Chapter 12—Capital Investment Decisions Key
1. Projects that do not affect the cash flows of other projects are called independent projects.
2. The process of planning, setting goals and priorities, arranging financing, and using certain criteria to select
long-term assets is called tactical decision making.
3. Projects that do not affect the cash flows of other projects are called mutually exclusive projects.
4. In capital investment decision making, it is usually assumed that managers should select projects that promise
to maximize the wealth of the owners of the firm.
5. Taxes are not an important consideration in forecasting cash flows.
6. Before-tax cash flows must be forecasted and used in capital investment decision making.
7. The two major categories of capital investment decision models are nondiscounting models and discounting
models.
8. Most firms use one type of discounting model.
9. In order to use the payback period model, the proposed investment must have even cash inflows.
10. If cash flows are uneven, the payback period assumes that the inflows during the last fraction of a year occur
evenly.
11. One way to use the payback period is to set a maximum payback period for all projects and to reject any
project that exceeds this level.
12. Sometimes firms require riskier projects to have shorter payback periods.
13. Companies considering projects with shorter lives are interested in longer payback periods.
14. A disadvantage of the payback period is that it ignores a project’s total profitability.
15. A disadvantage of the payback period is that it ignores the time value of money.
16. The accounting rate of return is used more often than the internal rate of return.
17. Both the payback period and the accounting rate of return ignore the time value of money.
18. Both the payback period and the accounting rate of return do not consider the profitability of a project over
its life span.
19. Two discounting models for capital investment decision making are net present value and internal rate of
return.
20. The difference between the present value of the cash inflows and outflows associated with a project is the
net present value model.
21. The minimum acceptable rate of return for a project is the required rate of return.
22. In practice, managers often choose a discount rate that is less than the cost of capital.
23. Suppose that the actual cost of capital is 10%, but the firm chooses a discount rate of 18%. Managers of that
company will be more likely to choose relatively short term investments.
24. If the net present value of an investment is zero, the investment earns less than the minimum required rate of
return.
25. The interest rate that sets the present value of a project’s cash inflows equal to the present value of the
project’s cost is called the internal rate of return.
26. The internal rate of return is the least widely used of the capital investment techniques.
27. One drawback to the internal rate of return model is that cash inflows must occur evenly over the life of the
investment.
28. A post audit evaluates the overall outcome of the investment and proposes corrective action if needed.
29. In general, it is best if post audits are done by company management, since they understand the actual
operating conditions.
30. A disadvantage of post audits is that they are costly.
31. Net present value analysis and internal rate of return analysis can sometimes produce erroneous choices
because they ignore the time value of money.
32. For independent projects, net present value analysis and internal rate of return analysis yield the same
decision.
33. The internal rate of return model does not consistently result in choices that maximize firm wealth.
34. A post audit is an analysis of a capital project before it is implemented.
35. A key element in the capital investment process is called a post audit.
36. Companies that perform post audits of capital projects do not experience any benefits.
37. Post audits ensure that resources are used wisely by evaluating profitability.
38. Because of the post audit, managers are more likely to make capital investment decisions in the best
interests of the firm.
39. Post audits supply feedback to managers that should help improve future decision making.
40. Less objective results are obtainable if an independent party performs the post audit of a capital investment.
41. The internal audit staff is usually the best choice for performing a post audit of a capital investment.
42. A obvious problem with post audits is that the assumptions driving the original analysis may often be
invalidated by changes in the actual operating environment.
43. Which of the following is true of capital investment decision making?
44. In general terms, a sound capital investment will
45. If the cash flows of a project are received evenly over the life of the project, the formula for the calculating
the payback period is
46. The payback period provides information to managers that can be used to help
47. Which of the following is a drawback of the payback period?
48. The most widely used nondiscounting model for capital investment decision making is the
49. A formula for the accounting rate of return is
50. Managers may use the accounting rate of return to evaluate potential investment projects because
51. The required rate of return used in the net present value model can also be called the
52. If net present value is negative, it means that the return on the investment is
53. The interest rate that sets the present value of a project’s cash inflows equal to the present value of the
project’s cost is called the ____.
54. Which of the following is true regarding the internal rate of return for a project?
55. Which of the following compares the actual benefits from an investment with the estimated benefits, and the
actual operating costs of the investment with estimated operating costs?
56. Which of the following is a disadvantage of post audits?
57. The capital investment decision making model that assumes that each cash inflow is reinvested at the
required rate of return is
58. The capital investment decision making model that assumes that each cash inflow is reinvested at the
project’s own rate of return is
59. Which of the following provides an absolute dollar measure?
60. The best model for choosing the best of several competing projects is
61. When investing in automated systems, which of the following intangible or indirect benefits may be
important?
62. Which of the following is true regarding the measurement and use of indirect and intangible benefits in
capital investment decision making?
63. To make a capital investment decision, a manager must estimate the
64. The time required for a firm to recover its original investment is the
65. When the risk of obsolescence is high, managers will want
66. One disadvantage of the payback period is that
67. A division manager was considering a project that required a significant initial investment. If accepted, the
project could have a negative impact on certain financial ratios that the firm was required to maintain to satisfy
bond contracts. To ensure that the ratios would not be adversely affected by the investment, the manager would
use which of the following capital investment models?
68. A division manager is considering a project that requires significant initial investment. The company’s top
management will not approve any project that does not return at least 12%. The manager will most likely use
which of the following capital investment models?
69. A division manager is choosing between two mutually exclusive projects.
Project A
Project B
Net present value
$235,000
$210,000
Internal rate of return
13%
15%
The company requires any project to earn at least 12%. The manager believes that cash inflows from the project can be reinvested at the rate of 12%.
Which project will the manager likely choose?
70. The earning of interest on interest is
71. A series of future cash flows is a(n) ____.
72. The reason that a discount factor in year 3 is less than a discount factor in year 2 is that
73. Figure 12-1.
A company is considering two projects.
Project I
Project II
Initial investment
$60,000
$60,000
Cash inflow Year 1
$30,000
$15,000
Cash inflow Year 2
$30,000
$15,000
Cash inflow Year 3
$30,000
$30,000
Cash inflow Year 4
$30,000
$70,000
Cash inflow Year 5
$30,000
$70,000
Refer to Figure 12-1. What is the payback period for Project I?
74. Figure 12-1.
A company is considering two projects.
Project I
Project II
Initial investment
$60,000
$60,000
Cash inflow Year 1
$30,000
$15,000
Cash inflow Year 2
$30,000
$15,000
Cash inflow Year 3
$30,000
$30,000
Cash inflow Year 4
$30,000
$70,000
Cash inflow Year 5
$30,000
$70,000
Refer to Figure 12-1. What is the payback period for Project II?
75. Figure 12-2.
A company is considering two projects.
Project A
Project B
Initial investment
$150,000
$150,000
Cash inflow Year 1
$50,000
$40,000
Cash inflow Year 2
$50,000
$40,000
Cash inflow Year 3
$50,000
$40,000
Cash inflow Year 4
$50,000
$60,000
Cash inflow Year 5
$50,000
$80,000
Refer to Figure 12-2. What is the payback period for Project A?
76. Figure 12-2.
A company is considering two projects.
Project A
Project B
Initial investment
$150,000
$150,000
Cash inflow Year 1
$50,000
$40,000
Cash inflow Year 2
$50,000
$40,000
Cash inflow Year 3
$50,000
$40,000
Cash inflow Year 4
$50,000
$60,000
Cash inflow Year 5
$50,000
$80,000
Refer to Figure 12-2. What is the payback period for Project B?
77. Joseph Claiborne has just invested $180,000 in a coffee shop. He expects to receive cash income of $40,000
a year. What is the payback period?
78. Lanny Sterling is considering an investment in a solar-powered irrigation system manufacturer. The initial
investment is $100,000. He expects to receive cash income of $50,000 a year. What is the payback period?
79. Elena Wallace invested $150,000 in a project that pays her an even amount per year for 10 years. The
payback period is 6 years. What are Elena’s yearly cash inflows from the project?
80. Chris Tellson invested in a project with a payback period of 4 years. The project brings $30,000 per year for
a period of 8 years. What was the initial investment?
81. Figure 12-3.
Darth Company is considering the purchase of new heavy construction equipment that will cost $2,000,000 and
have a life of 8 years with no expected salvage value. The expected cash flows associated with the project are as
follows:
Year
Cash Expenses & Depreciation
1
$1,900,000
2
$1,900,000
3
$1,900,000
4
$1,900,000
5
$1,900,000
6
$1,900,000
7
$1,900,000
8
$1,900,000
Refer to Figure 12-3. What is the average annual income for this project?
82. Figure 12-3.
Darth Company is considering the purchase of new heavy construction equipment that will cost $2,000,000 and
have a life of 8 years with no expected salvage value. The expected cash flows associated with the project are as
follows:
Year
Cash Expenses & Depreciation
1
$1,900,000
2
$1,900,000
3
$1,900,000
4
$1,900,000
5
$1,900,000
6
$1,900,000
7
$1,900,000
8
$1,900,000
Refer to Figure 12-3. What is the accounting rate of return for the project?
83. Larkin Bonnard has just invested $180,000 in a day spa. He expects to receive income of $40,000 a year,
and to have the investment for 10 years. What is the accounting rate of return?
84. Figure 12-4.
Cary Swenson is considering investing $30,000 in a project with the following cash revenues and expenses:
Revenues
Cash Expenses & Depreciation
Year 1
$10,000
$12,000
Year 2
$12,000
$11,000
Year 3
$15,000
$12,000
Year 4
$20,000
$12,000
Year 5
$22,000
$12,000
Year 6
$25,000
$15,000
Year 7
$25,000
$15,000
Year 8
$25,000
$15,000
Refer to Figure 12-4. What is the average income for the project?
