Planning for Capital Investments 24–21
99. A project with a profitability index of 1.156 also has net cash flows with a present value of
$69,360. The project’s internal rate of return was 10%. The initial investment was
a. $66,000.
b. $80,180.
c. $60,000.
d. $62,424.
100. Selma Inc. is comparing several alternative capital budgeting projects as shown below:
Projects
A B C
Initial investment $80,000 $120,000 $160,000
Present value of net cash flows 90,000 110,000 200,000
Using the profitability index, the projects rank as
a. A, C, B.
b. A, B, C.
c. C, A, B.
d. C, B, A.
101. Selma Inc. is comparing several alternative capital budgeting projects as shown below:
Projects
A B C
Initial investment $80,000 $120,000 $160,000
Present value of net cash flows 90,000 110,000 200,000
Using the profitability index, how many of the projects are acceptable?
a. 3
b. 2
c. 1
d. 0
102. If a project has a negative net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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103. If a project has a positive net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.
104. If a project has a zero net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.
105. If a project has a profitability index of 1.20, then the project’s internal rate of return is
a. equal to the discount rate.
b. less than the discount rate.
c. greater than the discount rate.
d. equal to 20%.
106. Cleaners, Inc. is considering purchasing equipment costing $60,000 with a 6-year useful
life. The equipment will provide cost savings of $14,600 and will be depreciated straight-
line over its useful life with no salvage value. Cleaners requires a 10% rate of return.
Present Value of an Annuity of 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784
What is the approximate net present value of this investment?
a. $27,600
b. $3,583
c. $1,772
d. $5,496
Planning for Capital Investments 24–23
107. Cleaners, Inc. is considering purchasing equipment costing $60,000 with a 6-year useful
life. The equipment will provide cost savings of $14,600 and will be depreciated straight-
line over its useful life with no salvage value. Cleaners requires a 10% rate of return.
Present Value of an Annuity of 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784
What is the approximate profitability index associated with this equipment?
a. 1.23
b. 1.03
c. 1.06
d. .73
108. Cleaners, Inc. is considering purchasing equipment costing $60,000 with a 6-year useful
life. The equipment will provide cost savings of $14,600 and will be depreciated straight-
line over its useful life with no salvage value. Cleaners requires a 10% rate of return.
Present Value of an Annuity of 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784
What is the approximate internal rate of return for this investment?
a. 9%
b. 10%
c. 11%
d. 12%
109.
Present Value of an Annuity of 1
Periods 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 9%. It is considering investing in a project
that costs $210,000 and is expected to generate cash inflows of $84,000 at the end of
each year for three years. The net present value of this project is
a. $212,604.
b. $42,000.
c. $21,261.
d. $2,604.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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110.
Present Value of an Annuity of 1
Periods 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 10%. It is considering investing in a
project that costs $50,000 and is expected to generate cash inflows of $25,000 at the end
of each year for three years. The profitability index for this project is
a. .80.
b. 1.00.
c. 1.24.
d. 1.27.
111.
Present Value of an Annuity of 1
Periods 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 8%. It is considering investing in a
project that costs $91,116 and is expected to generate cash inflows of $36,000 each year
for three years. The approximate internal rate of return on this project is
a. 8%.
b. 9%.
c. 10%.
d. less than the required 8%.
Planning for Capital Investments 24–25
112. Carr Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Soup Project Nuts
Initial investment $400,000 $600,000
Annual net income 30,000 46,000
Net annual cash inflow 110,000 146,000
Estimated useful life 5 years 6 years
Salvage value -0- -0-
The company requires a 10% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The cash payback period for Project Nuts is
a. 13.3 years.
b. 6.7 years.
c. 5.0 years.
d. 4.1 years.
113. Carr Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Soup Project Nuts
Initial investment $400,000 $600,000
Annual net income 30,000 46,000
Net annual cash inflow 110,000 146,000
Estimated useful life 5 years 6 years
Salvage value -0- -0-
The company requires a 10% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The net present value for Project Nuts is
a. $635,830.
b. $200,330.
c. $100,000.
d. $35,830.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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114. Carr Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Soup Project Nuts
Initial investment $400,000 $600,000
Annual net income 30,000 46,000
Net annual cash inflow 110,000 146,000
Estimated useful life 5 years 6 years
Salvage value -0- -0-
The company requires a 10% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The internal rate of return for Project Nuts is approximately
a. 11%.
b. 12%.
c. 10%.
d. 9%.
115. Carr Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Soup Project Nuts
Initial investment $400,000 $600,000
Annual net income 30,000 46,000
Net annual cash inflow 110,000 146,000
Estimated useful life 5 years 6 years
Salvage value -0- -0-
The company requires a 10% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The annual rate of return for Project Soup is
a. 7.5%.
b. 15.0%.
c. 27.5%.
d. 55%.
Planning for Capital Investments 24–27
116. A post-audit should be performed using
a. a different evaluation technique than that used in making the original decision.
b. the same evaluation technique used in making the original decision.
c. estimated amounts instead of actual figures.
d. an independent CPA.
117. A thorough evaluation of how well a project‘s actual performance matches the projections
made when the project was proposed is called a
a. pre-audit.
b. post-audit.
c. risk analysis.
d. sensitivity analysis.
118. Performing a post-audit is important because
a. managers will be more likely to submit reasonable data when they make investment
proposals if they know their estimates will be compared to actual results.
b. it provides a formal mechanism by which the company can determine whether existing
projects should be terminated.
c. it improves the development of future investment proposals because managers
improve their estimation techniques by evaluating their past successes and failures.
d. all of these.
119. A capital budgeting method that takes into consideration the time value of money is the
a. annual rate of return method.
b. return on stockholders’ equity method.
c. cash payback technique.
d. internal rate of return method.
120. The internal rate of return is the interest rate that results in a
a. positive NPV.
b. negative NPV.
c. zero NPV.
d. positive or negative NPV.
121. In using the internal rate of return method, the internal rate of return factor was 4.0 and
the equal annual cash inflows were $18,000. The initial investment in the project must
have been
a. $18,000.
b. $4,500.
c. $72,000.
d. $36,000.
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122. The capital budgeting technique that finds the interest yield of the potential investment is
the
a. annual rate of return method.
b. internal rate of return method.
c. net present value method.
d. profitability index method.
123. All of the following statements about the internal rate of return method are correct except
that it
a. recognizes the time value of money.
b. is widely used in practice.
c. is easy to interpret.
d. can be used only when the cash inflows are equal.
124. If the internal rate of return is used as the discount rate in the net present value calcula–
tion, the net present value will be
a. zero.
b. positive.
c. negative.
d. undeterminable.
125. If a project costing $80,000 has a profitability index of 1.00 and the discount rate was
12%, then the present value of the net cash flows was
a. $80,000.
b. less than $80,000.
c. greater than $80,000.
d. undeterminable.
126. If a project costing $40,000 has a profitability index of 1.00 and the discount rate was 8%,
then the project’s internal rate of return was
a. less than 8%.
b. equal to 8%.
c. greater than 8%.
d. undeterminable.
127. The internal rate of return factor is equal to the
a. capital investment divided by the net cash flows.
b. present value of net cash flows divided by the capital investment.
c. present value of net cash flows divided by the profitability index.
d. capital investment divided by the present value of the net cash flows.
Planning for Capital Investments 24–29
128. If a 2-year capital project has an internal rate of return factor equal to 1.690 and net
annual cash flows of $60,000, the initial capital investment was
a. $101,400.
b. $35,503.
c. $50,700.
d. $71,007.
129. If a 3-year capital project costing $77,310 has an internal rate of return factor equal to
2.577, the net annual cash flows assuming straight-line depreciation are
a. $25,770.
b. $30,000.
c. $10,000.
d. $38,655.
130. If the internal rate of return exceeds the discount rate, then the net present value of a
project is
a. positive.
b. negative.
c. zero.
d. one.
131. If the internal rate of return is less than the discount rate, then the net present value of a
project is
a. positive.
b. negative.
c. zero.
d. one.
132. If a project has a negative net present value, the internal rate of return will be
a. less than the discount rate.
b. greater than the discount rate.
c. equal to the discount rate.
d. a negative rate of return.
133. If a project has a zero net present value, then the internal rate of return will be
a. less than the discount rate.
b. greater than the discount rate.
c. equal to the discount rate.
d. a negative rate of return.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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134. Which of the following will cause the internal rate of return to increase?
a. An increase in the annual cash inflows
b. A decrease in the annual cash inflows
c. An increase in the discount rate
d. A decrease in the discount rate
135. If project A has a lower internal rate of return than project B, then project A will have a
a. lower NPV and a shorter payback period.
b. higher NPV and a longer payback period.
c. lower NPV and a longer payback period.
d. higher NPV and a shorter payback period.
136. The internal rate of return factor is also the
a. annual rate of return.
b. profitability index.
c. cash payback period.
d. present value factor for a single amount.
137. Use the following table:
Present Value of an Annuity of 1
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 8%. It is considering investing in a
project that costs $379,650 and is expected to generate cash inflows of $150,000 each
year for three years. The approximate internal rate of return on this project is
a. 8%.
b. 9%.
c. 10%.
d. The IRR on this project cannot be approximated.
