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Exam 15: Capital Investment Analysis

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Question 21

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The process by which management plans, evaluates, and controls long- term investment decisions involving fixed assets is called cost-volume-profit analysis.

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Question 22

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A capital expenditures budget summarizes the decisions made for the acquisition of fixed assets.

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Question 23

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In capital rationing, an initial screening of alternative proposals is usually performed by establishing minimum standards. Which of the following evaluation methods are normally used?

Qualitative considerations in capital investment decisions are most appropriate for strategic investments or those that are designed to affect a company's long-term ability to generate profits.

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $300,000 for 5 years. The expected average rate of return is 30%.

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 10,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$ The cash payback period for this investment is:

Heedy Inc. is considering a capital investment proposal that costs $460,000 and has an estimated life of four years, and no residual value. The estimated net cash flows are as follows: $\begin{array}{cr}\text { Net Cash Flow } & \text { Year } \\\$ 195,000 & 1 \\160,000 & 2 \\120,000 & 3 \\80,000 & 4\end{array}$ The minimum desired rate of return for net present value analysis is 10%. The present value of $1 at compound interest rates of 10% for 1, 2, 3, and 4 years is 0.909, 0.826, 0.751, and 0.683, respectively. Determine the net present value.

Leasing assets may be a favorable alternative to purchasing assets if the asset has a high risk of becoming obsolete.

By converting dollars to be received in the future into current dollars, the present value methods take into consideration that money:

The computations required for the net present value method are less than those the computation required for the average rate of return method.

Average rate of return equals average investment divided by estimated average annual income.

An anticipated purchase of equipment for $1,200,000, with a useful life of 8 years and no residual value, is expected to yield the following annual net incomes and net cash flows: $\begin{array}{l}\text { Net Cash}& \text {Net Income Flow}&\text { Year}\\\$ 330,000 & \$ 180,000&1 \\320,000 & 170,000&2 \\780,000 & 130,000&3 \\770,000 & 120,000&4 \\200,000 & 50,000 &5\\200,000 & 50,000&6 \\200,000 & 50,000 &7\\200,000 & 50,000&8\end{array}$ What is the cash payback period?

The methods of evaluating capital investment proposals can be grouped into two general categories: (1) methods that ignore present values and (2) methods that use present values.

A series of equal cash flows at fixed intervals is termed as a(n) :

If a proposed expenditure of $400,000 for a fixed asset with a 4-year life has an annual expected net cash flow and net income of $160,000 and $60,000, respectively, the cash payback period is 2.5 years.

The internal rate of return method of analyzing capital investment proposals uses the present value concept to compute the rate of return expected from the proposals.

When several alternative investment proposals of the same amount are being considered, the one with the largest net present value is the most desirable. If the alternative proposals involve different amounts of investment, it is useful to prepare a relative ranking of the proposals by using a(n) :

A $350,000 capital investment proposal has an estimated life of four years and no residual value. The estimated net cash flows are as follows: $\begin{array}{lll}\text { Year }&\text { Net Cash flow }&\text { Year }&\text { Net Cash Flow }\\1&\$150,000&3&\$104,000\\2&130,000&4&90,000\end{array}$ The minimum desired rate of return for net present value analysis is 12%. The present value of $1 at compound interest of 12% for 1, 2, 3, and 4 years is 0.893, 0.797, 0.712, and 0.636, respectively. Determine the net present value.

The rate of return is 10% and the cash to be received in one year is $10,000. Determine the present value amount, using the following partial table of present value of $1 at compound interest: $\begin{array} { | l | l | l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0.890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$

The computations required for the net present value method are more than the computation required for the average rate of return method.