Question 1

What is an advantage of the payback method?

Accepted Answer

A)  It considers the timing of cash flows. 
B)  It considers all relevant cash flows. 
C)  It considers the wealth of shareholders of the business. 
D)  It considers the hurdle rate. 
E)  It is very intuitive to use.

Question 2

If, when calculated IRR through interpolation, over a 10-year investment horizon, the NPV, using an interest rate of 12%, is ($3,752.76) and the NPV, using an interest rate of 3%, is $6,360.04, IRR for the project is

Accepted Answer

A)  9.2% 
B)  5.3% 
C)  4.5% 
D)  5.8% 
E)  8.7%

Question 3

Which of the following is considered a relevant cost when undertaking an investment analysis?

Accepted Answer

A)  Sunk cost. 
B)  Common future cost. 
C)  Interest payments. 
D)  Standard costs. 
E)  Opportunity cost.

Question 4

Aviation Cargo Ltd. (ACL) wants to spend $5 million to expand a runway at its air field to accommodate a new larger cargo jet. It estimates additional cash inflows of $1 million for the next ten years. What should ACL do?

Accepted Answer

A)  Accept the project because the payback period is six years. 
B)  Accept the project because the ARR is 20%. 
C)  Accept the project because the IRR is 15%. 
D)  Accept the project because the NPV is $1, 710,000. 
E)  Accept the project because the the profits will increase.

Question 5

A municipality is considering the purchase of two large lawn mowers which will be used to maintain baseball diamonds, soccer fields, parks and road boulevards. Increased fuel efficiency and improved speed, reducing employee hours, contribute to savings. Both machines have a useful life of six years. Machine A, costing $5,000, offers savings of $1000 a year and disposal value of $500. The Machine B costs $7,000, offers saving of $1,300 a year and a disposal value of $1,500. The municipality uses a 7% discount factor to assess its capital purchases.

Accepted Answer

A)  Purchase Machine A as it has shorter payback period, 4 years. 
B)  Purchase neither machine because both have negative net present values. 
C)  Purchase Machine B as it has a higher NPV, $195.90. 
D)  Purchase Machine B as it has a shorter payback period, 3.5 years. 
E)  Purchase Machine A as it has a lower NPV, $99.65.

Question 6

When identifying profitable project opportunities, management should

Accepted Answer

A)  Focus only on cash returns and always move forward with the highest cash flow project first 
B)  Develop projects at the senior management level and, thus, ensure support down through the company 
C)  Concentrate first on the best opportunity in the strongest product category 
D)  First focus on opportunities that utilize the lowest amount of capital required 
E)  Search for opportunities that mesh with strategic plans and utilize the company's core competencies

Question 7

A specialty original equipment manufacturer (OEM) to the automobile industry, has maintained an ROCE above 12% over the past four years by insisting on an ARR of over 12%. However, in the past four periods, consumer spending has begun to decline. Interest rates are falling. The company should

Accepted Answer

A)  Expect ROCE to drop significantly given fewer high yield investment opportunities available during economic slow-down 
B)  Focus R&D efforts to develop recession proof or counter cyclical investment opportunities 
C)  Shift resources immediately from producing vulnerable products to more recession proof market offerings 
D)  Review current process and financing contracts to institute cost cutting procedures 
E)  Take advantage of a well diversified product portfolio to limit exposure

Question 8

Capital rationing occurs when

Accepted Answer

A)  Expected cash inflows do not materialize when the project is implemented 
B)  There are too few investment opportunities that can match or exceed the hurdle rate 
C)  Poor investment decisions cause limited resources to be spread thinly among the several projects undertaken 
D)  There are more investment opportunities meeting the hurdle rate than can be undertaken by the company 
E)  Sufficient funds for a capital investment cannot be obtained from a single source

Question 9

Korral Kids is a chain of children's premium outdoor clothing that is expanding into a neighbouring city. It can lease space in a downtown location requiring a major refitting for a cost of $550,000. Instead it could lease a smaller mall location with lower traffic but would only require redecoration and furnishing at $250,000. Income before depreciation expense for the mall location over the next three years is $40,000, $65,000, $85,000. It is projected to be $90,000 for the three years after that. Expected cash inflow for the downtown location is projected at $90,000, $125,000, $165,000, and $185,000 for the three years after that. If the company is looking for a 14% return it should

Accepted Answer

A)  Invest in the downtown location as it has the highest cash flows 
B)  Invest in the downtown location as it has the highest NPV at $76,424 
C)  Invest in the mall location as it has the highest NPV at $33,520 
D)  Invest in the mall location as it has the highest present value at $283,520 
E)  Invest in the downtown location as it has the highest NPV at $576,424

Question 10

Omaro Ltd. would like to clear their warehouse and yard of damaged equipment and metal scrap. If the company purchases an industrial recycling bin for $1800, a contractor will pick up the materials and pay by the kilogram for the scrap. Omaro adjusts all cash flows for time value and uses a 10% discount rate. What dollar value of scrap do they have to generate each year to be able to break even on their investment in three years?

