Ch 11 Flashcards
Capital budgeting is used to evaluate the purchase of:
a machine
List the steps involved in capital budgeting process, with the first step on top.
Submit proposal
Evaluate proposal
Approve or reject proposals
All of the following are cash flows over the life of an asset except:
depreciation
An investment’s … period is the expected time to recover the initial investment amount.
payback
A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment A.
3 years
Reason: $15,000 / $5,000 = 3 years.
The process of evaluating and planning for long-term investments is called … budgeting.
capital
A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment B.
2.25 years
HOW
Characteristics of capital budgeting include: (Check all that apply.)
long-term investment
large amount of money is involved
outcome is uncertain
A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Using the payback period as the evaluation method, which investment should be chosen by management?
Investment B
Shortest payback
Place the following cash flows in the order that they would occur in a capital investment:
Acquisition
Use
Disposal
The formula to calculate the accounting rate of return is:
annual income/average investment
The capital budgeting evaluation method that measures the expected amount of time to recover the initial investment amount is the:
payback period.
Assume straight-line depreciation. A company plans to purchase machinery costing $1,000,000 with salvage value of $200,000 after 4 years. Annual income is expected to be $40,000 during the 4 years. Calculate the accounting rate of return. Round your answer to the nearest tenth of a percent.
6.7 %
Reason: Average investment = (1,000,000 + 200,000)/2 = 600,000. $40,000/600,000 = 6.7%
A company is considering a capital investment of $45,000 in new equipment which will improve production and increase cash flows by $15,000 per year for 6 years. The payback period is … years.
3 years
45,000÷15,000
A company is considering a capital investment of $16,000 in new equipment which will improve production and increase cash flows for the next five years at the following amounts: Year 1: $8,000; Year 2: $6,000; Year 3: $5,000; Year 4: $6,000; Year 5: $5,000. The payback period is … years.
2.4 years.
2+(2,000÷5,000)
Weaknesses of the payback period as a capital budgeting evaluation method include that it: (Check all that apply.)
ignores time value of money.
Weaknesses of the accounting rate of return as a capital budgeting evaluation method include that it: (Check all that apply.)
ignores time value of money.
does not directly consider cash flows and their timing.
If a company uses straight-line depreciation, the average investment is calculated as: (Check all that apply.)
(initial investment + salvage value)/2.
(beginning book value + salvage value)/2.
Assume straight-line depreciation and equal cash flows. A company plans to purchase equipment for $25,000. The equipment will have $0 salvage value and increase income by $7,500 annually during its 5-year life. The accounting rate of return is
…%.
60%
(7,500÷(25,000÷2))×100
A company’s required rate of return computed as an average of the rate the company must pay to its lenders and investors is called:
hurdle rate
A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment B.
2.25yrs
2+(1,000÷4,000)
The accounting rate of return:
does not directly consider cash flows and their timing.
An investment that costs $30,000 will produce annual cash flows of $10,000 for 4 years. Using a required return of 8%, the investment will generate (rounded to the nearest dollar) a:
Present Value of 1
Rate
Periods
7%
8%
9%
4
0.7629
0.7350
0.7084
Present Value of an Annuity of 1
Rate
Periods
7%
8%
9%
4
3.3872
3.3121
3.2397
positive NPV of $3,121.
Reason: $10,000 x 3.3121=$33,121. $33,121-$30,000=$3,121.
Or. (10,000×3.3121)−30,000
Bc used pres.value of annuity
The formula to calculate the accounting rate of return is:
annual income/average investment
The decision rule for NPV includes: (Check all that apply).
if an asset’s future net cash flows yield a positive net present value, invest.
when comparing projects with similar initial investments and risk, select the one with the highest net present value.
A company is evaluating an investment which has an initial investment of $4,000. Annual net cash flows is expected to be $2,000 over the next three years. The company requires a 10% annual return. The present value of an annuity factor for 10% and 3 periods is 2.4869. The present value of $1 factor for 10% and 3 periods is 0.7513. The net present value is $….
(round your answer to the nearest whole dollar).
$974
(2,000×2.4869)−4,000
The capital investment evaluation method that subtracts the initial investment from the discounted future net cash flows from the investment at the required rate of return is the:
net present value