138. A company is considering purchasing a machine that costs $280,000 and is estimated to
have no salvage value at the end of its 8-year useful life. If the machine is purchased,
annual revenues are expected to be $100,000 and annual operating expenses exclusive
of depreciation expense are expected to be $38,000. The straight-line method of
depreciation would be used.
If the machine is purchased, the annual rate of return expected on this machine is
a. 22.1%.
b. 44.3%.
c. 9.6%.
d. 19.3%.
Planning for Capital Investments 24–31
139. A company projects an increase in net income of $135,000 each year for the next five
years if it invests $900,000 in new equipment. The equipment has a five-year life and an
estimated salvage value of $300,000. What is the annual rate of return on this
investment?
a. 15.0%
b. 22.5%
c. 30.0%
d. 34.5%
140. Garza Company is considering buying equipment for $320,000 with a useful life of five
years and an estimated salvage value of $16,000. If annual expected income is $28,000,
the denominator in computing the annual rate of return is
a. $320,000.
b. $160,000.
c. $168,000.
d. $336,000.
141. Mussina Company had an investment which cost $250,000 and had a salvage value at
the end of its useful life of zero. If Mussina’s expected annual net income is $15,000, the
annual rate of return is:
a. 6.0%.
b. 10.2%.
c. 12.0%.
d. 15.0%.
142. Discounted cash flow techniques include all of the following except
a. profitability index.
b. annual rate of return.
c. internal rate of return.
d. net present value.
143. Which of the following is based directly on accrual accounting data rather than cash
flows?
a. Profitability index
b. Internal rate of return
c. Net present value
d. Annual rate of return
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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144. When calculating the annual rate of return, the average investment is equal to
a. (initial investment plus $0) divided by 2.
b. initial investment divided by life of project.
c. initial investment divided by 2.
d. (initial investment plus salvage value) divided by 2.
145. A project has an annual rate of return of 15%. The project cost $120,000, has a 5-year
useful life, and no salvage value. Straight-line depreciation is used. The annual net
income, exclusive of depreciation, was
a. $42,000.
b. $33,000.
c. $47,700.
d. $18,000.
146. A project that cost $75,000 has a useful life of 5 years and a salvage value of $3,000. The
internal rate of return is 12% and the annual rate of return is 18%. The amount of the
annual net income was
a. $7,020.
b. $6,480.
c. $4,680.
d. $4,320.
147. A project has annual income exclusive of depreciation of $80,000. The annual rate of
return is 15% and annual depreciation is $20,000. There is no salvage value. The internal
rate of return is 12%. The initial cost of the project was
a. $400,000.
b. $500,000.
c. $1,000,000.
d. $800,000.
148. A project that cost $80,000 with a useful life of 5 years is being considered. Straight–line
depreciation is being used and salvage value is $5,000. The project will generate annual
cash flows of $21,375. The annual rate of return is
a. 15%.
b. 50.3%.
c. 16%.
d. 17%.
Planning for Capital Investments 24–33
149. A company is considering purchasing factory equipment that costs $480,000 and is
estimated to have no salvage value at the end of its 8-year useful life. If the equipment is
purchased, annual revenues are expected to be $135,000 and annual operating expenses
exclusive of depreciation expense are expected to be $39,000. The straight-line method of
depreciation would be used.
If the equipment is purchased, the annual rate of return expected on this equipment is
a. 40.0%.
b. 7.5%.
c. 15.0%.
d. 20.0%.
150. A company is considering purchasing factory equipment that costs $480,000 and is
estimated to have no salvage value at the end of its 8-year useful life. If the equipment is
purchased, annual revenues are expected to be $135,000 and annual operating expenses
exclusive of depreciation expense are expected to be $39,000. The straight-line method of
depreciation would be used.
The cash payback period on the equipment is
a. 13.3 years.
b. 8.0 years.
c. 5.0 years.
d. 2.5 years.
151. The capital budgeting technique that indicates the profitability of a capital expenditure is
the
a. profitability index method.
b. net present value method.
c. internal rate of return method.
d. annual rate of return method.
152. The annual rate of return method is based on
a. accounting data.
b. the time value of money data.
c. market values.
d. cash flow data.
153. Disadvantages of the annual rate of return method include all of the following except that
a. it relies on accrual accounting numbers instead of actual cash flows.
b. it does not consider the time value of money.
c. no consideration is given as to when the cash inflows occur.
d. management is unfamiliar with the information used in the computation.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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154. A company projects an increase in net income of $30,000 each year for the next five
years if it invests $300,000 in new equipment. The equipment has a five-year life and an
estimated salvage value of $100,000. What is the annual rate of return on this
investment?
a. 10%
b. 15%
c. 20%
d. 25%
155. Colaw Company is considering buying equipment for $240,000 with a useful life of five
years and an estimated salvage value of $12,000. If annual expected income is $21,000,
the denominator in computing the annual rate of return is
a. $240,000.
b. $120,000.
c. $126,000.
d. $252,000.
156. The annual rate of return is computed by dividing expected annual
a. cash inflows by average investment.
b. net income by average investment.
c. cash inflows by original investment.
d. net income by original investment.
157. All of the following statements about the annual rate of return method are correct except
that it
a. indicates the profitability of a capital expenditure.
b. ignores the salvage value of an investment.
c. does not consider the time value of money.
d. compares the annual rate of return to management’s minimum rate of return.
Planning for Capital Investments 24–35
Answers to Multiple Choice Questions
BRIEF EXERCISES
BE 158
Diamond Company is considering investing in new equipment that will cost $1,400,000 with a 10-
year useful life. The new equipment is expected to produce annual net income of $90,000 over its
useful life. Depreciation expense, using the straight-line rate, is $140,000 per year.
Instructions
Compute the cash payback period.
BE 159
Madeline Company is proposing to spend $200,000 to purchase a machine that will provide
annual cash flows of $38,000. The appropriate present value factor for 10 periods is 5.65.
Instructions
Compute the proposed investment’s net present value and indicate whether the investment
should be made by Madeline Company.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
24–36
Solution 159 (5 min.)
BE 160
LakeFront Company is considering investing in a new dock that will cost $560,000. The company
expects to use the dock for 5 years, after which it will be sold for $300,000. LakeFront anticipates
annual cash flows of $110,000 resulting from the new dock. The company’s borrowing rate is 8%,
while its cost of capital is 10%.
Instructions
Calculate the net present value of the dock and indicate whether LakeFront should make the
investment.
BE 161
Mobil Company has hired a consultant to propose a way to increase the company’s revenues.
The consultant has evaluated two mutually exclusive projects with the following information
provided for each project:
Project Turtle Project Snake
Capital investment $1,105,000 $625,000
Annual cash flows 180,000 105,000
Estimated useful life 10 years 10 years
Mobil Company uses a discount rate of 9% to evaluate both projects.
Instructions
(a) Calculate the net present value of both projects.
(b) Calculate the profitability index for each project.
(c) Which project should Mobil accept?
Planning for Capital Investments 24–37
Solution 161 (10–15 min.)
Ex. 162
Carlson Bottling Corporation is considering the purchase of a new bottling machine. The machine
would cost $300,000 and has an estimated useful life of 8 years with zero salvage value.
Management estimates that the new bottling machine will provide net annual cash flows of
$52,500. Management also believes that the new bottling machine will save the company money
because it is expected to be more reliable than other machines, and thus will reduce downtime.
How much would the reduction in downtime have to be worth in order for the project to be
acceptable? Assume a discount rate of 9%
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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Ex. 163
Stanton Company is performing a post-audit of a project completed one year ago. The initial
estimates were that the project would cost $490,000, would have a useful life of 9 years, zero
salvage value, and would result in net annual cash flows of $90,000 per year. Now that the
investment has been in operation for 1 year, revised figures indicate that it actually cost
$510,000, will have a useful life of 11 years, and will produce net annual cash flows of $77,000
per year. Evaluate the success of the project. Assume a discount rate of 10%
BE 164
Mint Company is contemplating an investment costing $135,000. The investment will have a life
of 8 years with no salvage value and will produce annual cash flows of $25,305.
Instructions
What is the approximate internal rate of return associated with this investment?
Planning for Capital Investments 24–39
BE 165
Salt Company is considering investing in a new facility to extract and produce salt. The facility will
increase revenues by $220,000, but it will also increase annual expenses by $160,000. The
facility will cost $980,000 to build, and it will have a $20,000 salvage value at the end of its useful
life.
Instructions
Calculate the annual rate of return on this facility.
EXERCISES
Ex. 166
Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin
Beagle, production manager, is considering purchasing a machine that will make the corn dogs.
Austin has shopped for machines and found that the machine he wants will cost $215,000. In
addition, Austin estimates that the new machine will increase the company’s annual net cash
inflows by $33,000. The machine will have a 12-year useful life and no salvage value.
Instructions
(a) Calculate the cash payback period.
(b) Calculate the machine’s internal rate of return.
(c) Calculate the machine’s net present value using a discount rate of 10%.
(d) Assuming Corn Doggy, Inc.’s cost of capital is 10%, is the investment acceptable? Why or
why not?