Chapter 14 – Capital Investment Decisions
NPV
109. Refer to Figure 14–6. Roman Knoze is considering two investments. Each will cost $20,000 initially. Project 1 will
return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000 in year 1, $10,000 in year 2, and
$15,000 in year 3. Roman requires a minimum rate of return of 10%. What is the net present value of Project 2?
a.
b.
c.
d.
e.
NPV
110. Refer to Figure 14–6. Jan Rigby is considering an investment that will cost $20,000 initially, and return annual cash
flows of $10,000 in each of three years. Jan requires a minimum rate of return of 8%. What is the present value of the cash
inflows? (Note: there may be a rounding error depending on the table you use to compute your answer. Choose the
answer closest to the one you calculate.)
a.
b.
c.
d.
e.
NPV
111. 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 ____.
a.
present value
b.
discount rate
c.
company cost of capital
d.
payback period
e.
internal rate of return
e
112. Which of the following is true regarding the internal rate of return for a project?
Chapter 14 – Capital Investment Decisions
a.
If the internal rate of return is less than the required rate of return, the project will be rejected.
b.
If the internal rate of return is equal to the required rate of return, the net present value of the project is zero.
c.
If the internal rate of return is more than the required rate of return, the project will be accepted.
d.
Managers may believe (in most cases, incorrectly) that the internal rate of return is the compounded rate of
return earned by the initial investment.
e.
All of these.
113. Elizabeth Myers invested in a project that required an initial amount of $1,560, and returned one cash inflow of
$12,000 at the end of the 18th year. A partial table of the present value of an annuity of $1 in arrears is as follows:
Year
2%
4%
6%
8%
10%
12%
14%
16%
18
0.700
0.494
0.350
0.250
0.180
0.130
0.095
0.069
What is the internal rate of return for this investment?
a.
8%
b.
10%
c.
12%
d.
14%
e.
16%
114. Jerry Hall invested in a project that required an initial amount of $52,160, and returned cash inflows of $10,000 per
year for 10 years. A partial table of the present value of an annuity of $1 in arrears is as follows:
Year
2%
4%
6%
8%
10%
12%
14%
16%
10
7.983
8.111
7.360
6.710
6.145
5.650
5.216
4.833
What is the internal rate of return for this investment?
a.
8%
b.
10%
c.
12%
d.
14%
e.
16%
This discount factor matches the one for an internal rate of return of 14%.
115. Amatra Inc., has the opportunity to invest in new equipment that will cost $113,000. The net cash inflows for ten
years equal $20,000 per year. What is the internal rate of return for the investment? A partial table of the present value of
an annuity of $1 in arrears is as follows:
Year
2%
4%
6%
8%
10%
12%
14%
16%
10
7.983
8.111
7.360
6.710
6.145
5.650
5.216
4.833
a.
8%
Chapter 14 – Capital Investment Decisions
b.
10%
c.
12%
d.
14%
e.
16%
Discount factor = $113,000 / $20,000 = 5.650
116. Shoring Company is considering a project with an internal rate of return of 14.5%. Shoring requires a minimum rate
of return of 12%. The net present value of the project is
a.
negative.
b.
infinite.
c.
equal to zero.
d.
positive.
e.
None of these.
117. The internal rate of return is defined as
a.
a blend of the costs of capital from all sources.
b.
the minimal acceptable interest rate on investments.
c.
the difference between the present value of the cash inflows and outflows associated with a project.
d.
the interest rate that sets the present value of a project’s cash inflows equal to the present value of a project’s
cost.
118. Jones Company is considering the purchase of a new machine for $57,000. The machine would generate an annual
cash flow of $17,411 for 5 years. At the end of five years, the machine would have no salvage value. The company’s cost
of capital is 12%. The company uses straight-line depreciation.
What is the internal rate of return for the machine rounded to the nearest percent?
a.
12%
b.
18%
c.
14%
d.
16%
SUPPORTING CALCULATIONS:
119. A firm is considering a project requiring an investment of $27,000. The project would generate an annual cash flow
of $6,296 for the next seven years. The company uses the straight-line method of depreciation. The approximate internal
rate of return for the project is
a.
6%.
b.
8%.
c.
12%.
d.
14%.
Chapter 14 – Capital Investment Decisions
120. Cooper Industries is considering a project that would require an initial investment of $101,000. The project would
result in cost savings of $62,000 in year 1 and $70,000 in year two. The internal rate of return is
a.
between 16% and 17%.
b.
between 18% and 20%.
c.
under 15%.
d.
none of these.
@ 20% PV Factor = 1.52778
Figure 14–8.
