Which of the following best describes the internal rate of return method quizlet?

Global Toys, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available.

Year Cash Flow A Cash Flow B
0 -$ 52,000 -$ 97,000
1 20,500 22,500
2 27,200 27,500
3 22,500 31,500
4 8,500 243,000

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Terms in this set (97)

Capital budgeting is the process of making
long−run
planning decisions for investments in projects.

true

The accrual accounting
rate−of−return
method is a discounted cash flow approach to analyzing possible capital budget expenditures.

false

Upon which of the following items does discounted cash flow methods for capital budgeting​ focus?

cash inflows and required rate of return

Forge Company wants to purchase a new cutting machine for its sewing plant. The investment is expected to generate annual cash inflows of
$210,000.
The required rate of return is
18​%
and the current machine is expected to last for
five
years. Of the following​ choices, whterm-4ich is the dollar amount the company would be willing to spend for the​ machine, assuming its life is also
five
​years? Income taxes are not considered.

656,670
Work: 210,000 x PVAnn(18%,4)

The Comil Corporation recently purchased a new machine for its factory operations at a cost of
$442,200.
The investment is expected to generate
$120,000
in annual cash flows for a period of
six
years. The required rate of return is
10​%.
The old machine has a remaining life of
six
years. The new machine is expected to have zero value at the end of the
six−year
period. The disposal value of the old machine at the time of replacement is zero. What is the internal rate of​ return?

16%

Which of the following best explains why the net present value method of capital budgeting is preferred over the internal
rate−of−return
​method?

the net present values of individual projects can be added to determine the effects of accepting a combination of projects

Malive Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be​ $219,000. The annual cost savings if the new machine is acquired will be​ $35,000. The machine will have a
5−year
​life, at which time the terminal disposal value is expected to be zero. Malive Park is assuming no tax consequences. Malive Park has a​ 12% required rate of return. What is the payback period for the​ investment?

6.3 years

Which of the following statements is true of accrual accounting rate of return​ (AARR) method and internal rate of return​ (IRR) method

The AARR method calculates the return using
operating−income
numbers after considering accruals and​ taxes, whereas the IRR method calculates the return using
after−tax
cash flows and the time value of money.

Net initial investment includes​ ________

cash outflow to purchase new​ equipment, cash outflow for working​ capital, and
after−tax
cash inflow from disposal of the old equipment

Depreciation has no impact on a capital​ project's cash flows because depreciation is a noncash expense

true

Which of the following involves the process of making decisions for significant financial investments in projects to develop new​ products, expand production​ capacity, or remodel current production​ facilities?

capital budgeting

The accrual accounting
rate−of−return
method is a discounted cash flow approach to analyzing possible capital budget expenditures

false

Upon which of the following items does discounted cash flow methods for capital budgeting​ focus?

cash inflows and required rate of return

Which of the following methods utilizes discounted cash flows when analyzing potential capital​ expenditures?
​Methods:
1. Accrual accounting rate−of−return
2. Internal Rate of Return​ (IRR)
3. Payback Period
4. Net Present Value​ (NPV)

2 and 4

Net present value is calculated using which of the​ following?

required rate of return as a discount rate

Which of the following capital budgeting methods uses discounted cash​ flows?

net present value method

Which of the following methods is described as​ follows: "It calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time using the required rate of​ return"?

net present value method

In using the net present value​ method, only projects with a zero or positive net present value are acceptable because​ ________.

the return from these projects equals or exceeds the cost of capital

Which of the following is another term for required rate of​ return?

hurdle rate

Which of the following projects is rejected on the basis of net present value​ method?

Project B with an NPV of
​$(16,000​)

An annuity is​ ________.

a series of equal cash flows at equal time intervals

If the net present value for a project is​ positive, which of the following is​ true?

the project should be accepted because its expected rate of return is greater than the cost of capital

Forge Company wants to purchase a new cutting machine for its sewing plant. The investment is expected to generate annual cash inflows of
$180,000.
The required rate of return is
18​%
and the current machine is expected to last for
four
years. Of the following​ choices, which is the dollar amount the company would be willing to spend for the​ machine, assuming its life is also
four
​years? Income taxes are not considered.

484200

The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of
$470,000.
The investment is expected to generate
$205,000
in annual cash flows for a period of four years. The required rate of return is
10​%.
The old machine can be sold for
$40,000.
The machine is expected to have zero value at the end of the
four−year
period. What is the net present value of the​ investment? Would the company want to purchase the new​ machine? Income taxes are not considered.

219,850 yes

The capital budgeting method that calculates the discount rate at which the present value of expected cash inflows from a project equals the present value of expected cash outflows is the​ ________.

internal rate of return method

Which of the following best describes the internal
rate−of−return
​(IRR) method?

it calculates the discount rate at which sum of an​ investment's present value of all expected cash inflows equals the present value of its expected cash outflows

A general rule in capital budgeting is that a project is accepted only if the internal rate of return equals or​ ________.

exceeds the required rate of return

Locil Corporation recently purchased a new machine for
$306,425
with​ a(n)
seven−year
life. The old equipment has a remaining life of
seven
years and no disposal value at the time of replacement. Net cash flows will be
$85,000
per year. What is the internal rate of​ return?

20%

Soda Manufacturing Company provides vending machines for
soft−drink
manufacturers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of
eight
years and the new equipment will cost
$160,728
with a
eight−year
life. The expected additional cash inflows are
$37,000
per year. What is the internal rate of​ return?

16%

Diamond Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of
eight
years and the new equipment will cost
$141,969
with​ a(n)
eight−year
life. The expected additional cash inflows are
$37,000
per year. What is the internal rate of​ return?

20%

Midize Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van will cost
$29,140
with​ a(n)
four−year
life. The expected additional cash inflows are
$10,000
per year. What is the internal rate of​ return?

14%

Which of the following best explains why the net present value method of capital budgeting is preferred over the internal
rate−of−return
​method?

the net present values of individual projects can be added to determine the effects of accepting a combination of projects

In situations where the required rate of return is not constant for each year of the​ project, it is advantageous to use​ ________.

the net present value method

A
​"what−​if"
technique that examines how a result will change if the original predicted data are NOT achieved or if an underlying assumption changes is called​________.

sensitivity analysis

nvestment A requires a net investment of
$1,400,000
The required rate of return is
10​%
for the
five−year
annuity. What are the annual cash inflows if the net present value equals​ 0? (rounded)

369,296

Hypore Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be
$348,400.
The annual cost savings if the new machine is acquired will be
$80,000.
The machine will have a
6−year
​life, at which time the terminal disposal value is expected to be zero. Hypore Park Department is assuming no tax consequences. What is the internal rate of return for Hypore Park​ Department?

10%

Which of the following is an advantage of internal rate of return​ method?

The percentage returns computed under the IRR method are easy to understand and compare.

The net present value method assumes that project cash flows can be reinvested at the​ company's ________.

required rate of return

The internal rate of return method assumes that project cash flows can be reinvested at the​ project's ________.

internal rate of return

The NPV method is the preferred method over IRR for selecting projects because​ ________.

its result is expressed in dollars and management can make an assessment as to its financial impact on the value of the business

Discounted cash flow methods do not consider the present value of the cash flows after the recovery of the initial investment.

false

The three common discounted cash flow methods are net present​ value, internal rate of​ return, and payback.

false

The net present value​ (NPV) method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return

true

Discounted cash flow methods of evaluating capital expenditures focuses on the operating income as calculated under accrual accounting rules.

false

The net present value method can be used in situations where the required rate of return varies over the life of the project.

true

The net present value method accurately assumes that project cash flows can only be reinvested at the​ company's required rate of return.

true

If internal rate of return is less than required rate of​ return, the net present value is positive.

false

Managers prefer projects with higher IRRs to projects with lower​ IRRs, if all other things are equal.

true

The IRR method assumes that cash flows are reinvested at the​ company's required rate of return.

false

Which of the following methods is described as the method that measures the time it will take to​ recoup, in the form of future cash​ inflows, the total dollars invested in a​project?

the payback method

The net initial investment for a piece of construction equipment is
$2,200,000.
Annual cash inflows are expected to increase by
$500,000
per year. The equipment has​a(n)
9−year
useful life. What is the payback​ period?

4.4 years

The payback method of capital budgeting approach to an investment decision​ ________.

assumes that cash flows occur uniformly throughout the year

The payback method of capital budgeting approach to an investment decision​ ________.

does not consider cash flows that occur after the payback period

Malive Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be
$149,000.
The annual cost savings if the new machine is acquired will be
$45,000.
The machine will have a
6−year
​life, at which time the terminal disposal value is expected to be zero. Malive Park is assuming no tax consequences. Malive Park has a
12​%
required rate of return. What is the payback period for the​ investment?

3.3 years

Pearl Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of
seven
years and the new equipment has a value of
$319,400
with a
seven−year
life. The expected additional cash inflows are
$73,000
per year. What is the payback period for this​ investment?

4.4 years

Ambinu Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van has a value of
$163,750
with a
nine−year
life. The expected additional cash inflows are
$62,500
per year. What is the payback period for this​ investment?

2.6 years

A weaknesses of the payback method is that it does not consider a​ project's cash flows after the payback period.

true

Which of the following methods of capital budgeting divides the average annual accrual accounting income of a project by a measure of the investment in​ it?

accrual accounting rate of return

Accrual accounting rate of return is calculated by dividing​ ________.

an increase in expected average annual
after−tax
operating income by the net initial investment

Which of the following is the numerator in the mathematical expression for accrual accounting
rate−of−return
​(AARR)?

increase in expected average annual
after−tax
operating income

Which of the following statements is true of accrual accounting rate of return​ (AARR) method and internal rate of return​ (IRR) method?

The AARR method calculates the return using
operating−income
numbers after considering accruals and​ taxes, whereas the IRR method calculates the return using
after−tax
cash flows and the time value of money.

The AARR method is similar to the IRR method as​ ________.

both calculate the result in terms of percentage

Which of the following is a limitation of AARR​ method?

It does not consider time value of money.

Relevant annual earned income from a project is divided by capital invested in that project to calculate

accrual accounting rate of return

Accrual accounting rate of return is calculated by dividing an increase in expected average annual
after−tax
operating income by the net initial or average investment.

true

The accrual accounting
rate−of−return
method has a significant weakness for use in making capital budgeting decisions because it does NOT track cash flows and it ignores the time value of money.

true

As cash flows and time value of money are central to capital budgeting​ decisions, the AARR method is regarded as better than the IRR method.

false

Unlike the payback​ method, which ignores cash flows after the payback​ period, the AARR method considers income earned throughout a​ project's expected useful life.

true

Which of the following is a component of
net−initial−investment
cash​ flows?

initial working capital investment

The galaxy Corporation disposes a capital asset with an original cost of
$220,000
and accumulated depreciation of
$71,000
for
$56,000.
The​ company's tax rate is
40​%.
Calculate the
after−tax
cash inflow from the disposal of the capital asset.

93200

The Golden Shades Corporation disposes a capital asset with an original cost of
$280,000
and accumulated depreciation of
$160,000
for a salvage price of
$48,000.
Golden​ Shades's tax rate is
40​%.
Calculate the
after−tax
cash inflow from the disposal of the capital asset.

76,800

The Ambitz Corporation has an annual cash inflow from operations from its investment in a capital asset of
$45,000
​(excluding the​ deprecation) each year for
five
years. The​ corporation's income tax rate is
35​%.
Calculate the total
after−tax
cash inflow from operations for
five
years.

$146,250

The Venoid Corporation has an annual cash inflow from operations from its investment in a capital asset of
$26,000
​(excluding depreciation) each year for
five
years. The​ corporation's income tax rate is
35​%.
Calculate the total
after−tax
cash inflow from operations for
five
years.

84,500

A company is looking to purchase and replace a fixed asset for
$245,000.
It will sell the asset that will be replaced for
$47,000
but will incur a
$15,000
gain upon that sale. It must also commit​ $30,000 of
working−capital
to the investment. The​ firm's tax rate is
35​%.
What is the amount of the relevant initial​ investment?

233,250

The focus in capital budgeting should be on​ ________.

expected future cash flows that differ between alternatives

An example of a sunk cost in a capital budgeting decision for new equipment is​ ________.

the original price of an old equipment

Depreciation is usually NOT considered an operating cash flow in capital budgeting because​ ________.

deducting depreciation from operating cash flows would be counting the
lump−sum
amount twice

Net initial investment includes​ ________.

cash outflow to purchase new​ equipment, cash outflow for working​ capital, and
after−tax
cash inflow from disposal of the old equipment

The income taxes saved as a result of depreciation deductions are irrelevant because they decrease cash outflows.

false

Depreciation has no impact on a capital​ project's cash flows because depreciation is a noncash expense.

false

The use of an accelerated method of depreciation for tax purposes would usually decrease the present value of the investment.

false

Net initial investment in the project includes the acquisition of assets and any associated additions to working​ capital, minus the
after−tax
cash flow from the disposal of existing assets

true

Relevant cash flows are expected future cash flows that differ among the alternative uses of investment funds.

true

Cash flows from the terminal disposal of the investment include the
pre−tax
cash flow from terminal disposal of assets and the
pre−tax
cash flow from terminal recovery of
working−capital
investment.

false

In determining whether to keep a machine or replace​ it, the original cost of the machine is a sunk cost and is NOT a relevant factor.

true

In the net present value​ (NPV) method,
pre−tax
cash flows should be used instead of
after−tax
cash flows.

false

In calculating the net initial investment cash​ flows, any increase in working capital required for the project should be included.

true

A loss on the disposal of a replacement asset is an irrelevant fact when estimating relevant cash flows of a capital asset decision.

false

A commitment to a new capital project will always result in an increase in net working capital.

false

While calculating terminal recovery of working capital there are no tax consequences as there is no gain or loss on working capital.

true

Depreciation results in income tax cash savings that are equal to the depreciation expense multiplied by the​ company's income tax rate.

true

​"Only quantitative outcomes are relevant in capital budgeting​ analyses." Do you​ agree? Explain.

No. Quantitative outcomes are not the only relevant factors in capital budgeting. Many effects of capital budgeting​ decisions, are difficult to quantify in financial terms. These nonfinancial or qualitative factors​ (for example, the number of accidents in a manufacturing plant or employee​ morale) are important to consider in making capital budgeting decisions.

Distinguish different categories of cash flows to be considered in an​ equipment-replacement decision by a taxpaying company.
Select the relevant cash flow considerations in each of the three categories of cash flows for an equipment replacement project

1.Net initial investment:
-Initial machine investment
-Initial working-capital investment
-After-tax cash flow from current disposal of old machine
2.
-Cash flow from operations:
-Annual after-tax cash flow from operations (excluding the depreciation effect)
-Income tax cash savings from annual depreciation deductions
3.
-Terminal disposal of investment:
-After-tax cash flow from terminal recovery of working-capital investment
-After-tax cash flow from terminal disposal of machines

Select three ways income taxes can affect the cash inflows or outflows in a​ motor-vehicle-replacement decision by a taxpaying company.

Tax is payable on gain or loss on disposal of the existing motor vehicle.
2.
Additional depreciation deductions for the new vehicle result in tax cash savings.
3.
Tax is payable on gain or loss on the sale of the new vehicle at the project termination date.

Which of the following items describes a weakness of the internal​ rate-of-return method?

Cash flows from the investment are assumed in the IRR analysis to be reinvested at the internal rate of return

Alan's
Enterprises has purchased a new machine tool which will allow the company to improve the efficiency of its operations. On an annual​ basis, the machine will produce 16,000 units with an expected selling price of $19​, prime costs of $10 per​ unit, and a fixed cost allocation of $1 per unit. Annual depreciation on the machine is $18,000​, and the tax rate of the company is 38​%.
What is the annual cash flow generated from the new​ machine?

96,120

Nick's
Enterprises has purchased a new machine tool which will allow the company to improve the efficiency of its operations. On an annual​ basis, the machine will produce 20,000 units with an expected selling price of $10​, prime costs of $6 per​ unit, and a fixed cost allocation of $3 per unit. Annual depreciation on the machine is $12,000​, and the tax rate of the company is 25​%.
What is the annual cash flow generated from the new​ machine?

63000

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