Chapter 25 Capital Budgeting and Managerial Decisions
MULTIPLE CHOICE QUESTIONS
1) Capital budgeting is the process of analyzing alternative long-term investments and deciding which
assets to acquire or sell.
A) True
B) False
2) Capital budgeting decisions are risky because the outcome is uncertain, large amounts of money
are usually involved, the investment involves a long-term commitment, and the decision could be
difficult or impossible to reverse.
A) True
B) False
3) If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should
be accepted.
A) True
B) False
4) Neither the payback period nor the accounting rate of return methods of evaluating investments
considers the time value of money.
A) True
B) False
5) An opportunity cost is the potential benefit lost by taking a specific action when two or more
alternative choices are available.
A) True
B) False
6) A sunk cost will change with a future course of action.
A) True
B) False
7) An out–of-pocket cost requires a future outlay of cash and is relevant for current and future
decision making.
A) True
B) False
8) Another name for relevant cost is unavoidable cost.
A) True
B) False
9) Relevant benefits refer to the additional or incremental revenue generated by selecting a particular
course or action over another.
A) True
B) False
10) Significant sunk costs are relevant to decisions about the future.
A) True
B) False
11) The concept of incremental cost is the same as the concept of differential cost.
A) True
B) False
12) Additional business in the form of a special order of goods or services should be accepted when the
incremental revenue equals the incremental costs.
A) True
B) False
13) In a make or buy decision, management should focus on costs that are the same under the two
alternatives.
A) True
B) False
14) Part of the decision to accept additional business should be based on a comparison of the
incremental (differential) costs of the added production with the additional revenues to be received.
A) True
B) False
15) Incremental costs should be considered in a make or buy decision.
A) True
B) False
16) If a company has the capacity to produce either 10,000 units of Product A or 10,000 units of
Product B; assuming fixed costs are the same, production restrictions are the same for both
products, and the markets for both products are unlimited; the company should commit 100% of its
capacity to the product that has the higher contribution margin.
A) True
B) False
17) The decision to accept an additional volume of business should be based on a comparison of the
revenue from the additional business with the sunk costs of producing that revenue.
A) True
B) False
18) An advantage of the break-even time (BET) method over the payback period method is that it
recognizes the time value of money.
A) True
B) False
19) In ranking choices with the break-even time (BET) method, the investment with the longest BET
gets the highest rank.
A) True
B) False
20) When computing payback period, the year in which a capital investment is made is year 1.
A) True
B) False
21) The payback period method of evaluating an investment fails to consider cash inflows after the
point where an investment’s costs are fully recovered.
A) True
B) False
22) The time value of money is considered when calculating the payback period of an investment.
A) True
B) False
23) 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.
A) True
B) False
24) The payback period method, unlike the net present value method, does not ignore cash flows after
the point of cost recovery.
A) True
B) False
25) If two projects have the same risks, the same payback periods, and the same initial investments,
they are equally attractive.
A) True
B) False
26) 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.
A) True
B) False
27) If the straight-line depreciation method is used, the annual average investment amount used in
calculating rate of return is calculated as (beginning book value + ending book value)/2.
A) True
B) False
28) The accounting rate of return is based on cash flows rather than net income in its calculation.
A) True
B) False
29) 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.
A) True
B) False
30) Net cash flow is cash inflows minus cash outflows.
A) True
B) False
31) 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.
A) True
B) False
32) Restating future cash flows in terms of their present value is called discounting.
A) True
B) False
33) Restating future cash flows in terms of their future value is called discounting.
A) True
B) False
34) The internal rate of return equals the rate that yields a net present value of zero for an investment.
A) True
B) False
35) The internal rate of return method of evaluating capital investments cannot be used with uneven
cash flows.
A) True
B) False
36) Capital budgeting is the process of analyzing:
A) Long-term investments.
B) Short-term investments.
C) Investments with certain outcomes only.
D) Cash outflows only.
E) Operating revenues.
37) The process of analyzing alternative long-term investments and deciding which assets to acquire or
sell is known as:
A) Variance analysis.
B) Planning and control.
C) Capital budgeting.
D) Managerial accounting.
E) Master budgeting.
38) Capital budgeting decisions are generally based on:
A) Results from past outcomes only.
B) Tentative and potentially unreliable predictions of future outcomes.
C) Speculation of interest rates and economic performance only.
D) Results from current outcomes only.
E) Predictions of future outcomes where risk is eliminated.
39) The calculation of annual net cash flow from a particular investment project should include all of
the following except:
A) General and administrative expenses.
B) Depreciation expense.
C) Income taxes.
D) Revenues generated by the investment.
E) Cost of products generated by the investment.
40) Capital budgeting decisions are risky because all of the following are true except:
A) The investment involves a long-term commitment.
B) The decision could be difficult or impossible to reverse.
C) They rarely produce net cash flows.
D) Large amounts of money are usually involved.
E) The outcome is uncertain.
41) The process of restating future cash flows in today’s dollars is known as:
A) Discounting.
B) Capitalizing.
C) Payback period.
D) Annualization.
E) Budgeting.
42) A company’s required rate of return, typically its cost of capital, is called the:
A) Internal rate of return.
B) Hurdle rate.
C) Average rate of return.
D) Maximum rate.
E) Payback rate.
43) In business decision-making, managers typically examine the two fundamental factors of:
A) Capital investment and rate of return.
B) Risk and return.
C) Risk and payback.
D) Risk and capital investment.
E) Payback and rate of return.
44) A limitation of the internal rate of return method is that it:
A) Measures results in years.
B) Measures net income rather than cash flows.
C) Does not consider the time value of money.
D) Ignores varying risks over the life of a project.
E) Lacks ability to compare dissimilar projects.
45) An opportunity cost:
A) Requires a current outlay of cash.
B) Results from past managerial decisions.
C) Is irrelevant in decision making because it occurred in the past.
D) Is an unavoidable cost because it remains the same regardless of the alternative chosen.
E) Is the potential benefit lost by choosing a specific alternative course of action among two or
more.
46) The potential benefits lost by taking a specific action when two or more alternative choices are
available is known as a(n):
A) Out-of-pocket cost.
B) Sunk cost.
C) Alternative cost.
D) Opportunity cost.
E) Differential cost.
47) A cost that requires a future outlay of cash, and is relevant for current and future decision making,
is a(n):
A) Opportunity cost.
B) Sunk cost.
C) Uncontrollable cost.
D) Out-of-pocket cost.
E) Operating cost.
48) A cost that cannot be avoided or changed because it arises from a past decision, and is irrelevant to
future decisions, is called a(n):
A) Out-of-pocket cost.
B) Incremental cost.
C) Uncontrollable cost.
D) Opportunity cost.
E) Sunk cost.
49) A company paid $200,000 ten years ago for a specialized machine that has no salvage value and is
being depreciated at the rate of $10,000 per year. The company is considering using the machine in
a new project that will have incremental revenues of $28,000 per year and annual cash expenses of
$20,000. In analyzing the new project, the $200,000 original cost of the machine is an example of
a(n):
A) Variable cost.
B) Opportunity cost.
C) Out-of-pocket cost.
D) Sunk cost.
E) Incremental cost.
50) An additional cost incurred, only if a company pursues a particular course of action, is a(n):
A) Incremental cost.
B) Period cost.
C) Discount cost.
D) Pocket cost.
E) Sunk cost.
51) A company is considering a new project that will cost $19,000. This project would result in
additional annual revenues of $6,000 for the next 5 years. The $19,000 cost is an example of a(n):
A) Sunk cost.
B) Uncontrollable cost.
C) Fixed cost.
D) Opportunity cost.
E) Incremental cost.
52) Gordon Corporation inadvertently produced 10,000 defective digital watches. The watches cost $8
each to produce. A salvage company will purchase the defective units as they are for $3 each.
Gordon’s production manager reports that the defects can be corrected for $5 per unit, enabling
them to be sold at their regular market price of $12.50. Gordon should:
A) Sell the watches for $3 per unit.
B) Correct the defects and sell the watches at the regular price.
C) Scrap the watches.
D) Sell 5,000 watches to the salvage company and repair the remainder.
E) Sell the watches as they are because repairing them will cause their total cost to exceed their
selling price.