Present value of an Annuity of $1 in Arrears
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
4.433
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
121. Refer to Figure 14–8. Lucas Company is considering a project with an initial investment of $530,250 in new
equipment that will yield annual net cash flows of $95,000, and will be depreciated at $75,750 per year over its seven year
life. What is the internal rate of return?
a.
8%
b.
6%
c.
12%
d.
10%
e.
14%
PVAF of 4.288, n = 7, corresponds to 14%
Chapter 14 – Capital Investment Decisions
122. Refer to Figure 14–8. Sawyer Company is considering a project with an initial investment of $226,000 that will yield
annual net cash flows of $40,000, and will be depreciated at $22,600 per year over its ten year life. What is the internal
rate of return?
a.
6%
b.
8%
c.
10%
d.
12%
e.
14%
Discount factor = $226,000 / $40,000 = 5.650 corresponding to an IRR of 12%
Salvage value is zero after depreciation.
Figure 14–9.
Kenner Company is considering two projects.
Project A
Project B
Initial investment
$85,000
$24,000
Annual cash flows
$20,676
$6,011
Life of the project
6 years
5 years
Depreciation per year
$14,167
$4,800
Present value of an Annuity of $1 in Arrears
Periods
8%
10%
12%
14%
1
0.926
0.909
0.893
0.877
2
1.783
1.736
1.690
1.647
3
2.577
2.487
2.402
2.322
4
3.312
3.170
3.037
2.914
5
3.993
3.791
3.605
4.433
6
4.623
4.355
4.111
3.889
7
5.206
4.868
4.564
4.288
8
5.747
5.335
4.968
4.639
9
6.247
5.759
5.328
4.946
10
6.710
6.145
5.650
5.216
123. Refer to Figure 14–9. Which of the two projects, A or B, is better in terms of internal rate of return?
a.
project A with an IRR of 12%
b.
project B with an IRR of 14%
c.
project A with an IRR of 10%
d.
project B with an IRR of 10%
e.
both projects have the same IRR
Project A: Discount factor = $85,000 / $20,676 = 4.111, corresponding to an IRR of 12%
Project B: Discount factor = $24,000 / $6,011 = 3.993, corresponding to an IRR of 8%
124. Refer to Figure 14–9. Suppose that Kenner Company requires a minimum rate of return of 8%. Which project is
Discount rate = $530,250 / $95,000 = 5.582 corresponding to a 6% IRR
Salvage value is zero after depreciation.
Chapter 14 – Capital Investment Decisions
better in terms of net present value?
a.
project A with NPV of $10,585
b.
project B with NPV of $7,756
c.
project A with NPV of $4,210
d.
project B with NPV of $1,212
e.
both projects have the same NPV
Project A NPV = ($20,676 × 4.623) – $85,000 = $10,585
Project B NPV = ($6,011 × 3.993) – $24,000 = $(1.92)
125. 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?
a.
internal rate of return
b.
discounted returns
c.
postaudit
d.
opportunity cost
e.
capital investment decision making
126. Which of the following is a disadvantage of postaudits?
a.
They evaluate profitability rather than cash flows.
b.
They may point to the need for additional funding for the project.
c.
They tend to hold managers accountable for capital investment decision making.
d.
The assumptions driving the original analysis may be invalidated by changes in the actual operating
environment.
e.
All of these.
127. Which of the following is not a benefit of postaudits of capital investments?
a.
Considers changes in the actual operating environment.
b.
Guides managers to make capital investment in the best interests of the firm.
c.
Ensures that resources are used wisely by evaluating profitability.
d.
Supplies feedback to managers that should help improve decision making.
e.
All of these are benefits.
128. A follow-up analysis of a capital investment after it is implemented is called a
a.
capital investment review.
b.
profitability analysis.
Chapter 14 – Capital Investment Decisions
c.
postaudit.
d.
peer review.
129. The best person/group in a firm to perform a postaudit of a capital investment is usually
a.
the manager of that investment.
b.
the CEO.
c.
the board of directors.
d.
the internal audit staff.
e.
an external auditor.
130. The capital investment decision making model that assumes that each cash inflow is reinvested at the required rate of
return is
a.
net present value.
b.
internal rate of return.
c.
payback period.
d.
accounting rate of return.
e.
None of these.
a
131. The capital investment decision making model that assumes that each cash inflow is reinvested at the project’s own
rate of return is
a.
net present value.
b.
accounting rate of return.
c.
payback period.
d.
internal rate of return.
e.
None of these.
132. The best model for choosing the best of several competing projects is
a.
net present value.
b.
internal rate of return.
c.
payback period.
d.
accounting rate of return.
e.
None of these.
a
133. When investing in automated systems, which of the following intangible or indirect benefits may be important?
a.
improved customer satisfaction
b.
improved market share
Chapter 14 – Capital Investment Decisions
c.
reduced support labor cost
d.
reduced lead time
e.
All of these.
e
134. Which of the following is true regarding the measurement and use of indirect and intangible benefits in capital
investment decision making?
a.
ABC has made identifying indirect benefits easier.
b.
Intangible benefits cannot be measured.
c.
Indirect and intangible benefits should not be considered, only direct costs and benefits are considered.
d.
Actions by competitors are not considered.
e.
None of these.
a
135. 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?
a.
Project B
b.
Project A
c.
both Projects A and B
d.
neither Project A nor B
136. How do NPV and IRR differ?
a.
NPV measures profitability in absolute terms, whereas the IRR method measures profitability in relative
terms.
b.
IRR should be used for choosing among competing, mutually exclusive projects.
c.
NPV considers the time value of money and IRR does not.
d.
Both NPV and IRR will generate the same decisions.
a
137. Five mutually exclusive projects had the following information:
V
W
X
Y
Z
NPV
$(6,000)
$40,000
$30,000
$10,000
$20,000
IRR
8%
11%
13%
10%
12%
Which project is preferred?
a.
Project V
b.
Project W
c.
Project X
d.
Project Y
Chapter 14 – Capital Investment Decisions
SUPPORTING CALCULATIONS: Project W, because it has the highest NPV.
138. The earning of interest on interest is
a.
present value.
b.
future value.
c.
discount rate.
d.
compounding of interest.
e.
interest earned.
139. A series of equal future cash flows is a(n)
a.
future amount.
b.
future earnings.
c.
annuity.
d.
earnings to be discounted.
e.
insurance.
c
140. The reason that a discount factor in Year 3 is less than a discount factor in Year 2 is that
a.
cash flows are uneven.
b.
compounding does not occur.
c.
cash flows are even.
d.
present value is positive.
e.
a dollar received in 3 years is worth less than a dollar received in 2 years.
e
141. Mistral Manufacturing is considering an investment in a new, high-efficiency machine. The new machine requires an
initial investment of $1,750,000 and generates cash flows of either:
a. Even cash flows of $350,000 per year or
b. The following expected annual cash flows: $275,000, $420,000, $820,000, $470,000,
and $150,000
Required: Calculate the payback period for each case.
Even cash flows:
$1,750,000 / $350,000 = 5 years
Investment is paid back midyear in year 3, so 3.5 years.
Chapter 14 – Capital Investment Decisions
142. Brenning Company invested $3,000,000 in a new computer system. The following is the net income stream:
Year
Net income stream
1
$475,000
2
$375,000
3
$650,000
4
$900,000
5
$920,000
6
$800,000
Required: Calculate the accounting rate of return.
Average net income = $686,667
ARR = Average net income / Investment
$686,667 / $3,000,000 = 0.23
143. Billings Office Services is considering the purchase of a new computer system to replace the one in operation. Data
on the new computer system are:
Cost
$12,000
Salvage value at the end of 5 years
$1,000
Useful life, in years
5
Annual operating cost
$4,000
If the existing computer system is kept and used, it would require the purchase of additional hardware a year from now
costing $2,000. After using the system for five years, the salvage value would be $300. Additional information on the
existing system is:
Additional years of use
5
Annual operating costs
$9,000
Remaining book value
$12,000
Current salvage value
$3,000
Cost of capital
12%
The company uses the straight-line method of depreciation.
Required: Should the new system be purchased? Why or why not?
Period
Comment
0
Outlay cost
0
Salvage of old
1
Purchase of hardware
avoided
1−5
Lower operating Costs
value
Chapter 14 – Capital Investment Decisions
144. Dale Davis Company is evaluating a proposal to purchase a new machine that would cost $100,000 and have a
salvage value of $10,000 in 4 years. It would provide annual operating cash savings of $10,000, as follows:
Old Machine
New Machine
Salaries
$40,000
$36,000
Supplies
7,000
5,000
Maintenance
9,000
5,000
Total
$56,000
$46,000
If the new machine is purchased, the old machine will be sold for its current salvage value of $20,000. If the new machine
is not purchased, the old machine will be disposed of in 4 years at a predicted salvage value of $2,000. The old machine’s
present book value is $40,000. If kept, in 1 year the old machine will require repairs predicted to cost $35,000.
Dale Davis’s cost of capital is 14%.
Required: Should the new machine be purchased? Why or why not?
Present
Period
20,000
35,000
10,000