Chapter 25—Capital Investment Analysis Key
1. The process by which management plans, evaluates, and controls long-term investment decisions involving
fixed assets is called capital investment analysis.
2. The process by which management plans, evaluates, and controls long-term investment decisions involving
fixed assets is called cost-volume-profit analysis.
3. Care must be taken involving capital investment decisions, since normally a long-term commitment of funds
is involved and operations could be affected for many years.
4. Only managers are encouraged to submit capital investment proposals because they know the processes and
are able to match investments with long-term goals.
5. The methods of evaluating capital investment proposals can be grouped into two general categories that can
be referred to as (1) methods that ignore present value and (2) present values methods.
6. The methods of evaluating capital investment proposals can be grouped into two general categories that can
be referred to as (1) average rate of return and (2) cash payback methods.
7. Average rate of return equals average investment divided by estimated average annual income.
8. Average rate of return equals estimated average annual income divided by average investment.
9. The method of analyzing capital investment proposals in which the estimated average annual income is
divided by the average investment is the average rate of return method.
10. The excess of the cash flowing in from revenues over the cash flowing out for expenses is termed net cash
flow.
11. The excess of the cash flowing in from revenues over the cash flowing out for expenses is termed net
discounted cash flow.
12. The computations involved in the net present value method of analyzing capital investment proposals are
less involved than those for the average rate of return method.
13. The computations involved in the net present value method of analyzing capital investment proposals are
more involved than those for the average rate of return method.
14. Methods that ignore present value in capital investment analysis include the cash payback method.
15. Methods that ignore present value in capital investment analysis include the average rate of return method.
16. Methods that ignore present value in capital investment analysis include the internal rate of return method.
17. Methods that ignore present value in capital investment analysis include the net present value method.
18. The average rate of return method of capital investment analysis gives consideration to the present value of
future cash flows.
19. The cash payback method of capital investment analysis is one of the methods referred to as a present value
method.
20. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is
expected to yield total net income of $300,000 for the 5 years. The expected average rate of return is 30%.
21. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is
expected to yield total net income of $300,000 for the 5 years. The expected average rate of return is 37.5%.
22. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is
expected to yield total net income of $200,000 for the 5 years. The expected average rate of return on
investment is 50%.
23. The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is
expected to yield total net income of $200,000 for the 5 years. The expected average rate of return on
investment is 25.0%.
24. In net present value analysis for a proposed capital investment, the expected future net cash flows are
averaged and then reduced to their present values.
25. The expected period of time that will elapse between the date of a capital investment and the complete
recovery in cash of the amount invested is called the discount period.
26. The expected period of time that will elapse between the date of a capital investment and the complete
recovery in cash of the amount invested is called the cash payback period.
27. If a proposed expenditure of $70,000 for a fixed asset with a 4-year life has an annual expected net cash
flow and net income of $32,000 and $12,000, respectively, the cash payback period is 2.5 years.
28. If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected net cash
flow and net income of $32,000 and $12,000, respectively, the cash payback period is 4 years.
29. For years one through five, a proposed expenditure of $250,000 for a fixed asset with a 5-year life has
expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash flows of
$90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 3 years.
30. For years one through five, a proposed expenditure of $500,000 for a fixed asset with a 5-year life has
expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash flows of
$90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 5 years.
31. In net present value analysis for a proposed capital investment, the expected future net cash flows are
reduced to their present values.
32. If in evaluating a proposal by use of the net present value method there is a deficiency of the present value
of future cash inflows over the amount to be invested, the proposal should be rejected.
33. If in evaluating a proposal by use of the net present value method there is a deficiency of the present value
of future cash inflows over the amount to be invested, the proposal should be accepted.
34. If in evaluating a proposal by use of the net present value method there is an excess of the present value of
future cash inflows over the amount to be invested, the rate of return on the proposal exceeds the rate used in
the analysis.
35. If in evaluating a proposal by use of the net present value method there is an excess of the present value of
future cash inflows over the amount to be invested, the rate of return on the proposal is less than the rate used in
the analysis.
