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Exam 26: Capital Investment Decisions

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Question 31

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Which of the following best describes a capital budgeting post-audit?

A) an audit of an operating unit of a company
B) an audit performed only at the end of the project's life span
C) an analysis of an investment's cash flows prior to committing to the initial investment
D) a comparison of actual results of capital investments with projected results

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Question 32

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Lora Corporation will receive $10,000 a year at the end of each of the next five years.Using a discount rate of 14%,the present value of the receipts can be stated as ________.

A) PV = $10,000 (Ordinary Annuity FV factor, i = 14%, n = 5)
B) PV = $10,000 (PV factor, i = 14%, n = 5)
C) PV = $10,000 (Ordinary Annuity PV factor, i = 14%, n = 5)
D) PV = $10,000 (FV factor, i = 14%, n = 5)

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Question 33

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Many service,merchandising,and manufacturing firms use discounted cash flow methods to make capital investment decisions.

Compound interest assumes that all interest earned will remain invested and earn additional interest at the same interest rate.

Landmark Prints is considering an investment in new equipment costing $520,000.The equipment will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash inflows of $128,000 the first year,$160,000 the second year,and $154,000 every year thereafter until the fifth year.What is the payback period for this investment? The residual value is zero.(Round your answer to two decimal places.)

When a company is evaluating an investment proposal with high risk,a low discount rate should be used.

A company is evaluating three possible investments.Each uses the straight-line method of depreciation.The following information is provided by the company: $\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 210,000 & \$ 54,000 & \$ 210,000 \\\hline \text { Residual value } & 0 & 30,000 & 28,000 \\\hline \text { Net cash flows: } & & & \\\hline \text { Year 1 } & 70,000 & 34,000 & 82,000 \\\hline \text { Year 2 } & 70,000 & 25,000 & 52,000 \\\hline \text { Year 3 } & 70,000 & 21,000 & 62,000 \\\hline \text { Year 4 } & 70,000 & 18,000 & 22,000 \\\hline \text { Year 5 } & 70,000 & 0 & 0 \\\hline\end{array}$ What is the accounting rate of return for Project C? (Round your answer to two decimal places.)

The net present value of future cash inflows received in earlier years is higher than future cash inflows received in later years.

The accounting rate of return method considers the time value of money.

Discounted cash flow methods,such as net present value and internal rate of return,________.

Provide responses to the following questions regarding the discount rate. $\begin{array} {| l | l | } \hline \text { Question? } & \text { Your response } \\\hline \text { What does the discount rate } & \\\text { represent? } & \\\hline \text { What are other names for the } & \\\text { discount rate? } & \\\hline \text { Is the following statement true? } & \\\text { Discuss the reason for your } & \\\text { response. } \\\text { "The higher the risk, the lower the } \\\text { discount rate." }\\\hline \end{array}$

When the internal rate of return is the same as the required rate of return,the net present value of an investment will be positive.

Capital rationing is a process adopted when a company has limited resources,and it must find ways to reduce operating expenses in all of its divisions and units.

Lloyd's Moving Company is considering purchasing new equipment that costs $728,000.Its management estimates that the equipment will generate cash flows as follows: $\begin{array} { | r | c | } \hline \text { Year 1 } & \$ 206,000 \\\hline 2 & 206,000 \\\hline 3 & 254,000 \\\hline 4 & 254,000 \\\hline 5 & 156,000 \\\hline\end{array}$ Present value of $1: $\begin{array} { | l | r | r | r | r | r | } \hline & { 6 \% } &{ 7 \% } & { 8 \% } & { 9 \% } & 10 \% \\\hline 1 & 0.943 & 0.935 & 0.926 & 0.917 & 0.909 \\\hline 2 & 0.890 & 0.873 & 0.857 & 0.842 & 0.826 \\\hline 3 & 0.840 & 0.816 & 0.794 & 0.772 & 0.751 \\\hline 4 & 0.792 & 0.763 & 0.735 & 0.708 & 0.683 \\\hline 5 & 0.747 & 0.713 & 0.681 & 0.650 & 0.621 \\\hline\end{array}$ The company's annual required rate of return is 9%.Using the factors in the table,calculate the present value of the cash flows.(Round all calculations to the nearest whole dollar.)

Management's minimum desired rate of return on a capital investment is known as the return on investment.

The internal rate of return (IRR)is the rate of return,based on discounted cash flows,of a capital investment.

Discounted cash flow methods incorporate compound interest by assuming that companies will reinvest future cash flows when they are received.

Zane Set Designs Company has received an award which entitles it to receive annual payments of $10,000 at the end of each year for the next ten years.Which of the following is used to calculate today's value of this award?

List the steps of the capital budgeting process and identify actions that relate to each step.

A company is considering an iron ore extraction project that requires an initial investment of $1,300,000 and will yield annual cash flows of $789,314 for two years.The company's discount rate is 9%.Calculate IRR. Present value of ordinary annuity of $1: $\begin{array} { r r r r r r r r } & 10 \% & 12 \% & 14 \% & 15 \% & 16 \% & 18 \% & 20 \% \\1 & 0.909 & 0.893 & 0.877 & 0.870 & 0.862 & 0.847 & 0.833 \\2 & 1.736 & 1.690 & 1.647 & 1.626 & 1.605 & 1.566 & 1.528 \\3 & 2.487 & 2.402 & 2.322 & 2.283 & 2.246 & 2.174 & 2.106 \\4 & 3.170 & 3.037 & 2.914 & 2.855 & 2.798 & 2.690 & 2.589\end{array}$