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Managerial Accounting, 3e (Braun/Tietz)

Chapter 12 Capital Investment Decisions and the Time Value of Money 2014
1) Capital investments do not typically require large sums of money.
Answer: FALSE
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
2) The process of making capital investment decisions is referred to as capital budgeting.
Answer: TRUE
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
3) Self-check-in machines at airports are an example of capital assets.
Answer: TRUE
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
4) Capital budgeting is done when common stock is issued.
Answer: FALSE
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
5) Choosing among alternative capital investments is called a post-audit.
Answer: FALSE
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
1
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6) Post-audits of capital investments compare actual net cash inflows to projected net cash inflows.
Answer: TRUE
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
7) The costs to develop a major website for a company would be considered to be a capital asset if those
costs are significant and material (for example, the costs to develop the website exceed $100,000).
Answer: TRUE
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
8) The cost associated with renovating a warehouse to be used as a restaurant would be considered to be a
capital asset.
Answer: TRUE
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
9) The health care insurance cost of a company for its assembly-line workers would not be considered to
be a capital asset.
Answer: TRUE
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

2
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10) The following are all methods of analyzing capital investments except
A) Payback Period.
B) Regression Analysis.
C) Net Present Value (NPV).
D) Accounting Rate of Return (ARR).
Answer: B
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
11) Which of the following items would be considered a capital asset?
A) Purchase of office supplies to be used internally over the next year
B) Payment for this year's advertising campaign
C) Construction of a new store building
D) Donation of money to United Way
Answer: C
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
12) Which of the following is a characteristic of a capital asset?
A) The item will be used for a long period of time.
B) The item involves a significant sum of money.
C) None of these characteristics are correct.
D) Both A and B are correct.
Answer: D
Diff: 1
LO: 12-1
EOC: E12-16
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

3
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13) The process of choosing among different alternative investments due to limited resources is referred to
as
A) capital investing.
B) capital rationing.
C) resource rationing.
D) resource allocation.
Answer: B
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
14) The ________ capital budgeting method uses accrual accounting, rather than net cash flows, as a basis
for calculations.
A) ARR
B) Payback
C) NPV
D) IRR
Answer: A
Diff: 1
LO: 12-1
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
15) Regarding capital rationing decisions for capital assets, which of the following is true?
A) Companies should always choose the investment with the shortest payback period.
B) Companies should always choose the investment with the highest NPV.
C) Companies should always choose the investment with the highest ARR.
D) None of the above are true.
Answer: D
Diff: 1
LO: 12-1
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

4
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16) After a company invests in capital assets, it will perform a ________ in order to compare the actual to
the projected net cash inflows.
A) cash flow analysis
B) pre and post analysis
C) post-audit
D) post-cash flow
Answer: C
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
17) The term ________ is described as a "formal means of analyzing long-range investment alternatives."
A) annuity
B) time value of money
C) payback period
D) capital budgeting
Answer: D
Diff: 1
LO: 12-1
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
18) The term ________ is best described as a "relationship among principal, interest rate, and time."
A) capital budgeting
B) time value of money
C) payback period
D) annuity
Answer: B
Diff: 1
LO: 12-1
EOC: S12-7
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

5
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19) The term ________ is best described as "a stream of equal periodic payments."
A) time value of money
B) capital budgeting
C) annuity
D) payback period
Answer: C
Diff: 1
LO: 12-1
EOC: S12-7
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
20) The term ________ is best described as "the length of time required to recover the cost of an
investment."
A) time value of money
B) payback period
C) capital budgeting
D) annuity
Answer: B
Diff: 1
LO: 12-1
EOC: E12-17
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
21) The accounting rate of return uses non-cash flow factors including depreciation in calculating the
operating income of the asset.
Answer: TRUE
Diff: 1
LO: 12-2
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
22) Investments with longer payback periods are more desirable, all else being equal.
Answer: FALSE
Diff: 1
LO: 12-2
EOC: E12-17
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

6
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

23) The payback method can be used when the net cash inflows from a capital investment are unequal.
Answer: TRUE
Diff: 1
LO: 12-2
EOC: E12-18
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
24) Capital budgeting predictions must consider factors such as changing consumer preferences,
competition, and government regulations.
Answer: TRUE
Diff: 1
LO: 12-2
EOC: S12-1
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
25) The accounting rate of return method of analyzing capital budgeting decisions measures the average
annual rate of return from using the asset over its entire life.
Answer: TRUE
Diff: 2
LO: 12-2
EOC: E12-20
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
26) The accounting rate of return is a measure of profitability computed by dividing the average annual
operating income from an asset by the initial amount invested in the asset.
Answer: TRUE
Diff: 2
LO: 12-2
EOC: E12-20
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

7
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27) Accrual-based accounting is not used in determining the accounting rate of return.
Answer: FALSE
Diff: 1
LO: 12-2
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
28) The payback method primarily focuses on profitability and not time.
Answer: FALSE
Diff: 1
LO: 12-2
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
29) One advantage of the internal rate of return is that it considers the time value of money.
Answer: TRUE
Diff: 1
LO: 12-2
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
30) One disadvantage of the payback method is that it does not consider the time value of money.
Answer: TRUE
Diff: 1
LO: 12-2
EOC: S12-15
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
31) If the accounting rate of return exceeds the required accounting rate of return,
A) invest in the capital asset.
B) do not invest in the capital asset.
C) only invest if the payback period is also greater than the required rate of return.
D) only invest if the payback period is also less than the required rate of return.
Answer: A
Diff: 1
LO: 12-2
EOC: E12-20
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
8
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concepts
32) How does depreciation affect the calculation of a project's payback period?
A) Depreciation is deducted from the annual cash inflows.
B) Depreciation is added to the annual cash inflows.
C) Depreciation is only deducted if the payback period exceeds five years.
D) Depreciation does not affect the payback calculation.
Answer: D
Diff: 1
LO: 12-2
EOC: E12-17
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
33) How does depreciation affect the calculation of a project's accounting rate of return (ARR)?
A) Depreciation is added to the annual cash inflows.
B) Depreciation is deducted from the annual cash inflows.
C) Depreciation does not affect ARR.
D) Depreciation is only deducted if the ARR is less than the minimum required rate of return.
Answer: B
Diff: 1
LO: 12-2
EOC: E12-20
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
34) Which of the following is used as the equation's numerator when computing the payback period for a
capital asset with equal annual net cash inflows?
A) Expected annual cash inflow
B) Total cash inflows
C) Amount invested
D) Net cash outflow
Answer: C
Diff: 1
LO: 12-2
EOC: E12-17
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

9
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

35) Which of the following is used as the equation's numerator when computing the accounting rate of
return for a capital asset?
A) Average amount invested in the asset
B) Average annual operating income from the asset
C) Total amount invested in the asset
D) Average net cash flows from the asset
Answer: B
Diff: 1
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
36) All else being equal, a company would choose to invest in a capital asset if which of the following is
true?
A) If the payback period equals the amount invested
B) If the expected accounting rate of return is less than the required rate of return
C) If the expected accounting rate of return is greater than the required rate of return
D) If the average amount invested is equal to the net cash inflows
Answer: C
Diff: 2
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
37) The formula for calculating the accounting rate of return for a capital asset is
A) average annual operating income from asset/amount invested in asset.
B) average annual net cash inflow from asset/amount invested in asset.
C) (average annual operating income + depreciation expense)/amount invested in asset.
D) (average annual cash inflows - depreciation expense)/(amount invested in asset + residual value of
asset).
Answer: A
Diff: 1
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

10
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

38) Gomez Corporation is considering two alternative investment proposals with the following data:

Investment
Useful life
Estimated annual net
cash inflows for 8 years
Residual value
Depreciation method
Required rate of return

Proposal X
$ 850,000
8 years

Proposal Y
$ 468,000
8 years

$ 125,000
$ 40,000
Straight-line
14%

$ 78,000
$Straight-line
10%

How long is the payback period for Proposal X?


A) 10.90 years
B) 6.00 years
C) 6.80 years
D) 21.25 years
Answer: C
Explanation: C) Payback = Investment/annual cash flow
$850,000.00/$125,000.00 = 6.8 years
Diff: 1
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

11
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

39) Gomez Corporation is considering two alternative investment proposals with the following data:

Investment
Useful life
Estimated annual net
cash inflows for 8 years
Residual value
Depreciation method
Required rate of return

Proposal X
$ 850,000
8 years

Proposal Y
$ 468,000
8 years

$ 125,000
$ 40,000
Straight-line
14%

$ 78,000
$Straight-line
10%

How long is the payback period for Proposal Y?


A) 21.25 years
B) 6.00 years
C) 6.80 years
D) 11.70 years
Answer: B
Explanation: B) Payback = Investment/annual cash flow
$468,000/$78,000.00 = 6.0 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

12
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

40) Gomez Corporation is considering two alternative investment proposals with the following data:

Investment
Useful life
Estimated annual net
cash inflows for 8 years
Residual value
Depreciation method
Required rate of return

Proposal X
$ 850,000
8 years

Proposal Y
$ 468,000
8 years

$ 125,000
$ 40,000
Straight-line
14%

$ 78,000
$Straight-line
10%

What is the accounting rate of return for Proposal X?


A) 2.88 %
B) 14.71 %
C) 26.62 %
D) 2.79%
Answer: D
Explanation: D) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($125,000 - (850,000 - 40000/8))/850,000
($125,000 - 101,250)/850,000 = 2.79%
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

13
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

41) Gomez Corporation is considering two alternative investment proposals with the following data:

Investment
Useful life
Estimated annual net
cash inflows for 8 years
Residual value
Depreciation method
Required rate of return

Proposal X
$ 850,000
8 years

Proposal Y
$ 468,000
8 years

$ 125,000
$ 40,000
Straight-line
14%

$ 78,000
$Straight-line
10%

What is the accounting rate of return for Proposal Y?


A) 5.24%
B) 4.17%
C) 29.17%
D) 16.67%
Answer: B
Explanation: B) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($78,000 - (468,000/8))/468,000=
($78,000 - 58,500)/468,000 =4.17%
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

14
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

42) The Warren Company is considering investing in two alternative projects:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Project 1
$400,000
5
$100,000
$25,000
Straight-line
12%

Project 2
$250,000
6
$45,000
$15,000
Straight-line
8%

What is the payback period for Project 1?


A) 4.00 years
B) 5.56 years
C) 16.00 years
D) 8.89 years
Answer: A
Explanation: A) Payback = Investment/annual cash flow
$400,000/$100,000 = 4 years
Diff: 1
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

15
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

43) The Warren Company is considering investing in two alternative projects:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Project 1
$400,000
5
$100,000
$25,000
Straight-line
12%

Project 2
$250,000
6
$45,000
$15,000
Straight-line
8%

What is the payback period for Project 2?


A) 4.00 years
B) 5.56 years
C) 10.00 years
D) 16.00 years
Answer: B
Explanation: B) Payback = Investment/annual cash flow
$250,000/$45,000.00 = 5.56 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

16
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

44) The Warren Company is considering investing in two alternative projects:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Project 1
$400,000
5
$100,000
$25,000
Straight-line
12%

Project 2
$250,000
6
$45,000
$15,000
Straight-line
8%

What is the accounting rate of return for Project 1?


A) 43.75%
B) 6.25%
C) 1.88%
D) 25.00%
Answer: B
Explanation: B) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($100,000 - (400,000 - 25,000/5))/400,000
($100,000 - 75,000)/400,000 = 6.25%
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

17
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

45) The Warren Company is considering investing in two alternative projects:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Project 1
$400,000
5
$100,000
$25,000
Straight-line
12%

Project 2
$250,000
6
$45,000
$15,000
Straight-line
8%

What is the accounting rate of return for Project 2?


A) 33.67%
B) 3.00%
C) 18.00%
D) 2.33%
Answer: D
Explanation: D)
(Annual net cash flow - depreciation)/Investment = Accounting rate of return
($45,000 - (250,000 - 15,000/6))/250,000=
($45,000 - 39,167)250,000 =2.33 %
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
46) Ribelin Corporation is adding a new product line that will require an investment of $138,000. The
product line is estimated to generate cash inflows of $25,000 the first year, $23,000 the second year, and
$18,000 each year thereafter for ten more years. What is the payback period?
A) 7.26 years
B) 5.52 years
C) 7.00 years
D) 7.67 years
Answer: C
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

18
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47) Pitt Company is evaluating two possible investments in depreciable plant assets. The company uses
the straight-line method of depreciation. The following information is available:

Initial capital investment


Estimated useful life
Estimated residual value
Estimated annual net cash inflow
For 3 years
Required rate of return

Investment A Investment B
$112,500
$160,000
5 years
5 years
$10,000
$15,000
$25,000
10%

$40,000
12%

How long is the payback period for Investment A?


A) 4.50 years
B) 4.10 years
C) 11.25 years
D) 2.49 years
Answer: A
Explanation: A) Payback = Investment/annual cash flow
$112,500/25,000 = 4.50 years
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

19
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

48) Pitt Company is evaluating two possible investments in depreciable plant assets. The company uses
the straight-line method of depreciation. The following information is available:

Initial capital investment


Estimated useful life
Estimated residual value
Estimated annual net cash inflow
For 3 years
Required rate of return

Investment A Investment B
$112,500
$160,000
5 years
5 years
$10,000
$15,000
$25,000
10%

$40,000
12%

How long is the payback period for Investment B?


A) 3.63 years
B) 4.00 years
C) 2.40 years
D) 10.67 years
Answer: B
Explanation: B) Payback = Investment/annual cash flow
$160,000/40,000 = 4.00 years
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

20
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49) Landrum Corporation is considering investing in specialized equipment costing $250,000. The
equipment has a useful life of 5 years and a residual value of $20,000. Depreciation is calculated using the
straight-line method. The expected net cash inflows from the investment are:
Year 1
Year 2
Year 3
Year 4
Year 5
Total cash inflows

$ 60,000
$ 90,000
$110,000
$ 40,000
$ 25,000
$325,000

Landrum Corporation's required rate of return on investments is 14%.


What is the accounting rate of return on the investment?
A) 7.60%
B) 5.60%
C) 18.40%
D) 44.40%
Answer: A
Explanation: A) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($325,000/5 - (250,000 - 20,000)/5)/$250,000
($65,000 - $46,000)$/250,000 = 7.60 %
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
50) Cowell Corporation is considering an investment in new equipment costing $155,000. The equipment
will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash
inflows of $45,000 the first year, $65,000 the second year, and $90,000 every year thereafter until the fifth
year. What is the payback period for this investment? The equipment has no residual value.
A) 2.04 years
B) 3.44 years
C) 1.72 years
D) 2.50 years
Answer: D
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

21
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

51) Suppose Whole Foods is considering investing in warehouse-management software that costs
$600,000, has $60,000 residual value and should lead to cash cost savings of $130,000 per year for its fiveyear life. In calculating the ARR, which of the following figures should be used as the equation's
denominator?
A) $60,000
B) $600,000
C) $130,000
D) $275,000
Answer: B
Explanation: B) Investment = $600,000
Diff: 1
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
52) The Hanna Company uses straight-line depreciation and is considering a capital expenditure for
which the following relevant cash flow data have been estimated:
Estimated useful life:
3 years
Initial investment:
$500,000
Savings year 1:
$210,000
Savings year 2:
$150,000
Savings year 3:
$225,000
Residual value after 3 yrs
$ 50,000
Total net inflows during the useful life of the asset are
A) $635,000.
B) $535,000.
C) $585,000.
D) $85,000.
Answer: C
Explanation: C)
Savings year 1:
$210,000
Savings year 2:
$150,000
Savings year 3:
$225,000
Total
$585,000
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

22
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

53) The Hanna Company uses straight-line depreciation and is considering a capital expenditure for
which the following relevant cash flow data have been estimated:
Estimated useful life:
3 years
Initial investment:
$500,000
Savings year 1:
$210,000
Savings year 2:
$150,000
Savings year 3:
$225,000
Residual value after 3 yrs
$ 50,000
Total operating income from the asset over the 3-year period is
A) $85,000.
B) $150,000.
C) $435,000.
D) $135,000.
Answer: D
Diff: 2
LO: 12-2
EOC: E12-19
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
54) The Hanna Company uses straight-line depreciation and is considering a capital expenditure for
which the following relevant cash flow data have been estimated:
Estimated useful life:
3 years
Initial investment:
$500,000
Savings year 1:
$210,000
Savings year 2:
$150,000
Savings year 3:
$225,000
Residual value after 3 yrs
$ 50,000
The total depreciation expense over the life of the asset is
A) $150,000.
B) $550,000.
C) $450,000.
D) $585,000.
Answer: C
Explanation: C) Investment - residual value
$500,000 - 50,000 = 450,000
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
23
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

55) The Hanna Company uses straight-line depreciation and is considering a capital expenditure for
which the following relevant cash flow data have been estimated:
Estimated useful life:
3 years
Initial investment:
$500,000
Savings year 1:
$210,000
Savings year 2:
$150,000
Savings year 3:
$225,000
Residual value after 3 yrs
$ 50,000
The accounting rate of return is closest to
A) 39.00%.
B) 9.00%.
C) 30.00%.
D) 7.69%.
Answer: B
Explanation: B)
(Annual net cash flow - depreciation)/Investment = Accounting rate of return
(210,000 + 150,000 + 225,000) - (500,000 - 50,000)/500,000
(585,000 - 450,000)/500,000 = 27.00
Divide by 3 years = 9.00 %
Diff: 2
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

24
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

56) O'Mally Department Stores is considering two possible expansion plans. One proposal involves
opening 5 stores in Indiana at the cost of $1,920,000. Under the other proposal, the company would focus
on Kentucky and open 6 stores at a cost of $2,500,000. The following information is available:

Required investment
Estimated life
Estimated residual value
Estimated annual cash inflows over the next 10 years
Required rate of return

Indiana proposal Kentucky proposal


$1,920,000
$2,500,000
10 years
10 years
$50,000
$80,000
$400,000
$500,000
10%
10%

The payback period for the Kentucky proposal is closest to


A) 4.5 years.
B) 6.25 years.
C) 5.00 years.
D) 31.25 years.
Answer: C
Explanation: C) Investment/Annual cash flows
$2,500,000/500,000 = 5.0 yrs
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

25
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

57) O'Mally Department Stores is considering two possible expansion plans. One proposal involves
opening 5 stores in Indiana at the cost of $1,920,000. Under the other proposal, the company would focus
on Kentucky and open 6 stores at a cost of $2,500,000. The following information is available:

Required investment
Estimated life
Estimated residual value
Estimated annual cash inflows over the next 10 years
Required rate of return

Indiana proposal Kentucky proposal


$1,920,000
$2,500,000
10 years
10 years
$50,000
$80,000
$400,000
$500,000
10%
10%

The payback period for the Indiana proposal is closest to


A) 3.8 years.
B) 5.0 years.
C) 4.8 years.
D) 38.4 years.
Answer: C
Explanation: C) Investment/Annual cash flows
$1,920,000/400,000 = 4.8 yrs
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

26
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

58) O'Mally Department Stores is considering two possible expansion plans. One proposal involves
opening 5 stores in Indiana at the cost of $1,920,000. Under the other proposal, the company would focus
on Kentucky and open 6 stores at a cost of $2,500,000. The following information is available:

Required investment
Estimated life
Estimated residual value
Estimated annual cash inflows over the next 10 years
Required rate of return

Indiana proposal Kentucky proposal


$1,920,000
$2,500,000
10 years
10 years
$50,000
$80,000
$400,000
$500,000
10%
10%

The accounting rate of return for the Kentucky proposal is closest to


A) 10.32%.
B) 11.09%.
C) 10.00%.
D) 20.00%.
Answer: A
Explanation: A) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($500,000 - (2,500,000 - 80,000)/10)/2,500,000
($500,000 - 242,000)/2,500,000 = 10.32%
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

27
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

59) O'Mally Department Stores is considering two possible expansion plans. One proposal involves
opening 5 stores in Indiana at the cost of $1,920,000. Under the other proposal, the company would focus
on Kentucky and open 6 stores at a cost of $2,500,000. The following information is available:

Required investment
Estimated life
Estimated residual value
Estimated annual cash inflows over the next 10 years
Required rate of return

Indiana proposal Kentucky proposal


$1,920,000
$2,500,000
10 years
10 years
$50,000
$80,000
$400,000
$500,000
10%
10%

The accounting rate of return for the Indiana proposal is closest to


A) 10.32%.
B) 11.09%.
C) 20.83%.
D) 10.83%.
Answer: B
Explanation: B) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
($400,000 - (1,920,000 - 50,000)/10)/1,920,000
($400,000 - 187,000)/1,920,000 = 11.09375%
Diff: 2
LO: 12-2
EOC: E12-18
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
60) Runnin' Wild Family Fun Center bought new go-karts for its recreation facility. The useful life is 6
years. The go-karts had a total cost of $5,100 and will generate $1,700 total cash inflows each year for the
life of the go-karts. The residual value of the go-karts is $650. The payback period in years is closest to
A) 3.38.
B) 3.00.
C) 2.62.
D) 2.17.
Answer: B
Explanation: B) Investment/Annual cash flows
5,100/1,700 = 3.00 yrs
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

28
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

61) Speedy Print Shop bought a new high-speed photo copier for customers to be able to bring in their
digital pictures to make high-quality copies. Its useful life is 6 years. The copier cost $7,740 and will
generate annual cash inflows of $2,150. The residual value of the copier is $1,320. The payback period in
years is closest to
A) 4.21.
B) 3.60.
C) 2.99.
D) 2.23.
Answer: B
Explanation: B) Investment/Annual cash flows
$7,740/2,150 = 3.6 yrs
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
62) Buxton Corporation is evaluating a capital investment project which would require an initial
investment of $240,000 to purchase new machinery. The annual revenues and expenses generated
specifically by this project each year during the project's nine year life would be:
Sales
Variable expenses
Contribution margin
Fixed expenses:
Salaries expense
Rent expense
Depreciation expense
Total fixed expenses
Operating income

$185,000
$ 38,000
$147,000
$ 31,000
$ 24,000
$ 25,000
$ 80,000
$ 67,000

The residual value of the machinery at the end of the nine years would be $15,000. The payback period of
this potential project in years would be closest to
A) 2.6.
B) 3.6.
C) 3.1.
D) 1.4.
Answer: A
Explanation: A) Investment/Annual cash flows
$240,000 / (67,000 + 25,000) = 2.6 yrs
Diff: 3
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
29
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

63) Smith & Cramer, Computer Repair, is considering an investment in computer and network equipment
costing $254,000. This equipment would allow them to offer new programming services to clients. The
equipment will be depreciated on the straight-line basis over an eight-year period with an estimated
residual value of $60,000. Using the accounting rate of return model, what is the minimum average
annual operating income that must be generated from this investment in order to achieve an 11%
accounting rate of return?
A) $6,600
B) $21,340
C) $31,750
D) $27,940
Answer: D
Explanation: D) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
Annual net cash flow/254,000 = 11%
Annual net cash flow = 11% 254,000 = 27,940.
Diff: 3
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
64) Pro-Am Audio is a company that is contracted to DJ private events. Due to a recent increase in
bookings, Pro-Am is considering the purchase of another mobile DJ unit. Pro-Am uses the payback
method to evaluate its investments. The mobile DJ unit will cost $12,000, has a useful life of 10 years, and
will generate $2,000 in net cash inflows per year. The residual value of the unit is $1,000. What is the
payback period for the mobile DJ unit?
A) 6.50 years
B) 5.50 years
C) 6.00 years
D) 4.00 years
Answer: C
Explanation: C) Investment/Annual cash flows
12,000 / 2,000 = 6 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

30
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

65) Sparky the Electrician specializes in rewiring historic houses. Sparky recently purchased a new wirepulling device that will decrease the time to complete each job and increase total revenues. The device
will cost $4,375 and will increase net cash flows by $1,750 per year. The new device has a useful life of 7
years and a residual value of $250. What is the payback period for the new wire-pulling device?
A) 2.64 years
B) 2.50 years
C) 2.36 years
D) 2.19 years
Answer: B
Explanation: B) Investment/Annual cash flows
4,375 / 1,750 = 2.5 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
66) Bonneville Manufacturing is considering an investment that would require an initial net investment of
$650,000. The following revenues/expenses relate exclusively to the investment:
Sales
Variable expenses
Contribution margin
Fixed expenses
Salaries expense
Rent expense
Depreciation expense
Total fixed expenses
Operating income

$350,000
$40,000
$310,000
$28,000
$20,000
$40,000
$88,000
$222,000

The investment will have a residual value of $50,000 at the end of its 15 year useful life. What is the
payback period for this investment?
A) 1.86 years
B) 3.07 years
C) 2.93 years
D) 2.48 years
Answer: D
Explanation: D) Investment/Annual cash flows
$650,000 / (222,000 + 40,000) = 2.48 yrs
Diff: 3
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
31
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

67) GlenGary Investment Corporation is analyzing a proposal to build condo units in southern Florida.
The project will require an initial invest of $500,000. The building has a useful life of 20 years, a residual
value of $200,000, and is depreciated on a straight-line basis. GlenGary uses the accounting rate of return
model to evaluate investment projects. What is the minimum annual operating income that must be
generated by this project to achieve the 9% accounting return required by GlenGary?
A) $18,000
B) $45,000
C) $25,000
D) $27,000
Answer: B
Explanation: B) (Annual net cash flow - depreciation)/Investment = Accounting rate of return
Annual net cash flow/500,000 = 9%
Annual net cash flow = 9% 500,000 = 45,000.
Diff: 3
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
68) Globe Enterprises purchased a new machine with a total cost of $30,450 and a useful life of 6 years.
The machine will produce net cash inflows of $7,250 over its useful life and has a residual value of $2,125.
What is the payback period for the new machine?
A) 4.49 years
B) 3.91 years
C) 4.20 years
D) 3.25 years
Answer: C
Explanation: C) $30,450 / $7,250 = 4.20 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

32
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

69) Siesta Manufacturing has asked you to evaluate a capital investment project. The project will require
an initial investment of $88,000. The life of the investment is 7 years with a residual value of $4,000. If the
project produces net annual cash inflows of $16,000, what is the accounting rate of return?
A) 3.90%
B) 4.55%
C) 550.00%
D) 18.18%
Answer: B
Explanation: B) ($88,000 - 4,000)/7 years = $12,000 annual depreciation expense
$16,000 - $12,000/$88,000 = 4.55%
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
70) Abdul Corporation bought a new machine, which cost $90,000, has a useful life of 10 years, and will
generate annual cash inflows of $25,000. The residual value of the machine is $5,500. What is the payback
period?
Answer: $90,000/$25,000 = 3.60 years
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
71) The Toth Company bought a new specialty machine that cost $100,000 with a 4-year life with no
residual value. The company plans to generate annual cash inflows of $30,000 each year for 4 years.
Calculate the accounting rate of return.
Answer: 5.00%
Calculations:
($100,000 - 0)/4 years = $25,000 annual depreciation expense
$30,000 - $25,000/$100,000 = $5,000/$100,000 = 5.00%
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

33
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

72) The Hawn Corporation bought a new machine that cost $150,000 with a 10-year life and a residual
value of $20,000. The company plans to generate annual cash inflows of $40,000 over 10 years. Calculate
the accounting rate of return.
Answer: 18.00%
Calculations:
($150,000 - $20,000)/10 years = $13,000 annual depreciation expense
$40,000 - $13,000/$150,000 = $27,000/$150,000 = 18.00%
Diff: 2
LO: 12-2
EOC: E12-17
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
73) Sicily, Inc.., is considering investing $250,000 in a machine that will last 4 years with no residual value.
The new machine will generate annual operating income of $55,000 per year for 4 years. What is the
accounting rate of return?
Answer: 22%
Calculations:
$55,000/$250,000 = 22%
Diff: 2
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
74) Buller Manufacturing is considering acquiring another facility for a cost of $610,000. The required
payback period is 4.5 years. Assume annual net cash inflows are $150,000 for the first two years and
$125,000 for years 3 and 4. What must the inflow be in the fifth year to meet the 4.5 year payback period?
Answer: $120,000
Calculations:
$300,000 + $250,000 + .5X = $610,000; X = $120,000
Diff: 3
LO: 12-2
EOC: E12-20
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

34
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

75) One dollar to be received in the future is worth more than one dollar today.
Answer: FALSE
Diff: 1
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
76) The net present value method does not incorporate the time value of money.
Answer: FALSE
Diff: 1
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
77) The principal amount, the interest rate, and the number of periods are all factors needed to calculate
the time value of money.
Answer: TRUE
Diff: 1
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
78) Calculating interest on the principal and on all the interest earned to date is called compound interest.
Answer: TRUE
Diff: 1
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
79) When computing the present value of a future sum, the interest rate must always be expressed as an
annual rate.
Answer: FALSE
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
35
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

80) The Future Value of $1 table is used to calculate how much $100 in hand today would be worth in 5
years.
Answer: TRUE
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
81) The three factors that affect the time value of money are principal, number of periods, and the interest
rate.
Answer: TRUE
Diff: 1
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
82) Which of the following areas does not make significant use of time value of money concepts?
A) Capital investment analysis
B) Lending and borrowing
C) Personal finance planning
D) Marketing research
Answer: D
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
83) The time value of money is explained by which of the following?
A) Invested money earns income over time.
B) Money is more valuable over time.
C) A stream of payments is received over time.
D) Interest is always compounded over time.
Answer: A
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

36
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

84) Your grandfather has promised to give you $1,000 a year at the end of each of the next four years if
you earn Cs or better in all of your courses each year. Using a discount rate of 6%, which of the following
is correct for determining the present value of the gift?
A) PV = $1,000 6% 4
B) PV = $1,000 (PV factor, i = 4%, n = 6)
C) PV = $1,000 (Annuity PV factor, i = 6%, n = 4)
D) PV = $1,000 (Annuity FV factor, i = 6%, n = 4)
Answer: C
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
85) You have been awarded a scholarship that will pay you $500 per semester at the end of each of the
next 8 semesters that you earn a GPA of 3.5 or better. You are a very serious student and you anticipate
receiving the scholarship every semester. Using a discount rate of 3% per semester, which of the following
is the correct calculation for determining the present value of the scholarship?
A) PV = $500 3% 8
B) PV = $500 (Annuity PV factor, i = 3%, n = 8)
C) PV = $500 (Annuity FV factor, i = 6%, n = 4)
D) PV = $1,000 (PV factor, i = 3%, n = 4)
Answer: B
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
86) You won the lottery and have a number of choices as to how to take the money. Which choice yields a
greater present value?
A) $12,000 a year at the end of each of the next 6 years using a 6% discount rate
B) $53,500 (lump sum) now using a 6% discount rate
C) $90,000 (lump sum) 7 years from now using a 6% discount rate
D) $92,000 (lump sum) 7 years from now using an 8% discount rate
Answer: C
Diff: 2
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

37
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

87) When you graduate from college, your mother plans to give you a gift of $50,000 to start you on your
way. However, to determine what you learned in business school, your mother presents you with four
options on how to receive the gift. Which of the four options presented by your mother will yield the
greatest present value to you?
A) A lump sum of $50,000 today
B) $25,000 per year for the next 2 years using a 3% discount rate
C) A lump sum of $50,000 after grad school (2 years) assuming a 5% discount rate
D) A lump sum of $50,000 after grad school (2 years) assuming a 3% discount rate
Answer: A
Diff: 2
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
88) Your wealthy neighbor has promised to give you $2,000 a year at the end of each of the next four years
to help with college. Using a discount rate of 8%, the present value of the gift can be stated as
A) PV = $2,000 (PV factor, i = 4%, n = 4).
B) PV = $2,000 8% 5.
C) PV = $2,000 (Annuity FV factor, i = 8%, n = 4).
D) PV = $2,000 (Annuity PV factor, i = 8%, n = 4).
Answer: D
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
89) Your hard work in college paid off, quite literally, and you received a graduate assistantship for your
MBA program. The assistantship pays a stipend of $10,000 at the end of each of the next 2 years. Using an
average discount rate of 3%, the future value of your assistantship can be calculated by
A) PV = $10,000 3% 2.
B) PV = $10,000 (PV factor, i = 3%, n = 2).
C) PV = $10,000 (Annuity PV factor, i = 3%, n = 2).
D) PV = $10,000 (Annuity FV factor, i = 3%, n = 2).
Answer: D
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

38
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

90) The present value of an investment is affected by which of the following?


A) The interest rate
B) The number of time periods (length of the investment)
C) The type of investment (annuity versus lump sum)
D) All of the above
Answer: D
Diff: 2
LO: 12-3
EOC: S12-10
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
91) You win the lottery and must decide how to take the payout. Use an 8% discount rate. What is the
present value of $15,000 a year received at the end of each of the next six years?
A) $9,450
B) $90,000
C) $74,893
D) $69,345
Answer: D
Explanation: D) Present value annuity @ 8% for 6 yrs = 4.623 15,000 = $69,345
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
92) Assuming an interest rate of 10%, the present value of $50,000 to be received 8 years from now would
be closest to
A) $23,350.
B) $21,200.
C) $19,300.
D) $107,200.
Answer: A
Explanation: A) Present value @ 10% for 8 yrs = .467 50,000 = $23,350
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

39
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

93) Assuming an interest rate of 10%, the present value of $11,000 received at the end of each year for 6
years would be closest to
A) $6,204.
B) $66,000.
C) $47,905.
D) $84,876.
Answer: C
Explanation: C) Present value annuity @ 10% for 6 yrs = 4.355 11,000 = $47,905
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
94) Assuming an interest rate of 10%, if you invest a lump sum of $5,000 now, the balance of your
investment in 7 years will be closest to
A) $12,970.
B) $9,745.
C) $23,340.
D) $35,000.
Answer: B
Explanation: B) Future value @ 10% for 7 yrs = 1.949 5000 = 9,745
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
95) If you invest $1,200 at the end of every year for five years at an interest rate of 10%, the balance of your
investment in 5 years will be closest to
A) $1,933.
B) $6,000.
C) $7,326.
D) $4,549.
Answer: C
Explanation: C) Future value annuity @ 10 % for 5 yrs = 6.1051 1200 = 7,326
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

40
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

96) Income from an apartment building you own totals $260,000 per year. You plan on selling the building
and retiring to France in 12 years. Assuming you can invest the income from the building each year at 3%,
how much money will you have on which to retire?
A) $3,330,080
B) $4,060,680
C) $3,689,920
D) $2,558,040
Answer: C
Explanation: C) Future value @ 3% for 12 yrs = 14.192 260,000 = $3,689,920
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
97) You recently won a contest sponsored by a local radio station. The radio station will pay you $2,500 at
the end of each of the next 15 years. Assuming an interest rate of 3%, what is the present value of this
prize?
A) $46,498
B) $29,845
C) $28,240
D) $42,715
Answer: B
Explanation: B) Present value annuity @ 3% for 15 yrs = 11.938 2,500 = $29,845
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
98) The present value of $1,000,000 received in 13 years, given an interest rate of 3%, is
A) $681,000.
B) $661,000.
C) $1,469,000.
D) $10,635,000.
Answer: A
Explanation: A) Present value @ 3% for 13 yrs = 0.681 1,000,000 = $681,000
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

41
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

99) On a whim you purchased a scratch-off lottery ticket at the gas station. It must have been your lucky
day because you won $1,000,000. Being logical and rational you decide to invest the money at 3% for 10
years until you are ready to start a family. At the end of 10 years, how much will your investment be
worth?
A) $11,464,000
B) $1,344,000
C) $744,000
D) $1,384,000
Answer: B
Explanation: B) Future value @ 3% for 10 yrs = 1,000,000 1.344 = $1,344,000
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
100) Assuming an interest rate of 6%, the present value of $22,000 to be received 9 years from now would
be closest to
A) $16,434.
B) $13,024.
C) $37,162.
D) $35,068.
Answer: B
Explanation: B) Present value @ 6% for 9 yrs = .592 22,000 = $13,024
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
101) Assuming an interest rate of 6%, the present value of $18,000 received at the end of each year for 6
years would be closest to
A) $88,506.
B) $11,970.
C) $108,000.
D) $125,550.
Answer: A
Explanation: A) Present value annuity @ 6% for 6 yrs = 4.917 18,000 = $88,506
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
42
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

102) Assuming an interest rate of 6%, if you invest a lump sum of $6,500 now, the balance of your
investment in 7 years will be closest to
A) $45,500.
B) $11,642.
C) $36,283.
D) $9,776.
Answer: D
Explanation: D) Future value @ 6% for 7 yrs = 1.504 6,500 = $9,776
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
103) If you invest $5,000 at the end of every year for nine years at an interest rate of 6%, the balance of
your investment in 5 years will be closest to
A) $6,690.
B) $28,185.
C) $21,060.
D) $25,000.
Answer: B
Explanation: B) Future value annuity @ 6% for 5 yrs = 5.637 5,000 = $28,185
Diff: 1
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
104) You win the lottery and must decide how to take the payout. Use an 8% discount rate for all parts of
this question.
Required:
a. What is the present value of $12,000 a year received at the end of each of the next six years?
b. What is the present value of taking a $60,000 lump sum now?
c. What is the present value of a $90,000 lump sum taken in 7 years?
Answer:
a. ($12,000 4.623) = $55,476
b. $60,000
c. ($90,000 0.583) = $52,470
Diff: 2
LO: 9-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
43
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

105) Solve the following two cases (the cases are independent).
a. If you invest $5,000 today at 10% interest, what is the value of the investment at the end of 5 years?
b. If you invest $1,200 at the end of each of the next 5 years and the investment earns 10% interest, what
is the value of the investment at the end of 5 years?
Answer:
a. FV = $5,000 1.611 = $8,055
b. FVA = $1,200 6.105 = $7,326
Diff: 2
LO: 12-3
EOC: S12-7
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
106) The ARR allows managers to compare the present value of future cash generated by a project against
the cost of investing in that project.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: S12-11
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
107) Net present value and the internal rate of return are examples of discounted cash flow models used
in capital budgeting decisions.
Answer: TRUE
Diff: 2
LO: 12-4
EOC: S12-11
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
108) In calculating the net present value of an investment in equipment, the required investment and its
residual value should be subtracted from the present value of all future cash inflows.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: S12-11
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

44
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

109) The profitability index equals the present value of net cash inflows from the investment divided by
the cost of the investment.
Answer: TRUE
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
110) The residual value is considered in a net present value computation.
Answer: TRUE
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
111) A series of equal payments or deposits made at equal time intervals are called compound interest.
Answer: FALSE
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
112) The interest rate that makes the net present value of the investment equal to zero is the internal rate
of return.
Answer: TRUE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
113) The internal rate of return is used as the discount rate when calculating the net present value of a
project.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
45
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

114) The net present value method assumes that all cash inflows are immediately reinvested at a rate of
return equal to the internal rate of return.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
115) When evaluating capital investment projects, if the internal rate of return is less than the required
rate of return, the project will be accepted.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
116) When selecting a capital investment project from three alternatives, the project with the highest net
present value will always be preferable.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
117) The hurdle rate is the length of time it takes to recoup an investment's initial cost from the cash
inflows that investment generates.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

46
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

118) When evaluating the cash flows from an investment, a reduction in cash outflows is treated as the
same as an increase in cash inflows.
Answer: TRUE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
119) When the profitability index is less than 1.00 for a project, that project has a positive net present
value.
Answer: FALSE
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
120) What is an attribute of the internal rate of return?
A) It is the interest rate that makes the NPV of the investment equal to zero.
B) It is the interest rate that makes the cost of the investment equal to the present value of the investment's
net cash inflows.
C) It is used in the capital rationing process.
D) All of the above are attributes of the internal rate of return.
Answer: D
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
121) What would a project's profitability index be if the project has an internal rate of return which is
equal to the company's discount rate?
A) It would be 0.5.
B) It would be 0.0.
C) It would be 1.0.
D) It cannot be determined from information provided
Answer: B
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
47
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

