Chapter 13 multiple choice

Question 1

26. The capital budget for the year is approved by a company’s
    a. board of directors.
    b. capital budgeting committee.
    c. officers.
    d. shareholders

Answer 1

a

Question 2

27. Which of the following describes the capital budgeting evaluation process?
    a. The capital budget committee submits its proposals to the officers of the company who choose which projects will be forwarded to the shareholders for ultimate approval.
    b. The officiers of the company submit their proposals to the capital budget committee who choose which projects will be forwarded to the shareholders for ultimate approval.
    c. The officiers of the company submit their proposals to the capital budget committee who choose which projects will be forwarded to the board of directors for ultimate approval.
    d. The capital budget committee submits its proposal to the officers of the company who choose which projects will be forwarded to the board of directors for ultimate approval.

Answer 2

d

Question 3

28. Which of the following represents a cash inflow?
    a. the initial investment
    b. sale of old equipment
    c. repairs and maintenance
    d. increased operating costs

Answer 3

b

Question 4

29. Which of the following represents a cash outflow?
    a. overhaul of equipment
    b. increased cash received from customers
    c. reduced cash flows for operating costs
    d. salvage value of equipment when project is completed

Answer 4

a

Question 5

30. The capital budgeting decision depends in part on the
    a. availability of funds.
    b. relationships among proposed projects.
    c. risk associated with a particular project.
    d. all of these.

Answer 5

d

Question 6

31. Capital budgeting is the process
    a. used in sell or process further decisions.
    b. of determining how many common shares to issue.
    c. of making capital expenditure decisions.
    d. of eliminating unprofitable product lines.

Answer 6

c

Question 7

32. If an asset costs $60,000 and is expected to have a $5,000 salvage value at the end of its nine-year life, and generates annual net cash inflows of $10,000 each year, the cash payback period is
    a. 6.5 years.
    b. 6 years.
    c. 5.5 years.
    d. 9 years.

Answer 7

b

Question 8

33. If a payback period for a project is greater than its expected useful life, the
    a. project will always be profitable.
    b. entire initial investment will not be recovered.
    c. project would only be acceptable if the company’s cost of capital was low.
    d. project’s return will always exceed the company’s cost of capital.

Answer 8

b

Question 9

34. The cash payback technique
    a. should be used as a final screening tool.
    b. can be the only basis for the capital budgeting decision.
    c. is relatively easy to calculate and understand.
    d. considers the expected profitability of a project.

Answer 9

c

Question 10

35. The cash payback period is calculated by dividing the cost of the capital investment by the
    a. annual net income.
    b. net annual cash inflow.
    c. present value of the cash inflow.
    d. present value of the net income.

Answer 10

b

Question 11

36. When using the cash payback technique, the payback period is expressed in terms of
    a. a percent.
    b. dollars.
    c. years.
    d. months.

Answer 11

c

Question 12

37. A disadvantage of the cash payback technique is that it
    a. ignores obsolescence factors.
    b. ignores the cost of an investment.
    c. is complicated to use.
    d. ignores the time value of money.

Answer 12

d

Question 13

38. Bark Company is considering buying a machine for $120,000 with an estimated life of ten years and no salvage value. The straight-line method of depreciation will be used. The machine is expected to generate net income of $8,000 each year. The cash payback period on this investment is
    a. 15 years.
    b. 10 years.
    c. 6 years.
    d. 3 years.

Answer 13

c

Question 14

39. The discount rate is referred to by all of the following alternative names except the
    a. cost of capital.
    b. cutoff rate.
    c. hurdle rate.
    d. required rate of return.

Answer 14

a

Question 15

40. The rate that a company must pay to obtain funds from creditors and shareholders s known as the
    a. hurdle rate.
    b. cost of capital.
    c. cutoff rate.
    d. all of these.

