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Exam 24: Capital Budgeting and Investment Analysis

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Question 31

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A hurdle rate is the minimum acceptable rate of return for an investment.

A) True
B) False

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Question 32

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If two projects have the same risks,the same payback periods,and the same initial investments,they are equally attractive.

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B) False

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Question 33

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Capital budgeting decisions are risky because the outcome is uncertain,large amounts are usually involved,the investment involves a long-term commitment,and the decision could be difficult or impossible to reverse.

A company purchases a machine for $62,000.The machine has an expected life of 15 years and no salvage value.The company anticipates a yearly net income of $15,000 after taxes of 29% to be received uniformly throughout each year.What is the accounting rate of return?

A company is considering the purchase of a new machine for $72,000.Management predicts that the machine can produce sales of $21,000 each year for the next eight years.Expenses are expected to include direct materials,direct labor,and factory overhead totaling $5,000 per year plus depreciation of $9,000 per year.The company's tax rate is 40%.What is the payback period for the new machine?

Lower-risk investments require a higher rate of return compared with higher-risk investments.

A company is considering a proposal to invest $73,000 in a project that would provide the following net cash flows: $\begin{array} { l r } \text { Year 1 } & \$ 5,000 \\\text { Year 2 } & 12,000 \\\text { Year 3 } & 25,000 \\\text { Year 4 } & 29,000 \\\text { Year 5 } & 8,000\end{array}$ Compute the project's payback period.

Reference: 24_01 A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. $\begin{array}{llr}\text{Sales} & & \$ 90,000 \\\text{Costs:} & & \\\text{Manufacturing} & \$ 52,000 \\ \text{Depreciation on machine} & 4,000 \\ \text{Selling and administrative expenses} & 30,000 & \underline{(86,000) }\\\text{Income before taxes} & & \$ 4,000 \\\text{Income tax 50 \%} & & \underline{(2,000) }\\\text{Net income} & & \bold{\underline{\$ 2,000}}\end{array}$ -What is the payback period for this machine?

A company is considering a proposal to invest $30,000 in a project that would provide the following net cash flows: $\begin{array} { l l } \text { Year 1 } & \$ 6,500 \\\text { Year 2 } & 10,700 \\\text { Year 3 } & 15,000 \\\text { Year 4 } & 12,800\end{array}$ a.Compute the project's payback period. b.Compute the net present value of the project assuming a 10% discount rate with the following factors: PV factors for $1(yr.1: 0.9091; yr.2: 0.8264; yr.3:0 .7513; yr.4: 0.6830) c.Should the company invest in the machine? Why or why not?

Which of the following cash flows is not considered when using the net present value method?

A company is considering a proposal to invest $22,000 in a project that would provide the following net cash flows: $\begin{array} { l r } \text { Year 1 } & \$ 2,000 \\\text { Year 2 } & 4,000 \\\text { Year 3 } & 15,000 \\\text { Year 4 } & 18,000\end{array}$ Compute the project's payback period.

In using the internal rate of return method,management must consider a hurdle rate in making its decisions.What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

All capital investment evaluation methods use the time value of money concept.

An advantage of the break-even time (BET)method over the payback period method is that it recognizes the time value of money.

A company is considering a five-year project.It plans to invest $80,000 now and it forecasts cash inflows for each year of $22,857.The company requires a hurdle rate of 12%.Calculate the internal rate of return to determine whether it should accept this project.Selected factors for a present value of an annuity of 1 for five years are shown below: $\begin{array}{cc}\underline{\text{Interest}}&&\underline{\text{Present Value of an Annuity of 1}}\\\underline{\text{ Rate}}&&\underline{\text{ factor}}\\10 \%&&3.7908 \\12 \%&&3.6048 \\14 \%&&3.4331\end{array}$

A company is considering the purchase of a new machine for $48,000.Management predicts that the machine can produce sales of $16,000 each year for the next 10 years.Expenses are expected to include direct materials,direct labor,and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year.The company's tax rate is 40%.What is the approximate accounting rate of return for the machine?

What is discounting?

For projects financed from borrowed funds,the hurdle rate must exceed the _________________ paid on these funds.

The time expected to pass before the net cash flows from an investment would return its initial cost is called the:

Accounting rate of return is the simplest capital budgeting method.It gives managers an estimate of how soon they will recover their initial investment.