Chapter 19—Capital Investment Key
1. Capital investment decisions are concerned with planning, setting goals, arranging financing, and the
selection of long-term assets.
2. Independent projects directly affect the cash flows of other projects once accepted or rejected.
3. Nondiscounting models for making capital investments explicitly consider the time value of money.
4. Mutually exclusive projects are those which preclude the acceptance of all other competing projects.
5. Discounting models for making capital decisions ignore the time value of money.
6. The payback period is the time required for a company to recover its initial investment.
7. The accounting rate of return considers the profitability of a project as well as the time value of money.
8. Discounted cash flows are used by discounting models which are future cash flows expressed in terms of
their present value.
9. Net present value (NPV) is the difference between the present value of cash inflows and outflows associated
with a project.
10. In an independent project, the required rate of return is used to calculate the future value of future cash
flows.
11. If the net present value is greater than zero, the investment is profitable and acceptable.
12. The internal rate of return (IRR) is the interest rate that sets the present value of cash inflows of a project
equal to the present value of a project’s cost.
13. If the internal rate of return (IRR) is less than the cost of capital, then the investment is acceptable.
14. The internal rate of return (IRR) is the most widely used capital investment technique because it’s an easily
understood concept.
15. NPV reveals the wealth-maximization of a project more consistently than IRR.
16. NPV is preferred to IRR because it assumes that each cash inflow is not reinvested at the required rate of
return.
17. When conflicting signals are received from using NPV and IRR, NPV always produces the correct signal to
invest.
18. Computation of cash flows is the most critical step in the capital investment process.
19. the two ways to compute after-tax cash flows are the income method and the composition method.
20. In today’s markets, long-term investments in technology and pollution prevention can provide significant
competitive advantages.
21. Capital investment decisions are concerned with planning, setting goals, arranging financing, and the
selection of __________ assets.
22. Mutually exclusive projects do not affect the __________ of other projects.
23. The __________ rate of return uses income instead of cash flows.
24. The time required by a firm to recover its original investment is called the __________ period.
25. The difference between the present value of future cash flows and the initial investment outlay is called the
__________ value.
26. The required __________ is used to calculate the present value of future cash flows.
27. The __________ rate of return sets the present value of cash inflows equal to the present value of a project’s
cost.
28. NVP measures the __________ in a firm’s wealth caused by a project.
29. Accelerated methods of __________ are preferred because of the tax benefits created.
30. Investment outlays may be affected by substantial resources required by __________ items.
31. Decisions concerned with the process of planning, setting goals and priorities, arranging financing, and
using certain criteria to select long-term assets are called:
32. Projects that if accepted or rejected do NOT affect the cash flows of projects are called:
33. Projects that, if accepted preclude the acceptance of all other competing projects are called:
34. Which of the following is an example of an independent project?
35. Which of the following is NOT an example of information the payback period can provide to management?
36. When comparing the payback method and the accounting rate of return methods, which of the following is
true?
Profitability
Time Value of Money
I
Ignored by both methods
Ignored by both methods
II
Ignored by both methods
Used in accounting rate of return, ignored by payback method
III
Considered by accounting method, not by payback
Ignored by both methods
IV
Considered by accounting method, not by payback
Considered by both methods
37. The accounting rate of return on original investment is calculated as
38. RentitAll Management Services is considering an investment of $60,000. Data related to the investment are
as follows:
Year
Cash Flow
1
$20,000
2
24,000
3
30,000
4
40,000
5
20,000
Cost of capital is 18 percent.
What is the payback period in years approximated to two decimal points, assuming no taxes are paid?
39. Langueville Manufacturing Company is considering the following investment proposal:
Original investment
$13,500
Operations (per year for four years):
Cash receipts
$10,000
Cash expenditures
5,500
Salvage value of equipment after four years
$1,000
Discount rate
10%
The firm uses the straight-line method of depreciation with no mid-year convention.