Answer 15

b

Question 16

41. The higher the risk element in a project, the
    a. more attractive the investment.
    b. higher the net present value.
    c. higher the cost of capital.
    d. higher the discount rate

Answer 16

d

Question 17

42. If a company’s required rate of return is 10% and, in using the net present value method, a project’s net present value is zero, this indicates that the
    a. project’s rate of return exceeds 10%.
    b. project’s rate of return is less than the minimum rate required.
    c. project earns a rate of return of 10%.
    d. project earns a rate of return of 0%.

Answer 17

c

Question 18

43. Using the profitability index method, the present value of cash inflows for Project Flower is $88,000 and the present value of cash inflows of Project Plant is $48,000. If Project Flower and Project Plant require initial investments of $90,000 and $40,000, respectively, and have the same useful life, the project that should be accepted is
    a. Project Flower.
    b. Project Plant.
    c. Either project may be accepted.
    d. Neither project should be accepted

Answer 18

b

Question 19

44. Which of the following assumptions is made in order to simplify the net present value method?
    a. All cash flows come at the end of the year.
    b. All cash flows are immediately reinvested at the best rate available at the time.
    c. All cash flows come at the beginning of the year.
    d. All cash flows are not reinvested.

Answer 19

a

Question 20

45. When the annual cash flows from an investment are unequal, the appropriate table to use is the
    a. future value of 1 table.
    b. future value of annuity table.
    c. present value of 1 table.
    d. present value of annuity table.

Answer 20

c

Question 21

46. If a company uses a 12% discount rate with the net present value method, and then does the same analysis, but with a 15% discount rate, which of the following is likely to occur?
    a. The 12% rate will show the project is more profitable than the 15% rate.
    b. The 15% rate will show the project is more profitable than the 12% rate.
    c. Both rates will produce the same net present value.
    d. The relative profitability of the two studies depends only on the timing of the cash flows, not on the discount rate.

Answer 21

a

Question 22

47. Intangible benefits in capital budgeting would include all of the following except increased
    a. product quality.
    b. employee loyalty.
    c. salvage value.
    d. product safety.

Answer 22

c

Question 23

48. Intangible benefits in capital budgeting
    a. should be ignored because they are difficult to determine.
    b. include increased quality or employee loyalty.
    c. are not considered because they are usually not relevant to the decision.
    d. have a rate of return in excess of the company’s cost of capital.

Answer 23

b

Question 24

49. To avoid rejecting projects that actually should be accepted,
    
    1. intangible benefits should be ignored.
    2. conservative estimates of the intangible benefits’ value should be incorporated into the NPV calculation.
    3. calculate net present value ignoring intangible benefits and then, if the NPV is negative, estimate whether the intangible benefits are worth at least the amount of the negative NPV.
       a. 1
       b. 2
       c. 3
       d. both 2 and 3 are correct.

Answer 24

d

Question 25

50. All of the following statements about intangible benefits in capital budgeting are correct except that they
    a. include increased quality and employee loyalty.
    b. are difficult to quantify.
    c. are often ignored in capital budgeting decisions.
    d. cannot be incorporated into the NPV calculation

Answer 25

d

Question 26

51. In evaluating high-tech projects
    a. only tangible benefits should be considered.
    b. only intangible benefits should be considered.
    c. both tangible and intangible benefits should be considered.
    d. neither tangible nor intangible benefits should be considered.

Answer 26

c

Question 27

52. Using a number of outcome estimates to get a sense of the variability among potential returns is
    a. financial analysis.
    b. post-audit analysis.
    c. sensitivity analysis.
    d. outcome analysis.

Answer 27

c

Question 28

53. If a company’s required rate of return is 9%, and in using the profitability index method, a project’s index is greater than 1, this indicates that the project’s rate of return is
    a. equal to 9%.
    b. greater than 9%.
    c. less than 9%.
    d. unacceptable for investment purposes.

Answer 28

b

Question 29

54. The profitability index is calculated by dividing the
    a. total cash flows by the initial investment.
    b. present value of cash flows by the initial investment.
    c. initial investment by the total cash flows.
    d. initial investment by the present value of cash flows.

