Chapter 12 Capital Budgeting Decisions True/False



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Chapter 12

Capital Budgeting Decisions

True/False

1. Both the net present value method and the internal rate of return method can be used as a screening tool in capital budgeting decisions.

Level: Easy LO: 1 Ans: T

2. When considering a number of investment projects, the project that has the best payback period will also always have the highest net present value.

Level: Medium LO: 1,3 Ans: F

3. When discounted cash flow methods of capital budgeting are used, the working capital required for a project is ordinarily counted as a cash outflow at the beginning of the project and as a cash inflow at the end of the project.

Level: Medium LO: 1 Ans: T

4. Discounted cash flow techniques automatically provide for recovery of initial investment.

Level: Medium LO: 1 Ans: T

5. When computing the project profitability index of an investment project, the investment required will include any investment made in working capital at the beginning of the project.

Level: Medium LO: 2 Ans: T

6. If investment funds are limited, the net present value of one project should not be compared directly to the net present value of another project unless the initial investments in these projects are equal.

Level: Medium LO: 2 Ans: T

7. In calculating payback where new equipment is replacing old equipment, any salvage value to be received on disposal of the old equipment should be deducted from the cost of the new equipment.

Level: Medium LO: 3 Ans: T
8. In the payback method, depreciation is added back to net operating income when computing the net annual cash flow.

Level: Medium LO: 3 Ans: T

9. The simple rate of return method is desirable because of its simplicity and the fact that it takes the time value of money into account.

Level: Medium LO: 4 Ans: F


10. The present value of a cash flow will never be greater than the future dollar amount of the cash flow.

Level: Easy LO: 5 Ans: T



Multiple Choice

11. Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as:

A) an initial cash outflow.

B) a future cash inflow.

C) both an initial cash outflow and a future cash inflow.

D) irrelevant to the net present value analysis.

Level: Medium LO: 1 Ans: C

12. The net present value (NPV) method of investment project analysis assumes that the project’s cash flows are reinvested at the:

A) internal rate of return.

B) discount rate used in the NPV calculation.

C) firm’s simple rate of return.

D) firm’s average ROI.

Source: CMA, adapted

Level: Medium LO: 1 Ans: B

13. If taxes are ignored, all of the following items are included in a discounted cash flow analysis except:

A) future operating cash savings.

B) depreciation expense.

C) future salvage value.

D) investment in working capital.

Source: CMA, adapted

Level: Medium LO: 1 Ans: B

14. In capital budgeting computations, discounted cash flow methods:

A) automatically provide for recovery of initial investment.

B) can’t be used unless cash flows are uniform from year to year.

C) assume that all cash flows occur at the beginning of a period.

D) responses a, b, and c are all correct.

Level: Medium LO: 1 Ans: A

15. The investment required for the project profitability index should:

A) be reduced by the amount of any salvage recovered from the sale of old equipment.

B) be reduced by the amount of any salvage recovered from the sale of the new equipment at the end of its useful life.

C) be reduced by the amount of any salvage recovered from the sale of both the old and new equipment.

D) none of the above is correct.

Level: Medium LO: 2 Ans: A
16. A company wants to have $40,000 at the end of a five-year period through investment of a single sum now. How much needs to be invested in order to have the desired sum in five years, if the money can be invested at 10%:

A) $10,551

B) $8,000

C) $24,840

D) $12,882

Level: Easy LO: 1 Ans: C

17. The following data on a proposed investment project have been provided:

The net present value of the project would be:

A) $3,730

B) $0

C) $32,450



D) $88,370

Level: Medium LO: 1 Ans: A

18. Stratford Company purchased a machine with an estimated useful life of seven years. The machine will generate cash inflows of $9,000 each year over the next seven years. If the machine has no salvage value at the end of seven years, and assuming the company's discount rate is 10%, what is the purchase price of the machine if the net present value of the investment is $17,000?

A) $43,812

B) $26,812

C) $17,000

D) $22,195

Level: Hard LO: 1 Ans: B

19. Anthony operates a part time auto repair service. He estimates that a new diagnostic computer system will result in increased cash inflows of $1,500 in Year 1, $2,100 in Year 2, and $3,200 in Year 3. If Anthony's required rate of return is 10%, then the most he would be willing to pay for the new computer system would be:

A) $4,599

B) $5,501

C) $5,638

D) $5,107

Level: Medium LO: 1 Ans: B

20. Fossa Road Paving Company is considering an investment in a curb-forming machine. The machine will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa's discount rate is 18%. What is the net present value of this machine?

A) $5,840

B) $37,280

C) $(48,780)

D) $69,640

Level: Medium LO: 1 Ans: B

21. Apnea Video Rental Store is considering the purchase of an almost new minivan to use as a vehicle to deliver and pick up video tapes for customers. The minivan will cost $18,000 and is expected to last 8 years but only if the engine is overhauled at a cost of $3,000 at the end of year 3. The minivan is expected to have a $1,000 salvage value at the end of 8 years. This delivery service is expected to generate net cash inflows of $6,000 per year in each of the 8 years. Apnea's discount rate is 14%. What is the net present value of this investment opportunity?

A) $(2,826)

B) $(3,801)

C) $7,185

D) $8,160

Level: Medium LO: 1 Ans: D

22. In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. Pontic's discount rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10 years in order for it to be an acceptable project?

A) $50,690 or more

B) $41,315 or more

C) $105,315 or more

D) $94,316 or more

Level: Hard LO: 1 Ans: C

23. Naomi Corporation has a capital budgeting project that has a negative net present value of $36,000. The life of this project is 6 years. Naomi's discount rate is 20%. By how much would the annual cash inflows from this project have to increase in order to have a positive net present value?

A) $1,200 or more

B) $2,412 or more

C) $6,000 or more

D) $10,824 or more

Level: Hard LO: 1 Ans: D

24. A project requires an initial investment of $70,000 and has a project profitability index of 0.932. The present value of the future cash inflows from this investment is:

A) $70,000

B) $36,231

C) $135,240

D) Cannot be determined from the data provided.

Level: Medium LO: 2 Ans: C

25. Bowen Company is considering several investment proposals, as shown below:

If the project profitability index is used, the ranking of the projects would be:

A) A above

B) B above

C) C above

D) D above

Level: Easy LO: 2 Ans: A

26. Information on four investment proposals is given below:

Rank the proposals in terms of preference according to the project profitability index:

A) 1, 4, 3, 2

B) 4, 1, 3, 2

C) 3, 4, 1, 2

D) 2, 1, 4, 3

Level: Medium LO: 2 Ans: C

27. Information on four investment proposals is given below:

Rank the proposals in terms of preference using the project profitability index:

A) 3, 2, 1, 4

B) 2, 3, 1, 4

C) 2, 1, 3, 4

D) 4, 1, 2, 3

Level: Medium LO: 2 Ans: D

28. The Gomez Company is considering two projects, T and V. The following information has been gathered on these projects:

Based on this information, which of the following statements is (are) true?
I. Project T has the highest ranking according to the project profitability index criterion.

II. Project V has the highest ranking according to the net present value criterion.


A) Only I

B) Only II

C) Both I and II

D) Neither I nor II

Level: Medium LO: 2 Ans: A

29. Major Corporation is considering the purchase of a new machine for $5,000. The machine has an estimated useful life of 5 years and no salvage value. The machine will increase Major's cash flows by $2,000 annually for 5 years. Major uses straight-line depreciation. The company's required rate of return is 10%. What is the payback period for the machine?

A) 5.00 years

B) 2.50 years

C) 7.58 years

D) 8.34 years

Source: CPA, adapted

Level: Easy LO: 3 Ans: B

30. Harrison Company is studying a project that would have an eight-year life and would require a $300,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project:

The company's required rate of return is 10%. What is the payback period for this project?

A) 3 years

B) 2 years

C) 2.5 years

D) 2.67 years

Level: Medium LO: 3 Ans: B

31. An investment project requires an initial investment of $100,000. The project is expected to generate net cash inflows of $28,000 per year for the next five years. Assuming a 12% discount rate, the project's payback period is:

A) 0.28 years

B) 3.36 years

C) 3.57 years

D) 1.40 years

Source: CMA, adapted

Level: Medium LO: 3 Ans: C

32. Mercer Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $250,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $12,000 per year to operate and maintain, but would save $55,000 per year in labor and other costs. The old machine can be sold now for scrap for $10,000. The simple rate of return on the new machine is closest to:

A) 17.9%

B) 7.5%


C) 22.0%

D) 7.2%


Level: Hard LO: 4 Ans: B

33. Pearson Co. is considering the purchase of a $200,000 machine that is expected to reduce operating cash expenses by $65,000 per year. This machine, which has no salvage value, has an estimated useful life of 5 years and will be depreciated on a straight-line basis. For this machine, the simple rate of return would be:

A) 10%

B) 12.5%


C) 20%

D) 32.5%


Source: CPA, adapted

Level: Medium LO: 4 Ans: B

34. Assume you can invest money at a 14% rate of return. How much money must be invested now in order to be able to withdraw $5,000 from this investment at the end of each year for 8 years, the first withdrawal occurring one year from now?

A) $24,840

B) $23,195

C) $21,440

D) $1,755

Level: Easy LO: 5 Ans: B

35. How much would you have to invest today in the bank at an interest rate of 5% to have an annuity of $1,400 per year for 5 years, with nothing left in the bank at the end of the 5 years? Select the amount below that is closest to your answer.

A) $6,667

B) $6,061

C) $7,000

D) $1,098

Level: Easy LO: 5 Ans: B

36. You have deposited $15,584 in a special account that has a guaranteed interest rate. If you withdraw $3,700 at the end of each year for 5 years, you will completely exhaust the balance in the account. The guaranteed interest rate is closest to:

A) 6%


B) 19%

C) 24%


D) 4%

Level: Hard LO: 5 Ans: A

37. You have deposited $16,700 in a special account that has a guaranteed interest rate of 11% per year. If you are willing to completely exhaust the account, what is the maximum amount that you could withdraw at the end of each of the next 6 years? Select the amount below that is closest to your answer.

A) $3,465

B) $3,089

C) $2,783

D) $3,947

Level: Medium LO: 5 Ans: D


38. Latting Corporation has entered into a 7 year lease for a building it will use as a warehouse. The annual payment under the lease will be $4,781. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. What is the present value of the lease payments if the discount rate is 6%?

A) $31,573

B) $22,257

C) $33,467

D) $26,688

Level: Easy LO: 5 Ans: D

39. Schaad Corporation has entered into a 8 year lease for a piece of equipment. The annual payment under the lease will be $2,500, with payments being made at the beginning of each year. If the discount rate is 14%, the present value of the lease payments is closest to:

A) $20,000

B) $7,011

C) $17,544

D) $13,220

Level: Hard LO: 5 Ans: D

40. Tangen Corporation is considering the purchase of a machine that would cost $380,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $80,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $104,000. The company requires a minimum pretax return of 14% on all investment projects. The net present value of the proposed project is closest to:

A) $104,456

B) $24,456

C) $133,753

D) $60,936

Level: Easy LO: 1 Ans: D

41. The management of Urbine Corporation is considering the purchase of a machine that would cost $350,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $79,000 per year. The company requires a minimum pretax return of 14% on all investment projects. The net present value of the proposed project is closest to:

A) -$42,769

B) $124,000

C) -$93,877

D) $56,493

Level: Easy LO: 1 Ans: A

42. Riveros, Inc., is considering the purchase of a machine that would cost $120,000 and would last for 8 years. At the end of 8 years, the machine would have a salvage value of $29,000. The machine would reduce labor and other costs by $25,000 per year. Additional working capital of $9,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 18% on all investment projects. The net present value of the proposed project is closest to:

A) -$18,050

B) -$63,683

C) -$10,336

D) -$16,942

Level: Easy LO: 1 Ans: D

43. The management of Edelmann Corporation is considering the following three investment projects:

Rank the projects according to the profitability index, from most profitable to least profitable.

A) T,S,R

B) R,T,S


C) S,T,R

D) T,R,S


Level: Easy LO: 2 Ans: C

44. Villena Corporation is considering a project that would require an investment of $48,000. No other cash outflows would be involved. The present value of the cash inflows would be $52,800. The profitability index of the project is closest to:

A) 0.90

B) 0.10


C) 1.10

D) 0.09


Level: Easy LO: 2 Ans: B

45. Crowley Corporation is considering three investment projects-F, G, and H. Project F would require an investment of $21,000, Project G of $49,000, and Project H of $82,000. No other cash outflows would be involved. The present value of the cash inflows would be $21,210 for Project F, $57,820 for Project G, and $95,120 for Project H. Rank the projects according to the profitability index, from most profitable to least profitable.

A) F,H,G

B) G,H,F


C) H,F,G

D) H,G,F


Level: Easy LO: 2 Ans: B

46. The management of Cantell Corporation is considering a project that would require an initial investment of $47,000. No other cash outflows would be required. The present value of the cash inflows would be $55,930. The profitability index of the project is closest to:

A) 1.19

B) 0.81


C) 0.19

D) 0.16


Level: Easy LO: 2 Ans: C

47. Kautzer Corporation is considering a project that would require an investment of $418,000 and would last for 9 years. The incremental annual revenues and expenses generated by the project during those 9 years would be as follows:



The scrap value of the project’s assets at the end of the project would be $13,000. The payback period of the project is closest to:

A) 5.9 years

B) 6.1 years

C) 17.4 years

D) 16.9 years

Level: Easy LO: 3 Ans: A

48. The management of Helberg Corporation is considering a project that would require an investment of $203,000 and would last for 6 years. The annual net operating income from the project would be $103,000, which includes depreciation of $30,000. The scrap value of the project’s assets at the end of the project would be $23,000. The payback period of the project is closest to:

A) 1.5 years

B) 2.0 years

C) 1.4 years

D) 1.7 years

Level: Easy LO: 3 Ans: C

49. Wombles Corporation is contemplating purchasing equipment that would increase sales revenues by $478,000 per year and cash operating expenses by $249,000 per year. The equipment would cost $738,000 and have a 9 year life with no salvage value. The annual depreciation would be $82,000. The simple rate of return on the investment is closest to:

A) 19.9%


B) 30.8%

C) 31.0%


D) 11.1%

Level: Easy LO: 4 Ans: A

50. The management of Duker Corporation is investigating purchasing equipment that would increase sales revenues by $130,000 per year and cash operating expenses by $39,000 per year. The equipment would cost $328,000 and have an 8 year life with no salvage value. The simple rate of return on the investment is closest to:

A) 12.5%


B) 27.7%

C) 38.5%


D) 15.2%

Level: Easy LO: 4 Ans: D

51. An expansion at Fidell, Inc., would increase sales revenues by $75,000 per year and cash operating expenses by $38,000 per year. The initial investment would be for equipment that would cost $135,000 and have a 5 year life with no salvage value. The annual depreciation on the equipment would be $27,000. The simple rate of return on the investment is closest to:

A) 20.0%


B) 7.4%

C) 27.4%


D) 13.3%

Level: Easy LO: 4 Ans: B

52. Messersmith Corporation is investigating automating a process by purchasing a machine for $688,000 that would have an 8 year useful life and no salvage value. By automating the process, the company would save $160,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $19,000. The annual depreciation on the new machine would be $86,000. The simple rate of return on the investment is closest to:

A) 23.3%


B) 11.1%

C) 10.8%


D) 12.5%

Level: Easy LO: 4 Ans: B

53. The management of Stanforth Corporation is investigating automating a process. Old equipment, with a current salvage value of $24,000, would be replaced by a new machine. The new machine would be purchased for $516,000 and would have a 6 year useful life and no salvage value. By automating the process, the company would save $173,000 per year in cash operating costs. The simple rate of return on the investment is closest to:

A) 17.7%


B) 16.9%

C) 33.5%


D) 16.7%

Level: Easy LO: 4 Ans: A

Use the following to answer 54-56

Overland Company has gathered the following data on a proposed investment project:



The company uses straight-line depreciation on all equipment.

54. The payback period for the investment is:

A) 0.27 years

B) 3.75 years

C) 10.00 years

D) 2.13 years

Level: Easy LO: 3 Ans: B

55. The simple rate of return on the investment is:

A) 26.67%

B) 16.67%

C) 36.67%

D) 10.00%

Level: Medium LO: 4 Ans: B

56. The net present value of this investment is:

A) $40,000

B) $3,625

C) $57,831

D) $95,800

Level: Medium LO: 1 Ans: D

Use the following to answer 57-59

Perky Food Corporation produces and sells coffee jelly. Perky currently produces the jelly using a manual operation but is considering the purchase of machinery to automate its operations. Information related to the two operations is as follows:

Perky’s discount rate is 12%. Perky uses the straight-line method of depreciation.
57. What is the net present value of automating operations using the incremental cost approach?

A) $11,940

B) $56,940

C) $(104,106)

D) $112,684

Level: Medium LO: 1

Refer To: 12_02 Ans: C

58. What is the simple rate of return for automating operations?

A) 3.8%

B) 12.1%


C) 14.5%

D) 22.9%


Level: Medium LO: 4 Ans: A

59. What will be the effect on the net present value of the decision to automate operations if 60,000 jars instead of 50,000 jars are expected to be sold each year? (Assume no change in cost structure or selling price.)

A) no effect

B) $52,030 decrease

C) $63,179 increase

D) $115,208 increase

Level: Hard LO: 1 Ans: D

Use the following to answer 60-62

Tam Company is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in cash operating costs. The equipment’s estimated useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Tam’s required rate of return is 12%.

60. The net present value of this investment is:

A) $5,760

B) $6,440

C) $12,200

D) $13,000

Source: CPA, adapted

Level: Easy LO: 1 Ans: D

61. The payback period of this investment is:

A) 4 years

B) 1 year

C) 10 years

D) 5 years

Source: CPA, adapted

Level: Easy LO: 3 Ans: D

62. The simple rate of return of this investment is:

A) 8%

B) 20%


C) 12%

D) 10%


Source: CPA, adapted

Level: Easy LO: 4 Ans: D

Use the following to answer 63-64

Evans Company is considering rebuilding and selling used alternators for automobiles. The company estimates that the net cash flows (sales less cash operating expenses) arising from the rebuilding and sale of the used alternators would be as follows:



In addition, Evans Company would need to purchase equipment costing $275,000. The equipment would have a 12 year life and a $25,000 salvage value. The company’s required rate of return is 10%.

63. The payback period on this investment is:

A) 3.00 years

B) 2.75 years

C) 1.50 years

D) 4.00 years

Level: Easy LO: 3 Ans: B

64. The net present value of the project is closest to:

A) $364,090

B) $372,065

C) $339,090

D) $389,090

Level: Medium LO: 1 Ans: B

Use the following to answer 65-66

Baldock Inc. is considering the acquisition of a new machine that costs $420,000 and has a useful life of 5 years with no salvage value. The incremental net operating income and incremental net cash flows that would be produced by the machine are:

65. If the discount rate is 12%, the net present value of the investment is closest to:

A) $330,000

B) $539,365

C) $119,365

D) $420,000

Source: CMA, adapted

Level: Medium LO: 1 Ans: C

66. The payback period of this investment is closest to:

A) 5.0 years

B) 3.2 years

C) 1.9 years

D) 2.8 years

Source: CMA, adapted

Level: Medium LO: 3 Ans: D

Use the following to answer 67-68

Delley Inc. is considering the acquisition of equipment that costs $340,000 and has a useful life of 6 years with no salvage value. The incremental net cash flows that would be generated by the equipment are:

67. If the discount rate is 17%, the net present value of the investment is closest to:

A) $45,811

B) $385,811

C) $301,000

D) $117,341

Source: CMA, adapted

Level: Easy LO: 1 Ans: A

68. The payback period of this investment, rounded off to the nearest tenth of a year, is closest to:

A) 3.9 years

B) 3.6 years

C) 3.1 years

D) 5.0 years

Source: CMA, adapted

Level: Easy LO: 3 Ans: C

Use the following to answer 69-70

Westland College has a telephone system that is in poor condition. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:

Westland College uses a 10% discount rate and the total cost approach to capital budgeting analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of eight years.
69. The net present value of overhauling the present system is:

A) $(321,084)

B) $(532,516)

C) $(560,536)

D) $(592,516)

Level: Hard LO: 1 Ans: B

70. The net present value of the new system alternative is:

A) $(483,095)

B) $(583,095)

C) $(596,395)

D) $(536,395)

Level: Hard LO: 1 Ans: D

Use the following to answer 71-72

Lambert Manufacturing has $100,000 to invest in either Project A or Project B. The following data are available on these projects:



Both projects will have a useful life of 6 years. At the end of 6 years, the working capital investment will be released for use elsewhere. Lambert’s required rate of return is 14%. The company uses the total cost approach to evaluating alternatives.

71. The net present value of Project A is:

A) $51,000

B) $60,120

C) $55,560

D) $94,450

Level: Medium LO: 1 Ans: B

72. The net present value of Project B is:

A) $90,355

B) $76,115

C) $36,115

D) $54,355

Level: Medium LO: 1 Ans: D

Use the following to answer 73-75

Carlson Manufacturing has some equipment that needs to be rebuilt or replaced. The following information has been gathered relative to this decision:

Carlson uses the total cost approach and a discount rate of 12%. Regardless of which option is chosen, rebuild or replace, at the end of five years Carlson Manufacturing plans to close its domestic manufacturing operations and to move these operations to foreign countries.

73. If the new equipment is purchased, the present value of all cash flows that occur now is:

A) $(48,000)

B) $(39,000)

C) $(41,000)

D) $(37,000)

Level: Easy LO: 1 Ans: B

74. If the new equipment is purchased, the present value of the annual cash operating costs associated with this alternative is:

A) $(28,840)

B) $(19,160)

C) $(14,420)

D) $(36,050)

Level: Medium LO: 1 Ans: A

75. If the equipment is rebuilt, the present value of all cash flows that occur now is:

A) $(55,000)

B) $(25,000)

C) $(16,000)

D) $(23,000)

Level: Easy LO: 1 Ans: B

Use the following to answer 76-79

Cedar Hill Hospital needs to expand its facilities and desires to obtain a new building on a piece of property adjacent to its present location. Two options are available to Cedar Hill, as follows:

Option 1: Buy the property, erect the building, and install the fixtures at a total cost of $600,000. This cost would be paid off in five installments: an immediate payment of $200,000, and a payment of $100,000 at the end of each of the next four years. The annual cash operating costs associated with the new facilities are estimated to be $12,000 per year. The new facilities would be occupied for thirteen years, and would have a total resale value of $300,000 at the end of the 13-year period.

Option 2: A leasing company would buy the property and construct the new facilities for Cedar Hill which would then be leased back to Cedar Hill at an annual lease cost of $70,000. The lease period would run for 13 years, with each payment being due at the BEGINNING of the year. Additionally, the company would require an immediate $10,000 security deposit, which would be returned to Cedar Hill at the end of the 13-year period. Finally, Cedar Hill would have to pay the annual maintenance cost of the facilities, which is estimated to be $4,000 per year. There would be no resale value at the end of the 13-year period under this option.

The hospital uses a discount rate of 14% and the total-cost approach to net present value analysis in evaluating its investment decisions.

76. Under option 1, the present value of all cash outflows associated with buying the property, erecting the building, and installing the fixtures is closest to:

A) $(200,000)

B) $(491,400)

C) $(600,000)

D) $(387,200)

Level: Hard LO: 1 Ans: B

77. Under option 1, the net present value of all cash flows is closest to:

A) $(456,000)

B) $(600,000)

C) $(300,000)

D) $(507,000)

Level: Hard LO: 1 Ans: D

78. Under option 2, the present value of all the annual lease payments of $70,000 is closest to:

A) $(466,200)

B) $(408,900)

C) $(483,700)

D) $(910,000)

Level: Hard LO: 1 Ans: A

79. Under option 2, the present value of all cash flows associated with maintenance costs is closest to:

A) $(23,400)

B) $(52,000)

C) $(70,100)

D) $(4,000)

Level: Hard LO: 1 Ans: A


Use the following to answer 80-81

Clairmont Corporation is considering the purchase of a machine that would cost $150,000 and would last for 5 years. At the end of 5 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $37,000. The company requires a minimum pretax return of 12% on all investment projects.

80. The present value of the annual cost savings of $37,000 is closest to:

A) $133,385

B) $235,070

C) $185,000

D) $20,979

Level: Easy LO: 1 Ans: A

81. The net present value of the proposed project is closest to:

A) -$6,409

B) -$11,295

C) $1,385

D) -$16,615

Level: Easy LO: 1 Ans: A

Reference: 12_12

Use the following to answer 82-83

The management of Mashiah Corporation is considering the purchase of a machine that would cost $290,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $102,000 per year. The company requires a minimum pretax return of 13% on all investment projects.

82. The present value of the annual cost savings of $102,000 is closest to:

A) $849,012

B) $612,000

C) $195,872

D) $407,796

Level: Easy LO: 1 Ans: D

83. The net present value of the proposed project is closest to:

A) $154,663

B) $322,000

C) $117,796

D) $245,246

Level: Easy LO: 1 Ans: C

Use the following to answer 84-85

Lebert, Inc., is considering the purchase of a machine that would cost $380,000 and would last for 7 years. At the end of 7 years, the machine would have a salvage value of $49,000. The machine would reduce labor and other costs by $96,000 per year. Additional working capital of $6,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 18% on all investment projects.

84. The combined present value of the working capital needed at the beginning of the project and the working capital released at the end of the project is closest to:

A) $16,872

B) $0


C) -$4,116

D) -$13,111

Level: Easy LO: 1 Ans: C

85. The net present value of the proposed project is closest to:

A) $1,338

B) -$8,849

C) -$14,048

D) -$2,778

Level: Easy LO: 1 Ans: D

Use the following to answer 86-87

Dube Corporation is considering the following three investment projects:

86. The profitability index of investment project E is closest to:

A) 0.13

B) 1.13


C) 0.87

D) 0.12


Level: Easy LO: 2 Ans: A

87. Rank the projects according to the profitability index, from most profitable to least profitable.

A) F,E,D

B) D,F,E


C) F,D,E

D) E,F,D


Level: Medium LO: 2 Ans: D

Use the following to answer 88-89

The management of Keno Corporation is considering three investment projects-B, C, and D. Project B would require an investment of $15,000, Project C of $50,000, and Project D of $89,000. The present value of the cash inflows would be $16,350 for Project B, $56,500 for Project C, and $96,120 for Project D.

88. The profitability index of investment project C is closest to:

A) 0.13

B) 0.87


C) 0.12

D) 1.13


Level: Easy LO: 2 Ans: A

89. Rank the projects according to the profitability index, from most profitable to least profitable.

A) B,D,C

B) C,B,D


C) D,C,B

D) D,B,C


Level: Medium LO: 2 Ans: B

Essay

90. Tranter, Inc., is considering a project that would have a ten-year life and would require a $1,500,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows:



All of the above items, except for depreciation, represent cash flows. The company’s required rate of return is 12%.

Required:

(a.) Compute the project’s net present value.

(b.) Compute the project’s payback period.

(c.) Compute the project’s simple rate of return.

Level: Medium LO: 1,3,4

Ans:

(a.) Since depreciation is the only noncash item on the income statement, the net annual cash flow can be computed by adding back depreciation to net operating income.




(b.) The formula for the payback period is:

Payback period = Investment required Net annual cash inflow

= $1,500,000 $400,000 = 3.75 years

(c.) The formula for the simple rate of return is:

Simple rate of return = Net operating income Initial investment

= $250,000 ÷ $1,500,000 = 16.7%

91. Five years ago, the City of Paranoya spent $30,000 to purchase a computerized radar system called W.A.S.T.E. (Watching Aliens Sent To Earth). Recently, a sales rep from W.A.S.T.E. Radar Company told the city manager about a new and improved radar system that can be purchased for $50,000. The rep also told the manager that the company would give the city $10,000 in trade on the old system. The new system will last 10 years. The old system will also last that long but only if a $4,000 upgrade is done in 5 years. The manager assembled the following information to use in the decision as to which system is more desirable:

Required:

(a.) What is the City of Paranoya’s net present value for the decision described above? Use the total cost approach.

(b.) Should the City of Paranoya purchase the new system or keep the old system?

Level: Medium LO: 1

Ans:


(a.)

(b.) Keep the old system; the net present value of the costs under the old system is lower than for the new system.

92. The following data concern an investment project:

The working capital will be released for use elsewhere at the conclusion of the project.

Required:

Compute the project’s net present value.

Level: Medium LO: 1

Ans:

93. Five years ago, Joe Sarver purchased 600 shares of 9%, $100 par value preferred stock for $75 per share. Sarver received dividends on the stock each year for five years, and finally sold the stock for $90 per share. Instead of purchasing the preferred stock, Sarver could have invested the funds in a money market certificate yielding a 16% rate of return.

Required:

Determine whether or not the preferred stock provided at least the 16% rate of return that could have been received on the money market certificate.

Level: Hard LO: 1

Ans:

No, the stock did not provide a 16 percent rate of return.

94. Big Blue Co. is considering three investment opportunities having cash flows as described below:

Project I would require an immediate cash outlay of $10,000 and would result in cash savings of $3,000 each year for 8 years.

Project II would require cash outlays of $3,000 per year and would provide a cash inflow of $30,000 at the end of 8 years.

Project III would require a cash outlay of $10,000 now and would provide a cash inflow of $30,000 eight years from now.

Required:

If Big Blue has a required rate of return of 14%, determine which, if any, of the three projects is acceptable. Use the NPV method.

Level: Medium LO: 1

Ans:

Conclusion: Projects I and III have positive net present values and are thus acceptable. Project II would not be advisable since its net present value is negative.

95. Axillar Beauty Products Corporation is considering the production of a new conditioning shampoo which will require the purchase of new mixing machinery. The machinery will cost $375,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $50,000 at the end of 10 years. The machinery will also need a $35,000 overhaul at the end of year 6. A $40,000 increase in working capital will be needed for this investment project. The working capital will be released at the end of the 10 years. The new shampoo is expected to generate net cash inflows of $85,000 per year for each of the 10 years. Axillar’s discount rate is 16%.

Required:

(a.) What is the net present value of this investment opportunity?

(b.) Based on your answer to (a) above, should Axillar go ahead with the new conditioning shampoo?

Level: Medium LO: 1

Ans:


(a.)

(b.) Yes, accept project. The net present value is positive.

96. Lajara Inc. has provided the following data concerning a proposed investment project:



The company uses a discount rate of 13%.

Required:

Compute the net present value of the project.

Level: Easy LO: 1

Ans:

97. Burba Inc. is considering investing in a project that would require an initial investment of $200,000. The life of the project would be 8 years. The annual net cash inflows from the project would be $60,000. The salvage value of the assets at the end of the project would be $30,000. The company uses a discount rate of 17%.

Required:

Compute the net present value of the project.

Level: Easy LO: 1

Ans:

98. Grossett Corporation has provided the following data concerning a proposed investment project:

The company uses a discount rate of 10%. The working capital would be released at the end of the project.

Required:

Compute the net present value of the project.

Level: Easy LO: 1

Ans:

99. Woolfolk Corporation is considering investing $210,000 in a project. The life of the project would be 9 years. The project would require additional working capital of $46,000, which would be released for use elsewhere at the end of the project. The annual net cash inflows would be $42,000. The salvage value of the assets used in the project would be $32,000. The company uses a discount rate of 17%.

Required:

Compute the net present value of the project.

Level: Easy LO: 1 Ans:

100. Swaggerty Company is considering purchasing a machine that would cost $462,000 and have a useful life of 7 years. The machine would reduce cash operating costs by $115,500 per year. The machine would have no salvage value.

Required:

(a.) Compute the payback period for the machine.

(b.) Compute the simple rate of return for the machine.

Level: Easy LO: 3,4

Ans:

(a.) The payback period is computed as follows:



Payback period = Investment required ÷ Net annual cash flow

= $462,000 ÷ $115,500 = 4.00 years

(b.) The simple rate of return is computed as follows:

Simple rate of return = (Annual cost savings - Annual depreciation)

÷ Initial investment

= $(115,500 - $66,000) ÷ $462,000 = 10.71%

101. Alesi Company is considering purchasing a machine that would cost $243,600 and have a useful life of 8 years. The machine would reduce cash operating costs by $76,125 per year. The machine would have a salvage value of $60,900 at the end of the project.

Required:

(a.) Compute the payback period for the machine.

(b.) Compute the simple rate of return for the machine.

Level: Medium LO: 3,4

Ans:

(a.) The payback period is computed as follows:



Payback period = Investment required ÷ Net annual cash flow

= $243,600 ÷ $76,125 = 3.20 years

In this case the salvage value plays no part in the payback period since all of the investment is recovered before the end of the project.

