Question 1

The payback period can be determined by multiplying the amount invested by net cash flows received annually.

Accepted Answer

A) True 
 B)False

Question 2

Redman Company is considering an investment in new machinery. The details of the investment are as follows:
The company uses straight-line depreciation for its machinery and requires a 12% rate of return. The present value of $1 for 4 years at 12% is 0.636. The present value of an ordinary annuity for $1 for 4 years at 12% is 3.037.
(1) What is the payback period?
(2) What is the rate of return?
(3) What is the net present value?
(4) Would you advise the company to invest in this machinery?
 $\begin{array}{lr}
\text { Cost of the machinery } & \$ 250,000 \
\text { Annual cash flows } & \$ 75,000 \
\text { Useful life } & 4 \text { years } \
\text { Residual value } & \$ 25,000
\end{array}$

Accepted Answer

(1) 3.3
(2) 13.6%
(3

Question 3

Return on average investment: _____________%

Accepted Answer

The answer of Return on average investment: _____________%...

Question 4

Upper level managers at Rooney, Inc. are concerned that employee estimates of future cash flows from the new machine may be overly optimistic. To what dollar amount can the annual after tax cash flow fall before the investment in the new machine should be rejected?

Accepted Answer

A)  $640,000. 
B)  $224,640. 
C)  $168,080. 
D)  $137,961. 
A)  $640,000. 
B)  $224,640. 
C)  $168,080. 
D)  $137,961.

Question 5

Capital budget audits are often undertaken to ensure the accuracy of cash flow estimates.

Accepted Answer

A) True 
 B)False

Question 6

The higher the required rate of return of an investment, the less an investor will be willing to pay for the investment.

Accepted Answer

A) True 
 B)False

Question 7

Capital investments decisions are not affected by:

Accepted Answer

A)  Income taxes. 
B)  Non-financial considerations. 
C)  Depreciation methods. 
D)  Inventory levels. 
A)  Income taxes. 
B)  Non-financial considerations. 
C)  Depreciation methods. 
D)  Inventory levels.

Question 8

Copy Center is considering replacing its old copying machine, which has a $3,200 book value, with a new one. Discounted cash flow analysis of the proposal to acquire the new machine shows an estimated net present value of $2,800. If the new machine is acquired, the old machine will have no resale value and will be given away. The loss on disposal of the old machine:

Accepted Answer

A)  Is an opportunity cost of purchasing the new machine. 
B)  Exceeds the net present value of the new machine, indicating that the new machine should not be acquired. 
C)  Has already been deducted in arriving at the $2,800 net present value of the new machine. 
D)  Is a sunk cost and is not relevant to the decision at hand, except as it affects the timing of income tax payments. 
A)  Is an opportunity cost of purchasing the new machine. 
B)  Exceeds the net present value of the new machine, indicating that the new machine should not be acquired. 
C)  Has already been deducted in arriving at the $2,800 net present value of the new machine. 
D)  Is a sunk cost and is not relevant to the decision at hand, except as it affects the timing of income tax payments.

Question 9

The payback period for this investment is approximately:

Accepted Answer

A)  4.7 years. 
B)  9.4 years. 
C)  8.75 years. 
D)  5 years. 
A)  4.7 years. 
B)  9.4 years. 
C)  8.75 years. 
D)  5 years.

Question 10

Perhaps the most important financial considerations in a capital budgeting decision are its effects upon future cash flow and future profitability.

Accepted Answer

A) True 
 B)False

Question 11

A cost that has been incurred irrevocably by past actions is a (an):

Accepted Answer

A)  Capital expenditure. 
B)  Incremental cost. 
C)  Sunk cost. 
D)  Fixed cost. 
A)  Capital expenditure. 
B)  Incremental cost. 
C)  Sunk cost. 
D)  Fixed cost.

Question 12

Which of the following is not considered a capital investment?

Accepted Answer

A)  The purchase of a large machine. 
B)  The development of a new product line. 
C)  The purchase of a large order of raw materials used in the production process. 
D)  The acquisition of a subsidiary company. 
A)  The purchase of a large machine. 
B)  The development of a new product line. 
C)  The purchase of a large order of raw materials used in the production process. 
D)  The acquisition of a subsidiary company.

Question 13

The shortcomings of the payback method
What are the major shortcomings of relying too heavily upon the payback period in evaluating capital investment decisions?

Accepted Answer

The major shortcomings of the payback pe

Question 14

Capital budgeting
Mason Co. is evaluating two alternative investment proposals. Below are data for each proposal:
The following information was taken from present value tables:
All revenue and expenses other than depreciation will be received and paid in cash. The company uses a discount rate of 12% in evaluating all capital investments.
Compute the following for each proposal (round payback period to the nearest tenth of a year and round return on average investment to the nearest tenth of a percent):
(f) Based on your analysis, which proposal appears to be the best investment?
 $$\begin{array} { l r r } 
\text { Initial investment cost } & \text { Proposal A } & \text { Proposal B } \
\text { Estimated useful life } & \$ 84,000 & \$ 96,000 \
\text { Estimated salvage value } & 5 \text { years } & 6 \text { years } \
\text { Estimated annual net income } & \$ 4,000 & - 0 - \
& \$ 8,200 & \$ 8,000
\end{array}$$ $$\begin{array} { | l | r | } 
\hline & \text { Present Value } \
\hline \$ 1 \text { due in } 5 \text { years, discounted at } 12 \% \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots & .567 \
\hline \$ 1 \text { due in } 6 \text { years, discounted at } 12 \% \ldots \ldots \ldots \ldots \ldots \ldots \ldots \ldots & .507 \
\hline \$ 1 \text { received annually for } 5 \text { years, discounted at } 12 \% \ldots \ldots \ldots \ldots \ldots & 3.605 \
\hline \$ 1 \text { received annually for 6 years, discounted at } 12 \% \ldots \ldots \ldots \ldots \ldots & 4.111 \
\hline
\end{array}$$ $$\begin{array} { | l | l | l | } 
\hline & \text { Proposal A } & \text { Proposal B } \
\hline \text { (a) Annual net cash flow: } & \$ & \$ \
\hline \text { (b) Payback period (in years): } & \$ & \$ \
\hline \text { (c) Average investment: } & \$  & \$ \
\hline \text { (d) Return on average investment: } & \$--\% & \$--\% \
\hline \text { (e) Net present value: } & \$ & \$ \
\hline
\end{array}$$

Accepted Answer

Proposal A = $24,200, Proposal B = $24,0

Question 15

To determine the average investment over the life of an asset, divide the total depreciation of the investment by two.

Accepted Answer

A) True 
 B)False

Question 16

Joseph Company is considering replacing an existing piece of machinery with newer technology. In deciding whether to replace the existing machinery, management should consider which costs as relevant?

Accepted Answer

A)  Future costs which will be classified as fixed rather than variable. 
B)  Future costs which will be different under the two alternatives. 
C)  Sunk costs associated with the old machine. 
D)  Historical costs associated with the old machine. 
A)  Future costs which will be classified as fixed rather than variable. 
B)  Future costs which will be different under the two alternatives. 
C)  Sunk costs associated with the old machine. 
D)  Historical costs associated with the old machine.

Question 17

Investment center managers may be overly optimistic about the efficiency of the new capital investment and thus, may understate expected results.

Accepted Answer

A) True 
 B)False

Question 18

The return on average investment method of evaluating investment proposals takes into consideration both the amount and the timing of future cash flows.

Accepted Answer

A) True 
 B)False

Question 19

The payback period for this investment is:

Accepted Answer

A)  8 years. 
B)  4 years. 
C)  Over 13 years. 
D)  2.5 years. 
A)  8 years. 
B)  4 years. 
C)  Over 13 years. 
D)  2.5 years.

Question 20

The return on average investment computation ignores the timing of an investment's future cash flows.

Accepted Answer

A) True 
 B)False

Exam 26: Capital Budgeting

The payback period can be determined by multiplying the amount invested by net cash flows received annually.

Return on average investment: _____________%

Upper level managers at Rooney, Inc. are concerned that employee estimates of future cash flows from the new machine may be overly optimistic. To what dollar amount can the annual after tax cash flow fall before the investment in the new machine should be rejected?

Capital budget audits are often undertaken to ensure the accuracy of cash flow estimates.

The higher the required rate of return of an investment, the less an investor will be willing to pay for the investment.

Capital investments decisions are not affected by:

The payback period for this investment is approximately:

Perhaps the most important financial considerations in a capital budgeting decision are its effects upon future cash flow and future profitability.

A cost that has been incurred irrevocably by past actions is a (an):

Which of the following is not considered a capital investment?

The shortcomings of the payback method What are the major shortcomings of relying too heavily upon the payback period in evaluating capital investment decisions?

To determine the average investment over the life of an asset, divide the total depreciation of the investment by two.

Joseph Company is considering replacing an existing piece of machinery with newer technology. In deciding whether to replace the existing machinery, management should consider which costs as relevant?

Investment center managers may be overly optimistic about the efficiency of the new capital investment and thus, may understate expected results.

The return on average investment method of evaluating investment proposals takes into consideration both the amount and the timing of future cash flows.

The payback period for this investment is:

The return on average investment computation ignores the timing of an investment's future cash flows.

Accounting: Information for Decision Making

Basic Financial Statements

The Accounting Cycle: Capturing Economic Events

The Accounting Cycle: Accruals and Deferrals

The Accounting Cycle: Reporting Financial Results

Merchandising Activities

Financial Assets

Inventories and the Cost of Goods Sold

Plant and Intangible Assets

Liabilities

Stockholders Equity: Paid-In Capital

Income and Changes in Retained Earnings

Statement of Cash Flows

Financial Statement Analysis

Global Business and Accounting

Management Accounting: a Business Partner

Job Order Cost Systems and Overhead Allocations

Process Costing

Costing and the Value Chain

Cost-Volume-Profit Analysis

Incremental Analysis

Responsibility Accounting and Transfer Pricing

Operational Budgeting

Standard Cost Systems

Rewarding Business Performance

Forms of Business Organization

The Time Value of Money: Future Amounts and Present Values Answer Key

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