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Exam 16: Planning for Capital Investments

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Question 41

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Capital investment decisions involve all of the following, except:

A) the acquisition of short-term operational assets.
B) projects requiring relatively long periods of time and large cash flows.
C) the acquisition of long-term operational assets.
D) none of these answers is correct.

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

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Question 42

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Chichester Company is considering investing in the following two mutually exclusive projects: Required: 1) Which project is more desirable strictly in terms of cash inflows? Why? 2) Compute the present value of each project's cash inflows assuming the company's required rate of return is 10%. 3) What is the maximum amount Chichester should be willing to pay for each project? 4) Suppose each project costs $10,000. Which project(s) should be accepted?

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1) Project A is more desirable because t...

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Question 43

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

Seth Morrison is considering alternative proposals that involve different amounts of investments. To compare different size investment proposals, it may be helpful for Sarah to prepare a relative ranking of the proposals by using a(n) :

The cost of capital is sometimes referred to as the hurdle or discount rate.

A postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

George Company has the opportunity to purchase an asset that costs $40,000. The asset is expected to increase net income by $10,000 per year. Depreciation expense will be $5,000 per year. Based on this information the payback period is:

Which of the following does not represent an advantage of the unadjusted rate of return over the payback method for evaluating capital projects?

Seven Day Mini Mart is considering installing video games in its stores. The machines cost $300,000 and have an estimated six-year useful life. Ignore income taxes. The following projected income statement is provided: $\begin{array}{l}\begin{array} {|l|l|l| } \hline \text {Video game revenue }&&\$100,000\\\hline \text {Less expenses: }\\\hline \text {Electricity, supplies, etc.} & \$ 2,000 \\\hline \text {Insurance} & 7,000 & \\\hline \text {Maintenance} & 1,000 & \\\hline \text {Depreciation} & 50,000 & 60,000 \\\hline \text {Net income} & & \$ 40,000 \\\hline \\\hline\end{array}\end{array}$ Required: 1) Seven Day Mini Mart would like to recoup its original investment in less than five years. Compute the payback period for the video game machine investment. Would you recommend that the machines be purchased? Why or why not? 2) Seven Day Mini Mart's target unadjusted rate of return is 12%. Compute the unadjusted rate of return on the original investment. Would you recommend that the machines be purchased? Why or why not?

The cost of capital represents the maximum acceptable rate of return that a capital investment should earn.

An investment that costs $5,000 will produce annual cash flows of $2,000 for a period of 4 years. Given a desired rate of return of 8%, the investment will generate a present value index of (Do not round your PV factors and intermediate calculations.) :

Indicate whether each of the following statements is true or false. 1. An ordinary annuity assumes that cash flows occur at the beginning of each period. 2. To say that an investment earns the desired rate of return assumes that all cash flows generated by the investment are reinvested at the desired rate of return. 3. Managers should not use two different methods in evaluating capital investment decisions because different methods generally give different results. 4. Copley Corporation uses a required rate of return of 10% for its capital investment decisions. A particular project had a negative net present value. For this project, the actual rate of return was expected to be more than 10%. 5. The net present value of a capital investment project is calculated by subtracting the present value of expected cash inflows from the cost of the investment.

Which of the following statements describes the cost of capital?

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

Indicate whether each of the following statements is true or false. 1. In analysis of a capital investment, a cost saving is treated as a cash inflow. 2. The expected salvage value of an asset is a source of a cash outflow that should be considered in capital investment analyses. 3. Many capital investments require an increase in the amount of a company's working capital. 4. Incremental revenues are treated as cash outflows in capital investment analyses. 5. An increase in working capital, which may occur near the beginning of a capital investment project, is treated as a cash outflow.

Neighbors Company is considering the purchase of new equipment that will cost $130,000. The equipment will save the company $38,000 per year in cash operating costs. The equipment has an estimated useful life of five years and a zero expected salvage value. The company's cost of capital is 10%. Required: 1) Ignoring income taxes, compute the net present value and internal rate of return. Round net present value to the nearest dollar and round internal rate of return to the nearest whole percent. 2) Should the equipment be purchased? Why or why not?

A dollar to be received in the future is subject to the effects of risk and inflation.

For a capital investment project to be acceptable, it must generate a rate of return:

Capital investments differ from stock and bond investments in that stock and bond investments can be sold in organized markets.

Findell Corporation is considering two projects, A and B, and it has gathered the following estimates for the projects: $\begin{array} { | l | l | l | } \hline & \text { Project } A & \text { Project } \mathrm { B } \\\hline \text { Useful life } & \text { 5 years } & 5 \text { years } \\\hline \text { Present value of cash inflows } & \$ 84,360 & \$ 55,100 \\\hline \text { Present value of cash inflows } & \$ 77,000 & \$ 49,000 \\\hline & & \\\hline\end{array}$ What is the net present value for project B?