Test bank managerial accounting by kieso weygandt 5e ch12

CHAPTER 12
PLANNING FOR CAPITAL INVESTMENTS
SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY
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True-False Statements
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Multiple Choice Questions
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Brief Exercises
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149.

2

3

AP
E

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3,5

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E
AP

Exercises
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*
2,3,8

2,3,7

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AP
AN

157. 2,3,8
158. 2,3,8
159.
**

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160. 3,4
161. 3,5
162. 3,5,7

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163. 3,5,8
164. 3,6
165. 3,7

E
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12-2

Test Bank for ISV Managerial Accounting, Fourth Edition

Completion Statements
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167.

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171. 4

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*1,2,3,5,7
**2,3,5,7,8

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE
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TF
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109.
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Type

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Study Objective 1
MC
32. MC
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Study Objective 2
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Study Objective 3

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149. BE
158.
Study Objective 4
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78. MC
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Study Objective 5
MC

94. MC
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151.
Study Objective 6
MC
164. Ex
MC
173.
C
Study Objective 7
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123. MC
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MC
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127. MC
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Type

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BE
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Ex
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172.

C

MC
MC
MC
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BE

154.
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174.

C


Planning for Capital Investments

22.
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25.

TF
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MC
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Note: TF = True-False
MC = Multiple Choice

Study Objective 8
MC 139. MC
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MC 140. MC
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MC 141. MC
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MC 142. MC
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MC
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C = Completion
BE = Brief Exercise

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12-3

Ex
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C

Ex = Exercise

The chapter also contains one set of eight Matching questions and three Short-Answer Essay
questions.

CHAPTER STUDY OBJECTIVES
1. Discuss capital budgeting evaluation and explain inputs used in capital budgeting.
Management gathers project proposals from each department; a capital budget committee
screens the proposals and recommends worthy projects. Company officers decide which
projects to fund, and the board of directors approves the capital budget. In capital budgeting,
estimated cash inflows and outflows, rather than accrual-accounting numbers, are the
preferred inputs.
2. Describe the cash payback technique. The cash payback technique identifies the time
period required to recover the cost of the investment. The formula when net annual cash
flows are equal is: Cost of capital investment ÷ Estimated net annual cash flow = Cash
payback period. The shorter the payback period, the more attractive the investment.
3. Explain the net present value method. The net present value method compares the
present value of future cash inflows with the capital investment to determine net present
value. The NPV decision rule is: Accept the project if net present value is zero or positive.
Reject the project if net present value is negative.
4. Identify the challenges presented by intangible benefits in capital budgeting. Intangible
benefits are difficult to quantify, and thus are often ignored in capital budgeting decisions.
This can result in incorrectly rejecting some projects. One method for considering intangible
benefits is to calculate the NPV, ignoring intangible benefits; if the resulting NPV is below
zero, evaluate whether the benefits are worth at least the amount of the negative net present
value. Alternatively, intangible benefits can be incorporated into the NPV calculation, using
conservative estimates of their value.
5. Describe the profitability index. The profitability index is a tool for comparing the relative
merits of alternative capital investment opportunities. It is computed as: Present value of net
cash ÷ Initial investment. The higher the index, the more desirable the project.
6. Indicate the benefits of performing a post-audit. A post-audit is an evaluation of a capital
investment’s actual performance. Post-audits create an incentive for managers to make

accurate estimates. Post-audits also are useful for determining whether a company should
continue, expand, or terminate a project. Finally, post-audits provide feedback that is useful
for improving estimation techniques.


12-4

Test Bank for ISV Managerial Accounting, Fourth Edition

7. Explain the internal rate of return method. The objective of the internal rate of return
method is to find the interest yield of the potential investment, which is expressed as a
percentage rate. The IRR decision rule is: Accept the project when the internal rate of return
is equal to or greater than the required rate of return. Reject the project when the internal
rate of return is less than the required rate of return.
8. Describe the annual rate of return method. The annual rate of return uses accrual
accounting data to indicate the profitability of a capital investment. It is calculated as:
Expected annual net income ÷ Amount of the average investment. The higher the rate of
return, the more attractive the investment.

TRUE-FALSE STATEMENTS
1.

Capital budgeting decisions usually involve large investments and often have a significant
impact on a company's future profitability.

2.

The capital budgeting committee ultimately approves the capital expenditure budget for
the year.

3.

For purposes of capital budgeting, estimated cash inflows and outflows are preferred for
inputs into the capital budgeting decision tools.

4.

The cash payback technique is a quick way to calculate a project's net present value.

5.

The cash payback period is computed by dividing the cost of the capital investment by the
annual cash inflow.

6.

The cash payback method is frequently used as a screening tool but it does not take into
consideration the profitability of a project.

7.

The cost of capital is a weighted average of the rates paid on borrowed funds, as well as
on funds provided by investors in the company's stock.

8.