Accepted Answer

A)  $544 
B)  $ 600 
C)  $ 724 
D)  $ 844 
E)  $1,352

Question 11

Sam's Super Simonizing is a small car detailer that is replacing its upholstery cleaning machine at the beginning of the next fiscal. The old one will be worthless. A used one could be purchased leaving the company as well off as before. However, the preference is for a new one for $42,000 if it can be economically justified. To make a determination, after-tax cash flows for the investment period have to be calculated. The company estimates that the machine's efficiency will contribute to an improvement to EBIT of $7,400. Straight-line amortization is used and a projected lifetime of 10 years and no salvage value is expected. The company's tax rate is 28%, has no debt and its discount rate is 12%. The machine's CCA class has a rate of 25%. What is the after-tax cash flow at the end of Year 2?

Accepted Answer

A)  $6,040 
B)  $6,238 
C)  $8,469 
D)  $10,925 
E)  $12,899

Question 12

A customer has approached CapiCal industries with a purchase order for a specialty product it needs for the next three years. CapiCal no longer produces the product and the related fully depreciated manufacturing equipment was going to be sold for $50,000. It will take $35,000 to recondition it and approximately 155 hours employee time at $18.50 an hour to set the equipment up. Both set up and production can be incorporated in the current space and in the factory schedule without having to hire additional labour. Sales Revenue for the special order is expected to be $120,000 per year. Direct material for the special order will amount to 55% of revenue. Working capital will expand by $16,000 immediately. Allocated administration costs amount to $5,000. Interest expense is $1,400. The company uses straight-line amortization and a hurdle rate of 10%. What is the net present value (NPV) of the order?

Accepted Answer

A)  $33,290 
B)  $70,853 
C)  $75,744 
D)  $79,393 
E)  $82,874

Question 13

Ridman Academy is considering replacing their heating, ventilation and air conditioning (HVAC) system at a cost of $245,000. Annual cash savings from the new more efficient system will be $35,000 over the next 20 years. What is the internal rate of return for the project?

Accepted Answer

A)  10% 
B)  11% 
C)  12% 
D)  13% 
E)  14%

Question 14

An investment decision can also be assessed on the basis of the Triple Bottom Line accounting. In this methodology managers

Accepted Answer

A)  Assess a project on the basis of what is referred to as People, Plant and Profit impact 
B)  Are responsible for accounting results, cash flow performance and balance sheet impact 
C)  Assess a project on the basis of its impact on future profits, present profits and any restatement of past performance that may need to be undertaken 
D)  Are required to focus on the impact the use of capital will have on leverage, revenue and cash flow 
E)  Determine the profit potential utilizing zero cost of capital, weighted average cost of capital and real cost of capital

Question 15

A carpet manufacturer, whose discount rate is 10%, can purchase texturizing equipment for $1,250,000 to process yarn. Incremental income before straight line depreciation from sales of texturized carpets is projected over the next five years as $95,000, $165,000, $357,000, $725,000 and $315,000, respectively. The company believes that the fashion will pass and demand in Year 6 will all but disappear. The machine can be sold at the end of Year 5 for $250,000. What should you advise the company to do?

Accepted Answer

A)  Purchase the equipment as NPV is $86,952. 
B)  Not purchase the equipment as NPV is ($54,784). 
C)  Purchase the equipment as ARR is 10.9%. 
D)  Not purchase the equipment as the ARR is only 9.3%. 
E)  Purchase the equipment as both the NPV and ARR are negative.

Question 16

Ridman Academy's annual cash inflow from its $40,000 tuition per student is $5,000, net of expenses, and before amortization and interest. At a cost of $2.8 million, the Academy has acquired and refurbished an older office building to accommodate classrooms for 120 additional students. What is the expansion worth to the academy if the school expects a 9% return over the next 15 years?

Accepted Answer

A)  $1,247,379 
B)  $1,463,971 
C)  $1,893,308 
D)  $2,036,413 
E)  $14,816,540

Question 17

One of the important results of the large number of companies now using post-completion audits is that

Accepted Answer

A)  It is easier to discover fraudulent behaviour 
B)  Cost overruns on projects have been virtually eliminated 
C)  There is early detection of projects going wrong 
D)  A higher overall cash flow is being achieved 
E)  More realistic investment proposals are being submitted

Question 18

Some high tech firms have billions of dollars of cash in the bank. What does this tell you about these firms?

Accepted Answer

A)  They are charging too high a price for their products and services. 
B)  They have been able to cut way back on their expenses such as salaries. 
C)  They have been able to defer a large portion of their income taxes. 
D)  They are having trouble generation excellent new investment projects. 
E)  They are in need of better auditing because company's do not have that much cash.

Question 19

In periods of accelerating interest rates, what are the best measures to use when deciding between investment alternatives?

Accepted Answer

A)  Payback 
B)  ARR and Payback 
C)  Payback and NPV 
D)  NPV and IRR 
E)  IRR

Question 20

Air Porters Inc. is considering acquiring an airplane with a new type of engine that requires more frequent maintenance. Cash flows starting now and for the first eight years are as follows: ($2,000,000); $500,000; $500,000; ($100,000); $450,000; $450,000; ($110,000); $400,000; $400,000. How many internal rates of return does this investment project have?

Accepted Answer

A)  1 
B)  2 
C)  3 
D)  4 
E)  5

Exam 6: Making Capital Investment Decisions