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The document contains a series of multiple choice questions about capital investment methods such as net present value, internal rate of return, payback period, and discounted payback period. It provides examples of calculations using cash flow data for potential capital projects. The key methods assessed are NPV, IRR, simple payback period, and discounted payback period. Discount tables are also provided for present value calculations.

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17 views4 pages

PDF Document

The document contains a series of multiple choice questions about capital investment methods such as net present value, internal rate of return, payback period, and discounted payback period. It provides examples of calculations using cash flow data for potential capital projects. The key methods assessed are NPV, IRR, simple payback period, and discounted payback period. Discount tables are also provided for present value calculations.

Uploaded by

kalbrak203
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 11—Capital Investments

1. Which of the following is true of the net present value method?


a. It suggests that management should choose a project if the sum of its discounted cash
flows is negative.
b. It calculates the discount rate at which an investment’s present value of all expected
cash inflows equals its expected cash outflows.
c. It measures the time taken to recoup the net initial investment in a project, in the form
of future cash flows.
d. It calculates the expected monetary gain or loss from a project by using the required
rate of return.

2. Which of the following is true of the internal rate-of-return method?


a. It does not consider the time value of money to evaluate the investment alternatives.
b. It is less than the required rate of return when NPV is positive.
c. It implicitly assumes that project cash flows can be reinvested at the project’s rate of
return.
d. It can be used for investment analysis when the required rate of return varies over the
life of a project.

3. Which of the following is true of a discounted payback method?


a. It incorporates the time value of money.
b. It includes the cash flows beyond the payback period.
c. It favors projects with long-run cash flows.
d. It recoups the undiscounted capital investments.

4. The _______ method considers income earned throughout a project’s expected useful life
but ignores the time value of money.
a. internal rate of return
b. net present value
c. accrual accounting rate-of-return
d. payback period

5. Best Inc. invests in a new machine that costs $100,000. The increase in expected average
annual after-tax operating cash inflows is $8,000. The new machine results in additional
depreciation deductions of $1,200 per year. Based on this information, calculate the AARR
on net initial investment.
a. 5.9%
b. 7.9%
c. 3.2%
d. 6.8%

The following data apply to questions 6, 7, and 8:

Saffron Corporation is considering (as of 1/1/13), the replacement of an old machine that is
currently being used. The old machine is fully depreciated but can be used by the corporation
through 2016. If Saffron decides to replace the old machine, Jupiter Company has offered to
purchase it for $25,000 on the replacement date. The disposal value of the old machine would be
zero at the end of 2016. Saffron uses the straight-line method of depreciation for all classes of
machinery.

If the replacement occurs, a new machine would be acquired from M&M Machineries on
January 1, 2013. The purchase price of $250,000 for the new machine would be paid in cash at
the time of replacement. Due to the increased efficiency of the new machine, estimated annual
cash savings of $71,000 would be generated through 2016, the end of its expected useful life.
The new machine is expected to have a zero disposal price at the end of 2016.

All operating cash receipts, operating cash expenditures, and applicable tax payments and credits
are assumed to occur at the end of the year. Saffron employs the calendar year for reporting
purposes.

Discount tables for several different interest (discount) rates that are to be used in any
discounting calculations are given below. Assume that Saffron is not subject to income taxes.

Present Value of $1.00 Received at the End of Period


Period 6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621

Present Value of an Annuity of $1.00 Received at the End of Each Period


Period 6% 8% 10% 12% 14%
1 0.943 0.926 0.909 0.893 0.877
2 1.833 1.783 1.736 1.690 1.647
3 2.673 2.577 2.487 2.402 2.322
4 3.465 3.312 3.170 3.037 2.914
5 4.212 3.993 3.791 3.605 3.433

6. If Saffron requires investments to earn an 8% return, the net present value for replacing the
old machine with the new machine is:
a. $273,321.
b. $10,152.
c. $(14,848).
d. $225,000.

7. The internal rate-of-return, to the nearest percent, to replace the old machine is:
a. 10%.
b. 8%.
c. 12%.
d. 6%.

8. The payback period to replace the old machine with the new machine is:
a. 4.19 years.
b. 5.20 years.
c. 3.17 years.
d. 2.08 years.

The following data apply to questions 9 and 10:

Berry Corp. is considering the purchase of new equipment for $100,000. The firm expects the
equipment to provide a total cash savings of $420,000 over the next 5 years, due to reduced
operating expenses. The data for cash savings has been provided below:

Year Cash Savings


0
1 $46,000
2 52,000
3 85,000
4 125,000
5 112,000

Present Value of $1.00 Received at the End of Period


Period 6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621

Present Value of an Annuity of $1.00 Received at the End of Each Period


Period 6% 8% 10% 12% 14%
1 0.943 0.926 0.909 0.893 0.877
2 1.833 1.783 1.736 1.690 1.647
3 2.673 2.577 2.487 2.402 2.322
4 3.465 3.312 3.170 3.037 2.914
5 4.212 3.993 3.791 3.605 3.433

9. How much is the approximate payback period estimated on the investment?


a. 1.05 years
b. 2.02 years
c. 3.53 years
d. 4.42 years
10. If the cash flows are discounted at 8%, what is the discounted payback period?
a. 2.99 years
b. 1.58 years
c. 2.19 years
d. 3.63 years

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