Using the net present value method, a net present value of zero indicates that the project
would not be acceptable.

9.

The net present value method can only be used in capital budgeting if the expected cash
flows from a project are an equal amount each year.

10.

By ignoring intangible benefits, capital budgeting techniques might incorrectly eliminate
projects that could be financially beneficial to the company.

11.

To avoid accepting projects that actually should be rejected, a company should ignore
intangible benefits in calculating net present value.

12.

One way of incorporating intangible benefits into the capital budgeting decision is to
project conservative estimates of the value of the intangible benefits and include them in
the NPV calculation.


Planning for Capital Investments

12-5

13.

The profitability index is calculated by dividing the total cash flows by the initial
investment.

14.

The profitability index allows comparison of the relative desirability of projects that require
differing initial investments.

15.

Sensitivity analysis uses a number of outcome estimates to get a sense of the variability
among potential returns.

16.

A well-run organization should perform an evaluation, called a post-audit, of its investment
projects before their completion.

17.

Post-audits create an incentive for managers to make accurate estimates, since
managers know that their results will be evaluated.

18.

A post-audit is an evaluation of how well a project's actual performance matches the
projections made when the project was proposed.

19.

The internal rate of return method is, like the NPV method, a discounted cash flow
technique.

20.

The interest yield of a project is a rate that will cause the present value of the proposed
capital expenditure to equal the present value of the expected annual cash inflows.

21.

Using the internal rate of return method, a project is rejected when the rate of return is
greater than or equal to the required rate of return.

22.

Using the annual rate of return method, a project is acceptable if its rate of return is
greater than management's minimum rate of return.

23.

The annual rate of return method requires dividing a project's annual cash inflows by the
economic life of the project.

24.

A major advantage of the annual rate of return method is that it considers the time value of
money.

25.

An advantage of the annual rate of return method is that it relies on accrual accounting
numbers rather than actual cash flows.

Answers to True-False Statements
Item

1.
2.
3.
4.

Ans.

T
F
T
F

Item

5.
6.
7.
8.

Ans.

T
T
T
F

Item

9.
10.
11.
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Ans.

F
T
F
T

Item

13.
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Ans.

F
T
T
F

Item

17.

18.
19.
20.

Ans.

T
T
T
T

Item

21.
22.
23.
24.

Ans.

F
T
F
F

Item

25.

Ans.

F


12-6

Test Bank for ISV Managerial Accounting, Fourth Edition

MULTIPLE CHOICE QUESTIONS
26.

The capital budget for the year is approved by a company's
a. board of directors.
b. capital budgeting committee.
c. officers.
d. stockholders.

27.

All of the following are involved in the capital budgeting evaluation process except a
company's
a. board of directors.
b. capital budgeting committee.
c. officers.
d. stockholders.

28.

Most of the capital budgeting methods use
a. accrual accounting numbers.

b. cash flow numbers.
c. net income.
d. accrual accounting revenues.

29.

The first step in the capital budgeting evaluation process is to
a. request proposals for projects.
b. screen proposals by a capital budgeting committee.
c. determine which projects are worthy of funding.
d. approve the capital budget.

30.

The capital budgeting decision depends in part on the
a. availability of funds.
b. relationships among proposed projects.
c. risk associated with a particular project.
d. all of these.

31.

Capital budgeting is the process
a. used in sell or process further decisions.
b. of determining how much capital stock to issue.
c. of making capital expenditure decisions.
d. of eliminating unprofitable product lines.

32.

Net annual cash flow can be estimated by
a. deducting credit sales from net income.
b. adding depreciation expense to net income.
c. deducting credit purchases from net income.
d. adding advertising expense to net income.

33.

Which of the following is not a typical cash flow related to equipment purchase and
replacement decisions?
a. Increased operating costs
b. Overhaul of equipment
c. Salvage value of equipment when project is complete
d. Depreciation expense


Planning for Capital Investments

12-7

34.

Capital expenditure proposals are initially screened by the
a. board of directors.
b. executive committee.
c. capital budgeting committee.
d. stockholders.

35.

Capital budgeting decisions depend in part on all of the following except the
a. relationships among proposed projects.
b. profitability of the company.
c. company’s basic decision making approach.
d. risks associated with a particular project.

36.

The corporate capital budget authorization process consists of how many steps?
a. 4
b. 3
c. 2
d. 1

37.

Which of the following is not a capital budgeting decision?
a. Constructing new studios
b. Replacing old equipment
c. Scrapping obsolete inventory
d. Remodeling an office building

38.

Which of the following is a disadvantage of the cash payback technique?
a. It is difficult to calculate
b. It relies on the time value of money
c. It can only be calculated when there are equal annual net cash flows
d. It ignores the expected profitability of a project

39.

The payback period is often compared to an asset’s
a. estimated useful life.
b. warranty period.
c. net present value.
d. internal rate of return.

40.

Which of the following ignores the time value of money?
a. Internal rate of return
b. Profitability index
c. Net present value
d. Cash payback

41.

Brady Corp. is considering the purchase of a piece of equipment that costs $23,000.
Projected net annual cash flows over the project’s life are:
Year
1
2
3
4

Net Annual Cash Flow
$ 3,000
8,000
15,000

9,000

The cash payback period is


12-8

Test Bank for ISV Managerial Accounting, Fourth Edition
a.
b.
c.
d.

42.

2.63 years.
2.80 years.
2.20 years.
2.37 years.

Bradshaw Inc. is contemplating a capital investment of $85,000. The cash flows over the
project’s four years are:
Expected Annual
Year
1
2
3
4

Expected Annual

Cash Inflows
$30,000
45,000
60,000
50,000

Cash Outflows
$12,000
20,000
25,000
30,000

The cash payback period is
a. 2.17 years.
b. 3.35 years.
c. 2.30 years.
d. 3.47 years.
43.

Jordan Company is considering the purchase of a machine with the following data:
Initial cost
One-time training cost
Annual maintenance costs
Annual cost savings
Salvage value

$130,000
12,000
15,000
75,000

20,000

The cash payback period is
a. 2.37 years.
b. 2.17 years.
c. 1.89 years.
d. 1.73 years.
44.

If project A has a lower payback period than project B, this may indicate that project A may
have a
a. lower NPV and be less profitable.
b. higher NPV and be less profitable.
c. higher NPV and be more profitable.
d. lower NPV and be more profitable.

45.

Which of the following does not consider a company’s required rate of return?
a. Net present value
b. Internal rate of return
c. Annual rate of return
d. Cash payback

46.

The cash payback technique
a. considers cash flows over the life of a project.
b. cannot be used with uneven cash flows.
c. is superior to the net present value method.

d. may be useful as an initial screening device.


Planning for Capital Investments

12-9

47.

If an asset costs $210,000 and is expected to have a $30,000 salvage value at the end of
its ten-year life, and generates annual net cash inflows of $30,000 each year, the cash
payback period is
a. 8 years.
b. 7 years.
c. 6 years.
d. 5 years.

48.

If a payback period for a project is greater than its expected useful life, the
a. project will always be profitable.
b. entire initial investment will not be recovered.
c. project would only be acceptable if the company's cost of capital was low.
d. project's return will always exceed the company's cost of capital.

49.

The cash payback technique
a. should be used as a final screening tool.
b. can be the only basis for the capital budgeting decision.

c. is relatively easy to compute and understand.
d. considers the expected profitability of a project.

50.

The cash payback period is computed by dividing the cost of the capital investment by the
a. annual net income.
b. net annual cash inflow.
c. present value of the cash inflow.
d. present value of the net income.

51.

When using the cash payback technique, the payback period is expressed in terms of
a. a percent.
b. dollars.
c. years.
d. months.

52.

A disadvantage of the cash payback technique is that it
a. ignores obsolescence factors.
b. ignores the cost of an investment.
c. is complicated to use.
d. ignores the time value of money.

53.

Bark Company is considering buying a machine for $180,000 with an estimated life of ten

years and no salvage value. The straight-line method of depreciation will be used. The
machine is expected to generate net income of $12,000 each year. The cash payback
period on this investment is
a. 15 years.
b. 10 years.
c. 6 years.
d. 3 years.

54.

The discount rate is referred to by all of the following alternative names except the
a. cost of capital.
b. cutoff rate.
c. hurdle rate.
d. required rate of return.


12-10

Test Bank for ISV Managerial Accounting, Fourth Edition

55.

The rate that a company must pay to obtain funds from creditors and stockholders is
known as the
a. hurdle rate.
b. cost of capital.
c. cutoff rate.
d. all of these.

56.

The higher the risk element in a project, the
a. more attractive the investment.
b. higher the net present value.
c. higher the cost of capital.
d. higher the discount rate.

57.

If a company's required rate of return is 10% and, in using the net present value method,
a project's net present value is zero, this indicates that the
a. project's rate of return exceeds 10%.
b. project's rate of return is less than the minimum rate required.
c. project earns a rate of return of 10%.
d. project earns a rate of return of 0%.

58.

Using the profitability index method, the present value of cash inflows for Project Flower is
$88,000 and the present value of cash inflows of Project Plant is $48,000. If Project
Flower and Project Plant require initial investments of $90,000 and $40,000, respectively,
and have the same useful life, the project that should be accepted is
a. Project Flower.
b. Project Plant.
c. Either project may be accepted.
d. Neither project should be accepted.

59.

The primary capital budgeting method that uses discounted cash flow techniques is the
a. net present value method.
b. cash payback technique.
c. annual rate of return method.
d. profitability index method.

60.

When the annual cash flows from an investment are unequal, the appropriate table to use
is the
a. future value of 1 table.
b. future value of annuity table.
c. present value of 1 table.
d. present value of annuity table.

