Managerial accounting, 5th by jiambalvo test bank ch09

CHAPTER 9
Capital Budgeting Decisions
Summary of Questions by Objectives and Bloom’s Taxonomy
Item SO
BT Item
True-False Statements
1.
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8.
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9.
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7. 2,6

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Multiple Choice Questions
35.
1
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59.
36.
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60.
37.
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38.
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62.
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42.
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66.
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67.
44.
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68.
45. 1,2
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74.
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77.
54. 2,3
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78.
55.
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79.
56.
2
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80.
57.
2

AP
81.
58.
2
AP
82.
Matching
154. 1,2,3 K
4,6
Exercises
155.
1
AP 159.
156. 1,2
AP 160.
157.
2
AP 161.
158.
2
AP 162.

SO

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AP
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83.
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*102.
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*105.
*106.

6
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107.
6
*108 A1,2
109..
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AP
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163.
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2,4
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167.
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170.

2,4
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Item

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29.
30.
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*33.
*34.

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131.
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171.
172.

2,3,6
2,6

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AP


9-2

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

Challenge Exercises
173. 2,4
AP 174.

2,3

Short-Answer Essays
178.
7
K
180.
1
179.
1
K
181. 2,3,6

AN

175.

6

AP

176. 3,6,7

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182.
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184.
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177.

1,2

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186.

187.

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C


Chapter 9 Capital Budgeting Decisions

9-3

True-False
1.

One possible capital budgeting decision is the potential acquisition of a patent from a competitor.

2.

The time value of money concept recognizes that a dollar received today is worth more than a
dollar received in the future.

3.

Present value techniques are developed to equate future dollars to current dollars.

4.

In evaluating an investment opportunity, a company must know how much cash it receives from

or pays for an investment and the timing of the cash flows because receipts and payments that
occur in the future are worth more than those that occur earlier.

5.

If your required rate of return is 6%, the present value of $1,000 to be received three years from
today is $839.60.

6.

The process of determining present value removes the cost of interest from future cash flows to
determine the value of the amount today.

7.

Both the payback period and the net present value methods take into account the timing of future
cash flows.

8.

The net present value method equates cash inflows to revenues, and cash outflows to expenses, as
if occurring in the same accounting period.

9.

If the net present value is equal to zero, the project should be accepted.

10.

In net present value analysis, the purchase of equipment today results in a cash outflow that is not

discounted.

11.

The future value of all cash inflows minus the cash outflows equals the net present value of the
investment.

12.

The only cash outflow that may exist in a net present value analysis is the initial investment.

13.

If the required rate of return is greater than the internal rate of return of a potential investment, the
company should deem the investment acceptable.

14.

If the internal rate of return is used to calculate the net present value of a project, the net present
value will be zero.

15.

The internal rate of return method ignores the time value of money.

16.

The internal rate of return is the rate of return that management desires to earn on its investments.

17.

If the internal rate of return is greater than the required rate of return, the project should be
accepted.

18.

The cost of capital is the weighted average of the costs of debt and equity financing used to
generate capital for investments.


9-4

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

19.

Riskier investments demand lower rates of return.

20.

Soft benefits are those that often have a significant nonfinancial impact on an investment decision
and as such, should be included in the decision analysis.

21.

The more risky a potential investment is, the lower the company’s required rate of return will be.

22.

If an investment project generates tax-deductible expenses, cash inflows from the project will be

reduced by the taxes resulting from the increase in income taxes payable.

23.

Depreciation itself is not a cash outflow, though it reduces the amount of income taxes that a
company must pay.

24.

Cash flows used in calculating the net present value need not be adjusted for inflation because the
interest rate used to discount the cash flows has already considered inflation.

25.

The depreciation tax shield is the amount of income taxes that the company avoids as a result of
reporting depreciation expense.

26.

The net present value method can be used to determine the effect of discontinuing one of a
company’s products.

27.

Neither the accounting rate of return method nor the payback period method consider the timing
of all future cash flows related to a potential investment.

28.

The internal rate of return method and the payback period method will always give the same

decision as to whether to accept a project, if the same inputs are used.

29.

All else being equal, a company prefers projects with long payback periods, as these benefit the
company for longer time periods.

30.

The payback period method ignores cash flows that occur after the end of the payback period.

31.

A project with positive cash flows will always generate an acceptable accounting rate of return.

32.

Managers may be discouraged from using present value techniques for evaluating investments
because of the way in which their own performance is evaluated.

*33.

When using the NPV function in Microsoft © Excel, the initial cash flow at time zero is omitted
from the range selected for the function.

*34.

When using the internal rate of return function in Microsoft © Excel to calculate the internal rate of
return, the initial cash flow at time zero is omitted from the range selected for the function
because it is not discounted.

Material from the appendix to the chapter is marked with an asterisk (*).


Chapter 9 Capital Budgeting Decisions

9-5

Answers
1
2
3
4
5
6

T
T
T
F
T
T

7
8
9
10
11
12

F
T
T
T
F
F

13
14
15
16
17
18

F
T
F
F
T
T

19
20
21
22
23
24

F
T

F
F
T
F

25
26
27
28
29
30

T
T
T
F
F
T

31
32
33
34

F
T
T
F

9-6

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

MULTIPLE CHOICE
35.

Which of the following is not considered a capital budgeting project?
A.
Purchase of a new packaging machine
B.
Purchase of land on which to build a new factory
C.
Purchase of a new delivery truck to replace an old truck
D.
Purchase of inventory to be sold in the future

36.

Capital expenditure decisions
A.
are useful for estimating inventory acquisition costs.
B.
always involve the acquisition of long-lived assets.
C.
consist of a final list of approved projects.
D.
All of these answer choices are correct.

37.

Which of the following is not a component of a time value of money calculation?
A.
The amount of cash to be received
B.
The time until the cash will be received
C.
The opportunity costs of the alternative actions
D.
The required rate of return

38.

The basic concept involved in time value of money calculations is that
A.
it is better to receive a dollar today than to receive a dollar in the future.
B.
incremental revenues must exceed incremental costs.
C.
you get what you measure.
D.
revenue must be earned in order for net income to be generated

39.

Present value techniques
A.
determine the effects of time value of money on future net income that will be generated.
B.
are a way of converting future dollars into their equivalent current dollars.

C.
provide more conservative results than similar time value of money computations.
D.
treat a dollar received today to be worth the value of a dollar to be received a year from
today.

40.

Which of the following pairs of techniques use the time value of money concept?
A.
Payback period method and the internal rate of return method
B.
Internal rate of return method and the accounting rate of return method
C.
Accounting rate of return method and the payback period method
D.
Internal rate of return method and the net present value method

41.

Your required rate of return is greater than zero. How much is a payment of $3,000 to be received
a year from today worth?
A.
Less than $3,000 today
B.
Exactly $3,000 today
C.
More than $3,000 today
D.
Not enough information is provided to determine the answer.

Chapter 9 Capital Budgeting Decisions

9-7

42.

Which of the following would most likely be the present value of a 4-year annuity of $2,000 per
year, assuming a positive discount rate?
A.
$8,000
B.
$7,000
C.
$9,500
D.
$2,000

43.

Assuming a 6% rate of return, how does the present value of an amount to be received two years
from today compare to the present value of the same amount to be received three years from
today?
A.
The present value of the amount to be received in two years is greater than the present
value of amount to be received three years from today.
B.
The present value of the amount to be received in two years is lesser than the present
value of amount to be received three years from today.

C.
The present values of the two amounts are equal.
D.
It is impossible to tell unless the actual amount to be received is known.

44.

Suppose you face the prospect of receiving $800 per year for the next five years and a $200
payment at the end of six years. How much is this prospect worth today if the required rate of
return is 9%?
A.
$4,200
B.
$3,112
C.
$3,242
D.
$3,231

45.

In which of the following situations will an annuity table be useful?
I. Calculating the net present value of an investment with equal cash flows for the first
nine years, but a different flow in year 10
II. Calculating the internal rate of return of an investment with unequal cash flows each
year
III. Calculating the net present value of an investment with an equal cash flow in years
one through four, and a different equal cash flow in years 5 through 10
A.
I, II, and III

B.
II and III
C.
I and III
D.
I and II

46.

What is the present value factor for a $4,000 cash outflow that is made today?
A.
0.00
B.
Some value greater than 1.00
C.
1.00
D.
It depends on the rate of return that is required.

47.

If the time value of money techniques are used correctly, the present value of cash flows far in the
future will be
A.
lesser than the present value of the same amount of cash flows in the present.
B.
greater than the present value of the same amount of cash flows in the present.
C.
same as the future value of the same amount of cash flows in the present.
D.

greater than the future value of the same amount of cash flows in the present.


9-8

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

48.

An annuity is
A.
the time period in which the cash flows paid out for an investment will be recovered.
B.
a series of equal payments.
C.
necessary in order to calculate the net present value.
D.
used to calculate depreciation in order to provide a tax shield.

49.

If a 14% rate of return can be achieved, how much will need to be invested today in order to
receive $12,000 at the end of 3 years plus $10,000 at the end of 5 years? Round to the nearest
whole number.
A.
$33,053
B.
$5,194
C.
$11,426

D.
$13,294

50.

To achieve exactly a 13% rate of return, how much would need to be invested today in an
investment that returns $12,000 at the end of 3 years and $10,000 at the end of 5 years? Round to
the nearest whole number.
A.
$8,239
B.
$13,745
C.
$12,862
D.
$60,920

51.

Which of the following is not one of the steps in the net present value method?
A.
Identify the amount and timing of the cash flows.
B.
Discount the cash flows.
C.
Calculate the number of years required to recover the initial investment.
D.
Compare the discounted net cash flows to zero.

52.

What is the sum of the present values of all cash flows (inflows and outflows) called?
A.
Cost of capital
B.
Internal rate of return
C.
Net present value
D.
Required rate of return

53.

Projects A and B both have an initial outflow of $100,000. Project A will return a cash flow of
$30,000 each year for the next 5 years. Project B will return $40,000 in year 1, $30,000 in year 2,
$30,000 in year 3, $30,000 in year 4, and $20,000 in year 5. Which project will have the higher
net present value?
A.
Project A
B.
Project B
C.
The answer cannot be determined without knowing the required rate of return.
D.
The answer cannot be determined without knowing the initial investment.

54.

Projects with a negative net present value will always have a(n)
A.

payback period longer than the useful life of the investment.
B.
internal rate of return that is less than the required rate of return.
C.
accounting rate of return that is negative.
D.
series of cash outflows that is greater than the initial cost of the project.


Chapter 9 Capital Budgeting Decisions

9-9

55.

Projects with a negative net present value will always have a(n)
A.
payback period shorter than the life of the project.
B.
accounting rate of return that is greater than zero.
C.
an internal rate of return greater than the cost of capital.
D.
None of these answer choices are correct.

56.

The required rate of return used to calculate an investment’s net present value is related to the
firm’s
A.

contribution margin.
B.
cost of capital.
C.
depreciation methods.
D.
fixed costs.

57.

Maude Company’s required rate of return on capital budgeting projects is 9%. The company is
considering an investment that would yield a cash flow of $12,000 per year for five years.
Ignoring taxes, what is the most that the company will be willing to invest in this project?
A.
$46,676
B.
$38,994
C.
$60,000
D.
$55,046

58.

An investment that costs $50,000 will return $15,000 operating cash flows per year for five years.
Determine the net present value of the investment if the required rate of return is 14 percent.
Should the investment be undertaken?
A.
Yes, the profit is $25,000.
B.

No, the accounting return is less than 14%.
C.
No, the net present value is negative at $11,045.
D.
Yes, the net present value is positive at $1,496.50.

59.

Santo Automotive is considering producing a new automobile product, No Text, which
disengages the ability to text while driving. Marketing data indicate that the company will be able
to sell 40,000 units per year at $16 each. The product will be produced in a section of an existing
factory that is currently not in use. To produce No Text, Santo must buy a machine that costs
$820,000. The machine has an expected life of five years and will have an ending residual value
of $50,000. Santo will depreciate the machine over five years using the straight-line method. In
addition to the cost of the machine, the company will incur incremental annual manufacturing
costs of $390,000. The income tax rate is 30% and the company’s required rate of return is 10%.
How much is net operating cash flow each year?
A.
$67,200
B.
$221,200
C.
$175,000
D.
$250,000


9-10

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

60.

Santo Automotive is considering producing a new automobile product, No Text, which
disengages the ability to text while driving. Marketing data indicate that the company will be able
to sell 39,000 units per year at $16 each. The product will be produced in a section of an existing
factory that is currently not in use. To produce No Text, Santo must buy a machine that costs
$820,000. The machine has an expected life of five years and will have an ending residual value
of $50,000. Santo expects to generate net income of $56,000 per year. The income tax rate is 30%
and the company’s required rate of return is 10%. How much is the net present value?
A.
($23,932)
B.
$7,113
C.
$52,498
D.
None of these answer choices are correct.

61.

What does the cost of capital represent?
A.
The weighted average of fixed and variable costs
B.
The weighted average of the incremental cash inflows and outflows
C.
The weighted average of debt and equity financing
D.
The weighted average of the cost of borrowing on a long and short-term basis

62.

The return demanded by shareholders for the risk that they bear in supplying capital to the firm is
A.
less for riskier firms.
B.
only considered when a corporation has no debt.
C.
measured by the internal rate of return.
D.
called the cost of equity.

63.

Since present value analysis is concerned with cash flows, which of the following is not true?
A.
Depreciation is always an incremental cash inflow.
B.
Revenues are inflows in the period when the cash is received.
C.
Expenses are outflows in the period when they are paid.
D.
The salvage value of equipment is considered in the analysis.

64.

Natchez, Inc. is considering the purchase of a new machine costing $200,000. The company will
incur $5,000 per year in operating expenses but it will allow the company to earn an additional
$100,000 per year in revenues. Natchez expects the machine to provide future benefits for 3 years

and salvage value at the end of the 3-year period to be $10,000. The company uses straight-line
depreciation method. The income tax rate is 30%. If the required rate of return is 10%, how much
is the net present value of this project?
A.
$20,143
B.
$12,629
C.
$43,769
D.
None of these answer choices are correct.

65.

Discount Dollar Store is considering the purchase of a new machine costing $220,000. This
machine is estimated to generate an additional $88,000 per year in revenues. The machine will be
depreciated using the straight-line method over its 4-year life. There is no expected salvage value
at the end of its life. Expected annual net cash flows are $67,240 and expected annual net income
from the new machine total $12,240. The required rate of return is 8% and the income tax rate is
28%. How much is the net present value of this project?
A.
$2,706
B.
($179,460)
C.
$71,465
D.
$153,390

Chapter 9 Capital Budgeting Decisions

9-11

66.

Live Nutrition is considering the purchase of a new computer system for diagnosing health
problems. The company estimates that the system will result in increased operating cash flows of
$5,800 in year 1, $6,500 in year 2, and $11,400 in year 3. The company’s required rate of return is
8%. What is the maximum cost the company will be willing to pay for the computer system?
A.
$14,947
B.
$23,700
C.
$19,992
D.
$43,692

67.

The following data pertain to an investment proposal:
Required investment
$75,000
Annual cost savings
$18,000
Projected life of investment
8 years
Projected salvage value
$4,000

Required rate of return
16%
Ignoring income taxes, how much is the net present value of the proposed investment?
A.
$13,527
B.
$3,185
C.
$14,747
D.
$4,405

68.

Objective Products’ required rate of return on capital budgeting projects is 9%. The company is
considering an investment that would yield net annual operating cash flows of $30,000 for 3
years. What is the maximum amount that the company will be willing to invest in this project?
A.
$75,939
B.
$69,498
C.
$90,000
D.
$98,100

69.

Which of the following is the rate of return that equates the present value of future cash flows to
the investment outlay?

A.
Hurdle rate
B.
Internal rate of return
C.
Payback return
D.
Accounting rate of return

70.

Which statement(s) is/are true concerning the internal rate of return?
I.
It takes into account the time value of money.
II.
It is the rate of return that equates the present value of future cash flows to the
investment outlay.
A
I only
B.
II only
C.
Neither I nor II
D.
Both I and II

71.

Under which one of the following situations should a project be accepted?
A.

The internal rate of return is less than the cost of capital.
B.
The hurdle rate is greater than the required rate of return.
C.
The return on the project is equal to the required rate of return.
D.
The internal rate of return is less than the cost of capital.


9-12

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

72.

The cash inflows expected during a project’s life are equal in amount. In determining the internal
rate of return, how is the present value factor calculated?
A.
By dividing the initial outlay by the annuity amount
B.
By multiplying the annuity amount by the number of years it occurs
C.
By looking in the present value of an annuity table for the number of years and the
respective discount rate
D.
By dividing the present value of the annuity by the initial outlay

73.

Mexicali Foods determined the net operating cash inflows during a project’s life would not be

equal in amount. How can the internal rate of return be found?
A.
By averaging the cash flows and treating them as if they are equal
B.
By determining the accounting rate of return
C.
By determining the cost of equity
D.
By trial and error using present value tables, a spreadsheet program, or a financial
calculator

74.

The projected rate of return on a particular project is equal to the hurdle rate. Which statement is
true?
A.
The payback period will be longer than the period over which the return is expected to
occur.
B.
The project should be rejected.
C.
A lower discount rate should be used.
D.
The project should be accepted.

75.

Which of the following two methods are most likely give the same decision of accepting or
rejecting a particular project?
A.

Net present value and internal rate of return
B.
Accounting rate of return and payback period
C.
Accounting rate of return and internal rate of return
D.
Net present value and accounting rate of return

76.

Halloran, Inc. is planning a capital investment. The company has a 7.8% required rate of return
and a 6.3% cost of capital. Results of its budgeting calculations for three possible investments,
each with a 7-year expected useful life and no salvage value, follow:
Project 22
Project 33
Project 77

Payback Period Method
5.2
6.9
7.5

Net Present Value
$2,000
($2,000)
$0

Cost
$125,000
62,000

71,000

Which of the reasons below is true concerning the acceptability of a particular project?
A.
Project 33 incurs a net loss.
B.
Project 33 generates a return that is less than the required rate of return.
C.
The cash invested in Project 77 requires an additional half year to recover when
compared to Project 22.
D.
Project 77 will operate at breakeven.
77.

What are soft benefits?
A.
The reverse side of opportunity costs
B.
Benefits those are hard to quantify
C.
Projected cash flows that are expected to change
D.
Considerations needed when a project has a negative internal rate of return


Chapter 9 Capital Budgeting Decisions

9-13

78.

Which one of the following is a soft benefit?
A.
Decreased time to receive and process customers’ payments
B.
Enhanced reputation of the company
C.
Depreciation tax shield
D.
Reduction in the number of items spoiled during processing

79.

A project under consideration currently has a negative net present value of $11,600 using a 6%
rate of return and an estimated 4-year life. What must be the minimum present value of the soft
benefits of this project in order to make it acceptable? (Round the answer to nearest whole dollar.)
A.
$12,296
B.
$40,195
C.
$9,188
D.
$3,348

80.

The following data pertain to an investment proposal:
Required equipment investment
Annual cost savings

Projected life of investment
Projected salvage value
Required rate of return

$124,000
$52,000
4 years
$0
8%

The income tax rate is 28%. To which amount is the internal rate of return on this investment
closest?
A.
12.5%
B.
Less than 6%
C.
25%
D.
2.38%
81.

The following data pertain to an investment proposal:
Required equipment investment
Annual cost savings
Projected life of investment
Projected salvage value
Required rate of return

$120,200

$31,700
5 years
$0
9%

The income tax rate is 30%. To which amount is the internal rate of return on this investment
closest?
A.
3.8%
B.
10.0%
C.
9.0%
D.
38.1%
82.

An investment that costs $82,000 is expected to reduce cash operating costs by $27,000 per year
for 4 years. Based on the internal rate of return of the investment, should the investment be
undertaken if the required rate of return is 9 percent?
A.
No, the actual return of 3.04% is less than the required rate of return
B.
Yes, because the return of 12% is more than the hurdle rate
C.
Yes, because the IRR is more than 30%
D.
Yes, because the NPV exceeds the cost by $26,000

9-14

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

83.

An investment that costs $120,000 is estimated to reduce cash operating costs by $40,000 per
year for 4 years. The required rate of return is 10 percent. Determine the payback period
assuming an inflation rate of 8 percent on the operating costs saved.
A.
About 2.79 years
B.
About 2.92 years
C.
About 2.66 years
D.
About 3 years

84.

A company is contemplating an investment of $650,000 that is expected to yield a net present
value of zero. Which of the following statements is true?
A.
The internal rate of return of the investment is zero.
B.
The investment will yield an internal rate of return equal to the required rate of return.
C.
The investment will yield an accounting rate of return equal to the required rate of return.
D.
The investment will result in zero profit.

85.

Event Supplies is evaluating a renovation of its retail store. The cost of the renovation is
estimated to be $290,000 and will be depreciated over 8 years using the straight-line method. The
renovation is expected to generate additional annual revenue of $86,500, annual operating cash
flows are expected to increase by $50,775, and net income is expected to increase by $14,525 per
year. The company’s income tax rate is 30% and its minimum required rate of return is 9%. To
which of the following amounts is the internal rate of return of the renovation closest?
A.
5.7%
B.
8.2%
C.
25%
D.
16%

86.

Why does depreciation have an indirect effect on cash flows?
A.
It reduces the amount of income taxes a company must pay.
B.
It reduces the original cash outflow associated with the asset.
C.
It reduces the annual operating cash flows.
D.
It causes net income to be less than operating cash flows.

87.

Maxson, Inc.’s revenues are collected when they are earned and its operating expenses are paid
when they are incurred. Which of the following summarizes the calculation of operating cash
flows if the income tax rate is 30%?
A.
Revenues – operating expenses + income taxes = Operating cash flows
B.
Net income – income taxes + depreciation = Operating cash flows
C.
Net income – depreciation = Operating cash flows
D.
Revenues – operating expenses – income taxes + depreciation = Operating cash flows

88.

Why may worthwhile investment opportunities be rejected if inflation is ignored?
A.
Inflation effects generally increase estimated future cash flows, which increases the NPV
and the likelihood of acceptance.
B.
The payback period for projects will be shorter than it would be if the future cash flow
amounts were adjusted for inflation, which decreases the likelihood of acceptance.
C.
Inflation effects generally reduce future profits and operating cash flows making the NPV
smaller than if inflation is ignored, which in turn decreases the likelihood of acceptance.
D.
Estimated future cash flows adjusted for inflation have larger NPVs, which increases the
likelihood of rejection.

Chapter 9 Capital Budgeting Decisions

9-15

89.

Which one of the following is a long-run decision that is not a capital budgeting decision, for
which time value of money analyses are appropriate?
A.
Decision to drop a product line
B.
Decision to repave a parking lot
C.
Decision to acquire a patent from a competitor
D.
Decision to hire additional workers

90.

Celebration Cruises wants to acquire a new tender at a cost $425,000. The tender will have an
estimated salvage value at the end of its 8-year life of $50,000. It is expected that annual
incremental income before taxes will be $36,000. Celebration Cruises plans to make the purchase
on January 1, 2014. The company’s cost of capital is 9% and the required rate of return is 10%.
The income tax rate is 32%. How much is the depreciation tax shield for 2014?
A.
$17,000
B.
$46,875
C.

$53,125
D.
$15,000

91.

A company is considering investing in a piece of machinery that will cost $550,000. It will
provide an additional $160,000 in sales each year and its annual cash operating expenses are
expected to be $52,000. Management plans to depreciate the machine on a straight-line basis over
a 10-year life with no estimated salvage value. The company has a 40% tax rate. How much is net
annual operating cash flow expected if the machinery is acquired?
A.
$64,800
B.
$96,000
C.
$86,800
D.
$118,000

92.

Sunny Farms is considering investing in a chicken plucker machine that will cost $300,000. The
investment will provide an additional $90,000 in sales annually. Sunny Farms’ annual cash
operating expenses are expected to be $22,000. The machine will be depreciated on a straight-line
basis over a 10-year life with a $12,000 estimated salvage value. The company has a 30% tax rate
and its required rate of return is 10%. How much is the annual depreciation tax shield?
A.
$9,600
B.

$8,640
C.
$28,800
D.
$30,000

93.

A company is considering investing in a piece of machinery costing $400,000. The investment
will provide an additional $142,000 in additional sales each year and its annual cash operating
expenses are expected to be $51,000. The machine will be depreciated on a straight-line basis
over an 8-year life with no estimated salvage value. The company has a 40% tax rate. How much
are annual operating cash flows?
A.
$54,600
B.
$24,600
C.
$4,600
D.
$74,600


9-16

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

94.

Testor Labs determined it would recover its investment of a new laboratory at 12.5 years. What

did Testor Labs calculate?
A.
The breakeven point
B.
The payback period
C.
The net present value
D.
The accounting return period

95.

Why is the payback period often criticized?
A.
It requires trial and error to determine the quantitative amount on which to make a
decision.
B.
It ignores the cash flows after the end of the payback period.
C.
It requires the estimate of a hurdle rate that is subject to uncertain economic effects.
D.
It is based on accounting income, which most likely differs from the actual cash flows.

96.

Which of the following statements about the payback period method is true?
A.
All other things being equal, a company would prefer a project with a longer payback
period.
B.

The payback period method ignores the time value of money.
C.
The payback period method is more sophisticated and yields better decisions than the
internal rate of return method.
D.
The payback period method takes into account the total stream of cash flows, which are
difficult to predict.

97.

Hammer Saw Tools is considering a $7,000 investment. Which of the following alternative cash
inflows has the shortest payback period?
A.
$8,000 in Year 5
B.
$0 in Year 1, $8,000 in Year 2
C.
$1,500 per year for Years 1 through 5
D.
$3,000 in year 1, $2,500 per year for Years 3 and 4

98.

JT Corp. has a cost of capital of 6.2% and a required rate of return of 7.9%. The company
evaluated an investment and determined the IRR to be zero. Should JT accept or reject the
investment and why?
A.
Accept, because the investment will generate the minimum required return
B.
Reject, because the investment will not generate any cash flows.

C.
Accept, because the required rate of return is greater than the cost of capital
D.
Reject, because investment will generate a return that is less than the minimum required
rate of return

99.

An investment project has an accounting rate of return of 10.8%. The initial outlay for the
investment is $91,000. The hurdle rate is 10.2%. Which of the following indicates a proper
interpretation?
A.
The investment earns a net income of 10.8 cents on each dollar invested.
B.
The investment earns a cash return of 10.8 cents on each dollar invested.
C.
The investment earns a net income of 10.8 cents on each dollar of sales generated.
D.
The investment earns a cash return of 10.8 cents on each dollar of sales generated


Chapter 9 Capital Budgeting Decisions

9-17

100.

Why might the accounting rate of return be low in the initial years of an investment?
A.
Because the depreciation tax shield is negative

B.
Because customers are not willing to spend money in the initial years
C.
Because the investment base will be higher in the initial years
D.
Because the company must pay for the investment at the beginning of the first year

101.

A company with $800,000 in operating assets is considering purchasing a machine that costs
$300,000 with an estimated salvage value of $40,000. The acquisition is expected to reduce
operating costs by $55,000 in year 1, with a $5,000 increase in cost savings per year for each of
the remaining years of its 6-year life. How long is the payback period?
A.
4.7 years
B.
5.7 years
C.
5.5 years
D.
4.4 years

*102.

Oakridge Appliances is deciding whether to purchase a machine for $84,000 that is expected to
yield the following net cash flow savings:
Year 1
Year 2
Year 3

$25,000
$40,000
$45,000

What is the internal rate of return on this project?
A.
43.7%
B.
13.4%
C.
29.8%
D.
23.6%
103.

Redrum Hotel is considering a project with a 5-year life and which would require a $325,000
investment in equipment with no salvage value. The project would provide income each year as
follows for the life of the project:
Sales
Variable costs
Fixed costs
Income before taxes

$225,000
$80,000
95,000

175,000
$ 50,000

The income tax rate is 30%. Depreciation is included in the fixed costs amount. The company’s
required rate of return is 8%. Calculate the payback period for this project.
A.
3.25 years
B.
6.50 years
C.
2.83 years
D.
9.29 years
104.

Hurlizter Pianos has just purchased a piece of equipment at a cost of $345,000. This equipment
will reduce cash operating costs by $65,000 each year for the next 5 years. This equipment has a
salvage value of $20,000. Ignoring income taxes, how long will it take for the company to
recover its entire cash investment?
A.
5.23 years
B.
5.00 years
C.
4.92 years
D.
The company will never recover its entire investment.


9-18

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

*105.

When using Microsoft© Excel to calculate the internal rate of return, which item can you safely
omit from the function wizard and still calculate the internal rate of return?
A.
The initial cash flow
B.
The annual cash flows
C.
A guess at the internal rate of return
D.
None of these answer choices are correct

*106.

When using Microsoft© Excel to calculate the net present value, what should you do with the
initial cash outflow?
A.
Include it in the range of cells in the function
B.
Add it to the results from the net present value function
C.
Subtract it from the results from the net present value function
D.
Discount it at the required rate of return

107.

A proposed acquisition of a forklift on January 1, 2014 will cost $86,000. The company has
estimated the forklift’s salvage value at the end of its estimated 5-year life to be $21,000. The

following amounts have been provided by the management:
Net income
Operating cash flows

2014
$7,300
$20,300

2015
$8,700
$21,700

2016
$8,000
$21,000

2017
$5,100
$18,100

2018
$1,400
$14,400

The company’s required rate of return is 7.6% and its cost of capital is 5.4%. The income tax rate
is 32%. Calculate the payback period.
A.
4.34 years
B.
2.82 years

C.
14.10 years
D.
4.50 years
*108.

In using Microsoft© Excel to calculate NPV of a capital investment, the following data was input:
A
B
C
D
E
F
1
1-1-10
2010
2011
2012
2013
2 Cash flows
−46,000 12.600
18,500
21,500
10,500
Which choice is a correct format in which to enter into the NPV wizard if the discount rate is
9.72%?
Rate
Value1 Value2 Value3 Value4 Value5
A.
9.72

12,600
18,500
21,500
10,500
0
B.
0.972
12,600
18,500
21,500
10,500
0
C.
9.72 −46,000
12,600
18,500
21,500
10,500
D.
0.0972
12,600
18,500
21,500
10,500
0

109.

How much will you need to invest today at 10% to have a total of $10,000 accumulated six years
from today?

A.
$7,050
B.
$17,715
C.
$5,645
D.
$5,584


Chapter 9 Capital Budgeting Decisions

9-19

110.

Donaldson, Inc. analyzed an investment and determined that the proposed investment will earn a
return of 9.9%. Donaldson’s cost of capital is 6.5% and required rate of return is 9%. Currently,
Donaldson’s other investments are earning 11%. Will Donaldson be motivated to accept the
investment?
A.
Yes, because the expected return is greater than the cost of capital
B.
No, because it will cause its current return to decline
C.
Yes, because the expected return is less than the required rate of return
D.
No, because the expected return is less than the required rate of return

111.

An investment was analyzed and its NPV was determined to be $2,000. The company’s expected
rate of return was 12%. The manager of the division is currently earning 12% on its other
investments. This investment will generate losses for the first two years. Which of the following
statements best describes what the manager will likely be motivated to do if he is evaluated based
on profits?
A.
Accept the proposal since the rate of return expected is equal to the rate used for the
analysis
B.
Accept the proposal since the rate of return on the investment is equal to the required rate
of return
C.
Do not accept the proposal since the rate of return expected is less than the rate used for
the analysis
D.
Do not accept the proposal since losses are expected for the first two years

112.

Which of the following is a partial solution to motivate managers to accept proposed investments
that are projected to generate net losses for the initial years, in spite of the internal rate of return
expected to be greater than the required rate of return?
A.
Evaluate managers based on long-term profitability
B.
Evaluate managers on the short-run expectations of investments
C.
Do not evaluate managers based on investments
D.

Do not allow managers to make decisions on which investments to accept

113.

How much would you have to deposit in the bank today so that you could withdraw $2,000 per
year for 4 years earning 8%?
A.
$1,470
B.
$10,560
C.
$5,880
D.
$6,624

114.

An investment promises a return of $8,000 per year at the end of each of the next six years. How
much will you be willing to invest today to receive the $8,000 payments and earn a return of 7%?
A.
$31,982
B.
$3,360
C.
$48,000
D.
$38,132

115.

You will need $12,000 at the end of each of the next four years. If an interest rate of 6% is
appropriate, how much must you deposit today to receive these payments?
A.
$41,581
B.
$2,880
C.
$50,880
D.
$38,021


9-20

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

116.

Calculate the present value of an annuity of $42,000 per year for each of the next 15 years. Use a
required rate of return of 6%.
A.
$262,899
B.
$163,449
C.
$166,468
D.
$407,914

117.

Sanders Company has a 15% minimum required rate of return. What is the present value of the
expected operating cash flows of $300,000 per year for each of the next ten years?
A.
$2,608,000
B.
$741,600
C.
$2,281,830
D.
$1,505,631

118.

On January 1, 2014, Sanford, Inc. plans to purchase a machine for $68,000 that has an estimated
salvage value of $12,000, and an estimated life of 4 years. The machine is expected to generate
the following cash flows and income over the next 4 years:
Net income
Operating cash flows

2013
$12,500
26,500

2014
$10,300
24,300

2015
$13,000

27,000

2016
$ 2,000
16,000

Sanford’s required rate of return is 9.5%, and the cost of capital is 7.5%. How much is the
accounting rate of return?
A.
94.50%
B.
33.75%
C.
23.63%
D.
58.63%
119.

A project with an initial cost of $314,000 will generate no returns in the first two years of
operations, and operating cash flows of $150,000 per year in Years 3, 4, and 5. The required rate
of return is 7%. To which amount is the net present value of the project closest?
A.
$29,830
B.
$343,830
C.
$61,900
D.
$393,645

120.

Which amount is never used as part of the calculation of the annual operating cash flows in a
capital budgeting decision?
A.
Cost savings due to reduced labor with the new asset
B.
The salvage value of the new asset
C.
Additional variable overhead costs expected for the new machine
D.
Additional revenue due to an increased selling price

121.

What is IRR?
A.
The rate of return that causes the investment to exactly breakeven
B.
The rate of return that is the minimum acceptable by the company
C.
The rate of return that is equal to the company’s hurdle rate
D.
The rate of return that would result in zero net present value of the investment


Chapter 9 Capital Budgeting Decisions

9-21

122.

Landy Company is using the internal rate of return method to decide whether to make an
investment that will cost $120,000 and which is expected to generate economic resources for 5
years. Landry determines the IRR is 3.12. What information does the IRR provide?
A.
Landy expects to earn 3.12% of its investment as cash flows each year the asset is used.
B.
Landy expects to earn a 3.12% return over the life of its investment.
C.
Landy expects the asset will produce profits equal to 3.12% of the asset’s cost each year.
D.
Landy expects to recover its cash over 3.12 years.

123.

A project that costs $100,000 yields a cash flow of $18,000 per year for 9 years. How much is the
net present value of the project using a 16% cost of capital?
A.
$162,000
B.
$62,000
C.
($17,082)
D.
$82,918

124.

Why is the depreciation tax shield a component of analyzing investment decisions?

A.
Depreciation causes a cash outflow that is added to determine net income.
B.
Though no cash was paid out, depreciation was included on the tax return, which caused
the company to have to pay taxes on the amount of depreciation.
C.
Depreciation lowers income tax expense to be paid, though no cash flow occurs for the
depreciation amount.
D.
Depreciation creates cash flows that do not appear on the income statement.

125.

An investment of $100,000 promises net operating cash inflows of $40,000 per year for each of
the next three years. If the required rate of return is 14%, what is the net present value of the
project?
A.
$92,864
B.
$20,000
C.
($7,135)
D.
($19,000)

126.

When the NPV is calculated, what occurs?
A.
The company adds the rate of return to the future incoming cash flows.

B.
The company factors in inflation to future cash flows.
C.
Interest is removed from the future cash flows to reflect the cost of money over time.
D.
The company factors in its cost of capital to reflect the proper rate on earnings.

127.

Double, Inc. analyzed an investment with a required rate of return of 8.2%. Because the Federal
Reserve increased interest rates in the market, Double decided to change the analysis to a 8.8%
discount rate. The annual net income and cash flows remained the same. What happened to the
net present value?
A.
It increased
B.
It remained the same
C.
It decreased
D.
The amount of the cash flows is needed in order to determine the effect


9-22

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

128.

A proposed project will require an initial investment of $1,000,000 and will generate net

operating cash inflows of $250,000 per year for five years. What is the internal rate of return?
A.
Less than 9%
B.
11%
C.
13%
D.
Over 15%

129.

An investment is expected to generate net operating cash inflows of $25,000 per year for each of
the next 5 years. If the initial amount invested is $101,000, which of the following is closest to
the internal rate of return?
A.
24.8%
B.
6.5%
C.
4.0%
D.
7.5%

130.

An investment of $143,000 is expected to generate net operating cash inflows of $62,000 in each
of three years. What is the internal rate of return?
A.
Less than 1%

B.
Between 2% and 3%
C.
Between 13% and 15%
D.
Greater than 30%

131.

Pinkela Company reported revenues of $275,000 and expenses of $100,000 last year. The income
tax rate was 40%. Depreciation expense of $25,000 was included in the expenses. How much was
the net operating cash flows?
A.
$120,000
B.
$105,000
C.
$130,000
D.
$145,000

132.

After deducting income taxes at 30%, the annual cash basis income is estimated at $30,000.
Depreciation expense is $8,000 per year on a machine with a 6-year life. How much are annual
incremental operating cash flows?
A.
$15,400
B.
$27,600

C.
$38,000
D.
$32,400

133.

A project with an initial cost of $81,000 is expected to produce cash flows of $20,000 per year
and net income of $9,000 for each of the next 7 years. The asset has an estimated 7-year life and a
$4,000 salvage value. What is the projected payback period?
A.
4.01 years
B.
9.0 years
C.
7.0 years
D.
0.3 years


Chapter 9 Capital Budgeting Decisions

134.

9-23

Icy Treats, Inc. wants to purchase of a new ice cream truck with a cost of $51,000. Icy Treats has
a cost of capital of 7.4% and a required rate of return of 10.4%. Its income tax rate is 32%. The
acquisition is proposed for January 1, 2014. Icy Treats expects it can sell the truck for $7,000 at
end of its useful life of 4 years. Icy Treats estimates the following incremental amounts to be

generated by the truck:
Net income
Operating cash flows

Year 1
$4,200
15,200

Year 2
$5,600
16,600

Year 3
$6,100
17,100

Year 4
$5,800
16,800

How much is the accounting rate of return?
A.
14.48%
B.
56.64%
C.
10.64%
D.
18.71%
135.

A project with an initial cost of $450,000 is expected to generate returns of $80,000 per year for
each of the next five years. What is the project’s payback period?
A.
5.6 years
B.
5.0 years
C.
0.17 years
D.
The investment will never be recovered.

136.

An investment of $400,000 is expected to generate the following cash flows:
Year 1
Year 2
Year 3
Year 4
Year 5

$60,000
$120,000
$50,000
$150,000
$200,000

What is the investment’s payback period?
A.
4.1 years

B.
3.5 years
C.
4.4 years
D.
5.1 years
137.

A $600,000 investment is expected to generate cash flows of $120,000 per year for each of the
next six years. What is the investment’s payback period?
A.
6.0 years
B.
5.0 years
C.
4.0 years
D.
2.5 years

138.

A project that requires an investment of $42,000 is expected to generate $14,000 of net income in
Year 1, $18,000 of net income in Year 2, and $21,000 of net income in Year 3. Operating cash
flows expected in Year 1 are $16,000, with Year 2 as $12,000, and year 3 as $13,000. What is the
accounting rate of return for this investment?
A.
11.7%
B.
75.4%
C.

42.1%
D.
84.1%


9-24

Test Bank to accompany Jiambalvo Managerial Accounting, 5th edition

139.

Haven Company is considering the construction of a new parking lot. It will cost $125,000 to
construct the lot. The income tax rate is 30%. Determine the payback period if the expected net
annual operating cash inflows are $18,000 per year and the expected net income is $13,400.
A.
4.0 years
B.
9.9 years
C.
6.9 years
D.
9.3 years

140.

Kahlen Upholstery is considering entering a new line of operations. Starting the business will
require an initial investment in equipment of $400,000 with a salvage value of $40,000. It is
expected that the new business will increase net income by $80,000 per year for five years. The
equipment will be depreciated over a five-year period using straight-line depreciation with no
residual value. How much is the accounting rate of return of the new business?

A.
20.0%
B.
40.0%
C.
36.4%
D.
111.1%

141.

Webster Corporation is considering producing a new automobile product, Glisten. Research has
determined that the company will be able to sell 50,000 units per year at $13. The product will be
produced in a section of an existing factory that is currently not in use. To produce Glisten,
Webster must buy a machine that costs $380,000. The machine has an expected life of five years
and will have an ending residual value of $40,000. Webster will depreciate the machine over five
years using the straight-line method. In addition to the cost of the machine, the company will
incur incremental manufacturing costs of $535,000. Webster has an income tax rate of 30 percent,
and the company’s required rate of return is 7 percent. Calculate the payback period.
A.
3.8 years
B.
3.3 years
C.
4.7 years
D.
None of these answer choices are correct.

142.

Webster Corp. is considering producing a new waxing product, Glisten. Research has determined
that the company will be able to sell 50,000 units per year at $13. The product will be produced in
a section of an existing factory that is currently not in use. To produce Glisten, Webster must buy
a machine that costs $380,000. The machine has an expected life of five years and will have an
ending residual value of $40,000. Webster will depreciate the machine over five years using the
straight-line method. In addition to the cost of the machine, the company will incur incremental
manufacturing costs of $535,000. Webster has an income tax rate of 30 percent, and the
company’s required rate of return is 7 percent. How much is the accounting rate of return?
A.
8.7%
B.
48.0%
C.
15.7%
D.
19.4%

143.

A project that required a $420,000 investment generated no net income in the first year of its
operations, net income of $86,000 in the second year, and net income of $100,000 in the third
year. How much is the accounting rate of return for this investment?
A.
88.6%
B.
44.3%
C.
14.8%
D.
29.5%

Chapter 9 Capital Budgeting Decisions

9-25

144.

Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The equipment
will generate operating cash flows of $18,550 per year and will have no salvage value at the end
of its expected life. The income tax rate is 30%. Straight-line depreciation is used. What is the net
present value using a 6% required rate of return?
A.
$44,994
B.
$64,278
C.
$2,878
D.
($449)

145.

Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The equipment
will generate operating cash flows of $18,550 per year and will have no salvage value at the end
of its life. The income tax rate is 30%. Straight-line depreciation is used. How much is the
internal rate of return?
A.
3.3%
B.

8.0%
C.
30.2%
D.
5.68%

146.

Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The equipment
will generate operating cash flows of $18,550 per year and will have no salvage value at the end
of its life. The income tax rate is 30%. Straight-line depreciation is used. How much is the
depreciation tax shield?
A.
$10,745
B.
$15,350
C.
$4,605
D.
$5,565

147.

Sticky Sam buys a piece of equipment for $61,400 that has a useful life of 4 years. The equipment
will generate operating cash flows of $18,550 per year and will have no salvage value at the end
of its life. The income tax rate is 30%. Straight-line depreciation is used. What is the payback
period?
A.
3.3 years
B.

4.7 years
C.
1.21 years
D.
None of these answer choices are correct.

148.

Chiller Time wants to purchase a new ice cream truck which costs $56,000. The company has a
cost of capital of 8%, required rate of return of 10%, and the prevailing income tax rate is 30%.
The acquisition is proposed for January 1, 2014. Chiller Time expects it can sell the truck for
$8,000 at end of its useful life of 4 years. Chiller Time predicts the new truck will generate net
income of $5,000 and operating cash flows of $17,000 during 2014, with an increase of 5% each
subsequent year. What is the accounting rate of return?
A.
22.4%
B.
16.8%
C.
44.9%
D.
17.7%