85. Figure 12-4.
Cary Swenson is considering investing $30,000 in a project with the following cash revenues and expenses:
Revenues
Cash Expenses & Depreciation
Year 1
$10,000
$12,000
Year 2
$12,000
$11,000
Year 3
$15,000
$12,000
Year 4
$20,000
$12,000
Year 5
$22,000
$12,000
Year 6
$25,000
$15,000
Year 7
$25,000
$15,000
Year 8
$25,000
$15,000
Refer to Figure 12-4. What is the accounting rate of return for the project?
86. Figure 12-4.
Cary Swenson is considering investing $30,000 in a project with the following cash revenues and expenses:
Revenues
Cash Expenses & Depreciation
Year 1
$10,000
$12,000
Year 2
$12,000
$11,000
Year 3
$15,000
$12,000
Year 4
$20,000
$12,000
Year 5
$22,000
$12,000
Year 6
$25,000
$15,000
Year 7
$25,000
$15,000
Year 8
$25,000
$15,000
Refer to Figure 12-4. Assuming straight-line depreciation over eight years, what is the payback period for the project?
87. Figure 12-5.
Junior Simons is considering investing $20,000 in a project with the following cash revenues and expenses:
Revenues
Cash Expenses & Depreciation
Year 1
$8,000
$8,000
Year 2
$12,000
$8,000
Year 3
$15,000
$9,000
Year 4
$20,000
$10,000
Year 5
$20,000
$10,000
Refer to Figure 12-5. Assuming straight-line depreciation over five years, what is the payback period for this investment?
88. Figure 12-5.
Junior Simons is considering investing $20,000 in a project with the following cash revenues and expenses:
Revenues
Cash Expenses & Depreciation
Year 1
$8,000
$8,000
Year 2
$12,000
$8,000
Year 3
$15,000
$9,000
Year 4
$20,000
$10,000
Year 5
$20,000
$10,000
Refer to Figure 12-5. What is the accounting rate of return for the project?
89. Figure 12-6.
Present value of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
0.925
0.890
0.857
0.826
0.797
0.769
3
0.889
0.840
0.794
0.751
0.712
0.675
4
0.855
0.792
0.735
0.683
0.636
0.592
5
0.822
0.747
0.681
0.621
0.567
0.519
6
0.790
0.705
0.630
0.564
0.507
0.456
7
0.760
0.665
0.583
0.513
0.452
0.400
8
0.731
0.627
0.540
0.467
0.404
0.351
9
0.703
0.592
0.500
0.424
0.361
0.308
10
0.676
0.558
0.463
0.386
0.322
0.270
Present value of an Annuity of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
1.886
1.833
1.783
1.736
1.690
1.647
3
2.775
2.673
2.577
2.487
2.402
2.322
4
3.630
3.465
3.312
3.170
3.037
2.914
5
4.452
4.212
3.993
3.791
3.605
3.433
6
5.242
4.917
4.623
4.355
4.111
3.889
7
6.002
5.582
5.206
4.868
4.564
4.288
8
6.733
6.210
5.747
5.335
4.968
4.639
9
7.435
6.802
6.247
5.759
5.328
4.946
10
8.111
7.360
6.710
6.145
5.650
5.216
Refer to Figure 12-6. Morgan Clinical Practice is considering an investment in new imaging equipment that will cost $400,000. The equipment is
expected to yield cash inflows of $80,000 per year for a six year period. Morgan set a required rate of return at 10%. What is the net present value of
the investment? (Note: there may be rounding error depending on the table you use to compute your answer. Choose the answer closest to the one
you calculate.)
90. Figure 12-6.
Present value of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
0.925
0.890
0.857
0.826
0.797
0.769
3
0.889
0.840
0.794
0.751
0.712
0.675
4
0.855
0.792
0.735
0.683
0.636
0.592
5
0.822
0.747
0.681
0.621
0.567
0.519
6
0.790
0.705
0.630
0.564
0.507
0.456
7
0.760
0.665
0.583
0.513
0.452
0.400
8
0.731
0.627
0.540
0.467
0.404
0.351
9
0.703
0.592
0.500
0.424
0.361
0.308
10
0.676
0.558
0.463
0.386
0.322
0.270
Present value of an Annuity of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
1.886
1.833
1.783
1.736
1.690
1.647
3
2.775
2.673
2.577
2.487
2.402
2.322
4
3.630
3.465
3.312
3.170
3.037
2.914
5
4.452
4.212
3.993
3.791
3.605
3.433
6
5.242
4.917
4.623
4.355
4.111
3.889
7
6.002
5.582
5.206
4.868
4.564
4.288
8
6.733
6.210
5.747
5.335
4.968
4.639
9
7.435
6.802
6.247
5.759
5.328
4.946
10
8.111
7.360
6.710
6.145
5.650
5.216
Refer to Figure 12-6. Morgan Clinical Practice is considering an investment in new imaging equipment that will cost $400,000. The equipment is
expected to yield cash inflows of $80,000 per year for a six year period. At the end of the sixth year, the firm expects to recover $150,000 from the
sale of the equipment. Morgan set a required rate of return at 10%. What is the net present value of the investment? (Note: there may be rounding
error depending on the table you use to compute your answer. Choose the answer closest to the one you calculate.)