Chapter 9 Capital Budgeting Decisions
9-21
122. Landy Company is using the internal rate of return method to decide whether to make an
investment that will cost $120,000 and which is expected to generate economic
resources for 5 years. Landry determines the IRR is 3.12. What information does the
IRR provide?
A. Landy expects to earn 3.12% of its investment as cash flows each year the asset
is used.
B. Landy expects to earn a 3.12% return over the life of its investment.
C. Landy expects the asset will produce profits equal to 3.12% of the asset’s cost
each year.
D. Landy expects to recover its cash over 3.12 years.
123. A project that costs $100,000 yields a cash flow of $18,000 per year for 9 years. How
much is the net present value of the project using a 16% cost of capital?
A. $162,000
B. $62,000
C. ($17,082)
D. $82,918
124. Why is the depreciation tax shield a component of analyzing investment decisions?
A. Depreciation causes a cash outflow that is added to determine net income.
B. Though no cash was paid out, depreciation was included on the tax return, which
caused the company to have to pay taxes on the amount of depreciation.
C. Depreciation lowers income tax expense to be paid, though no cash flow occurs
for the depreciation amount.
D. Depreciation creates cash flows that do not appear on the income statement.
125. An investment of $100,000 promises net operating cash inflows of $40,000 per year for
each of the next three years. If the required rate of return is 14%, what is the net present
value of the project?
A. $92,864
B. $20,000
C. ($7,136)
D. ($19,000)
126. When the NPV is calculated, what occurs?
A. The company adds the rate of return to the future incoming cash flows.
B. The company factors in inflation to future cash flows.
C. Interest is removed from the future cash flows to reflect the cost of money over
time.
D. The company factors in its cost of capital to reflect the proper rate on earnings.
127. Double, Inc. analyzed an investment with a required rate of return of 8.2%. Because the
Federal Reserve increased interest rates in the market, Double decided to change the
analysis to a 8.8% discount rate. The annual net income and cash flows remained the
same. What happened to the net present value?
A. It increased
B. It remained the same
C. It decreased
D. The amount of the cash flows is needed in order to determine the effect
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-22
128. A proposed project will require an initial investment of $1,000,000 and will generate net
operating cash inflows of $250,000 per year for five years. What is the internal rate of
return?
A. Less than 9%
B. 11%
C. 13%
D. Over 15%
129. An investment is expected to generate net operating cash inflows of $25,000 per year for
each of the next 5 years. If the initial amount invested is $101,000, which of the following
is closest to the internal rate of return?
A. 24.8%
B. 6.5%
C. 4.0%
D. 7.5%
130. An investment of $143,000 is expected to generate net operating cash inflows of
$62,000 in each of three years. What is the internal rate of return?
A. Less than 1%
B. Between 2% and 3%
C. Between 13% and 15%
D. Greater than 30%
131. Pinkela Company reported revenues of $275,000 and expenses of $100,000 last year.
The income tax rate was 40%. Depreciation expense of $25,000 was included in the
expenses. How much was the net operating cash flows?
A. $120,000
B. $105,000
C. $130,000
D. $145,000
132. After deducting income taxes at 30%, the annual cash basis income is estimated at
$30,000. Depreciation expense is $8,000 per year on a machine with a 6-year life. How
much are annual incremental operating cash flows?
A. $15,400
B. $27,600
C. $38,000
D. $32,400
133. A project with an initial cost of $81,000 is expected to produce cash flows of $20,000 per
year and net income of $9,000 for each of the next 7 years. The asset has an estimated
7-year life and a $4,000 salvage value. What is the projected payback period?
A. 4.05 years
B. 9.0 years
C. 7.0 years
D. 0.25 years
Chapter 9 Capital Budgeting Decisions
9-23
134. Icy Treats, Inc. wants to purchase of a new ice cream truck with a cost of $51,000. Icy
Treats has a cost of capital of 7.4% and a required rate of return of 10.4%. Its income
tax rate is 32%. The acquisition is proposed for January 1, 2017. Icy Treats expects it
can sell the truck for $7,000 at end of its useful life of 4 years. Icy Treats estimates the
following incremental amounts to be generated by the truck:
Year 1 Year 2 Year 3 Year 4
Net income $4,200 $5,600 $6,100 $5,800
Operating cash flows 15,200 16,600 17,100 16,800
How much is the accounting rate of return?
A. 14.48%
B. 56.64%
C. 10.64%
D. 18.71%
135. A project with an initial cost of $450,000 is expected to generate returns of $80,000 per
year for each of the next five years. What is the project’s payback period?
A. 5.6 years
B. 5.0 years
C. 0.17 years
D. The investment will never be recovered.
136. An investment of $400,000 is expected to generate the following cash flows:
Year 1 $60,000
Year 2 $120,000
Year 3 $50,000
Year 4 $150,000
Year 5 $200,000
What is the investment’s payback period?
A. 4.1 years
B. 3.5 years
C. 4.4 years
D. 5.1 years
137. A $600,000 investment is expected to generate cash flows of $120,000 per year for each
of the next six years. What is the investment’s payback period?
A. 6.0 years
B. 5.0 years
C. 4.0 years
D. 2.5 years
138. A project that requires an investment of $42,000 is expected to generate $14,000 of net
income in Year 1, $18,000 of net income in Year 2, and $21,000 of net income in Year 3.
Operating cash flows expected in Year 1 are $30,000, with Year 2 as $26,000, and Year
3 as $27,000. What is the accounting rate of return for this investment?
A. 11.7%
B. 75.4%
C. 42.1%
D. 84.1%
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-24
139. Haven Company is considering the construction of a new parking lot. It will cost
$125,000 to construct the lot. The income tax rate is 30%. Determine the payback period
if the expected net annual operating cash inflows are $18,000 per year and the expected
net income is $13,400.
A. 4.0 years
B. 9.9 years
C. 6.9 years
D. 9.3 years
140. Kahlen Upholstery is considering entering a new line of operations. Starting the business
will require an initial investment in equipment of $400,000 with a salvage value of
$40,000. It is expected that the new business will increase net income by $80,000 per
year for five years. The equipment will be depreciated over a five-year period using
straight-line depreciation with no residual value. How much is the accounting rate of
return of the new business?
A. 20.0%
B. 40.0%
C. 36.4%
D. 111.1%
141. Webster Corporation is considering producing a new automobile product, Glisten.
Research has determined that the company will be able to sell 50,000 units per year at
$13. The product will be produced in a section of an existing factory that is currently not
in use. To produce Glisten, Webster must buy a machine that costs $380,000. The
machine has an expected life of five years and will have an ending residual value of
$40,000. Webster will depreciate the machine over five years using the straight–line
method. In addition to the cost of the machine, the company will incur incremental cash
manufacturing costs of $535,000. Webster has an income tax rate of 30 percent, and the
company’s required rate of return is 7 percent. Calculate the payback period.
A. 3.8 years
B. 3.3 years
C. 4.7 years
D. None of these answer choices are correct.
142. Webster Corp. is considering producing a new waxing product, Glisten. Research has
determined that the company will be able to sell 50,000 units per year at $13. The
product will be produced in a section of an existing factory that is currently not in use. To
produce Glisten, Webster must buy a machine that costs $380,000. The machine has an
expected life of five years and will have an ending residual value of $40,000. Webster
will depreciate the machine over five years using the straight-line method. In addition to
the cost of the machine, the company will incur incremental manufacturing costs of
$535,000. Webster has an income tax rate of 30 percent, and the company’s required
rate of return is 7 percent. How much is the accounting rate of return?
A. 8.7%
B. 48.0%
C. 15.7%
D. 19.4%
Chapter 9 Capital Budgeting Decisions
9-25
143. A project that required a $420,000 investment generated no net income in the first year
of its operations, net income of $86,000 in the second year, and net income of $100,000
in the third year. How much is the accounting rate of return for this investment?
A. 88.6%
B. 44.3%
C. 14.8%
D. 29.5%
144. Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The
equipment will generate operating cash flows of $18,550 per year and will have no
salvage value at the end of its expected life. The income tax rate is 30%. Straight-line
depreciation is used. What is the net present value using a 6% required rate of return?