What is the payback period in years approximated to two decimal points, assuming no taxes are paid?
40. Azimuth Company was considering the purchase of equipment. Details on the equipment are as follows:
Year
Original Investment
Cash Flow
0
$200,000
1
$40,000
2
40,000
3
60,000
4
40,000
5
60,000
6
30,000
What is the payback period in years, assuming no taxes are paid?
41. Beduin Services is considering an investment of $25,000. Data related to the investment are as follows:
Year
Cash Flow
1
$10,000
2
11,000
3
8,000
4
15,000
5
15,000
Cost of capital is 14 percent.
What is the payback period in years approximated to two decimal points, assuming no taxes are paid?
42. Alberto Company is considering the purchase of a new machine for $110,000. The machine generates
annual revenues of $68,750 and annual expenses of $41,250, which includes $8,250 of depreciation. What is the
payback period in years on the machine approximated to one decimal point?
43. Evaristo Corporation is considering an investment in equipment for $45,000. Data related to the investment
are as follows:
Cash Flow before
Year
Depreciation and Taxes
1
$30,000
2
30,000
3
30,000
4
30,000
5
30,000
Cost of capital is 18 percent.
Evaristo uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of the
equipment is five years with no salvage value.
What is the payback period in years approximated to two decimal points?
44. Milagros Company is considering an investment in equipment for $60,000. Milagros uses the straight-line
method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent and the life of the
equipment is five years with no salvage value. The expected income before depreciation and taxes is projected
to be $30,000 per year.
What is the payback period in years approximated to two decimal points?
45. Anselmo Corp. is considering the purchase of a new machine for $76,000. The machine would generate an
annual cash flow of $23,214 for five years. At the end of five years, the machine would have no salvage value.
The company’s cost of capital is 12 percent. The company uses straight-line depreciation with no mid-year
convention.
What is the payback period in years for the machine approximated to two decimal points, assuming no taxes are
paid?
46. Joyous Corporation is considering an investment in equipment for $25,000. Data related to the investment
are as follows:
Cash Flow before
Year
Depreciation and Taxes
1
$12,500
2
12,500
3
12,500
4
12,500
Joyous uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent and the life of the equipment
is four years with no salvage value. Cost of capital is 12 percent.
What is the payback period in years approximated to two decimal points?
47. Gunslinger Company is considering the purchase of pipe cutting equipment. Data on the equipment are as
follows:
Original investment
$35,000
Net annual cash inflow
$8,000
Expected economic life in years
5
Salvage value at the end of five years
$3,500
The company uses the straight-line method of depreciation with no mid-year convention.
What is the accounting rate of return on original investment rounded to the nearest percent, assuming no taxes are paid?
48. Melancholy Company is considering the purchase of production equipment that costs $800,000. The
equipment is expected to generate an annual cash flow of $250,000 and have a useful life of five years with no
salvage value. The firm’s cost of capital is 12 percent. The company uses the straight-line method of
depreciation with no mid-year convention. There are no income taxes.
The payback period in years for the project is
49. Davidson, Inc., is considering the purchase of production equipment that costs $300,000. The equipment is
expected to generate an annual cash flow of $100,000 and have a useful life of five years with no salvage value.
The firm’s cost of capital is 14 percent. The company uses the straight-line method of depreciation with no mid–
year convention. Ignore income taxes.
Payback for the project is
50. A project requires an investment of $40,000 in equipment. Annual cash flows of $8,000 are expected to
occur for the next eight years. No salvage value is expected. The company uses the straight-line method of
depreciation with no mid-year convention. Ignore income taxes.
The accounting rate of return on the original investment for the project is
51. Spaniel Company is considering the purchase of a new machine for $80,000. The machine would generate
an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years, the
machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses straight-
line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the accounting rate of return on the original investment in the machine approximated to two decimal
points?
