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 aproject?
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 hasa(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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