A. $44,994
B. $64,278
C. $2,878
D. ($449)
145. Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The
equipment will generate operating cash flows of $18,550 per year and will have no
salvage value at the end of its life. The income tax rate is 30%. Straight-line depreciation
is used. How much is the internal rate of return?
A. 3.3%
B. 8.0%
C. 30.2%
D. 5.68%
146. Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The
equipment will generate operating cash flows of $18,550 per year and will have no
salvage value at the end of its life. The income tax rate is 30%. Straight-line depreciation
is used. How much is the depreciation tax shield?
A. $10,745
B. $15,350
C. $4,605
D. $5,565
147. Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The
equipment will generate operating cash flows of $18,550 per year and will have no
salvage value at the end of its life. The income tax rate is 30%. Straight-line depreciation
is used. What is the payback period?
A. 3.3 years
B. 4.7 years
C. 1.21 years
D. None of these answer choices are correct.
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-26
148. Chiller Time wants to purchase a new ice cream truck which costs $56,000. The
company has a cost of capital of 8%, required rate of return of 10%, and the prevailing
income tax rate is 30%. The acquisition is proposed for January 1, 2017. Chiller Time
expects it can sell the truck for $8,000 at end of its useful life of 4 years. Chiller Time
predicts the new truck will generate net income of $5,000 and operating cash flows of
$17,000 during 2017, with an increase of 5% each subsequent year. What is the
accounting rate of return?
A. 22.4%
B. 16.8%
C. 44.9%
D. 17.7%
149. Wilson Productions bought a piece of equipment for $53,400 that will last for 5 years.
The equipment will generate annual net operating cash inflows of $13,600 and will have
a $1,000 salvage value at the end of its life. Straight-line depreciation is used. The
income tax rate is 30%. What is the net present value using a 7% required rate of
return?
A $2,362
B. $3,076
C. $3,362
D. None of these answer choices are correct.
150. Wonton Productions bought a piece of equipment for $55,898 that will last for 5 years.
The equipment will generate net operating cash flows of $14,000 per year and will have
no salvage value at the end of its life. Straight-line depreciation is used. The income tax
rate is 30%. What is the internal rate of return?
A. 3.99%
B. 8.00%
C. 25.05%
D. 32%
151. Wonton Productions bought a piece of equipment for $55,898 that will last for 5 years.
The equipment will generate net operating cash flows of $14,000 per year and will have
no salvage value at the end of its life. Straight-line depreciation is used. The income tax
rate is 30%. How much is net income or (loss) in year 2?
A. $17,354
B. $25,180
C. $2,820
D. $10,646
152. Ranger Enterprises bought a piece of equipment for $64,000 that will last for 5 years.
The equipment will generate net operating cash flows of $14,000 per year and will have
a $3,000 salvage value at the end of its life. Straight-line depreciation is used. The
income tax rate is 30%. How long is the payback period?
A. 4.6 years
B. 6.5 years
C. 3.8 years
D. None of these answer choices are correct.
Chapter 9 Capital Budgeting Decisions
9-27
153. Ranger Enterprises bought a piece of equipment for $64,000 that will last for 5 years.
The equipment will generate net operating cash flows of $14,000 per year and will have
a $3,000 salvage value at the end of its life. Straight-line depreciation is used. The
income tax rate is 30%. What is the amount to be used in the denominator in
determining the accounting rate of return?
A. $12,200
B. $64,000
C. $13,400
D. $33,500
Answers to Multiple Choice
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-28
MATCHING
154. Match each of the following terms with the phrase that most closely describes it. Each
answer may be used only once.
1.
Accounting rate of return
6.
Internal rate of return
2.
Capital budget
7.
Net present value
3.
Capital expenditure
decision
8.
Payback period
4.
Cost of capital
9.
Present value analysis
5.
Depreciation tax shield
10.
