Chapter 8—Long-Term (Capital Investment) Decisions
MULTIPLE CHOICE
1. The time value of money concept focuses on:
a.
revenues alone.
b.
expenses alone.
c.
cash flows.
d.
net income.
2. Which of the following is classified as a capital investment decision?
a.
Purchase of a building
b.
Purchase of inventory
c.
Paying interest on bonds issued
d.
Purchase of a 6-month treasury bill
3. Which of the following statements is true regarding the concept of the time value of money?
a.
A dollar paid today is worth the same as a dollar paid in the future.
b.
A dollar received today is worth the same as a dollar received in the future.
c.
A dollar received today is worth more than a dollar received in the future.
d.
A dollar received today is worth less than a dollar received in the future.
4. A quantitative analysis of capital investment decisions should consider:
a.
accrued revenues.
b.
accrued expenses.
c.
accounting net income.
d.
time value of money.
5. Which of the following is not a typical cash outflow associated with a capital investment?
a.
Repairs and maintenance needed for purchased equipment
b.
Additional operating costs resulting from the capital investment
c.
Salvage value received when the newly purchased equipment is sold
d.
Purchase price of new equipment
6. When using the NPV method, the interest rate used to discount cash flows should not be thought of as
the:
a.
hurdle rate.
b.
internal rate of return.
c.
minimum required rate of return.
d.
discount rate.
7. Which of the following statements is false regarding the interest rate used in NPV calculations?
a.
Some companies use their cost of capital as the discount rate.
b.
The interest rate used may be adjusted for uncertainty.
c.
It should be equal to the maximum required rate of return needed to make the investment
profitable.
d.
The interest rate used may be higher or lower than the investment’s actual internal rate of
return.
8. If an investment’s net present value is positive, then:
a.
The investment provides a return greater than the discount rate.
b.
The investment provides a return less than the discount rate.
c.
The present value of the cash outflows must have been greater than the present value of
the cash inflows.
d.
The investment should be deemed as unacceptable.
9. When using the NPV method for a particular investment decision, if the present value of all cash
inflows is greater than the present value of all cash outflows, then:
a.
the discount rate used was too high.
b.
the investment provides an actual rate of return greater than the discount rate.
c.
the investment provides an actual rate of return equal to the discount rate.
d.
the discount rate was too low.
10. When using the NPV method for a particular investment decision, if the present value of the cash
inflows is equal to the present value of the cash outflows, then:
a.
the discount rate used was too high.
b.
the investment should not be made.
c.
the investment has an actual rate of return of zero percent.
d.
the discount rate is equal to the internal rate of return.
11. If the net present value of an investment is negative, then:
a.
the actual rate of return is less than the discount rate.
b.
the actual rate of return is more than the discount rate.
c.
the actual rate of return is negative.
d.
the discount rate is negative.
12. If the net present value of an investment is negative, then:
a.
the present value of the cash inflows is greater than the present value of the cash outflows.
b.
the discount rate is negative.
c.
the actual rate of return is less than the discount rate used.
d.
increasing the cost of the investment will change the net present value to a positive
number.
13. Blossoms Inc., a local florist, is considering replacing its current refrigerator used for storing flowers
with a larger one. The estimated cost of the new refrigerator will be $30,000. Using a discount rate of
15%, the company calculates a net present value for the new refrigerator of $6,000. Based on this
information, which of the following statements is true?
a.
If the actual cost of the new refrigerator ends up being greater than $36,000, the net
present value will become negative.
b.
If the actual cost of the new refrigerator ends up being less than $36,000, the net present
value will become negative.
c.
If the actual cost of the new refrigerator ends up being $30,000, the actual rate of return is
equal to 15%.
d.
If the actual cost of the new refrigerator ends up being less than $30,000, the company
should not make the investment.
14. Woody Manufacturing Inc. is considering the purchase of a new machine. They have narrowed their
choices down to two machines, Machine #1 and Machine #2, each having a cost of $35,000. The
following information is available regarding the expected cash inflows from each machine:
Year
Machine #1
Machine #2
1
$14,000
$42,000
2
14,000
0
3
14,000
0
When using net present value analysis, Woody uses the same cost of capital for both machines and
both machines have a positive net present value.
Based on the above information, which of the following statements is true?
a.
Machine #1 will have a higher net present value than Machine #2.
b.
Machine #1 will have a lower net present value than Machine #2.
c.
Machines #1 and #2 will have the same net present values.
d.
Machines #1 and #2 will have the same internal rates of return.
15. Cameo Inc., a local company specializing in home repairs, is considering replacing its older van with a
new and larger one. The estimated cost of the new van will be $45,000. Using a discount rate of 16%,
the company calculates a net present value for the new van of $(7,000). Based on this information,
which of the following statements is true?
a.
The actual rate of return on the new van is negative.
b.
If the company purchases the van, they are guaranteed a rate of return of 16%.
c.
Using a higher discount rate should cause the net present value to become positive.
d.
If the actual cost of the new van ends up being less than $38,000, the net present value will
become positive.
16. Newman Auto Repair is considering the purchase of a hydraulic machine costing approximately
$35,000. Using a discount rate of 18%, the present value of future cash inflows are calculated to be
$42,000. To yield at least an 18% return, the actual cost of the machine should not exceed the $35,000
estimate by more than:
a.
$28,000.
b.
$49,000.
c.
$7,000.
d.
$6,300.
17. Mid-Town Plumbers Inc. is considering the purchase of a machine costing approximately $6,000.
Using a discount rate of 19%, the present value of future cash inflows are calculated to be $6,700. To
yield at least an 19% return, the actual cost of the machine should not exceed the $6,000 estimate by
more than:
a.
$4,000
b.
$6,000
c.
$800
d.
$700
18. Big Al’s is considering the purchase of a capital investment costing $33,000. Annual cash savings of
$8,000, with a present value at 14 percent of $37,111, are expected for the next eight years. Given this
information, which of the following statements is true?
a.
This investment offers an actual rate of return of 14%.
b.
This investment offers an actual rate of return of less than 14%.
c.
This investment offers an actual rate of return of more than 14%.
d.
This investment offers a negative rate of return.
19. Floyd Manufacturing purchased an asset costing $65,000. Annual operating cash inflows are expected
to be $12,000 each year for ten years. No salvage value is expected at the end of the asset’s life.
Assuming Floyd’s cost of capital is 11 percent, what is the asset’s net present value? (ignore income
taxes)
a.
$4,443
b.
$5,670
c.
$4,560
d.
$17,670
20. O’Malley Inc. purchased an asset costing $90,000. Annual operating cash inflows are expected to be
$20,000 each year for six years. No salvage value is expected at the end of the asset’s life. Assuming
O’Malley’s cost of capital is 16 percent, what is the asset’s net present value? (ignore income taxes)
a.
$(16,306)
b.
$30,000
c.
$(5,600)
d.
$4,800
21. C & K Inc. purchased a delivery van costing $65,000. Annual operating cash inflows are expected to
be $18,000 each year for six years. At the end of the asset’s life, the salvage value is expected to be
$5,000. Assuming C & K’s cost of capital is 15 percent, what is the asset’s net present value? (ignore
income taxes)
a.
$3,121
b.
$22,044
c.
$5,283
d.
$959
22. Mid-Town Products Inc. purchased equipment costing $150,000. Annual operating cash inflows are
expected to be $26,000 each year for fifteen years. At the end of the equipment’s life, the salvage value
is expected to be $18,000. If Mid-Town’s cost of capital is 14 percent, what is the asset’s net present
value? (ignore income taxes)
a.
$4,245
b.
$2,212
c.
$18,000
d.
$23,592
23. Palmetto Products is considering the purchase of a new industrial machine. The estimated cost of the
machine is $50,000. The machine is expected to generate annual cash inflows for the next four years as
follows:
Year
Annual cash flow
1
$25,000
2
20,000
3
20,000
4
15,000
The machine is not expected to have a residual value at the end of its useful life. If Palmetto uses a
discount rate of 16%, what is the expected net present value of the machine? (ignore taxes)
a.
$12,800
b.
$18,969
c.
$(5,816)
d.
$7,515
24. Pristine Products is considering the purchase of a new machine. The estimated cost of the machine is
$45,000. The machine is expected to generate annual cash inflows for the next four years as follows:
Year
Annual cash flow
1
$10,000
2
15,000
3
25,000
4
27,000
The machine is not expected to have a residual value at the end of its useful life. If the company uses a
discount rate of 15%, what is the expected net present value of the machine? (ignore taxes)
a.
$6,914
b.
$6,253
c.
$(2,757)
d.
$4,200
25. Trenton Inc. is considering an equipment purchase that has a cost of $15,000. The equipment is
expected to have a salvage value of $2,000 at the end of three years. In addition, the equipment is
expected to generate cash flows over the next three years as follows:
Year
Annual cash flow
1
$8,000
2
$6,000
3
$3,000
If Trenton’s cost of capital is equal to 14 percent, the net present value of the equipment is: (ignore
income taxes)
a.
$(1,340).
b.
$10.
c.
$(357).
d.
$993.
26. Grant Inc. would like to replace an outdated piece of equipment with a newer model. Grant has
determined that the new equipment needs to generate annual cash inflows of $10,000 for six years and
have a salvage value at the end of year six of $4,000. Grant uses a cost of capital equal to 15 percent
when making capital investment decisions. Given this information, which of the following statements
is true regarding the cost of the new equipment if, using net present value analysis, Grant decides to
purchase the new equipment because it has a positive net present value?
a.
The cost of the equipment was $64,000 or less.
b.
The cost of the equipment was $73,600 or less.
c.
The cost of the equipment was $39,574 or less.
d.
The cost of the equipment was $52,983 or less.
27. Bluebird Inc. requires all capital investments to generate an internal rate of return of 14%. Bluebird is
currently considering an investment that is expected to generate annual cash inflows of $12,000 for 5
years. The cost of the investment should not exceed:
a.
$60,000.
b.
$41,197.
c.
$31,164.
d.
$6,233.
28. Oakwood Inc. requires all capital investments to generate an internal rate of return of 16%. Oakwood
is currently considering an investment that is expected to generate annual cash inflows of $15,000 for
7 years. The cost of the investment should not exceed:
a.
$16,800.
b.
$37,149.
c.
$60,579.
d.
$105,000.
29. Butner Inc. requires all capital investments to generate an internal rate of return of 14%. The company
is considering an investment costing $100,000 that is expected to generate equal, annual cash inflows
for ten years. The annual cash inflows are expected to be:
a.
$19,171.
b.
$16,000.
c.
$38,088.
d.
$12,800.
30. NPV calculations generally require which of the following simplifying assumptions?
a.
All cash flows occur in the middle of the period.
b.
All cash flows occur evenly during the period.
c.
Cash flows occur equally at the beginning and end of the period.
d.
All cash flows occur at the end of the period.
31. The NPV method assumes that cash inflows associated with a particular capital investment decision
are:
a.
reinvested only at the beginning of the year.
b.
immediately reinvested.
c.
reinvested only in the last year of the investment’s life.
d.
not reinvested.
32. The NPV method assumes that cash flows are reinvested at:
a.
the government’s prime rate.
b.
the internal rate of return.
c.
the company’s discount rate.
d.
an average of the internal rate of return and the discount rate.
33. The IRR method assumes that cash inflows associated with a particular investment occur:
a.
uniformly throughout the year.
b.
only at the end of the year.
c.
only at the beginning of the year.
d.
only at the time of the initial investment.
34. The IRR method assumes that cash inflows associated with a particular capital investment decision
are:
a.
reinvested only at the beginning of the year.
b.
never reinvested.
c.
reinvested only in the last year of the investment’s life.
d.
immediately reinvested.
35. The IRR method assumes that cash flows are reinvested at:
a.
the internal rate of return of the original investment.
b.
the company’s discount rate.
c.
the lower of the company’s discount rate or internal rate of return.
d.
an average of the internal rate of return and the discount rate.
36. If the net present value (NPV) of an investment is zero, then the internal rate of return (IRR) is:
a.
less than the discount rate.
b.
more than the discount rate.
c.
equal to the discount rate.
d.
negative.
37. If a project has an internal rate of return of 12% and a negative net present value, which of the
following statements is true regarding the discount rate used for the net present value computation?
a.
The discount rate must have been greater than 12%.
b.
The discount rate must have been less than 12%.
c.
The discount rate must have been equal to 12%.
d.
The discount rate must have been 0%.
38. If a project has an internal rate of return of 14% and a positive net present value, which of the
following statements is true regarding the discount rate used for the net present value computation?
a.
The discount rate must have been greater than 14%.
b.
The discount rate must have been less than 14%.
c.
The discount rate must have been equal to 14%.
d.
The discount rate must have been 0%.
39. The internal rate of return (IRR) of a project can be calculated using all of the following except:
a.
a financial calculator.
b.
present value tables.
c.
a spreadsheet application, such as Excel.
d.
the payback method.
40. Finch Corporation purchased an asset costing $12,000. Annual operating cash inflows generated from
the asset are expected to be $2,168 each year for eight years. No salvage value is expected at the end of
the asset’s life. Using time value of money tables, which of the following rates is closest to the internal
rate of return on the project?
a.
8%
b.
9%
c.
10%
d.
16%
41. Cardinal Inc. purchased an asset costing $25,000. Annual operating cash inflows generated from the
asset are expected to be $6,595 each year for five years. No salvage value is expected at the end of the
asset’s life. Using time value of money tables, which of the following rates is closest to the internal rate
of return on the project?
a.
4%
b.
26%
c.
10%
d.
32%
42. Deciding whether or not an investment meets a predetermined company standard is called a:
a.
preference decision.
b.
payback decision.
c.
screening decision.
d.
profitability decision.
43. A company choosing between two or more acceptable investment alternatives is called a:
a.
profitability decision.
b.
payback decision.
c.
screening decision.
d.
preference decision.
44. The calculation of the profitability index (PI) is most helpful for which type of decisions?
a.
Screening decisions
b.
Preference decisions
c.
Qualitative decisions
d.
Short-term decisions
45. Which of the following statements regarding the profitability index is true?
a.