(b.) The simple rate of return is computed as follows:



Simple rate of return = (Annual cost savings - Annual depreciation)

÷ Initial investment

= $(76,125 - $22,838) ÷ $243,600 = 21.88%

102. Yeung Corporation is considering the purchase of a machine that would cost $330,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $33,000. The machine would reduce labor and other costs by $86,000 per year. The company requires a minimum pretax return of 12% on all investment projects.

Required:

Determine the net present value of the project. Show your work!

Level: Easy LO: 1

Ans:

103. The management of Glasco Corporation is considering the purchase of a machine that would cost $270,000, would last for 8 years, and would have no salvage value. The machine would reduce labor and other costs by $63,000 per year. The company requires a minimum pretax return of 18% on all investment projects.

Required:

Determine the net present value of the project. Show your work!

Level: Easy LO: 1

Ans:

104. Lovan, Inc., is considering the purchase of a machine that would cost $450,000 and would last for 8 years, at the end of which, the machine would have a salvage value of $63,000. The machine would reduce labor and other costs by $76,000 per year. Additional working capital of $3,000 would be needed immediately, all of which would be recovered at the end of 8 years. The company requires a minimum pretax return of 8% on all investment projects.

Required:

Determine the net present value of the project. Show your work!

Level: Easy LO: 1

Ans:

105. Dimpson Corporation is considering the following three investment projects:

Required:

Rank the investment projects using the profitability index. Show your work!

Level: Easy LO: 2

Ans:

106. The management of Grayer Corporation is considering the following three investment projects:



The only cash outflows are the initial investments in the projects.

Required:

Rank the investment projects using the profitability index. Show your work!

Level: Easy LO: 2

Ans:

107. Flamio Corporation is considering a project that would require an initial investment of $210,000 and would last for 6 years. The incremental annual revenues and expenses for each of the 6 years would be as follows:



At the end of the project, the scrap value of the project’s assets would be $24,000.

Required:

Determine the payback period of the project. Show your work!

Level: Easy LO: 3

Ans:

Payback period = Investment required Net annual cash inflow

= $186,000 $97,000 = 1.92 years

108. The management of Sobus Corporation is considering a project that would require an initial investment of $458,000 and would last for 9 years. The annual net operating income from the project would be $58,000, including depreciation of $48,000. At the end of the project, the scrap value of the project’s assets would be $26,000.

Required:

Determine the payback period of the project. Show your work!

Level: Easy LO: 3

Ans:

Payback period = Investment required Net annual cash inflow

= $432,000 $106,000 = 4.08 years

109. Shiffler Corporation is contemplating purchasing equipment that would increase sales revenues by $246,000 per year and cash operating expenses by $133,000 per year. The equipment would cost $275,000 and have a 5 year life with no salvage value. The annual depreciation would be $55,000.

Required:

Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

Level: Easy LO: 4

Ans:


Simple rate of return = [Incremental revenues - (Cash operating expenses + Depreciation)] ÷ Initial investment

= [$246,000 - ($133,000 + $55,000)] $275,000

= [$58,000] $275,000 = 21.1%

110. The management of Moya Corporation is investigating purchasing equipment that would cost $336,000 and have an 8 year life with no salvage value. The equipment would allow an expansion of capacity that would increase sales revenues by $288,000 per year and cash operating expenses by $164,000 per year.

Required:

Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

Level: Easy LO: 4

Ans:


Simple rate of return = [Incremental revenues - (Cash operating expenses + Depreciation)] ÷ Initial investment

= [$288,000 - ($164,000 + $42,000)] $336,000

= [$82,000] $336,000 = 24.4%

111. Hinck Corporation is investigating automating a process by purchasing a new machine for $520,000 that would have an 8 year useful life and no salvage value. By automating the process, the company would save $134,000 per year in cash operating costs. The company’s current equipment would be sold for scrap now, yielding $22,000. The annual depreciation on the new machine would be $65,000.

Required:

Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

Level: Easy LO: 4

Ans:


Simple rate of return = (Cost savings - Depreciation) Initial investment

= ($134,000 - $65,000) ($520,000 - $22,000)

= $69,000 $498,000 = 13.9%

112. The management of Kleppe Corporation is investigating automating a process by replacing old equipment by a new machine. The old equipment would be sold for scrap now for $19,000. The new machine would cost $180,000, would have a 9 year useful life, and would have no salvage value. By automating the process, the company would save $30,000 per year in cash operating costs.

Required:

Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

Level: Easy LO: 4

Ans:


Depreciation on the new machine = $180,000 9 = $20,000

Simple rate of return = (Cost savings - Depreciation) Initial investment

= ($30,000 - $20,000) ($180,000 - $19,000)

= $10,000 $161,000 = 6.2%





Brewer, Introduction to Managerial Accounting, 3/e

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