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Exam 11: Capital Budgeting

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Question 1

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Norwood, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, net present value, and profitability index for each of the projects are as follows: In what order should Norwood prioritize investment in the projects?

A) A, B, C
B) C, B, A
C) A, C, B
D) C, A, B

E) B) and C)
F) B) and D)

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Question 2

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Olive Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $250,000. The equipment will have an initial cost of $1,300,000 and have an 8-year life. There is no salvage value for the equipment. If the hurdle rate is 10%, what is the internal rate of return? Ignore income taxes.

A) Between 6% and 8%
B) Between 8% and 10%
C) Greater than 10%
D) Less than zero

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

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Question 3

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Which of the following statements is correct about capital assets?

The accounting rate of return is the only method that focuses on net income rather than cash flow

The internal rate of return is a measure of:

The accounting rate of return is calculated as:

Which of the following methods is calculated as annual net income as a percentage of the original investment in assets?

York Inc. is trying to decide whether to lease or purchase a piece of equipment needed for the next ten years. The equipment would cost $90,000 to purchase, and maintenance costs would be $10,000 per year. After ten years, York estimates it could sell the equipment for $40,000. If York leases the equipment, it would pay $24,000 each year, which would include all maintenance costs. The hurdle rate for York is 10%. a. What is the net present value of the cost of purchasing the equipment? b. What is the net present value of the cost of leasing the equipment? c. Based on financial factors, should York purchase or lease the equipment? Why?

If you invest $10,000 today in a savings account that earns 5% interest, compounded annually, how much would be in the account at the end of ten years?

You will need at least $5,000 in four years and your friend says she can either loan you $5,000 all at once four years from now or she can deposit $1,200 in your savings account at the end of each year for the next four years. Your savings account earns 7% interest, compounded annually. Which option would be worth more to you four years from now, and how much more?

Which of the following statements is correct about the net present value method?

When deciding between mutually exclusive investments, a manager should choose the option with the lowest depreciation

Byron Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. The salvage value of the equipment is estimated to be $75,000. If the hurdle rate is 15%, what is the approximate net present value? Ignore income taxes.

Projects that are unrelated to one another, so that investing in one project does not preclude or affect the choice about investing in the other alternatives, are:

Preference decisions compare an investment with some minimum criteria

Clyde Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The equipment has no salvage value. The hurdle rate is 8%. Ignore income taxes. Answer the following: a. What is the accounting rate of return? b. What is the payback period? c. What is the net present value? d. What would the net present value be with a 12% hurdle rate? e. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?

Homer Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. If the salvage value of the equipment is estimated to be $75,000, what is the annual net cash flow?

Boxwood, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, and net present value for each of the projects are as follows: In what order should Boxwood prioritize investment in the projects?

Wilson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The salvage value of the equipment is estimated to be $100,000. If the hurdle rate is 10%, what is the internal rate of return?

The payback method: