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Exam 16: Planning for Capital Investments

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Question 71

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Indicate whether each of the following statements is true or false. When unequal cash inflows are expected from a capital investment, the payback period can be calculated by accumulating incremental cash inflows or by using average annual cash inflows. _____The unadjusted rate of return is also called the simple rate of return. ______The unadjusted rate of return can be calculated as average increase in cash inflows divided by net cost of the original investment. ______The unadjusted rate of return does not take the time value of money into account. ______The unadjusted rate of return should be calculated using the initial cost of the investment, rather than the average invested capital. ______

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Question 72

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Evergreen Company has two investment opportunities. Both investments cost $5,000 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{crc}&\text { Investment I }&\text {Investment II }\\\text { Period 1 } & \$ 1,850 & \$ 3,870 \\\text { Period 2 } & 1,850 & 3,360 \\\text { Period 3 } & 3,360 & 3,360 \\\text { Period } 4 & \underline{6,040} &\underline{ 1,510}\\\text { Total } &\underline{\$ 13,100}&\underline{\$ 13,100}\end{array}$ Select the correct statement.

A) Time value of money techniques are not useful for comparing these investments.
B) Evergreen should choose Investment II because it generates more immediate cash inflows.
C) Evergreen should be indifferent between the two investments because they provide the same total cash inflows.
D) Evergreen should choose Investment I because of the time value of money.

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

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Question 73

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The present value index indicates the:

The present value of an annuity of $1 table could be constructed using the factors contained in the present value of $1 table.

An investment that costs $40,000 will produce annual cash flows of $12,000 for a period of 4 years. Given a desired rate of return of 10%, 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.)

Sources of cash outflows from capital investments include incremental expenses and installation costs.

Seth Morrison is considering alternative proposals that involve different amounts of investments. To compare different sizes of investment proposals, it may be helpful for Seth to prepare a relative ranking of the proposals by using a(n) :

Gordon Company is considering a three-year capital investment that will return $150,000 per year. The present value of this annuity at the company's required rate of return of 12% is $360,275.Required:Complete the table that has been started below to show the return on investment at 12% and the amount of investment recovered each year. Remember that the investment balance should be zero at the end of the three years. (Round to the nearest whole dollar.)

Kerwin Company is considering a purchase of equipment that costs $50,000. If the useful life is expected to be 5 years and Kerwin's required rate of return is 12%, what is the minimum annual cash inflow that the equipment must offer 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 your final answer to the nearest dollar.)

Describe what is meant by the time value of money.

Indicate whether each of the following statements is true or false. The net present value method provides a direct measure of the rate of return to be expected from a capital investment project. ______Managers who want to know the rate of return to expect from a capital investment project should calculate the net present value. ______The internal rate of return for a capital investment is the rate that would produce a net present value of zero. ______For a capital investment project to be acceptable, the internal rate of return should be higher than the hurdle rate. ______A capital investment project that has a positive net present value may have an internal rate of return that is lower than the hurdle or required rate of return. ______

A capital investment project may provide cash inflows from:

Which of the following is not a major cash inflow from a capital investment?

Morrisey Company has two investment opportunities. Both investments cost $5,500 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{ccc}&\text { Investment I}&\text { Investment II }\\\text { Period 1 } & \$ 1,000 & \$ 1,000 \\\text { Period } 2 & 1,000 & 2,000\\\text { Period } 3 & 2,000 & 3,000\\\text { Period } 4 &\underline{ 4,000} & \underline{2,000} \\ \text { Total } &\underline{ \$ 8,000 }& \underline{\$ 8,000}\end{array}$ What is the net present value of Investment II assuming an 8% minimum rate of return? (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.)

Which of the following is not a factor in explaining why the present value of a future dollar is less than one dollar?

A capital investment decision is essentially a decision to exchange current cash outflows for future cash inflows.

The process by which management evaluates long-term investment decisions involving long-term operational assets is called:

Southport Company is considering the purchase of a piece of equipment that costs $114,000. The equipment would be depreciated on a straight-line basis to its expected salvage value of $6,500 over its 10 years useful life. Assuming a tax rate of 40%, what is the annual amount of the depreciation tax shield provided by this investment?

Levin Company is considering two new machines that should produce considerable cost savings in its assembly operations. The cost of each machine is $14,000 and neither is expected to have a salvage value at the end of a 4-year useful life. Levin's required rate of return is 12% and the company prefers that a project return its initial outlay within the first half of the project's life. The annual after-tax cash savings for each machine is provided in the following table: $\begin{array}{l}\text { Annual After-tax cash savings }\\\begin{array} { c r r } \text { Year } & \text { Machine A} & \text { Machine B} \\1 & \$ 5,000 & \$ 8,000 \\2 & 5,000 & 6,000 \\3 & 5,000 & 4,000 \\4 & 5,000 & 2,000 \\\text { Total } & \$ 20,000 & \$ 20,000\end{array}\end{array}$ (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required:Compute the payback period for each machine using the incremental approach and comment on the results.Compute the unadjusted rate of return based on average investment for each machine. The machines will be depreciated on a straight-line basisCompute the net present value for each machine.Which machine would you recommend? Explain your reasoning.Use the present value table to compute the approximate internal rate of return for Machine A.

George Company has the opportunity to purchase an asset that costs $40,000. The asset is expected to increase net income by $10,000 per year. Depreciation expense will be $5,000 per year. Based on this information the payback period is: