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Exam 11: Capital Budgeting and Investment Analysis

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Question 71

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A minimum acceptable rate of return for an investment decision is called the:

A) Internal rate of return.
B) Average rate of return.
C) Hurdle rate of return.
D) Maximum rate of return.
E) Payback rate of return.

F) A) and B)
G) B) and D)

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Question 72

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A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of $1 for five years are shown below:

A) The project should be accepted.
B) The project should be rejected because it earns less than 10%.
C) The project earns more than 10% but less than 12%. At a hurdle rate of 12%, the project should be rejected.
D) Only 9% is acceptable.
E) Only 10% is acceptable.

F) B) and D)
G) A) and B)

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Question 73

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Projects with shorter payback periods have higher risk, as the company has less time to respond to unanticipated changes.

In evaluating capital budgeting alternatives, there are two primary methods that do not consider the time value of money. These methods are ________ and ________. There are also two primary methods that consider the time value of money; these are ________ and ________.

Capital budgeting decisions are generally based on:

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.

The net present value decision rule is: When an asset's expected cash flows yield a positive net present value when discounted at the required rate of return, the asset should be acquired.

The minimum acceptable rate of return on an investment, often the company's cost of capital, is called the ________.

The net present value decision rule requires that when an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the project should be ________.

The calculation of annual net cash flow from a particular investment project should include all of the following except:

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

When making capital budgeting decisions, companies usually prefer shorter payback periods. Explain why shorter payback periods are desirable.

A project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows: $\begin{array} { l c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\$ 12,000 & \$ 8,000 & \$ 10,000 & \$ 30,000\end{array}$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $\begin{array} { c c c } = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\0.9091 & 0.8264 & 0.7513\end{array}$

A company can buy a machine that is expected to have a three-year life and a $30,000 salvage value. The machine will cost $1,800,000 and is expected to produce a $200,000 after-tax net income to be received at the end of each year. If a table of present values of $1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and 0.7118 for three years, what is the net present value of the cash flows from the investment, discounted at 12%?

Using a profitability index allows management to rank projects of similar risks with different investment amounts.

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

A positive profitability index indicates a positive net present value.

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

The capital budgeting process involves all of the following except:

A disadvantage of using the payback period to compare investment alternatives is that: