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Exam 16: Planning for Capital Investments

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Question 41

Multiple Choice

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The length of time required to recover the initial investment in a capital asset is known as the:

A) rate of return.
B) investment period.
C) present value period.
D) payback period.

E) C) and D)
F) None of the above

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Question 42

Multiple Choice

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Which one of the following statements best describes an ordinary annuity?

A) Series of cash inflows of varying amounts collected at the end of each period
B) Series of cash flows of equal amounts collected at the end of each period
C) Series of cash flows of varying amounts collected at the beginning of each period
D) Series of cash flows of equal amounts collected at the beginning of each period

E) All of the above
F) C) and D)

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Question 43

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Weston Company is considering a capital project that delivers a $59,500 annual net cash flow before tax. The investment will result in annual depreciation expense of $13,800 over the project's four-year useful life. Assuming a tax rate of 40%, what amount of annual after-tax net cash flow will be provided by this project?

How would an organization benefit from conducting postaudits of its capital investment decisions?

A customary assumption in capital budgeting analysis is that:

If a project has a positive net present value, its internal rate of return will exceed the firm's hurdle rate.

Assuming equal time intervals between the payments and a constant rate of return, which of the following cash flow patterns represents an annuity? $\begin{array}{rrrrrrr}&\text { Year } & \text { Year } & \text { Year } & \text { Year } 4 & \text { Year }5& \text { Year } 6 \\\text {A) }&\$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 \\\text {B) }&\$ 500 & \$ 0 & \$ 500& \$ 500 & \$500& \$0\\\text {C) }&\$100&\$200&\$300&\$400&\$500&\$600\end{array}$

Because of the expense of applying multiple techniques, managers should use a single capital budgeting technique to analyze potential capital investments.

Indicate whether each of the following statements is true or false. The payback method does not take the time value of money into account. ______The unadjusted rate of return indicates the length of time required to recover the initial cost of an investment. ______The payback period can only be calculated for capital investments that are expected to provide equal annual cash inflows over their useful lives. ______Generally, investments with shorter payback periods are preferred. ______Use of the payback method to analyze capital investments is the best way of identifying the projects that will make the greatest contribution to a company's profits. ______

The cost of capital is sometimes referred to as the hurdle or discount rate.

Capital investments differ from stock and bond investments in that stock and bond investments can be sold in organized markets.

Describe the decision rules management should use for accepting and rejecting capital projects under each of the following capital budgeting models: net present value model, internal rate of return model, payback period, and the unadjusted rate of return model.

Mary needs to have $20,000 one year from today. The formula to compute the amount of money that must be invested today is future value ÷ (1 − interest rate).

The time value of money concept recognizes that a dollar today is worth more than a dollar tomorrow. Which of the following is not a factor in causing the present value of cash inflows to diminish over time?

Grayson Company is considering a purchase of equipment that costs $49,000 and is expected to offer annual cash inflows of $13,000. Grayson's minimum required rate of return is 10%. How many years must the cash flows last for the investment to be acceptable? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round to the nearest whole year.)

An investment that costs $20,000 will produce annual cash flows of $5,000 for a period of 6 years. Further, the investment has an expected salvage value of $3,000. Given a desired rate of return of 12%, what will the investment generate? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

Benson Corporation is considering an investment in equipment that would cost $50,000 and provide annual cash inflows of $14,000. The company's required rate of return is 12%; the internal rate of return for the investment is 10.5%. Should the company make this investment?

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: $\begin{array}{ccc}\text { Year } & \text { Investment A} &\text { Investment B} \\0 & \$(5,800) & \$(7,200) \\1 & 2,320 & 3,480 \\2 & 2,320 & 2,320 \\3 & 2,320 & 2,320 \\4 & 2,320 & 1,160\end{array}$ Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

Chichester Company is considering investing in the following two mutually exclusive projects: $\begin{array}{l}\text { Annual cash Inflows }\\\begin{array} { c r r } \text { Year } & \text { Project A } & \text { Project B} \\1 & \$ 5,000 & \$ 3,500 \\2 & 4,000 & 3 , 500 \\3 & 3,000 & 3, 500 \\4 & 2,000 & 3, 500 \\\text { Total } & \$ 14,000 & \$ 14,000\end{array}\end{array}$ (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required:Which project is more desirable strictly in terms of cash inflows? Why?Compute the present value of each project's cash inflows assuming the company's required rate of return is 10%.What is the maximum amount Chichester should be willing to pay for each project?Suppose each project costs $10,000. Which project(s) should be accepted?

How does depreciation serve as a tax shield? How is the amount of the annual tax shield calculated?