61.

A company's cost of capital refers to the
a. rate the company must pay to obtain funds from creditors and stockholders.
b. total cost of a capital project.
c. cost of printing and registering common stock shares.
d. rate of return earned on common stock.


Planning for Capital Investments

12-11

62.

When a capital budgeting project generates a positive net present value, this means that
the project earns a return higher than the
a. internal rate of return.
b. annual rate of return.
c. required rate of return.
d. profitability index.

63.

A negative net present value indicates that the
a. project is acceptable.
b. wrong discount rate was used.
c. project’s annual rate of return exceeds the discount rate..
d. present value of the cash inflows was less than the present value of the cash out
flows.

64.

A company’s discount rate is based on the
a. cost of capital and the internal rate of return.
b. cost of capital and the risk element.
c. cut-off rate and the risk element.
d. cut-off rate and the internal rate of return.

65.

The discount rate that will result in the lowest net present value for a project is
a. any rate lower that the cost of capital.
b. any rate higher than the cost of capital.
c. the lowest rate used to evaluate the project.

d. the highest rate used to evaluate the project.

66.

The discount rate that will result in the highest net present value for a project is
a. any rate lower that the cost of capital.
b. any rate higher than the cost of capital.
c. the lowest rate used to evaluate the project.
d. the highest rate used to evaluate the project.

67.

Which of the following will increase the net present value of a project?
a. An increase in the initial investment
b. A decrease in annual cash inflows
c. An increase in the discount rate
d. A decrease in the discount rate

68.

A project with a zero net present value indicates that it is
a. unacceptable.
b. profitable.
c. acceptable.
d. going to have an acceptable cash payback period.

69.

Companies often assume that the risk element in the discount rate is
a. zero.

b. greater that zero.
c. less than zero.
d. known with certainty.


12-12

Test Bank for ISV Managerial Accounting, Fourth Edition

70.

If a project has a salvage value greater than zero, the salvage value will
a. have no effect on the net present value.
b. increase the net present value.
c. increase the payback period.
d. decrease the net present value.

71.

Sloan Inc. recently invested in a project with a 3-year life span. The net present value was
$3,000 and annual cash inflows were $7,000 for year 1; $8,000 for year 2; and $9,000 for
year 3. The initial investment for the project, assuming a 15% required rate of return, was
Year
1
2
3
a.
b.
c.
d.

72.

Present Value
of 1 at 15%
.870
.756
.658

PV of an Annuity
of 1 at 15%
.870
1.626
2.283

$15,264.
$15,060.
$9,744.
$12,792.

Mini Inc. is contemplating a capital project costing $31,346. The project will provide annual
cost savings of $12,000 for 3 years and have a salvage value of $2,000. The company’s
required rate of return is 10%. The company uses straight-line depreciation.
Year
1
2
3

Present Value
of 1 at 10%

.909
.826
.751

PV of an Annuity
of 1 at 10%
.909
1.736
2.487

This project is
a. unacceptable because it earns a rate less than 10%.
b. acceptable because it has a positive NPV.
c. unacceptable because it has a negative NPV.
d. acceptable because it has a zero NPV.
73.

Johnson Corp. has an 8% required rate of return. It’s considering a project that would
provide annual cost savings of $20,000 for 5 years. The most that Johnson would be
willing to spend on this project is
Year
1
2
3
4
5
a.
b.
c.
d.

$50,364.
$66,240.
$79,860.
$13,620.

Present Value
of 1 at 8%
.926
.857
.794
.735
.681

PV of an Annuity
of 1 at 8%
.926
1.783
2.577
3.312
3.993


Planning for Capital Investments
74.

12-13

Benaflek Co. purchased some equipment 3 years ago. The company’s required rate of
return is 12%, and the net present value of the project was $(450). Annual cost savings

were: $5,000 for year 1; $4,000 for year 2; and $3,000 for year 3. The amount of the initial
investment was
Year
1
2
3
a.
b.
c.
d.

Present Value
of 1 at 12%
.893
.797
.712

PV of an Annuity
of 1 at 12%
.893
1.690
2.402

$10,239.
$9,158.
$10,058.
$9,339.

75.

In capital budgeting, intangible benefits should be
a. excluded entirely.
b. included using optimistic estimated values.
c. included using conservative estimated values.
d. included only when benefits are known with certainty.

76.

Miles, Inc. is considering the purchase of a new machine for $100,000 that has an
estimated useful life of 5 years and no salvage value. The machine will generate net
annual cash flows of $17,500. It is believed that the new machine will reduce downtime
because of its reliability. Assume the discount rate is 8%. In order to make the project
acceptable, the reduction in downtime must be worth
Year
1
2
3
4
5
a.
b.
c.
d.

Present Value
of 1 at 8%
.926
.857
.794
.735

.681

PV of an Annuity
of 1 at 8%
.926
1.783
2.577
3.312
3.993

$3,993 per year.
$8,277 per year.
$3,044 per year.
$7,544 per year.

77.

Intangible benefits in capital budgeting would include all of the following except increased
a. product quality.
b. employee loyalty.
c. salvage value.
d. product safety.

78.

Intangible benefits in capital budgeting
a. should be ignored because they are difficult to determine.
b. include increased quality or employee loyalty.
c. are not considered because they are usually not relevant to the decision.
d. have a rate of return in excess of the company’s cost of capital.

12-14
79.

Test Bank for ISV Managerial Accounting, Fourth Edition
To avoid rejecting projects that actually should be accepted,

a.
b.
c.
d.

1. intangible benefits should be ignored.
2. conservative estimates of the intangible benefits' value should be incorporated into
the NPV calculation.
3. calculate net present value ignoring intangible benefits and then, if the NPV is
negative, estimate whether the intangible benefits are worth at least the amount of
the negative NPV.
1
2
3
both 2 and 3 are correct.

80.

All of the following statements about intangible benefits in capital budgeting are correct
except that they
a. include increased quality and employee loyalty.
b. are difficult to quantify.

c. are often ignored in capital budgeting decisions.
d. cannot be incorporated into the NPV calculation.

81.

In evaluating high-tech projects,
a. only tangible benefits should be considered.
b. only intangible benefits should be considered.
c. both tangible and intangible benefits should be considered.
d. neither tangible nor intangible benefits should be considered.

82.

Using a number of outcome estimates to get a sense of the variability among potential
returns is
a. financial analysis.
b. post-audit analysis.
c. sensitivity analysis.
d. outcome analysis.

83.

If a company's required rate of return is 9%, and in using the profitability index method, a
project's index is greater than 1, this indicates that the project's rate of return is
a. equal to 9%.
b. greater than 9%.
c. less than 9%.
d. unacceptable for investment purposes.

84.

The profitability index is computed by dividing the
a. total cash flows by the initial investment.
b. present value of cash flows by the initial investment.
c. initial investment by the total cash flows.
d. initial investment by the present value of cash flows.

85.

The capital budgeting method that takes into account both the size of the original
investment and the discounted cash flows is the
a. cash payback method.
b. internal rate of return method.
c. net present value method.
d. profitability index.


Planning for Capital Investments

12-15

86.

The profitability index
a. does not take into account the discounted cash flows.
b. is calculated by dividing total cash flows by the initial investment.
c. allows comparison of the relative desirability of projects that require differing initial
investments.
d. will never be greater than 1.

87.

The capital budgeting method that allows comparison of the relative desirability of projects
that require differing initial investments is the
a. cash payback method.
b. internal rate of return method.
c. net present value method.
d. profitability index.

88.

The following information is available for a potential investment for Panda Company:
Initial investment
Net annual cash inflow
Net present value
Salvage value
Useful life

$80,000
20,000
36,224
10,000
10 yrs.

The potential investment’s profitability index is
a. 4.00.
b. 2.85.
c. 2.50.
d. 1.45.
89.

An approach that uses a number of outcome estimates to get a sense of the variability
among potential returns is
a. the discounted cash flow technique.
b. the net present value method.
c. risk analysis.
d. sensitivity analysis.

90.

If a project’s profitability index is greater than 1, then the
a. project should always be accepted.
b. project’s net present value is negative.
c. project’s internal rate of return is less than the discount rate.
d. project should be accepted if funds are available.

91.

If a project’s profitability index is less than 1, then
a. its net present value is zero.
b. its net present value is positive.
c. it should be rejected.
d. its internal rate of return is greater than the discount rate.

92.

If a project’s profitability index is equal to 1, then
a. its net present value is zero.
b. its net present value is positive.
c. it should be rejected.

d. its internal rate of return is greater than the discount rate.


12-16

Test Bank for ISV Managerial Accounting, Fourth Edition

93.

A project with an initial investment of $50,000 and a profitability index of 1.239 also has an
internal rate of return of 12%. The present value of net cash flows is
a. $56,000.
b. $61,950.
c. $40,355.
d. $50,000.

94.

A project with a profitability index of 1.156 also has net cash flows with a present value of
$46,240. The project’s internal rate of return was 10%. The initial investment was
a. $44,000.
b. $53,453.
c. $40,000.
d. $41,616.

Use the following information for questions 95 and 96.
Selma Inc. is comparing several alternative capital budgeting projects as shown below:

Initial investment
Present value of net cash flows

A
$40,000
60,000

Projects
B
C
$60,000 $ 80,000
55,000
100,000

95.

Using the profitability index, the projects rank as
a. A, C, B.
b. A, B, C.
c. C, A, B.
d. C, B, A.

96.

Using the profitability index, how many of the projects are acceptable?
a. 3
b. 2
c. 1
d. 0

97.

If a project has a negative net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.

98.

If a project has a positive net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.

99.

If a project has a zero net present value, its profitability index will be
a. one.
b. greater than one.
c. less than one.
d. undeterminable.


Planning for Capital Investments
100.

12-17

If a project has a profitability index of 1.20, then the project’s internal rate of return is
a. equal to the discount rate.

b. less than the discount rate.
c. greater than the discount rate.
d. equal to 20%.

Use the following information for questions 101–103.
Cleaners, Inc. is considering purchasing equipment costing $30,000 with a 6-year useful life. The
equipment will provide cost savings of $7,300 and will be depreciated straight-line over its useful
life with no salvage value. Cleaners requires a 10% rate of return.
Period
6

8%
4.623

Present Value of an Annuity of 1
9%
10%
11%
12%
4.486
4.355
4.231
4.111

15%
3.784

101.

What is the approximate net present value of this investment?

a. $13,800
b. $1,792
c. $886
d. $2,748

102.

What is the approximate profitability index associated with this equipment?
a. 1.23
b. 1.03
c. 1.06
d. .73

103.

What is the approximate internal rate of return for this investment?
a. 9%
b. 10%
c. 11%
d. 12%

Use the following table for questions 104–106.
Periods
1
2
3
104.

Present Value of an Annuity of 1
8%

9%
10%
.926
.917
.909
1.783
1.759
1.736
2.577
2.531
2.487

A company has a minimum required rate of return of 9%. It is considering investing in a
project that costs $175,000 and is expected to generate cash inflows of $70,000 at the
end of each year for three years. The net present value of this project is
a. $177,170.
b. $35,000.
c. $17,718.
d. $2,170.


12-18

Test Bank for ISV Managerial Accounting, Fourth Edition

105.

A company has a minimum required rate of return of 9%. It is considering investing in a
project that costs $75,000 and is expected to generate cash inflows of $30,000 at the end
of each year for three years. The profitability index for this project is

a. .99.
b. 1.00.
c. 1.01.
d. 1.20.

106.

A company has a minimum required rate of return of 8%. It is considering investing in a
project that costs $91,116 and is expected to generate cash inflows of $36,000 each year
for three years. The approximate internal rate of return on this project is
a. 8%.
b. 9%.
c. 10%.
d. less than the required 8%.

Use the following information for questions 107–110.
Carr Company is considering two capital investment proposals. Estimates regarding each project
are provided below:
Project Soup
Project Nuts
Initial investment
$600,000
$900,000
Annual net income
30,000
63,000
Net annual cash inflow
150,000
213,000
Estimated useful life

5 years
6 years
Salvage value
-0-0The company requires a 10% rate of return on all new investments.
Periods
5
6

Present Value of an Annuity of 1
9%
10%
11%
12%
3.890
3.791
3.696
3.605
4.486
4.355
4.231
4.111

107.

The cash payback period for Project Soup is
a. 20 years.
b. 10 years.
c. 5 years.
d. 4 years.

108.

The net present value for Project Nuts is
a. $927,615.
b. $274,368.
c. $150,000.
d. $27,615.

109.

The internal rate of return for Project Nuts is approximately
a. 10%.
b. 11%.
c. 12%.
d. 9%.


Planning for Capital Investments

12-19

110.

The annual rate of return for Project Soup is
a. 5%.
b. 10%.
c. 25%.
d. 50%.

111.

A post-audit should be performed using
a. a different evaluation technique than that used in making the original decision.
b. the same evaluation technique used in making the original decision.
c. estimated amounts instead of actual figures.
d. an independent CPA.

112.

A thorough evaluation of how well a project's actual performance matches the projections
made when the project was proposed is called a
a. pre-audit.
b. post-audit.
c. risk analysis.
d. sensitivity analysis.

113.

Performing a post-audit is important because
a. managers will be more likely to submit reasonable data when they make investment
proposals if they know their estimates will be compared to actual results.
b. it provides a formal mechanism by which the company can determine whether existing
projects should be terminated.
c. it improves the development of future investment proposals because managers
improve their estimation techniques by evaluating their past successes and failures.
d. all of these.

114.

A capital budgeting method that takes into consideration the time value of money is the

a. annual rate of return method.
b. return on stockholders' equity method.
c. cash payback technique.
d. internal rate of return method.

115.

The internal rate of return is the interest rate that results in a
a. positive NPV.
b. negative NPV.
c. zero NPV.
d. positive or negative NPV.

116.

In using the internal rate of return method, the internal rate of return factor was 4.0 and
the equal annual cash inflows were $16,000. The initial investment in the project must
have been
a. $16,000.
b. $4,000.
c. $64,000.
d. $32,000.


12-20

Test Bank for ISV Managerial Accounting, Fourth Edition

117.

The capital budgeting technique that finds the interest yield of the potential investment is
the
a. annual rate of return method.
b. internal rate of return method.
c. net present value method.
d. profitability index method.

118.

All of the following statements about the internal rate of return method are correct except
that it
a. recognizes the time value of money.
b. is widely used in practice.
c. is easy to interpret.
d. can be used only when the cash inflows are equal.

119.

If the internal rate of return is used as the discount rate in the net present value calculation, the net present value will be
a. zero.
b. positive.
c. negative.
d. undeterminable.

120.

If a project costing $50,000 has a profitability index of 1.00 and the discount rate was
12%, then the present value of the net cash flows was
a. $50,000.
b. less than $50,000.

c. greater than $50,000.
d. undeterminable.

121.

If a project costing $40,000 has a profitability index of 1.00 and the discount rate was 9%,
then the project’s internal rate of return was
a. less than 9%.
b. equal to 9%.
c. greater than 9%.
d. undeterminable.

122.

The internal rate of return factor is equal to the
a. capital investment divided by the net cash flows.
b. present value of net cash flows divided by the capital investment.
c. present value of net cash flows divided by the profitability index.
d. capital investment divided by the present value of the net cash flows.

123.

If a 2-year capital project has an internal rate of return factor equal to 1.690 and net
annual cash flows of $25,000, the initial capital investment was
a. $42,250.
b. $14,793.
c. $21,125.
d. $29,586.

Planning for Capital Investments

12-21

124.

If a 3-year capital project costing $38,655 has an internal rate of return factor equal to
2.577, the net annual cash flows assuming straight-line depreciation are
a. $12,885.
b. $15,000.
c. $5,000.
d. $19,328.

125.

If the internal rate of return exceeds the discount rate, then the net present value of a
project is
a. positive.
b. negative.
c. zero.
d. one.

126.

If the internal rate of return is less than the discount rate, then the net present value of a
project is
a. positive.
b. negative.
c. zero.
d. one.

127.

If a project has a negative net present value, the internal rate of return will be
a. less than the discount rate.
b. greater than the discount rate.
c. equal to the discount rate.
d. a negative rate of return.

128.

If a project has a zero net present value, then the internal rate of return will be
a. less than the discount rate.
b. greater than the discount rate.
c. equal to the discount rate.
d. a negative rate of return.

129.

Which of the following will cause the internal rate of return to increase?
a. An increase in the annual cash inflows
b. A decrease in the annual cash inflows
c. An increase in the discount rate
d. A decrease in the discount rate

130.

If project A has a lower internal rate of return than project B, then project A will have a
a. lower NPV and a shorter payback period.
b. higher NPV and a longer payback period.

c. lower NPV and a longer payback period.
d. higher NPV and a shorter payback period.

131.

The internal rate of return factor is also the
a. annual rate of return.
b. profitability index.
c. cash payback period.
d. present value factor for a single amount.


12-22

Test Bank for ISV Managerial Accounting, Fourth Edition

132.

Discounted cash flow techniques include all of the following except
a. profitability index.
b. annual rate of return.
c. internal rate of return.
d. net present value.

133.

Which of the following is based directly on accrual accounting data rather than cash
flows?
a. Profitability index
b. Internal rate of return

c. Net present value
d. Annual rate of return

134.

When calculating the annual rate of return, the average investment is equal to
a. (initial investment plus $0) divided by 2.
b. initial investment divided by life of project.
c. initial investment divided by 2.
d. (initial investment plus salvage value) divided by 2.

135.

A project has an annual rate of return of 15%. The project cost $60,000, has a 5-year
useful life, and no salvage value. Straight-line depreciation is used. The annual net
income, exclusive of depreciation, was
a. $21,000.
b. $16,500.
c. $31,800.
d. $9,000.

136.

A project that cost $50,000 has a useful life of 5 years and a salvage value of $2,000. The
internal rate of return is 12% and the annual rate of return is 18%. The amount of the
annual net income was
a. $4,680.
b. $4,320.
c. $3,120.
d. $2,880.

137.

A project has annual income exclusive of depreciation of $48,000. The annual rate of
return is 15% and annual depreciation is $12,000. There is no salvage value. The internal
rate of return is 12%. The initial cost of the project was
a. $240,000.
b. $300,000.
c. $600,000.
d. $480,000.

138.

A project that cost $80,000 with a useful life of 5 years is being considered. Straight-line
depreciation is being used and salvage value is $5,000. The project will generate annual
cash flows of $21,375. The annual rate of return is
a. 15%.
b. 50.3%.
c. 16%.
d. 17%.


Planning for Capital Investments

12-23

Use the following information for questions 139 and 140.
A company is considering purchasing factory equipment that costs $480,000 and is estimated to
have no salvage value at the end of its 8-year useful life. If the equipment is purchased, annual
revenues are expected to be $135,000 and annual operating expenses exclusive of depreciation

expense are expected to be $57,000. The straight-line method of depreciation would be used.
139.

If the equipment is purchased, the annual rate of return expected on this equipment is
a. 32.5%.
b. 3.8%.
c. 7.5%.
d. 16.3%.