A profitability index greater than 1.0 means that the investment will take longer than one
year to pay for itself.
b.
A profitability index greater than 1.0 means that the investment should not be made.
c.
When comparing projects, the one with the highest profitability index will have a longer
payback period.
d.
When comparing projects, the one with the highest profitability index is preferred.
46. Which of the following statements comparing the NPV and IRR methods is false?
a.
Both the NPV and IRR methods can be used for screening decisions.
b.
Only the NPV method can be used to compare investments of various size or magnitude.
c.
Both the NPV and IRR methods can take income tax effects into account.
d.
Both the NPV and IRR methods are used for long-term decision making.
47. Vess Inc. is considering the following two projects:
Project #1
Project #2
Initial investment
$20,000
$60,000
PV of cash inflows
26,000
66,000
Which of the following statements is true when comparing each of these projects?
a.
Project #1 has a higher profitability index.
b.
Project #2 has a higher net present value.
c.
They both have the same profitability index.
d.
They both have an unacceptable profitability index.
48. NC Products Inc. is considering investing in one of two projects. Both projects have a net present
value of $25,000; however, Project #1 requires an initial investment of $300,000 while Project #2
requires an initial investment of $700,000. Based on this information, which of the following
statements is true?
a.
Project #2 will have a higher profitability index.
b.
Project #1 will have a higher profitability index.
c.
Both projects will have the same profitability index.
d.
There is not enough information to determine the profitability index of either project.
49. Charles Inc. has the following information available regarding one of the projects it is considering:
Initial investment
$50,000
PV of cash inflows
55,000
The profitability index of this project is:
a.
5,000.
b.
0.9090.
c.
1.10.
d.
105,000.
50. Peterson Inc. has the following information available regarding one of the projects it is considering:
Initial investment
$75,000
PV of cash inflows
$100,000
Internal rate of return
15%
The profitability index of this project is:
a.
1.33.
b.
0.75.
c.
0.15.
d.
0.33.
51. Adam’s Manufacturing has the following information available regarding one of the projects it is
considering:
Initial investment
$500,000
Net present value
80,000
The profitability index of this project is:
a.
6.25.
b.
0.16.
c.
1.16.
d.
0.86.
52. RicChallengingson Corporation has the following information available regarding one of the projects
it is considering:
Initial investment
$800,000
Net present value
100,000
The profitability index of this project is:
a.
0.889.
b.
1.125.
c.
8.000.
d.
0.125.
53. Talley Manufacturing has a project that requires an initial investment of $150,000 and has the
following expected stream of cash flows:
Year
Annual cash flow
1
$ 40,000
2
90,000
3
120,000
Assuming the company’s cost of capital is 14 percent, what is the profitability index for the project?
a.
0.849
b.
1.320
c.
1.502
d.
1.405
54. ABC Manufacturing has a project that requires an initial investment of $100,000 and has the following
expected stream of cash flows:
Year
Annual cash flow
1
$80,000
2
60,000
3
20,000
Assuming the company’s cost of capital is 12 percent, what is the profitability index for the project?
a.
0.749
b.
1.335
c.
1.600
d.
2.985
55. Haven Inc. is in the 35 percent tax bracket and has a 12 percent rate of return. The after-tax rate of
return is:
a.
12.0 percent.
b.
7.8 percent.
c.
4.2 percent.
d.
34.3 percent.
56. Morris Manufacturing is in the 25 percent tax bracket and has a 10 percent rate of return. The after-tax
rate of return is:
a.
7.5 percent.
b.
3.6 percent.
c.
36 percent.
d.
4.4 percent.
57. Which of the following expenses for accounting purposes generates an indirect after-tax cash inflow
for purposes of net present value computations?
a.
Repairs expense
b.
Salaries expense
c.
Depreciation expense
d.
Tax expense
58. Which of the following statements is false regarding the impact of taxes on net present value
computations?
a.
Most for-profit companies should take into account the impact of income taxes on capital
investment decisions.
b.
The disposal of a long-term asset may have tax consequences.
c.
After-tax cash inflows will be less than before-tax cash inflows.
d.
All tax-deductible expenses involve cash outflows.
59. Assuming taxes are a consideration, which of the following would not have an overall positive effect
on cash inflows when a company is computing the net present value of a potential capital investment?
a.
The asset’s salvage value
b.
Cost savings per year
c.
Depreciation expense
d.
Initial capital investment
60. Siddon Inc. is considering investing in equipment that costs $24,000. The equipment would be
depreciated using the straight-line method with no half-year convention over five years and have no
salvage value. If the company has a 35 percent income tax rate and desires an after-tax rate of return of
11 percent on investments, the total present value of the depreciation tax shield is:
a.
$8,652.
b.
$8,400.
c.
$6,209.
d.
$997.