Chapter 13 Review Questions
3. Why are the net present value and internal rate of return methods of capital
budgeting superior to the payback method?
A. Because they are easier to implement.
B. Because they consider the time value of money.
C. Because they require less input.
D. Because they reflect the effects of depreciation and income taxes.
4. How are the following items used in the calculation of the net present value of a
proposed project? (Ignore income tax considerations.)
Depreciation Expense
A) Include
B) Include
C) Exclude
D) Exclude
Salvage Value
Include
Exclude
Include
Exclude
A. Option A
B. Option B
C. Option C
D. Option D
5. The net present value method takes into account which of the following?
Cash Flow over Life of Project
A) No
B) No
C) Yes
D) Yes
Time Value of Money
Yes
No
No
Yes
A. Option A
B. Option B
C. Option C
D. Option D
6. The net present value method of capital budgeting assumes that cash flows are
reinvested at what rate?
A. The internal rate of return on the project.
B. The rate of return on the company's debt.
C. The discount rate used in the analysis.
D. A zero rate of return.
7. Some investment projects require that a company expand its working capital to
service the greater volume of business that will be generated. Under the net present
value method, how should the investment of working capital be treated?
A. An initial cash outflow for which no discounting is necessary.
B. A future cash inflow for which discounting is necessary.
C. Both an initial cash outflow for which no discounting is necessary and a future cash
inflow for which discounting is necessary.
D. Irrelevant to the net present value analysis.
9. Which of the following capital budgeting techniques consider(s) cash flow over the
entire life of the project?
Internal Rate of Return
A) Yes
B) Yes
C) No
D) No
A. Option A
B. Option B
C. Option C
D. Option D
Payback
Yes
No
Yes
No
10. Which of the following is a weakness of the internal rate of return method for
screening investment projects?
A. It does NOT consider the time value of money.
B. It implicitly assumes that the company is able to reinvest cash flows from the project
at the company's discount rate.
C. It implicitly assumes that the company is able to reinvest cash flows from the project
at the internal rate of return.
D. It does NOT take into account all of the cash flows from a project.
11. If the net present value of a project is zero, based on a discount rate of 16%, which
of the following statements about the project's internal rate of return is correct?
A. It is equal to 16%.
B. It is less than 16%.
C. It is greater than 16%.
D. It cannot be determined from the information given.
12. What does the payback method measure?
A. How quickly investment dollars may be recovered.
B. The cash flow from an investment.
C. The economic life of an investment.
D. The profitability of an investment.
13. An investment project that requires a present investment of $210,000 will have cash
inflows of R dollars each year for the next five years. The project will terminate in five
years. Consider the following statements (ignore income tax considerations):
I. If R is less than $42,000, the payback period exceeds the life of the project.
II. If R is greater than $42,000, the payback period exceeds the life of the project.
III. If R equals $42,000, the payback period equals the life of the project.
Which statement(s) is(are) true?
A. I and II only.
B. I and III only.
C. II and III only.
D. I, II, and III.
14. Which one of the following statements about the payback method of capital
budgeting is correct?
A. The payback method does NOT consider the time value of money.
B. The payback method considers cash flows after the payback has been reached.
C. The payback method uses discounted cash flow techniques.
D. The payback method will lead to the same decision as other methods of capital
budgeting.
15. Which of the following statements about the evaluation of an investment having
uneven cash flows using the payback method is correct?
A. It CANNOT be done.
B. It can be done only by matching cash inflows and investment outflows on a year-byyear basis.
C. It will produce essentially the same results as those obtained through the use of
discounted cash flow techniques.
D. It requires the use of a sophisticated calculator or computer software.
16. What is the capital budgeting method that divides a project's annual incremental net
income by the initial investment?
A. The internal rate of return method.
B. The simple (or accounting) rate of return method.
C. The payback method.
D. The net present value method.
26. A planned factory expansion project has an estimated initial cost of $800,000. Using
a discount rate of 20%, the present value of future cost savings from the expansion is
$843,000. To yield exactly a 20% internal rate of return, the actual investment cost
cannot exceed the $800,000 estimate by more than which of the following? (Ignore
income taxes in this problem.)
A. $1,075.
B. $20,000.
C. $43,000.
D. $160,000.
53. Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The
auto was purchased for $9,000 and will have a six-year useful life and a $3,000 salvage
value. Delivering prescriptions (which the pharmacy has never done before) should
increase gross revenues by at least $5,000 per year. The cost of these prescriptions to
the pharmacy will be about $2,000 per year. The pharmacy depreciates all assets using
the straight-line method. What is the payback period for the auto? (Ignore income taxes
in this problem.)
A. 1.2 years.
B. 1.8 years.
C. 2.0 years.
D. 3.0 years.
9000/ (5000-2000) = 3 yrs
54. A company with $800,000 in operating assets is considering the purchase of a
machine that costs $75,000 and which is expected to reduce operating costs by
$20,000 each year. The payback period for this machine in years is closest to which of
the following? (Ignore income taxes in this problem.)
A. 0.27 years.
B. 3.75 years.
C. 10.70 years.
D. 40.00 years.
75000 / 20000 = 3.75 yrs
55. The Higgins Company has just purchased a piece of equipment at a cost of
$120,000. This equipment will reduce operating costs by $40,000 each year for the next
eight years. This equipment replaces old equipment that was sold for $8,000 cash.
What is the new equipment's payback period? (Ignore income taxes in this problem.)
A. 2.8 years.
B. 3.0 years.
C. 8.0 years.
D. 10.0 years.
(120000 - 8000) / 40000 = 2.8 yrs
56. The Keego Company is planning a $200,000 equipment investment that has an
estimated five-year life with no estimated salvage value. The company has projected
the following annual cash flows for the investment.
Year
Cash Inflows
1
$120,000
2
$60,000
3
$40,000
4
$40,000
5
$40,000
Total
$300,000
Assuming that the cash inflows occur evenly over the year, what is the payback period
for the investment? (Ignore income taxes in this problem.)
A. 0.75 years.
B. 1.67 years.
C. 2.50 years.
D. 4.91 years.
200000 - 120000 - 60000 = 20000 remaining after year 2
Payback = 2 + 20000/40000 = 2/5 yrs
57. Denny Corporation is considering replacing a technologically obsolete machine with
a new state-of-the-art numerically controlled machine. The new machine would cost
$450,000 and would have a ten-year useful life. Unfortunately, the new machine would
have no salvage value. The new machine would cost $20,000 per year to operate and
maintain, but would save $100,000 per year in labour and other costs. The old machine
can be sold now for scrap for $50,000. The simple rate of return on the new machine is
closest to which of the following? (Ignore income taxes in this problem.)
A. 7.78%.
B. 8.75%.
C. 20.00%.
D. 22.22%.
(100000 - 20000 - 450000/10) / (450000 - 50000) = 8.75%
58. The Jason Company is considering the purchase of a machine that will increase
revenues by $32,000 each year. Cash outflows for operating this machine will be
$6,000 each year. The cost of the machine is $65,000. It is expected to have a useful
life of five years with no salvage value. For this machine, what is the simple rate of
return? (Ignore income taxes in this problem.)
A. 9.2%.
B. 20.0%.
C. 40.0%.
D. 49.2%.
(65000 - 6000 - 65000/5) / 65000 = 20%
59. Perkins Company is considering several investment proposals, as shown below:
Investment required
Present value of
Future net cash flows
A
$80,000
Investment Proposal
B
C
$100,000
$60,000
D
$75,000
96,000
150,000
120,000
84,000
Profitability Index = Present value of future net cash flows / Investment required
What are the preference rankings of the proposals, using the profitability index?
A. D, B, C, A.
B. B, D, C, A.
C. D, C, B, A.
D. A, C, B, D.
60. Information on four investment proposals is given below:
Proposal
Investment
Net Present Value
1
$50,000
$30,000
2
$60,000
$24,000
3
$30,000
$15,000
4
$45,000
$9,000
What are preference rankings of the four proposals according to the profitability index?
A. 3, 4, 1, 2.
B. 1, 2, 3, 4.
C. 1, 3, 2, 4.
D. 2, 1, 4, 3.
Profitability index for #1 = (30+50 / 50) = 1.6
Bugle's Bagel Bakery is investigating the purchase of a new bagel-making machine.
This machine would provide an annual operating cost savings of $3,650 for each of the
next four years. In addition, this new machine would allow the production of one new
type of bagel that would result in selling 1,500 dozen more bagels each year. The
company earns a contribution margin of $0.90 on each dozen bagels sold. The
purchase price of this machine is $13,450, and it will have a four-year useful life. Bugle's
discount rate is 14%. (Ignore income taxes in this problem.)
89. What is the total annual cash inflow from this machine for capital budgeting
purposes?
A. $3,650.
B. $4,750.
C. $5,000.
D. $5,150.
(1500 bagels x .90 contribution margin each) + $3650 = $5000
Oriental Company has gathered the following data on a proposed investment project:
Investement in Depreciable Equipment
Annual Net Cash Flows
Life of the Equipment
Salvage Value
Discount Rate
$200,000
$50,000
10 years
-010%
The company uses straight-line depreciation on all equipment. (Ignore income taxes in
this problem.)
94. What would be the payback period for the investment?
A. 0.25 years.
B. 2.41 years.
C. 4.00 years.
D. 10.00 years.
200000/ 50000 = 4 years
95. What would be the simple rate of return on the investment?
A. 10%.
B. 15%.
C. 25%.
D. 35%.
(50000 - 200000/10) / 200000 = 15%