Exam 26: Capital Budgeting

Kenny Company is considering the possibility of investing $1,500,000 in a special project.This venture will return $375,000 per year for 12 years in after tax cash flows.Depreciation on the project will be $187,500 per year using straight-line depreciation.The payback period for the project is:

Appraising rate of return adequacy What factors should be taken into consideration when appraising the adequacy of the rate of return of a capital investment proposal?

Which method of project selection gives consideration to the time value of money in a capital budgeting decision?

Results of capital budgeting processes may have serious implications for employees.

The president of Nash Company is considering a proposal by the factory manager for the purchase of a machine for $72,500.The useful life would be eight years,with no residual scrap value.The use of the machine will produce a positive annual cash flow of $14,000 a year for eight years.An annuity table shows that the present value of $1 received annually for eight years and discounted at 10% is 5.335.The net present value of the proposal,discounted at 10%,is:

A failure of the return on average investment method is that no consideration is given to the time value of money.

The reliability of estimates is a critical factor in capital budget proposals.

The residual value of an asset should be subtracted from the cost of the asset when determining the average amount invested.

[The following information applies to the questions displayed below.] Newport Corporation is considering investing $65,000 in equipment to produce a new product.The useful service life of the equipment is estimated to be ten years,with no salvage value.Straight-line depreciation is used.The company estimates that production and sale of the new product will increase net income by $6,500 per year. -The expected rate of return on average investment in this equipment is:

Capital budgeting estimates often involve a considerable degree of uncertainty.

Of the following techniques of capital budgeting,which one explicitly incorporates an estimate of an interest rate into the basic computation?

Jericho Corporation is considering the purchase of new equipment costing initially $96,000.The equipment has an estimated life of 6 years with no salvage value.Straight-line depreciation is to be used.Net annual after tax cash flow is estimated to be $31,200 for 6 years.The payback period is:

The present value of money is always:

[The following information applies to the questions displayed below.] Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows: All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes. -The payback period for the investment in equipment is closest to:

A machine cost $46,000 and had a useful life of 4 years and a residual value of $7,000.What is the net present value of the machine if the annual cash flow is $16,000 and the company uses a discount rate of 10%? An annuity table shows the present value of $1 at 10% for 4 years to be 0.683.The present value of an ordinary annuity of $1 discounted at 10% for 4 years is 3.170.

The payback period analysis fails to consider the cash flows over the entire life of the investment.

[The following information applies to the questions displayed below.] Lazar Corporation is evaluating a proposal to invest in a machine costing $89,000.The machine has an estimated useful life of ten years,and an estimated salvage value of $14,000.The machine will increase the company's net income by approximately $9,600 per year.All revenue and expenses other than depreciation will be received and paid in cash. -The expected rate of return on average investment of the machine is:

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

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