36. A present value index can be used to rank competing capital investment proposals when the net present
value method is used.
37. The internal rate of return method of analyzing capital investment proposals uses the present value concept
to compute an internal rate of return expected from the proposals.
38. A series of equal cash flows at fixed intervals is termed an annuity.
39. A qualitative characteristic that may impact upon capital investment analysis is the impact of investment
proposals on product quality.
40. A qualitative characteristic that may impact upon capital investment analysis is manufacturing flexibility.
41. A qualitative characteristic that may impact upon capital investment analysis is employee morale.
42. A qualitative characteristic that may impact upon capital investment analysis is manufacturing productivity.
43. A qualitative characteristic that may impact upon capital investment analysis is manufacturing control.
44. The process by which management allocates available investment funds among competing capital
investment proposals is termed present value analysis.
45. The process by which management allocates available investment funds among competing capital
investment proposals is termed capital rationing.
46. The payback method can be used only when net cash inflows are the same for each period.
47. The accounting rate of return method of analyzing capital budgeting decisions measures the average rate of
return from using the asset over its entire life.
48. The accounting rate of return is a measure of profitability computed by dividing the average annual cash
flows from an asset by the average amount invested in the asset.
49. Net present value and the payback period are examples of discounted cash flow methods used in capital
budgeting decisions.
50. In calculating the net present value of an investment in equipment, the required investment and its terminal
residual value should be subtracted from the present value of all future cash inflows.
51. In calculating the present value of an investment in equipment, the present value of the terminal residual
value should be added to the cash inflows.
52. The time expected to pass before the net cash flows from an investment would return its initial cost is called
the amortization period.
53. A company is considering purchasing a machine for $21,000. The machine will generate income from
operations of $2,000; annual cash flows from the machine will be $3,500. The payback period for the new
machine is 10.5 years.
54. A company is considering purchasing a machine for $21,000. The machine will generate income from
operations of $2,000; annual cash flows from the machine will be $3,500. The payback period for the new
machine is 6 years.
55. A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual cash
inflows from the investment are $36,000 (year 1), $30,000 (year 2), $18,000 (year 3), $12,000 (year 4), and
$6,000 (year 5). The average income from operations over the 5-year life is $20,400. The payback period is
3.5 years.
56. A company is considering the purchase of a new machine for $48,000. Management expects that the
machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct
materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All
revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 6 years.
57. A company is considering the purchase of a new machine for $48,000. Management expects that the
machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct
materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All
revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 12
years.
58. A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no
salvage value. The company expects to sell the machine’s output of 3,000 units evenly throughout each year.
Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per
year of $6,000. The payback period for the machine is 4 years.
59. A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no
salvage value. The company expects to sell the machine’s output of 3,000 units evenly throughout each year.
Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per
year of $6,000. The payback period for the machine is 12 years.
60. A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no
salvage value. The company expects to sell the machine’s output of 3,000 units evenly throughout each year.
Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per
year of $6,000. The accounting rate of return for the machine is 16.7%.
61. A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no
salvage value. The company expects to sell the machine’s output of 3,000 units evenly throughout each year.
Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per
year of $6,000. The accounting rate of return for the machine is 50%.
62. The process by which management plans, evaluates, and controls long-term investment decisions involving
fixed assets is called:
63. Decisions to install new equipment, replace old equipment, and purchase or construct a new building are
64. Which of the following is important when evaluating long-term investments?
65. Which of the following are present value methods of analyzing capital investment proposals?
66. Which of the following is a present value method of analyzing capital investment proposals?
67. By converting dollars to be received in the future into current dollars, the present value methods take into
consideration that money:
68. Which of the following are two methods of analyzing capital investment proposals that both ignore present
value?
69. The method of analyzing capital investment proposals that divides the estimated average annual income by
the average investment is:
70. The primary advantages of the average rate of return method are its ease of computation and the fact that:
71. The expected average rate of return for a proposed investment of $600,000 in a fixed asset, with a useful life
of four years, straight-line depreciation, no residual value, and an expected total net income of $240,000 for the
4 years, is:
72. The amount of the average investment for a proposed investment of $90,000 in a fixed asset, with a useful
life of four years, straight-line depreciation, no residual value, and an expected total net income of $21,600 for
the 4 years, is:
73. The amount of the estimated average income for a proposed investment of $90,000 in a fixed asset, giving
effect to depreciation (straight-line method), with a useful life of four years, no residual value, and an expected
total income yield of $21,600, is:
74. An anticipated purchase of equipment for $580,000, with a useful life of 8 years and no residual value, is
expected to yield the following annual net incomes and net cash flows:
Year
Net Income
Net Cash Flow
1
$60,000
$110,000
2
50,000
100,000
3
50,000
100,000
4
40,000
90,000
5
40,000
90,000
6
40,000
90,000
7
40,000
90,000
8
40,000
90,000
What is the cash payback period?
75. Which method for evaluating capital investment proposals reduces the expected future net cash flows
originating from the proposals to their present values and computes a net present value?
76. Which of the following can be used to place capital investment proposals involving different amounts of
investment on a comparable basis for purposes of net present value analysis?
77. An analysis of a proposal by the net present value method indicated that the present value of future cash
inflows exceeded the amount to be invested. Which of the following statements best describes the results of this
analysis?
78. Which method of evaluating capital investment proposals uses the concept of present value to compute a
rate of return?
79. Which of the following is a method of analyzing capital investment proposals that ignores present value?
80. The methods of evaluating capital investment proposals can be separated into two general groups—present
value methods and:
81. The rate of earnings is 10% and the cash to be received in three years is $10,000. Determine the present
value amount, using the following partial table of present value of $1 at compound interest:
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
82. Using the following partial table of present value of $1 at compound interest, determine the present value of
$20,000 to be received four years hence, with earnings at the rate of 10% a year:
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
83. When several alternative investment proposals of the same amount are being considered, the one with the
largest net present value is the most desirable. If the alternative proposals involve different amounts of
investment, it is useful to prepare a relative ranking of the proposals by using a(n):
84. Which method of evaluating capital investment proposals uses present value concepts to compute the rate of
return from the net cash flows expected from capital investment proposals?
85. A series of equal cash flows at fixed intervals is termed a(n):
86. The present value index is computed using which of the following formulas?
87. Hazard Company is considering the acquisition of a machine that costs $525,000. The machine is expected
to have a useful life of 6 years, a negligible residual value, an annual cash flow of $150,000, and annual
operating income of $87,500. What is the estimated cash payback period for the machine?
88. The expected average rate of return for a proposed investment of $8,000,000 in a fixed asset, using straight
line depreciation, with a useful life of 20 years, no residual value, and an expected total net income of
$12,000,000 is:
89. The present value factor for an annuity of $1 is determined using which of the following formulas?
90. The management of Nebraska Corporation is considering the purchase of a new machine costing $490,000.
The company’s desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1
through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information,
use the following data in determining the acceptability in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$100,000
$180,000
2
40,000
120,000
3
40,000
100,000
4
10,000
90,000
5
10,000
120,000
The cash payback period for this investment is:
91. The management of Nebraska Corporation is considering the purchase of a new machine costing $490,000.
The company’s desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1
through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information,
use the following data in determining the acceptability in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$100,000
$180,000
2
40,000
120,000
3
40,000
100,000
4
10,000
90,000
5
10,000
120,000
The average rate of return for this investment is:
92. The management of Arkansas Corporation is considering the purchase of a new machine costing $490,000.
The company’s desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1
through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information,
use the following data in determining the acceptability in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$100,000
$180,000
2
40,000
120,000
3
40,000
100,000
4
10,000
90,000
5
10,000
120,000
The net present value for this investment is:
93. The management of California Corporation is considering the purchase of a new machine costing $400,000.
The company’s desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1
through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information,
use the following data in determining the acceptability in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$100,000
$180,000
2
40,000
120,000
3
20,000
100,000
4
10,000
90,000
5
10,000
90,000
The present value index for this investment is:
94. The management of Wyoming Corporation is considering the purchase of a new machine costing $375,000.
The company’s desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5
years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability
in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$18,750
$93,750
2
18,750
93,750
3
18,750
93,750
4
18,750
93,750
5
18,750
93,750
The cash payback period for this investment is:
95. The management of Wyoming Corporation is considering the purchase of a new machine costing $375,000.
The company’s desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5
years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability
in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$18,750
$93,750
2
18,750
93,750
3
18,750
93,750
4
18,750
93,750
5
18,750
93,750
The average rate of return for this investment is:
96. The management of Wyoming Corporation is considering the purchase of a new machine costing $375,000.
The company’s desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5
years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability
in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$18,750
$93,750
2
18,750
93,750
3
18,750
93,750
4
18,750
93,750
5
18,750
93,750
The net present value for this investment is:
97. The management of Wyoming Corporation is considering the purchase of a new machine costing $375,000.
The company’s desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5
years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability
in this situation:
Year
Income from
Operations
Net Cash
Flow
1
$18,750
$93,750
2
18,750
93,750
3
18,750
93,750
4
18,750
93,750
5
18,750
93,750
The present value index for this investment is:
98. Motel Corporation is analyzing a capital expenditure that will involve a cash outlay of $208,240. Estimated
cash flows are expected to be $40,000 annually for seven years. The present value factors for an annuity of $1
for 7 years at interest of 6%, 8%, 10%, and 12% are 5.582, 5.206, 4.868, and 4.564, respectively. The internal
rate of return for this investment is:
99. Tennessee Corporation is analyzing a capital expenditure that will involve a cash outlay of $109,332.
Estimated cash flows are expected to be $36,000 annually for four years. The present value factors for an
annuity of $1 for 4 years at interest of 10%, 12%, 14%, and 15% are 3.170, 3.037, 2.914, and 2.855,
respectively. The internal rate of return for this investment is:
100. Below is a table for the present value of $1 at Compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
5
.747
.621
.567
Below is a table for the present value of an annuity of $1 at compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
1.833
1.736
1.690
3
2.673
2.487
2.402
4
3.465
3.170
3.037
5
4.212
3.791
3.605
Using the tables above, what would be the present value of $15,000 (rounded to the nearest dollar) to be received four years from today, assuming
an earnings rate of 10%?
101. Below is a table for the present value of $1 at Compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
5
.747
.621
.567
Below is a table for the present value of an annuity of $1 at compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
1.833
1.736
1.690
3
2.673
2.487
2.402
4
3.465
3.170
3.037
5
4.212
3.791
3.605
Using the tables above, what would be the present value of $10,000 (rounded to the nearest dollar) to be received three years from today, assuming
an earnings rate of 6%?
102. Below is a table for the present value of $1 at Compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
5
.747
.621
.567
Below is a table for the present value of an annuity of $1 at compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
1.833
1.736
1.690
3
2.673
2.487
2.402
4
3.465
3.170
3.037
5
4.212
3.791
3.605
Using the tables above, what is the present value of $4,000 (rounded to the nearest dollar) to be received at the end of each of the next four years,
assuming an earnings rate of 12%?
103. Below is a table for the present value of $1 at Compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
.890
.826
.797
3
.840
.751
.712
4
.792
.683
.636
5
.747
.621
.567
Below is a table for the present value of an annuity of $1 at compound interest.
Year
6%
10%
12%
1
.943
.909
.893
2
1.833
1.736
1.690
3
2.673
2.487
2.402
4
3.465
3.170
3.037
5
4.212
3.791
3.605
Using the tables above, if an investment is made now for $23,500 that will generate a cash inflow of $8,000 a year for the next 4 years, what would
be the net present value (rounded to the nearest dollar) of the investment, (assuming an earnings rate of 10%)?