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Exam 11: Capital Budgeting and Investment Analysis

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Question 41

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Which methods of evaluating a capital investment project use cash flows as a measurement basis?

A) Net present value, accounting rate of return, and internal rate of return.
B) Internal rate of return, payback period, and accounting rate of return.
C) Accounting rate of return, net present value, and payback period.
D) Payback period, internal rate of return, and net present value.
E) Net present value, payback period, accounting rate of return, and internal rate of return.

F) B) and C)
G) A) and C)

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Question 42

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All projects with a profitability index of less than 1 should be accepted.

A) True
B) False

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Question 43

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The payback period reflects the amount of time for the investment to generate enough net cash flow to return the cash initially invested to purchase it.

A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $12,000 per year including depreciation of $3,000 per year. Income tax expense is $1,600 per year based on a tax rate of 40%. What is the payback period for the new machine?

Capital budgeting decisions are risky because all of the following are true except:

The net present value decision rule is: When an asset's expected cash flows yield a positive net present value when discounted at the required rate of return, the asset should be acquired.

Dracor Company is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $280,000 with a 7-year life, no salvage value, and will be depreciated using straight-line depreciation. The expected annual income related to this equipment follows. Compute the (a payback period and (b accounting rate of return for this equipment. $\begin{array} { | l | r | r | } \hline \text { Sales } & & \$ 900,000 \\\hline \text { Costs: } & & \\\hline \text { Manufacturing } & \$ 545,000 & \\\hline \text { Depreciation on machine } & 40,000 & \\\hline \text { Selling and administrative expenses } & 249,000 & ( 834,000 ) \\\hline \text { Income before taxes } & & 66,000 \\\hline \text { Income tax } ( 30 \% ) & & ( 19,800 \\\hline \text { Net income } & & \$ 46,200 \\\hline\end{array}$

A company is considering two projects, Project A and Project B. The following information is available for each project: Project A Project B Investment $500,000 $2,000,000 Net present value of cash flows $600,000 $800,000 Calculate the profitability index for each project. Based on the profitability index, which project, if any, should the company pursue and why?

Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

Which of the following is an objective of capital budgeting?

A company is evaluating the purchase of a machine for $750,000 with a six-year useful life and no salvage value. The company uses straight-line depreciation and it assumes that the annual net cash flow from using the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is the company's average investment?

The calculation of the payback period for an investment when net cash flow is even (equal) is:

The internal rate of return method of evaluating capital investments cannot be used with uneven cash flows.

The payback method, unlike the net present value method, ignores cash flows after the point of cost recovery.

The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.

A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. The company's after-tax net income, based on a tax rate of 40%, is $2,400. What is the approximate accounting rate of return for the machine?

Three widely used methods of comparing investment alternatives are payback period, net present value, and rate of return on average investment.

A machine costs $180,000 and will have an eight-year life, a $20,000 salvage value, and straight-line depreciation is used. Management estimates the machine will yield an after-tax net income of $12,500 each year. Compute the accounting rate of return for the investment.

The accounting rate of return is based on cash flows rather than net income in its calculation.

The expected amount of time to recover the initial amount of an investment is called the: