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Exam 10: Planning for Capital Investments

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Question 61

True/False

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A postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

A) True
B) False

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Question 62

Multiple Choice

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When calculating the present value of an ordinary annuity, it is assumed that:

A) cash flows will be reinvested at the required rate of return.
B) cash flows occur at the end of each accounting period.
C) the investor will wait until the end of the investment period to withdraw cash flows.
D) cash flows will be reinvested at the required rate of return and cash flows occur at the end of each accounting period.

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

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Question 63

Multiple Choice

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Grayson Company is considering 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? (Do not round your intermediate calculations. Round to nearest whole year.)

Six years ago, Neighborhood Hardware paid a contractor $45,000 to expand the store. At that time, the company calculated a net present value of about $6,000 for the expansion. Now, the company believes that the investment increased annual cash inflows by $8,000 per year for each of the six years. The company has a desired rate of return of 10%. Ignoring income tax considerations, what was the net present value actually achieved for this capital investment? (Do not round your intermediate calculations. Round your answer to the nearest dollar.)

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

The instantaneous computation power of spreadsheet software makes it ideal for answering "what-if" questions regarding present values.

Select the incorrect statement concerning the internal rate of return (IRR) method of evaluating capital projects.

Weston Company is considering a capital project that delivers a $50,000 annual net cash flow before tax. The investment will result in annual depreciation expense of $10,000 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?

Young Corporation is considering purchasing equipment that costs $80,000 and is expected to provide the following cash inflows over its five-year useful life: What is the payback period of this investment project (rounded to the nearest year) ? $\begin{array} { | l | l | } \hline \text { Year } & \text { Cash inflow } \\\hline 1 & \$ 18,000 \\\hline 2 & 22,000 \\\hline 3 & 24,000 \\\hline 4 & 16,000 \\\hline 5 & 9,000 \\\hline\end{array}$

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B? $\begin{array} { | l | c | c | } \hline \text { Year } & \text { Investment } \mathrm { A } & \text { Investment B } \\\hline 0 & ( \$ 5,000 ) & ( \$ 6,000 ) \\\hline 1 & 2,000 & 3,000 \\\hline 2 & 2,000 & 2,000 \\\hline 3 & 2,000 & 2,000 \\\hline 4 & 2,000 & 1,000 \\\hline\end{array}$

Select the incorrect statement regarding postaudits of capital investment decisions.

When a capital investment is expected to provide unequal annual cash inflows, the payback period cannot be calculated.

The cost of capital represents the maximum acceptable rate of return that a capital investment should earn.

Capital investment decisions involve investments in current assets.

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

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 payback method of evaluating capital investments measures the recovery of the investment, but it does not measure profitability.

The review of a capital budgeting decision to determine whether a project was accepted that should have been rejected is referred to as:

Why does a company use its cost of capital as the minimum required rate of return for its capital investment decisions?

Indicate whether each of the following statements is true or false.The further into the future a cash receipt is expected to occur, the higher is its present value.The return on investment measures the compensation a company expects to receive from investing in capital assets.Most companies use their cost of capital to estimate the minimum return on investment required from capital investments.When a company invests in capital assets, it sacrifices present dollars for the opportunity to receive future dollars.The required rate of return on a capital investment is also referred to as the hurdle rate or discount rate.