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Exam 16: Planning for Capital Investments

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Question 1

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Which of the following statements is incorrect?

A) The further into the future a cash receipt is expected to occur, the lower is its present value.
B) The return on investment measures the compensation a company expects to receive from investing in capital assets.
C) Most companies use their cost of capital to estimate the minimum return on investment required from capital investments.
D) When a company invests in capital assets, it sacrifices future dollars for the opportunity to receive present dollars.

E) B) and C)
F) B) and D)

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Question 2

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Jiminez Company has two investment opportunities. Both investments cost $5,000 and will provide the following net cash flows: $\begin{array}{lcc}\text { Year }& \text { Investment A} & \text { Investment B} \\1 & \$ 3,000 & \$ 3,000 \\2 & 3,000 & 4,000 \\3 & 3,000 & 2,000 \\4 & 3,000 & 1,000\end{array}$ What is the total present value of Investment A's cash flows assuming an 8% minimum rate of return? ( PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

A) $14,936.
B) $4,936.
C) $7,000.
D) $12,000.

E) A) and D)
F) B) and C)

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Question 3

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Young Corporation is considering purchasing equipment that costs $80,000 and is expected to provide the following cash inflows over its five-year useful life: $\begin{array} { l r } \text { Year } & \text { Cash inflow } \\1 & \$ 18,000 \\2 & 22,000 \\3 & 24,000 \\4 & 16,000 \\5 & 9,000\end{array}$ What is the payback period of this investment project? (Rounded to the nearest year.)

A series of equal cash flows at fixed intervals is termed a(n) :

Theresa is considering starting a small business. She plans to purchase equipment costing $145,000. Rent on the building used by the business will be $26,000 per year while other operating costs will total $30,000 per year. A market research specialist estimates that Theresa's annual sales from the business will amount to $80,000. Theresa plans to operate the business for 6 years. Disregarding the effects of taxes, what will be the amount of annual net cash flow generated by the business?

When the effect of income taxes is considered in a capital budgeting analysis, the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

The cost of capital is called all of the following except:

Cash inflows generated by capital investments include all of the following except:

A project's net present value can be found by subtracting the cost of the project from the total present value of the future cash flows generated by the project.

Which of the following is not a criterion that is used to determine whether a project is acceptable under the net present value method?

An investment that costs $6,300 will produce annual cash flows of $2,780 for a period of 4 years. Given a desired rate of return of 9%, what is the present value index? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to three decimal points.)

Which of the following is the approximate internal rate of return for an investment that costs $33,550 and provides a $5,000 annuity for 10 years? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Which method of evaluating capital investment decisions uses the concept of present value to compute a rate of return?

Generally, the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

When calculating the present value of an ordinary annuity, it is assumed that:

When a capital investment is expected to provide unequal annual cash inflows, the payback period can be calculated by accumulating the incremental cash inflows until the sum equals the amount of the original investment.

Indicate whether each of the following statements is true or false: A postaudit should be conducted at the time a capital investment is purchased. ______The postaudit of a capital investment project should be made using the same analytical technique that was used in deciding to make the investment. ______The purpose of postaudits is to improve a company's capital investment decision process. ______The postaudit process uses expected cash flows and the company's cost of capital. ______Making good estimates of future cash flows is important in making capital investment decisions. ______

Finnegan Company plans to invest in a new operating plant that is expected to cost $500,000. The projected incremental income from the investment is as follows: $\begin{array}{cc}&\text { Net Income }\\\text { Year } & \text { After Tax } \\1 & \$ 30,000 \\2 & \$ 45,000 \\3 & \$ 50,000 \\4 & \$ 55,000 \\5 & \$ 40,000 \\6 & \$ 20,000\end{array}$ The unadjusted rate of return on the initial investment would be approximately:

Select the incorrect statement concerning the internal rate of return (IRR) method of evaluating capital projects.

Indicate whether each of the following statements is true or false. In analysis of a capital investment, a cost saving is treated as a cash inflow. ______The expected salvage value of an asset is a source of a cash outflow that should be considered in capital investment analyses. ______Many capital investments require an increase in the amount of a company's working capital. ______Incremental revenues are treated as cash outflows in capital investment analyses. ______An increase in working capital, which may occur near the beginning of a capital investment project, is treated as a cash outflow. ______