it:
A) Does not consider the time value of money.
B) Measures results in years.
C) Lacks ability to compare dissimilar projects.
D) Ignores varying risks over the life of a project.
E) Measures net income rather than cash flows.
60) The break-even time (BET) method is a variation of the:
A) Payback method.
B) Internal rate of return method.
C) Accounting rate of return method.
D) Net present value method.
E) Present value method.
61) The calculation of the payback period for an investment when net cash flow is even (equal)
is:
A) Cost of investment/Annual net cash flow
B) Cost of investment/Total net cash flow
C) Annual net cash flow/Cost of investment
D) Total net cash flow/Cost of investment
E) Total net cash flow/Annual net cash flow
62) Capital budgeting decisions usually involve analysis of:
A) Cash outflows only.
B) Short-term investments only.
C) Long-term investments only.
D) Investments with certain outcomes only.
E) Operating revenues.
63) Capital budgeting decisions are generally based on:
A) Tentative predictions of future outcomes.
B) Perfect predictions of future outcomes.
C) Results from past outcomes only.
D) Results from current outcomes only.
E) Speculation of interest rates and economic performance only.
64) The net cash flow of a particular investment project:
A) Does not take income taxes into consideration.
B) Equals the total of the cash inflows of the project.
C) Equals the total of the cash outflows of the project.
D) Does not include depreciation.
E) Is equal to operating income each period.
65) Which of the following is an objective of capital budgeting?
A) To eliminate all risk.
B) To discount all future and past cash flows.
C) To earn a satisfactory return on investment.
D) To reverse past decisions.
E) To reduce the number of investment activities.
66) The time value of money concept:
A) Means that a dollar today is worth less than a dollar tomorrow.
B) Means that a dollar tomorrow is worth more than a dollar today.
C) Means that a dollar today is worth more than a dollar tomorrow.
D) Means that “Time is money.”
E) Does not involve the concept of compound interest.
67) A minimum acceptable rate of return for an investment decision is called the:
A) Internal rate of return.
B) Average rate of return.
C) Hurdle rate of return.
D) Maximum rate of return.
E) Payback rate of return.
68) The rate that yields a net present value of zero for an investment is the:
A) Internal rate of return.
B) Accounting rate of return.
C) Net present value rate of return.
D) Zero rate of return.
E) Payback rate of return.
69) Which methods of evaluating a capital investment project ignore the time value of money?
A) Net present value and accounting rate of return.
B) Accounting rate of return and internal rate of return.
C) Internal rate of return and payback period.
D) Payback period and accounting rate of return.
E) Net present value and payback period.