Required rate of return
A. Weighted average of the costs of debt and equity financing used to generate
capital for investments
B. The rate of return that equates the present value of future cash flows to the
investment outlay
C. Decisions involving the acquisition of long-lived assets
D. The average cost of borrowing funds for a company
E. Average after-tax income from a project divided by the average investment in the
project
F. Hurdle rate; the minimum acceptable rate of return on an investment
G. Tax savings resulting from depreciation
H. The length of time it takes to recover the initial cost of an investment
I. The sum of the present values of all cash flows
J. A method of investment analysis that expresses future cash flows in terms of
their value today
K. The list of approved capital expenditures
L. The remaining useful life of an asset
Chapter 9 Capital Budgeting Decisions
9-29
EXERCISES
155. How much is the present value of $6,500 to be received at the end of six years, if the
required rate of return is 15%?
Answer
156. Maxwell Industries has a required rate of return of 8%. How much is the present value of
a. $15,000 to be received at the end of 8 years?
b. $12,000 to be received per year for 5 years?
Answer
157. How much is the present value of $5,000 per year for four years. The required rate of
return is 10%?
Answer
158. Bouquet Florist is considering replacing an old refrigeration unit with a larger unit to store
flowers. Because the new refrigeration unit has a larger capacity, the company estimates
that it can sell an additional $14,000 of flowers a year at a cost of $5,000. Although it will
cost an extra $2,400 per year for maintenance, the new unit is energy efficient and will
save $1,400 in electricity cost each year. The new refrigeration unit costs $35,000 and
has an expected life of 10 years. At the end of 10 years, the new unit has an expected
residual value of $6,000. Determine the net present value of the investment after taxes if
the required rate of return is 8 percent. Income taxes are 30%. Should the investment be
undertaken?
Answer
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-30
159. Brown Shoe Company is considering investing in one of two machines that cut leather
for shoes. Machine A costs $55,000 and is expected to save the company $13,000
annual operating cash flows for six years. Machine B costs $89,000 and is expected to
save the company $22,000 annual cash flows for six years. Determine the net present
value for each machine and decide which machine should be purchased if the required
rate of return is 10 percent.
160. Sports & More is considering the development of an e-commerce business. The
company estimates that development will require an initial outlay of $350,000. Other
cash flows are estimated as follows:
Year 1 ($60,000)
Year 2 $140,000
Year 3 $210,000
Year 4 $130,000
Assuming the company limits its analysis to four years due to economic uncertainties,
determine the net present value of the e-commerce business. Should the company
develop the e-commerce business if the required rate of return is 6 percent?
Answer
Chapter 9 Capital Budgeting Decisions
9-31
161. An investment of $185,575 is expected to generate returns of $65,000 per year for each
of the next four years. What is the investment’s internal rate of return?
162. A project will require an initial investment of $620,000 and will return $165,000 of
operating cash flows each year for five years. The required rate of return is 9%. How
much is the project’s net present value? Based on this analysis, should the company
proceed with the project?
163. The accountant of Fixer Depot prepared the following annual analysis of a $65,000
investment in equipment that has a life of 4 years:
Cost savings $21,000
Taxes on savings (6,300)
Depreciation tax shield 4,875
Operating cash flows 19,575
After reviewing the calculation, the operations manager made the following observation:
“You’ve assumed that there won’t be inflation. I think it is reasonable to assume that
labor and costs other than depreciation will increase by 3% per year. Why don’t you redo
the analysis with that assumption?”
The accountant replied: “Inflation is built into our 8% required rate of return.”
a. What does the accountant mean by “inflation is built into our 8% required rate of
return?”
b. Redo the analysis assuming an inflation rate of 3%. Should the company make
the investment in the equipment?
Answer
Test Bank to accompany Jiambalvo Managerial Accounting, 6th Edition
9-32
164. Saren Millworks is contemplating the purchase of a new casting oven. The oven will cost
$40,000 but will generate additional revenue of $30,000 per year for ten years.
Additional costs, other than depreciation, will equal $15,000 per year. The oven has an
expected life of ten years, at which time it will have no residual value. Saren uses the
straight-line method of depreciation. Determine the net present value of the investment if
the required rate of return is 14% and the tax rate is 40%. Should Saren Millworks make
the investment in the boiler?