52. Hollister Company is considering the purchase of a new machine for $60,000. The machine would generate
an annual cash flow before depreciation and taxes of $25,647 for four years. At the end of four years, the
machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses straight-
line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the accounting rate of return on the original investment in the machine approximated to two decimal
points?
53. Which of the following methods uses income instead of cash flows?
54. Los Gatos Shop is considering the purchase of a used wide-format printer costing $9,600. The wide-format
printer would generate a net cash inflow of $4,000 per year for three years. At the end of three years, the printer
would have no salvage value. The company’s cost of capital is 10 percent. The company uses straight-line
depreciation with no mid-year convention.
What is the accounting rate of return on the original investment in the press to the nearest percent, assuming no
taxes are paid?
55. A firm is evaluating a project that has a net present value of $0 when a discount rate of 8 percent is used. A
discount rate of 6 percent will result in a
56. If the net present value is positive, it could signal
57. A firm is evaluating a project that has a net present value of $0 when a discount rate of 9 percent is used. A
discount rate of 7 percent will result in a
58. Sansariff Company invests in a new piece of equipment costing $40,000. The equipment is expected to yield
the following amounts per year for the equipment’s four-year useful life:
Cash revenues
$ 60,000
Cash expenses
(32,000)
Depreciation expenses (straight-line)
(10,000)
Income provided from equipment
$ 18,000
Cost of capital
14%
What is the net present value of this investment in equipment, assuming no taxes are paid?
59. Avionics Corp. is considering the purchase of a new machine for $76,000. The machine would generate an
annual cash flow of $23,214 per year for five years. At the end of five years, the machine would have no
salvage value. The company’s cost of capital is 12 percent. The company uses straight-line depreciation with no
mid-year convention.
What is the net present value for the machine, assuming no taxes are paid?
60. Edmundo Services is considering an investment of $25,000. Data related to the investment are as follows:
Year
Cash Flow
1
$10,000
2
11,000
3
8,000
4
15,000
5
15,000
Cost of capital is 14 percent.
What is the net present value of the investment, assuming no taxes are paid?
61. Los Gatos Shop is considering the purchase of a used wide-format printer costing $9,600. The wide-format
printer would generate a net cash inflow of $4,000 per year for three years. At the end of three years, the printer
would have no salvage value. The company’s cost of capital is 10 percent. The company uses straight-line
depreciation with no mid-year convention.
What is the net present value for the press, assuming no taxes are paid?
62. Somozas Manufacturing Company is considering the following investment proposal:
Original investment
$12,500
Operations (per year for four years):
Cash receipts
$10,000
Cash expenditures
5,500
Salvage value of equipment after four years
$1,000
Discount rate
12%
The firm uses the straight-line method of depreciation with no mid-year convention.
What is the net present value for the investment, assuming no taxes are paid?
63. The present value of $10,000 to be received ten years from now and earning a 12 percent return (rounded)
is
64. Canyon Company is considering an investment of $45,000. Data related to the investment are as follows:
Year
Cash Flow
1
$15,000
2
18,000
3
22,500
4
30,000
5
15,000
Cost of capital is 18 percent.
What is the net present value of the investment, assuming no taxes are paid?
65. Laramie Corporation is considering an investment in equipment for $20,000. Laramie uses the straight-line
method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of the
equipment is five years with no salvage value. The expected income before depreciation and taxes is projected
to be $10,000 per year. The cost of capital is 20 percent.
What is the net present value of the investment?
66. MakeitRite Company is considering the purchase of a new machine for $80,000. The machine would
generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years,
the machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses
straight-line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the net present value for the machine?
67. The present value of $10,000 to be received each year for ten years and earning a 14 percent return
(rounded) is
68. Galveston Corporation is considering an investment in equipment for $45,000. Data related to the
investment are as follows:
Cash Flow before
Year
Depreciation and Taxes
1
$30,000
2
30,000
3
30,000
4
30,000
5
30,000
Cost of capital is 18 percent.
Galveston uses the straight-line method of depreciation with no mid-year convention. In addition, their tax rate is 40 percent, and the life of the
equipment is five years with no salvage value.
What is the net present value of the investment?
69. The present value of $7,500 to be received each year for five years and earning an 10 percent return
(rounded) is
70. Jacuzzi Corporation is considering an investment in equipment for $25,000. Data related to the investment
are as follows:
Cash Flow before
Year
Depreciation and Taxes
1
$12,500
2
12,500
3
12,500
4
12,500
Jacuzzi uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of the equipment
is four years with no salvage value. Cost of capital is 12 percent.
What is the net present value of the investment?
71. Clemente Company is considering the purchase of a new machine for $160,000. The machine would
generate an annual cash flow before depreciation and taxes of $62,588 for four years. At the end of four years,
the machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses
straight-line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the net present value for the machine?
72. The following information pertains to an investment by the Town of Sutton:
Investment
$140,000
Annual revenues
$96,000
Annual variable costs
$32,000
Annual fixed out-of-pocket costs
$20,000
Salvage value
$12,000
Discount rate
12%
Expected life of project
8 years
Ignore income taxes. The present value of the salvage value (rounded) is
73. The present value of $20,000 to be received five years from now and earning a 6 percent return (rounded) is
74. Spiritlight Ventures is considering the following investment:
Investment
$140,000
Annual revenues
$96,000
Annual variable costs
$32,000
Annual fixed out-of-pocket costs
$20,000
Salvage value
$12,000
Discount rate
12%
Expected life of project
8 years
Ignore income taxes. The present value of the annual cash flow (rounded) is
75. The present value of $4,000 to be received three years from now and earning a 12 percent return (rounded)
is
76. A firm is considering a project with an annual cash flow of $200,000. The project would have a 7-year life,
and the company uses a discount rate of 10 percent. Ignoring income taxes, what is the maximum amount the
company could invest in the project and have the project still be acceptable?
77. A firm is considering a project with an annual cash flow of $80,000. The project would have a 10-year life,
and the company uses a discount rate of 8 percent. Ignoring income taxes, what is the maximum amount the
company could invest in the project and have the project still be acceptable (rounded)?
78. The following information pertains to an investment:
Investment
$240,000
Annual revenues
$140,000
Annual variable costs
$30,000
Annual fixed out-of-pocket costs
$22,000
Salvage value
$54,000
Discount rate
16%
Expected life of project
3 years
Ignoring income taxes, the present value of the salvage value (rounded) is
79. The present value of $4,000 to be received each year for three years and earning a 10 percent return
(rounded) is
80. A capital investment project requires an investment of $100,000 and has an expected life of four years.
Annual cash flows at the end of each year are expected to be as follows:
Year
Amount
1
$40,000
2
$48,000
3
$76,000
4
$56,000
Ignoring income taxes, the net present value of the project using a 8 percent discount rate is
81. Vociferous Company is considering the purchase of production equipment that costs $800,000. The
equipment is expected to generate an annual cash flow of $250,000 and have a useful life of five years with no
salvage value. The firm’s cost of capital is 12 percent. The straight-line method with no mid-year convention is
used.
Ignoring income taxes, the net present value of the project is
82. A firm is considering a project with an annual cash flow of $240,000. The project would have an 8-year life,
and the company uses a discount rate of 12 percent. Ignoring income taxes, what is the maximum amount the
company could invest in the project and have the project still be acceptable (rounded)?
83. The internal rate of return is defined as
84. Which of the following methods consider the time value of money?
85. Linda’s Graphic Designs is considering the purchase of a used color Laser Printer costing $38,400. The
Printer would generate an annual cash flow of $16,000 for three years. At the end of three years, the Printer
would have no salvage value. The company’s cost of capital is 10 percent. The company uses straight-line
depreciation with no mid-year convention.
What is the internal rate of return to the nearest percent for the Printer, assuming no taxes are paid?