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Exam 11: Capital Budgeting

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Question 31

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You have a savings account that earns 5% interest, compounded annually. A friend has offered you an investment opportunity; he says that if you invest in his new business, he will pay you $10,000 a year for the next five years. What is the maximum amount you would be willing to invest in your friend's business?

A) $43,295
B) $47,500
C) $47,619
D) $50,000

E) All of the above
F) A) and D)

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Question 32

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If the hurdle rate is greater than the internal rate of return, the net present value will be:

A) positive.
B) negative.
C) zero.
D) equal to the hurdle rate.

E) A) and D)
F) B) and D)

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Question 33

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How much would you need to deposit in a savings account that earns 7%, compounded annually, to withdraw $20,000 eight years from now?

Norwood, Inc., which has a hurdle rate of 12%, is considering three different independent investment opportunities. Each project has a seven-year life. The annual cash flows and initial investment for each of the projects are as follows: a. What is the present value of the annual cash flows for each of the three projects? b. What is the net present value of each of the projects? c. What is the profitability index of each of the projects? (Round to two decimal places.) d. In what order should Norwood prioritize investment in the projects?

A decision that requires managers to choose from among a set of alternative capital investment opportunities is a(n) :

The internal rate of return is the rate of return that yields a zero net present value

Briar Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $1,200,000 and have an 8-year life. The salvage value of the equipment is estimated to be $200,000. The hurdle rate is 8%. Ignore income taxes. Answer the following: a. What is the accounting rate of return? b. What is the payback period? c. What is the net present value? d. What would the net present value be with a 12% hurdle rate? e. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?

A problem in which you must calculate how much money you will have in the future as a result of depositing a fixed amount of money each period is a:

A decision that occurs when managers evaluate a proposed capital investment to determine whether it meets some minimum criteria is a(n) :

Addison Corp. is considering the purchase of a new piece of equipment. The equipment will have an initial cost of $900,000, a 6-year life, and no salvage value. If the accounting rate of return for the project is 5%, what is the annual increase in net cash flow? Ignore income taxes.

The payback period method ignores the time value of money

You won the lottery, and the jackpot was $12,000,000. You can either receive the $12,000,000 in equal installments over 20 years, or you can receive a lump sum today. The amount of the lump sum you'll receive today is based on the present value of the equal installment payments. a. What is the present value of the lottery winnings taken in equal installments over 20 years at 8% interest? b. What is the present value of the lottery winnings taken in equal installments over 20 years at 10% interest? c. Which interest rate yields the greatest amount of cash today?

Which of the following is not a limitation of using the accounting rate of return method for capital budgeting?

You are saving for a car that costs $28,000 that you hope to purchase in five years. How much will you need to deposit today in a savings account that earns 8%, compounded annually, to withdraw enough for the purchase?

An acquaintance of yours owes you $1,000, but only has $800 to pay you now. He says he can either give you the $800 now in full settlement of the debt, or he can give you $1,000 one year from now. If you would let him keep the money for two years, though, he would give you $1,100 at that point. You have a savings account that earns 12% interest. a. What is the present value of the payment now? b. What is the present value of the payment a year from now? c. What is the present value of the payment two years from now? d. Which option would be best for you financially?

Mindy Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $500,000 and have an 8-year life. The equipment has no salvage value. The hurdle rate is 10%. Answer the following: a. What is the net present value? b. What would the net present value be with a 15% hurdle rate? c. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?

When cash flows are equal each year, the payback period is calculated as:

Which of the following is not a characteristic of an annuity?

Byron Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. The salvage value of the equipment is estimated to be $75,000. If the hurdle rate is 10%, what is the internal rate of return?

How does the accounting rate of return differ from the return on investment formula?