Chapter 15: Capital Budgeting IM 17
publicly accessible website, in whole or in part.
3. The appendix illustrates how to compute the present value of an annuity.
LO.11: (Appendix 2) What are the advantages and disadvantages of the accounting rate of return
method?
O. Accounting Rate of Return
1. The accounting rate of return (ARR) measures the rate of earnings obtained on the average
capital investment over a project’s life; the formula to calculate the ARR is as follows:
working capital items.
b. Investment cost, salvage value, and working capital released at the end of the project’s life
are summed and divided by two to obtain the average investment.
the time value of money.
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Multiple Choice Questions
1. (LO.1) Which of the following is not a quantitative capital project evaluation method illustrated in
the text?
a. Discounted payback period
2. (LO.2) The payback period for an investment project is defined as the
a. number of years required for cumulative project profits to equal the initial investment.
The next three questions are based on the following information:
A Company is reviewing an investment proposal whose initial cost will be $105,000 and whose
returns are presented in the following schedule:
Annual
Net After-Tax Annual
Year Book Value Cash Flows Net Income
1 $70,000 $50,000 $15,000
2 42,000 45,000 17,000
provided below:
Present Value of PV of an Annuity of
$1 Received at $1 Received at
Year the End of Period the end of Each Period
1 .93 .93
2 .86 1.79
3. (LO.2) The traditional payback period for the investment proposal is
a. 0.875 years.
4. (LO.3) The net present value of the investment proposal is
a. ($30,240).
b. $58,100.
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5. (LO.3) What is the investment’s profitability index?
a. 1.90
6. (LO.3) Select the incorrect capital budgeting decision rule from the following.
d. No general decision rule is available for the payback model.
7. (LO.4) Select the incorrect statement concerning the internal rate of return (IRR) method of
evaluating capital projects.
d. Manually finding the IRR of a project that has unequal annual cash flows requires an iterative
trial-and-error process.
8. (LO.5) Which of the following equations correctly computes the tax benefit of depreciation?
d. Depreciation tax deduction
9. (LO.6) All of the following are limitations of the payback method of evaluating capital projects
except:
probabilities.
b. the time value of money is ignored.
10. (LO.7) The rankings of mutually exclusive investments determined using the internal rate of return
(IRR) method and the net present value (NPV) method may be different when
different.
11. (LO.8) A formal method of considering capital project risk requires making adjustments to the
discount or hurdle rate. Under the risk–adjusted discount rate method, the decision maker
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12. (LO.9) Select the incorrect statement concerning postinvestment audits.
a. In a postinvestment audit of a capital project, information on actual project results is gathered
increases.
c. A postinvestment audit eliminates the likelihood that project sponsors will provide overly
optimistic forecasts of future revenues or cost savings.
originally to determine project acceptance.
13. (LO.10 Appendix 1) Select the incorrect statement concerning the time value of money.
d. The time between interest computations is referred to as the compounding period.
14. (LO.11 Appendix 2) All of the following capital budgeting models measure project returns using
cash flows except the
a. accounting rate of return model.
15. (LO.11 Appendix 2) G Company is reviewing an investment proposal that will cost $100,000 and
that is expected to have the following returns:
Annual
Net After-Tax Annual
Year Cash Flows Net Income
1 $40,000 $50,000
investment?
a. 35%
b. 40%
c. 70%
d. 80%
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Multiple Choice Solutions
1. c
2. c
3. c (CMA Adapted)
Investment
Recovered
Through
Year Cash Flows Unrecovered Years
0 $105,000
2.25 years
4. b (CMA Adapted)
Present
Annual Value Present
Net After-Tax of $1 Value of
Year Cash Flows Factor Cash Flows
1 $50,000 .93 $ 46,500
2 45,000 .86 38,700
5. b (CMA Adapted)
$163,100 / $105,000 = 1.55
6. b
7. c
13. b
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14. a
15. a