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Exam 11: Capital Budgeting and Investment Analysis

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Question 41

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A limitation of the internal rate of return method is that it:

A) Does not consider the time value of money.
B) Measures results in years.
C) Lacks ability to compare dissimilar projects.
D) Ignores varying risks over the life of a project.
E) Measures net income rather than cash flows.

F) B) and D)
G) C) and D)

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Question 42

Multiple Choice

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Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows: The present value factors of $1 each year at 15% are: The present value of an annuity of $1 for 3 years at 15% is 2.2832. The net present value of Investment A is:

A) $18,266.
B) $(15,000) .
C) $9,000.
D) $(20,549) .
E) $3,266.

F) B) and D)
G) All of the above

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Question 43

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The time value of money concept works on the principle that a dollar tomorrow is worth more than a dollar today.

If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be rejected.

The accounting rate of return is calculated as:

Nebraska Co. is reviewing a capital investment of $100,000. This project's projected cash flows over a five-year period are estimated at $35,000 each year. Required: (a) Calculate the payback period. (b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below: Present Value Periods of 1 at 12% 1…… 0.8929 2…… 0.7972 3…… 0.7118 4…… 0.6355 5…… 0.5674 (c) Using the results in (a) and (b), make a recommendation for the project.

Identify at least three reasons for managers to favor the internal rate of return (IRR) over other capital budgeting approaches.

The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

A company is planning to purchase a machine that will cost $24,000 with a six-year life and no salvage value. The company uses straight-line depreciation. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the accounting rate of return for this machine?

How does the calculation of break-even time (BET) differ from the calculation of payback period (PBP)?

Trevoline Company is deciding between two projects. Each project requires an initial investment of $350,000. The projected net cash flows for the two projects are listed below. The revenue is to be received at the end of each year. Trevoline requires a 10% return on its investments. The present value of an annuity of 1 and present value of an annuity factors for 10% are presented below. Use net present value to determine which project should be pursued and explain why.

A company is trying to decide which of two new product lines to introduce in the coming year. The predicted revenue and cost data for each product line follows: The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that cash flows will be spread evenly throughout each year. Calculate each product's payback period. If the company requires a payback period of three years or less, which, if either, product should be chosen?

Which of the following is an objective of capital budgeting?

The net present value capital budgeting method considers all estimated cash flows for the project's expected life.

A company's required rate of return, typically its cost of capital is called the:

In ranking choices with the break-even time (BET) method, the investment with the longest BET gets the highest rank.

Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?

If the straight-line depreciation method is used, the annual average investment amount used in calculating the accounting rate of return is calculated as (beginning book value + ending book value)/2.

Briefly describe both the payback period method and the net present value method of comparing investment alternatives.