Chapter 24—Capital Investment Decisions Key
1. Projects that do not affect the cash flows of other projects are called mutually exclusive projects.
2. The process of planning, setting goals and priorities, arranging financing, and using certain criteria to select
long-term assets is called capital investment decisions.
3. Projects that if accepted preclude the acceptance of all other competing projects are called mutually exclusive
projects.
4. In capital investment decision making, it is usually assumed that managers should select projects that attempt
to maximize the wealth of the owners of the firm.
5. Taxes are 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 independent and mutually exclusive.
8. In order to use the payback period model, the proposed investment must have even cash inflows.
9. If cash flows are uneven, the payback period assumes that the inflows during the last fraction of a year occur
evenly.
10. 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.
11. Sometimes firms require riskier projects to have longer payback periods.
12. Companies considering projects with shorter lives are interested in longer payback periods.
13. A disadvantage of the payback period is that it ignores a project’s total profitability.
14. A disadvantage of the payback period is that it ignores the time value of money.
15. Only accounting rate of return ignores the time value of money.
16. The payback period considers the profitability of a project over its entire life span.
17. Two discounting models for capital investment decision making are net present value and internal rate of
return.
18. The difference between the present value of the cash inflows and outflows associated with a project is the
internal rate of return model.
19. The minimum acceptable rate of return for a project is the required rate of return.
20. In practice, managers often choose a discount rate that is higher than the cost of capital.
21. Suppose that the actual cost of capital is 10 percent, but the firm chooses a discount rate of 18 percent.
Managers of that company will be more likely to choose relatively short term investments.
22. If the net present value of an investment is zero, the investment earns less than the minimum required rate of
return.
23. 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.
24. The internal rate of return is the least widely used of the capital investment techniques.
25. One drawback to the internal rate of return model is that cash inflows must occur evenly over the life of the
investment.
26. The internal rate of return is the most widely used of the capital investment techniques.
27. A postaudit evaluates the overall outcome of the investment and proposes corrective action if needed.
28. In general, it is best if postaudits are done by company management, since they understand the actual
operating conditions.
29. A disadvantage of postaudits is that they are costly.
30. A postaudit is an analysis of a capital project before it is implemented.
31. A key element in the capital investment process is called a postaudit.
32. Companies that perform postaudits of capital projects experience a number of benefits.
33. Postaudits ensure that resources are used wisely by evaluating profitability.
34. Because of the postaudit, managers are more likely to make capital investment decisions in the best interests
of the firm.
35. Postaudits supply feedback to managers that should help improve future decision making.
36. Less objective results are obtainable if an independent party performs the postaudit of a capital investment.
37. The internal audit staff is usually the best choice for performing a postaudit of a capital investment.
38. An obvious problem with postaudits is that the assumptions driving the original analysis may often be
invalidated by changes in the actual operating environment.
39. Net present value analysis and internal rate of return analysis can sometimes produce erroneous choices
because they ignore the time value of money.
40. For independent projects, net present value analysis and internal rate of return analysis yield the same
decision.
41. The internal rate of return model does not consistently result in choices that maximize firm wealth.
42. _______________________ are concerned with the process of planning, setting goals and priorities,
arranging financing, and using certain criteria to select long-term assets.
43. The process of making capital investment decisions often is referred to as ________________.
44. The two types of capital budgeting projects are ________________ and _______________.
45. ______________________ are projects that, if accepted or rejected, do not affect the cash flows of other
projects.
46. _____________________ explicitly consider the time value of money.
47. _______________________ ignore the time value of money.
48. The ______________ is the time required for a firm to recover its original investment.
49. The _________________________ measures the return on a project in terms of income.
accounting rate of return or
ARR
50. _______________________ are the future cash flows expressed in terms of their present value.
51. The difference between the present value of the cash inflows and the outflows associated with a project is
known as the ___________________.
52. The ___________________ is the minimum acceptable rate of return.
53. The _______________________ is defined as the interest rate that sets the present value of a project’s cash
inflows equal to the present value of the project’s cost.
54. If the internal rate of return (IRR) is greater than the required rate, the project is deemed ___________.
55. If the internal rate of return (IRR) is less than the required rate of return, the project is __________.
56. A key element in the capital investment process is a follow-up analysis of a capital project once it is
implemented; this analysis is a called a _____________.
57. The major disadvantage of a postaudit is that it is ____________.
58. When choosing among competing projects, the ___________________ model correctly identifies the best
investment alternative.
59. When choosing among competing alternatives the ________________ model may choose an inferior
project.
60. The amount that must be invested now to produce a future value is known as the ____________ of the
future amount.
61. The value of an investment at the end of its life is called its ________________.
62. Which of the following is true of capital investment decision making?
63. In general terms, a sound capital investment will earn
64. To make a capital investment decision, a manager must estimate the
65. 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
66. The payback period provides information to managers that can be used to help
67. Which of the following is a drawback of the payback period?
68. A formula for the accounting rate of return is
69. Managers may use the accounting rate of return to evaluate potential investment projects because
70. The time required for a firm to recover its original investment is the
71. When the risk of obsolescence is high, managers will want
72. One disadvantage of the payback period is that
73. 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
debt 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?
74. Greg Moss has just invested $120,000 in a coffee shop. He expects to receive cash income of $15,000 a
year. What is the payback period?
75. Carol Harrison is considering an investment in a retail shopping mall. The initial investment is $400,000.
She expects to receive cash income of $80,000 a year. What is the payback period?
76. 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?
77. Tessa Wilson invested in a project with a payback period of 6 years. The project brings $18,000 per year for
a period of 9 years. What was the initial investment?
78. Neil Morrison has just invested $130,000 in a restaurant. He expects to receive income of $24,000 a year,
and to have the investment for 8 years. What is the accounting rate of return?
79. An investment of $5,000 provides an average net cash flows of $320 with zero salvage value. Depreciation
is $35 per year. The accounting rate of return using the original investment is
80. Buster Evans is considering investing $20,000 in a project with the following annual cash revenues and
expenses:
Cash
Cash
Revenues
Expenses
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
Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?
81. Coriander Company is considering a project with an initial investment of $426,800 in new equipment that
will yield annual net cash flows of $80,000, and will be depreciated at $53,350 per year over its eight year life.
What is the accounting rate of return?
82. 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
83. Oakland Shop is considering the purchase of a used printing press costing $9,600. The printing press would
generate a net cash inflow of $4,000 per year for three years. At the end of three years, the press 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?
84. Figure 14-1.
A company is considering two projects.
Project I
Project II
Initial investment
$120,000
$120,000
Cash inflow Year 1
$40,000
$20,000
Cash inflow Year 2
$40,000
$20,000
Cash inflow Year 3
$40,000
$32,000
Cash inflow Year 4
$40,000
$48,000
Cash inflow Year 5
$40,000
$50,000
Refer to Figure 14-1. What is the payback period for Project I?
85. Figure 14-1.
A company is considering two projects.
Project I
Project II
Initial investment
$120,000
$120,000
Cash inflow Year 1
$40,000
$20,000
Cash inflow Year 2
$40,000
$20,000
Cash inflow Year 3
$40,000
$32,000
Cash inflow Year 4
$40,000
$48,000
Cash inflow Year 5
$40,000
$50,000
Refer to Figure 14-1. What is the payback period for Project II?
86. Figure 14-2.
A company is considering two projects.
Project A
Project B
Initial investment
$200,000
$200,000
Cash inflow Year 1
$50,000
$90,000
Cash inflow Year 2
$50,000
$90,000
Cash inflow Year 3
$50,000
$40,000
Cash inflow Year 4
$50,000
$30,000
Cash inflow Year 5
$50,000
$30,000
Refer to Figure 14-2. What is the payback period for Project A?
87. Figure 14-2.
A company is considering two projects.
Project A
Project B
Initial investment
$200,000
$200,000
Cash inflow Year 1
$50,000
$90,000
Cash inflow Year 2
$50,000
$90,000
Cash inflow Year 3
$50,000
$40,000
Cash inflow Year 4
$50,000
$30,000
Cash inflow Year 5
$50,000
$30,000
Refer to Figure 14-2. What is the payback period for Project B?
88. Figure 14-3.
Davis Company is considering the purchase of a new piece of equipment that will cost $1,600,000 and have a
life of five years with no expected salvage value. The expected cash flows associated with the project are as
follows:
Cash
Cash Expenses &
Year
Revenues
Depreciation
1
$1,500,000
$900,000
2
$1,500,000
$900,000
3
$1,500,000
$900,000
4
$1,500,000
$900,000
5
$1,500,000
$900,000
Refer to Figure 14-3. What is the average annual income for this project?
89. Figure 14-3.
Davis Company is considering the purchase of a new piece of equipment that will cost $1,600,000 and have a
life of five years with no expected salvage value. The expected cash flows associated with the project are as
follows:
Cash
Cash Expenses &
Year
Revenues
Depreciation
1
$1,500,000
$900,000
2
$1,500,000
$900,000
3
$1,500,000
$900,000
4
$1,500,000
$900,000
5
$1,500,000
$900,000
Refer to Figure 14-3. What is the accounting rate of return for the project?
90. Figure 14-4.
Sony Lavery is considering investing $45,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$18,000
$8,000
Year 2
$22,000
$10,000
Year 3
$22,000
$9,000
Year 4
$24,000
$9,000
Year 5
$26,000
$9,000
Year 6
$28,000
$12,000
Year 7
$28,000
$11,000
Year 8
$28,000
$12,000
Refer to Figure 14-4. What is the average income for the project?
91. Figure 14-4.
Sony Lavery is considering investing $45,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$18,000
$8,000
Year 2
$22,000
$10,000
Year 3
$22,000
$9,000
Year 4
$24,000
$9,000
Year 5
$26,000
$9,000
Year 6
$28,000
$12,000
Year 7
$28,000
$11,000
Year 8
$28,000
$12,000
Refer to Figure 14-4. What is the accounting rate of return for the project?
92. Figure 14-4.
Sony Lavery is considering investing $45,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$18,000
$8,000
Year 2
$22,000
$10,000
Year 3
$22,000
$9,000
Year 4
$24,000
$9,000
Year 5
$26,000
$9,000
Year 6
$28,000
$12,000
Year 7
$28,000
$11,000
Year 8
$28,000
$12,000
Refer to Figure 14-4. Assuming straight-line depreciation over eight years, what is the payback period for the project?
93. Figure 14-5.
Sara Turner is considering investing $60,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$16,000
$16,000
Year 2
$18,000
$16,000
Year 3
$17,000
$17,000
Year 4
$26,000
$14,000
Year 5
$26,000
$14,000
Refer to Figure 14-5. Assuming straight-line depreciation over five years, what is the payback period for this investment?
94. Figure 14-5.
Sara Turner is considering investing $60,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$16,000
$16,000
Year 2
$18,000
$16,000
Year 3
$17,000
$17,000
Year 4
$26,000
$14,000
Year 5
$26,000
$14,000
Refer to Figure 14-5. What is the accounting rate of return for the project?
95. Figure 14-7.
Osler Company is considering an investment with the following data:
Initial cost
$200,000
Annual net cash inflows
$ 25,000
Expected life
10 years
Salvage value
none
Depreciation will be taken on a straight-line basis over the expected life of the investment.
Refer to Figure 14-7. What is the accounting rate of return for the investment?
96. Figure 14-7.
Osler Company is considering an investment with the following data:
Initial cost
$200,000
Annual net cash inflows
$ 25,000
Expected life
10 years
Salvage value
none
Depreciation will be taken on a straight-line basis over the expected life of the investment.
Refer to Figure 14-7. The company requires a minimum rate of return of 4%. What is the net present value of the investment?
Period
1
2
3
4
5
6
7
8
9
10
4%
0.962
1.886
2.775
3.630
4.452
5.242
6.002
6.773
7.435
8.111
97. Which of the following provides an absolute dollar measure?
98. The required rate of return used in the net present value model can also be called the
99. If net present value is negative, it means that the return on the investment is
100. A division manager is considering a project that requires a 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?
101. 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
102. Jackson 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?