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Exam 24: Capital Budgeting and Investment Analysis

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Question 1

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If the straight-line depreciation method is used,the annual average investment amount used in calculating the accounting rate of return is calculated as (beginning book value + ending book value)/2.

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B) False

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Question 2

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When comparing investments with similar lives and risks,a company will prefer the investment with the higher rate of return.

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B) False

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Question 3

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Which of the following is an objective of capital budgeting?

A positive profitability index indicates a positive net present value.

The ________ is computed by discounting the future net cash flows from the investment at the project's required rate of return and then subtracting the initial amount invested.

Capital budgeting decisions usually involve analysis of:

Soft capital rationing is imposed by external factors,such as debt covenants.

A company is considering the purchase of a new piece of equipment for $90,000.Predicted annual cash inflows from this investment are $36,000 (year 1) ,$30,000 (year 2) ,$18,000 (year 3) ,$12,000 (year 4) and $6,000 (year 5) .The payback period is:

The process of restating cash flows in terms of their present values is called discounting.

A new manufacturing machine is expected to cost $278,000,have an eight-year life,and a $30,000 salvage value.The machine will yield an annual incremental after-tax income of $35,000 after deducting the straight-line depreciation.Compute the accounting rate of return for the investment.

The accounting rate of return uses cash flows in its calculation.

A company is considering two projects,Project A and Project B.The following information is available for each project: Calculate the profitability index for each project.Based on the profitability index,which project,if any,should the company pursue and why?

When the amount invested differs substantially across projects,NPV is of limited value for comparison purposes.You have evaluated three projects of substantially different investment amounts using the net present value (NPV)method.How would you decide which one of the projects to select?

A company is evaluating the purchase of a machine for $750,000 with a six-year useful life and no salvage value.The company uses straight-line depreciation and it assumes that the annual net cash flow from using the machine will be received uniformly throughout each year.In calculating the accounting rate of return,what is the company's average investment?

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 straight-line depreciation of $4,000 per year.The company's after-tax net income,based on a tax rate of 40%,is $2,400.What is the approximate accounting rate of return for the machine?

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.

Two investments with exactly the same payback periods are always equally valuable to an investor.

A company is considering the purchase of new equipment for $42,000.The projected annual cash inflow is $18,000.The machine has a useful life of 3 years and no salvage value.Management of the company requires a 12% return on investment.The present value of an annuity of $1 for various periods follows: What is the net present value of this machine assuming all cash flows occur at year-end?

The payback period is the amount of time for the investment to generate enough net cash flow to return the initial cost of investment.

Accounting rate of return gives managers an estimate of how soon they will recover their initial investment.