Answer 29

b

Question 30

55. The capital budgeting method that takes into account both the size of the original investment and the discounted cash flows is the
    a. cash payback method.
    b. internal rate of return method.
    c. net present value method.
    d. profitability index.

Answer 30

d

Question 31

56. The profitability index
    a. does not take into account the discounted cash flows.
    b. is calculated by dividing total cash flows by the initial investment.
    c. allows comparison of the relative desirability of projects that require differing initial investments.
    d. will never be greater than 1

Answer 31

c

Question 32

57. The capital budgeting method that allows comparison of the relative desirability of projects that require differing initial investments is the
    a. cash payback method.
    b. internal rate of return method.
    c. net present value method.
    d. profitability index.

Answer 32

d

Question 33

58.	The following information is available for a potential investment for Panda Company:
	Initial investment	$40,000
	Net annual cash inflow	10,000
	Net present value	18,112
	Salvage value	5,000
	Useful life	10 yrs.
	The potential investment’s profitability index is
a.	4.00.
b.	2.85.
c.	2.50.
d.	1.45.

Answer 33

d

Question 34

59. An approach that uses a number of outcome estimates to get a sense of the variability among potential returns is
    a. the discounted cash flow technique.
    b. the net present value method.
    c. risk analysis.
    d. sensitivity analysis

Answer 34

d

Question 35

60. Post-audits of capital projects
    a. are usually foolproof.
    b. are done using different evaluation techniques than were used in making the original capital budgeting decision.
    c. provide a formal mechanism by which the company can determine whether existing projects should be supported or terminated.
    d. all of these.

Answer 35

c

Question 36

61. A post-audit should be performed using
    a. a different evaluation technique than that used in making the original decision.
    b. the same evaluation technique used in making the original decision.
    c. estimated amounts instead of actual figures.
    d. an independent advisor.

Answer 36

b

Question 37

62. A thorough evaluation of how well a project’s actual performance matches the projections made when the project was proposed is called a
    a. pre-audit.
    b. post-audit.
    c. risk analysis.
    d. sensitivity analysis.

Answer 37

b

Question 38

63. Performing a post-audit is important because
    a. managers will be more likely to submit reasonable data when they make investment proposals if they know their estimates will be compared to actual results.
    b. it provides a formal mechanism by which the company can determine whether existing projects should be terminated.
    c. it improves the development of future investment proposals because managers improve their estimation techniques by evaluating their past successes and failures.
    d. all of these.

Answer 38

d

Question 39

64. A capital budgeting method that takes into consideration the time value of money is the
    a. annual rate of return method.
    b. return on shareholders’ equity method.
    c. cash payback technique.
    d. internal rate of return method.

Answer 39

d

Question 40

65. The internal rate of return is the interest rate that results in a
    a. positive NPV.
    b. negative NPV.
    c. zero NPV.
    d. positive or negative NPV

Answer 40

c

Question 41

66. In using the internal rate of return method, the internal rate of return factor was 4.0 and the equal annual cash inflows were $16,000. The initial investment in the project must have been
    a. $8,000.
    b. $16,000.
    c. $64,000.
    d. $32,000

Answer 41

c

Question 42

67. The capital budgeting technique that finds the interest yield of the potential investment is the
    a. annual rate of return method.
    b. internal rate of return method.
    c. net present value method.
    d. profitability index method.

Answer 42

b

Question 43

68. All of the following statements about the internal rate of return method are correct except that it
    a. recognizes the time value of money.
    b. is widely used in practice.
    c. is easy to interpret.
    d. can be used only when the cash inflows are equal

Answer 43

d

Question 44

Use the following table for questions 69–72.

	Present Value of an Annuity of 1 Periods	 8%	 9% 10%1	     .926	.91 .909 2	1.783  1.759  1.736 3	2.577 2.531 2.487

69. A company has a minimum required rate of return of 9% and is considering investing in a project that costs $50,000 and is expected to generate cash inflows of $30,000at the end of each year for two years. The net present value of this project is
    a. $20,000.
    b. $10,000.
    c. $6,920.
    d. $2,770.

Answer 44

d

Question 45

Present Value of an Annuity of 1
Periods 8% 9% 10%1 .926 .91 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

70. A company has a minimum required rate of return of 9% and is considering investing in a project that costs $50,000 and is expected to generate cash inflows of $20,000 at the end of each year for three years. The profitability index for this project is
    a. .99.
    b. 1.00.
    c. 1.01.
    d. 1.20.

Answer 45

c

Question 46

Present Value of an Annuity of 1
Periods 8% 9% 10%1 .926 .91 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

71. A company has a minimum required rate of return of 8% and is considering investing in a project that costs $67,145 and is expected to generate cash inflows of $27,000 each year for three years. The approximate internal rate of return on this project is
    a. 8%.
    b. 10%.
    c. 9%.
    d. less than the required 8%.

Answer 46

b

Question 47

Present Value of an Annuity of 1
Periods 8% 9% 10%1 .926 .91 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

72. A company has a minimum required rate of return of 10% and is considering investing in a project that requires an investment of $68,000 and is expected to generate cash inflows of $30,000 at the end of each year for 3 years. The present value of future cash inflows for this project is
    a. $68,000.
    b. $74,610.
    c. $7,930.
    d. $6,610

Answer 47

b

Question 48

A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life. If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000. The straight-line method of depreciation would be used.

77. If the equipment is purchased, the annual rate of return expected on this equipment is
    a. 37.5%.
    b. 31.25%.
    c. 11.25%.
    d. 6.25%.

Answer 48

c

Question 49

A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life. If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000. The straight-line method of depreciation would be used.

78. The cash payback period on the equipment is
    a. 8.89 years.
    b. 5.0 years.
    c. 3.2 years.
    d. 2.67 years

Answer 49

c

Question 50

79. The annual rate of return method is also referred to as:
    a. simple rate of return method.
    b. accounting rate of return method.
    c. unadjusted rate of return method.
    d. all of the above.

Answer 50

d

Question 51

80. The annual rate of return method is based on
    a. accounting data.
    b. the time value of money data.
    c. market values.
    d. cash flow data.

Answer 51

a

Question 52

81. What is the main disadvantage of the annual rate of return method?
    a. It is only valid for investments with a one year time perspective.
    b. It incorporates depreciation into the calculations, which increases the uncertainty of the calculations associated with estimating the life and salvage value of the investment.
    c. No consideration is given as to when the cash inflows occur.
    d. It does not consider the time value of money

Answer 52

d

Question 53

A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $50,000. The company uses the straight-line method of depreciation.

82. What is the net annual cash flow?
    a. $40,000
    b. $90,000
    c. $130,000
    d. $140,000

Answer 53

c

Question 54

A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $50,000. The company uses the straight-line method of depreciation.

83. What is the cash payback period?
    a. 12.5 years
    b. 5.56 years
    c. 3.85 years
    d. 3.57 years

Answer 54

c

Question 55

A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $50,000. The company uses the straight-line method of depreciation.

84. What is the annual rate of return?
    a. 8%
    b. 14.5%
    c. 18%
    d. 26.7%

Answer 55

b

Question 56

85. All of the following statements about the annual rate of return method are correct except that it
    a. indicates the profitability of a capital expenditure.
    b. ignores the salvage value of an investment.
    c. does not consider the time value of money.
    d. compares the annual rate of return to management’s minimum rate of return.

Answer 56

b

Question 57

88. Doris Co. is considering purchasing a new machine which will cost $200,000, but which will decrease costs each year by $50,000. The useful life of the machine is 10 years. The machine would be depreciated straight-line with no residual value over its useful life at the rate of $20,000/year. The payback period is
    a. 5.0 years
    b. 4.5 years
    c. 4.0 years
    d. 10.0 years

Answer 57

c

Question 58

90. Mystery Co. is considering purchasing a new piece of equipment that will cost $600,000. The equipment has an estimated useful life of 8 years and no salvage value. The equipment will produce cash inflows of $215,000 per year and net income of $90,000 per year. Mystery requires a 10% rate of return. What is the payback period for this equipment?
    a. 8.0 years
    b. 3.75 years
    c. 2.79 years
    d. 6.67 years

Answer 58

c

Question 59

94. Capital budgeting relies on cash inflows and outflows as preferred inputs for calculations because
    a. managers prefer to use cash figures rather than accounting figures.
    b. GAAP does not apply to capital budgeting decisions.
    c. projects require cash paid out and firms want to know when cash will be returned.
    d. cash figures are easier to calculate than accounting figures.

Answer 59

c

Question 60

95. Which of the following would not be considered as an input into a capital budgeting decision?
    a. Scrap value of equipment sold at the end of a project
    b. Labour savings as a result of mechanization of a process
    c. Cost outlays many years after the project has started
    d. Amortization on a straight line basis

Answer 60

d

Question 61

96. The cash payback method is useful because
    a. it gives a broad indication when outlays will be recovered by the firm.
    b. it gives a specific date as to when outlays will be recovered by the firm.
    c. it avoids using complicated accounting data in capital budgeting decisions.
    d. it is easy to communicate the relation between cash received and ultimate profitability of a project to everyone in the organization.

Answer 61

a

Question 62

97. The major difficulty of the cash payback method is
    a. it ignores any salvage values at the end of a project.
    b. it ignores the time value of money in the calculations.
    c. it ignores the overall cash flow of the project.
    d. it ignores the overall profitability of the project.

Answer 62

d

Question 63

98. When evaluating a project, companies should always use
    a. the Bank of Canada rate of interest.
    b. the rate that is currently charged at its bank.
    c. the current corporate borrowing rate.
    d. the corporate borrowing rate adjusted for any perceived risk of the project.

Answer 63

d

Question 64

99. An intangible benefit of a project would best be described as?
    a. Goodwill will be increased on the balance sheet as a result of the project.
    b. The company’s bankers may offer a lower rate of interest for certain projects.
    c. The company’s presence in its market is enhanced by the project.
    d. The company may be allowed deferred income tax payment terms as a result of the project.

Answer 64

c

Question 65

100. When accepting large capital projects, a company should
     a. pay strict attention to what the numbers indicate and accept or reject a project accordingly.
     b. pay close attention to trends in the marketplace before accepting or rejecting a project.
     c. assess the numbers on the project and then go with management’s best judgment.
     d. assess the numbers on the project then review the intangible benefits before accepting or rejecting a project

Answer 65

b

Question 66

101. Sensitivity analysis on a potential project
     a. is only useful to perform when there are firm calculations on the project available.
     b. is useful to perform when uncertainty exists and calculations are based on estimates.
     c. is designed to ensure that management is aware of all possible outcomes of the project.
     d. is designed to provide an escape-hatch for management should the project not succeed.

Answer 66

b

Question 67

102. In using the Internal Rate of Return method
     a. management can ignore the cost of capital for the project.
     b. management must understand its own required rate of return for projects.
     c. the Net Present Value method can be ignored in assessing the project.
     d. both the Net Present Value and Cash Payback methods can be ignored in assessing the project.

Answer 67

b

Question 68

103. The major difference between the Net Present Value method and the Annual Rate of Return method in evaluating a capital project is
     a. the ARR method is easier for accountants to justify than the NPV method.
     b. the NPV method is easier for managers to justify than the ARR method.
     c. the ARR method focuses on overall profitability of a project.
     d. the NPV method focuses on the overall profitability of a project.
      

Answer 68

c