140.

The cash payback period on the equipment is
a. 13.3 years.
b. 8.0 years.
c. 6.2 years.
d. 3.1 years.

141.

The capital budgeting technique that indicates the profitability of a capital expenditure is
the
a. profitability index method.
b. net present value method.
c. internal rate of return method.
d. annual rate of return method.

142.

The annual rate of return method is based on
a. accounting data.

b. the time value of money data.
c. market values.
d. cash flow data.

143.

Disadvantages of the annual rate of return method include all of the following except that
a. it relies on accrual accounting numbers instead of actual cash flows.
b. it does not consider the time value of money.
c. no consideration is given as to when the cash inflows occur.
d. management is unfamiliar with the information used in the computation.

144.

A company projects an increase in net income of $90,000 each year for the next five years
if it invests $450,000 in new equipment. The equipment has a five-year life and an
estimated salvage value of $150,000. What is the annual rate of return on this
investment?
a. 20%
b. 30%
c. 25%
d. 50%


12-24

Test Bank for ISV Managerial Accounting, Fourth Edition

145.

Colaw Company is considering buying equipment for $60,000 with a useful life of five
years and an estimated salvage value of $4,000. If annual expected income is $5,000, the
denominator in computing the annual rate of return is
a. $60,000.
b. $30,000.
c. $32,000.
d. $28,000.

146.

The annual rate of return is computed by dividing expected annual
a. cash inflows by average investment.
b. net income by average investment.
c. cash inflows by original investment.
d. net income by original investment.

147.

All of the following statements about the annual rate of return method are correct except
that it
a. indicates the profitability of a capital expenditure.
b. ignores the salvage value of an investment.
c. does not consider the time value of money.
d. compares the annual rate of return to management’s minimum rate of return.

Answers to Multiple Choice Questions
Item

26.
27.

28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.

Ans.

a
d
b
a
d
c
b
d
c
b
a

c
d
a
d
b
b
a

Item

44.
45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.

Ans.

c
d
d
b
b
c
b
c
d
c
a
b
d
c
b
a
c
a

Item

62.
63.
64.
65.
66.
67.
68.
69.

70.
71.
72.
73.
74.
75.
76.
77.
78.
79.

Ans.

c
d
b
d
c
d
c
a
b
b
d
c
a
c
d
c
b

d

Item

80.
81.
82.
83.
84.
85.
86.
87.
88.
89.
90.
91.
92.
93.
94.
95.
96.
97.

Ans.

Item

Ans.

Item

Ans.

d
c
c
b
b
d
c
d
d
d
d
c
a
b
c
a
b
c

98.
99.
100.
101.
102.
103.
104.
105.

106.
107.
108.
109.
110.
111.
112.
113.
114.
115.

b
a
c
b
c
d
d
c
b
d
d
b
b
b
b
d
d
c

116.
117.
118.
119.
120.
121.
122.
123.
124.
125.
126.
127.
128.
129.
130.
131.
132.
133.

c
b
d
a
a
b
a
a
b
a
b

a
c
a
c
c
b
d

Item

134.
135.
136.
137.
138.
139.
140.
141.
142.
143.
144.
145.
146.
147.

Ans.

d
b
a

d
a
c
c
d
a
d
b
c
b
b


Planning for Capital Investments

12-25

BRIEF EXERCISES
BE 148
Diamond Company is considering investing in new equipment that will cost $600,000 with a 10year useful life. The new equipment is expected to produce annual net income of $40,000 over its
useful life. Depreciation expense, using the straight-line rate, is $60,000 per year.
Instructions
Compute the cash payback period.
Solution 148

(5 min.)

$600,000 ÷ ($40,000 + $60,000) = 6 years
BE 149
Madeline Company is proposing to spend $160,000 to purchase a machine that will provide

annual cash flows of $30,000. The appropriate present value factor for 10 periods is 5.65.
Instructions
Compute the proposed investment’s net present value and indicate whether the investment
should be made by Madeline Company.
Solution 149

(5 min.)

Cash inflows ($30,000 × 5.65)
Cash outflow—investment ($160,000 × 1.00)
Net present value

Present Value
$169,500
160,000
$ 9,500

The investment should be made because the net present value is positive.
BE 150
LakeFront Company is considering investing in a new dock that will cost $280,000. The company
expects to use the dock for 5 years, after which it will be sold for $150,000. LakeFront anticipates
annual cash flows of $55,000 resulting from the new dock. The company’s borrowing rate is 8%,
while its cost of capital is 10%.
Instructions
Calculate the net present value of the dock and indicate whether LakeFront should make the
investment.
Solution 150

(5 min.)

Present value of annual cash flows
Present value of salvage value
Capital investment
Net present value

Cash Flows × 10% Discount Factor
$55,000
×
3.79079
150,000
×
.62092

=
=
=

Present Value
$208,493
93,138
301,631
280,000
$ 21,631