122) What will happen to the net present value (NPV) of a project if the discount rate is increased from
8% to 10%?
A) NPV will always decrease.
B) NPV will always increase.
C) The discount rate change will not affect NPV.
D) We cannot determine the direction of the effect on NPV from the information provided.
Answer: A
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
123) What will happen to the internal rate of return (IRR) of a project if the discount rate is decreased
from 9% to 7%?
A) IRR will always increase.
B) The discount rate change will not affect IRR.
C) IRR will always decrease.
D) We cannot determine the direction of the effect on IRR from the information provided.
Answer: B
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
124) The net present value method assumes that the cash inflows from a project are immediately
reinvested at the
A) internal rate of return.
B) accounting rate of return.
C) market rate of return.
D) required rate of return.
Answer: D
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

48
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

125) A company finds that the residual value of $8,000 for the equipment in a capital budgeting project
has been inadvertently omitted from the calculation of the net present value (NPV) for that project. How
does this omission affect the NPV of that project?
A) The project's NPV should be higher, but be less than $8,000 higher, with the residual value included.
B) The project's NPV should be $8,000 higher with the residual value included.
C) The project's NPV should be $8,000 lower with the residual value included.
D) The project's NPV should be lower, but be less than $8,000 lower, with the residual value included.
Answer: A
Diff: 1
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
126) Which of the following is a weakness of the internal rate of return (IRR)?
A) IRR assumes that the cash inflows from the project are immediately reinvested at the minimum
required rate of return.
B) IRR ignores the time value of money.
C) IRR assumes that the cash inflows from the project are immediately reinvested at the internal rate of
return.
D) IRR is not a percentage rate, but is expressed in dollars.
Answer: C
Diff: 1
LO: 12-4
EOC: E12-29
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
127) Another name for the minimum desired rate of return is
A) discount rate.
B) required rate of return.
C) hurdle rate.
D) All of the above
Answer: D
Diff: 2
LO: 12-4
EOC: E12-29
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

49
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

128) A company would consider all of the following in computing the IRR of an investment, except
A) predicted cash inflows over the life of the project.
B) the cost of the project.
C) depreciation expense on the assets of the project.
D) present value factors.
Answer: C
Diff: 2
LO: 12-4
EOC: E12-29
AACSB: Reflective Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
129) (Present value tables are required.) Mantua Motors is evaluating a capital investment opportunity.
This project would require an initial investment of $38,000 to purchase equipment. The equipment will
have a residual value at the end of its life of $3,000. The useful life of the equipment is 5 years. The new
project is expected to generate additional net cash inflows of $12,000 per year for each of the five years.
Mantua Motors' required rate of return is 14%. The net present value of this project is closest to
A) ($1,994).
B) $4,753.
C) $3,196.
D) $28,386.
Answer: B
Explanation: B) Annual cash flow ($12,000 3.433) = $41,213
Residual value ($3,000 0.519)
= 1,557
Less investment cost
= (38,000)
Net present value
$ 4,753
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

50
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

130) (Present value tables are required.) Maersk Metal Stamping is analyzing a special investment project.
The project will require the purchase of two machines for $30,000 and $8,000 (both machines are
required). The total residual value at the end of the project is $1,500. The project will generate cash
inflows of $11,000 per year over its 8-year life. If Maersk requires a 6% return, what is the net present
value (NPV) of this project?
A) $30,308
B) $8,332
C) $2,456
D) $9,453
Answer: D
Explanation: D)
Year(s)
Amount
Facctor
Present value
Initial investment
in equipment
Additional equipment
needed
Annual net cash inflow
Residual value
Net present value

Now

$(30,000)

1.000

$(30,000)

Now
1 to 8
8

$(8,000)
$11,000
$1.500

1.000
4.212
0.747

$(8,000)
$46,332
$1,121
$9,453

Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
131) (Present value tables are required.) Figgey, a plastics processor, is considering the purchase of a highspeed extruder as one option. The new extruder would cost $52,000 and would have a residual value of
$5,000 at the end of its 8 year life. The annual operating expenses of the new extruder would be $8,000.
The other option that Figgey has is to rebuild its existing extruder. The rebuilding would require an
investment of $30,000 and would extend the life of the existing extruder by 8 years. The existing extruder
has annual operating costs of $11,000 per year and does not have a residual value. Figgey discount rate is
14%. Using net present value analysis, which option is the better option and by how much?
A) Better by $8,083 to rebuild existing extruder
B) Better by $8,083 to purchase new extruder
C) Better by $6,328 to rebuild existing extruder
D) Better by $6,328 to purchase new extruder
Answer: C
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
51
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

132) (Present value tables are required.) The Speedy-Delivery Company has two options for its delivery
truck. The first option is to purchase a new truck for $15,000. The new truck will have a useful life of 5
years and a residual value of $2,000. Operating costs for the new truck will be $200. The second option is
to overhaul its existing truck. The cost of the overhaul will be $8,000. The overhauled truck will have a
useful life of 5 years and a residual value of $0. Operating costs for the overhauled truck will be $600.
Using Speedy's discount rate of 5%, which option is better and by what amount?
A) Better to overhaul by $3,700
B) Better to purchase new by $3,700
C) Better to overhaul by $5,144
D) Better to purchase new by $5,144
Answer: A
Explanation: A)

Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

52
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

133) (Present value tables are required.) Interior Products, Inc. is evaluating the purchase of a new
machine to use in its manufacturing process. The new machine would cost $41,000 and have a useful life
of 6 years. At the end of the machine's life, it would have a residual value of $2,500. Annual cost savings
from the new machine would be $12,400 per year for each of the six years of its life. Interior Products, Inc.
has a minimum required rate of return of 16% on all new projects. The net present value of the new
machine would be closest to
A) $3,669.
B) $5,719.
C) $4,694.
D) $46,719.
Answer: B
Explanation: B) Cost of Equipment
$-41,000
Residual value
2,500
PV 16% 6 yrs
0.410
1,025
Annual Expense
12,400
PFA 16% 6 yrs
3.685
45,694
Total
5,719
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
134) (Present value tables are required.) Westin Manufacturing is considering the purchase of a new
machine to use in its packing department. The new machine will have an initial cost of $170,000, a useful
life of 12 years and a $10,000 residual value. Westin will realize $15,750 in annual savings for each of the
machine's 12-year useful life. Given Westin's 4% required rate of return, the new machine will have a net
present value (NPV) of
A) ($28,436).
B) ($15,936).
C) ($154,064).
D) ($22,186).
Answer: B

Explanation: B)
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

53
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

135) (Present value tables are required.) Calby Enterprises is evaluating the purchase of a new computer
network system. The new system would cost $25,000 and have a useful life of 6 years. At the end of the
system's life, it would have a residual value of $3,000. Annual operating cost savings from the new system
would be $8,800 per year for each of the six years of its life. Calby Enterprises has a minimum required
rate of return of 12% on all new projects. The net present value of the new network system would be
closest to
A) $9,656.
B) $12,698.
C) $11,177.
D) $37,698.
Answer: B
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
136) (Present value tables are required.) Karpets Industries is investing in a new high-speed loom for
weaving its rugs and carpets. The new loom will have a useful life of 7 years and cost $80,000. The loom's
residual value is $5,000. Assume that Karpets requires a return of 10% and that the loom will create
annual cost savings of $16,250. What is the net present value (NPV) of the new loom?
A) $1,670
B) ($3,460)
C) $81,670
D) ($895)
Answer: A
Explanation: A)

Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

54
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

137) (Present value tables are required.) Renfroe Corporation is considering the purchase of a machine
that would cost $22,712 and would have a useful life of 5 years. The machine would generate $6,300 of net
annual cash inflows per year for each of the 5 years of its life. The internal rate of return on the machine
would be closest to
A) 8%.
B) 10%.
C) 12%.
D) 14%.
Answer: C
Explanation: C) Costs $22,712/6,300 net cash flow = 3.605
Closest FVA
= >12.00%
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
138) (Present value tables are required.) Hincapie Manufacturing evaluating investing in a new metal
stamping machine costing $30,924. Hincapie estimates that it will realize $12,000 in annual cash inflows
for each year of the machine's 3-year useful life. The internal rate of return (IRR) for the machine is
approximately
A) 8%.
B) 10%.
C) 5%.
D) 6%.
Answer: A
Explanation: A) Costs $30,924/12,000 net cash flow = 2.577
Closest FVA for 3 years
= 8%
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

55
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

139) (Present value tables are required.) Currence Corporation is considering the purchase of a special
blow-molding machine that would cost $59,752 and would have a useful life of 8 years. The machine
would generate $11,200 of net annual cash inflows per year for each of the 8 years of its life. The internal
rate of return on the machine would be closest to
A) 8%.
B) 10%.
C) 12%.
D) 14%.
Answer: B
Explanation: B)
Costs
$59,752/11,200 net cash flow = 5.335
Closest FVA
= >10.00 %
Diff: 3
LO: 12-4
EOC: P12-58
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
140) (Present value tables are required.) Vino Winery is considering the purchase of a state-of-the-art
bottling machine. The new machine will cost $28,250 and will have a useful life of 10 years. The new
machine will provide net cash savings of $5,000 per year. What is the internal rate of return (IRR) for the
new bottling machine?
A) 8%
B) 10%
C) 12%
D) 14%
Answer: C
Explanation: C)
Costs
$28,250/5,000 net cash flow = 5.65
Closest FVA
= >12.00 %
Diff: 3
LO: 12-4
EOC: P12-58
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

56
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

141) (Present value tables are required.) Lenardi Corporation is evaluating the purchase of a new machine
that would have an initial cost of $125,000. This new machine would have a profitability index of 1.25. The
company's discount rate is 12%. What is the present value of the net cash inflows of the new machine
project?
A) $15,000
B) $156,250
C) $100,000
D) $1,041,667
Answer: B
Explanation: B) Costs 125,000 1.25 Profitability index = 156,250
Diff: 3
LO: 12-4
EOC: P12-58
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
142) Senseman Company has three potential projects from which to choose. Selected information on each
of the three projects follows:

Investment required
Net present value of project

Project A
$ 42,500
$ 45,700

Project B
$ 56,000
$ 75,400

Project C
$ 53,700
$ 70,200

Using the profitability index, rank the projects from most profitable to least profitable.
A) A, B, C
B) C, B, A
C) B, A, C
D) B, C, A
Answer: D
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

57
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143) Silver Creations is evaluating a project that would require an initial investment of $36,000. The
present value of the net cash inflows associated with this project would be $43,200. The profitability index
for this project would be closest to
A) 0.83.
B) 1.20.
C) 0.20.
D) 5.00.
Answer: B
Explanation: B) Net cash inflows $43,200/36,000 Invest. = 1.20
Diff: 3
LO: 12-4
EOC: P12-59
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment
144) (Present value tables are needed.) Cleveland Cove Enterprises is evaluating the purchase of an
elaborate hydraulic lift system for all of its locations to use for the boats brought in for repair. The
company has narrowed their choices down to twothe B14 Model and the F54 Model. Financial data
about the two choices follows.
B14 Model
$ 320,000
8
$ 70,000
$ 30,000
Straight-line
14%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

F54 Model
$ 240,000
8
$ 35,000
$ 10,000
Straight-line
10%

What is the total present value of future cash inflows from the F54 Model?
A) $(48,605)
B) $186,725
C) $191,395
D) $167,035
Answer: C
Diff: 3
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

58
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

145) (Present value tables are needed.) Cleveland Cove Enterprises is evaluating the purchase of an
elaborate hydraulic lift system for all of its locations to use for the boats brought in for repair. The
company has narrowed their choices down to two: the B14 Model and the F54 Model. Financial data
about the two choices follows.
B14 Model
$ 320,000
8
$ 70,000
$ 30,000
Straight-line
14%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

F54 Model
$ 240,000
8
$ 35,000
$ 10,000
Straight-line
10%

What is the total present value of future cash inflows from the B14 Model?
A) $15,260
B) $335,260
C) $383,980
D) $191,395
Answer: B
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

59
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

146) (Present value tables are needed.) Cleveland Cove Enterprises is evaluating the purchase of an
elaborate hydraulic lift system for all of its locations to use for the boats brought in for repair. The
company has narrowed their choices down to two: the B14 Model and the F54 Model. Financial data
about the two choices follows.
B14 Model
$ 320,000
8
$ 70,000
$ 30,000
Straight-line
14%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

F54 Model
$ 240,000
8
$ 35,000
$ 10,000
Straight-line
10%

What is the net present value of the F54 Model?


A) $15,260 positive
B) $48,605 negative
C) $191,395 positive
D) $156,395 positive
Answer: B
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

60
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

147) (Present value tables are needed.) Cleveland Cove Enterprises is evaluating the purchase of an
elaborate hydraulic lift system for all of its locations to use for the boats brought in for repair. The
company has narrowed their choices down to two: the B14 Model and the F54 Model. Financial data
about the two choices follows.
B14 Model
$ 320,000
8
$ 70,000
$ 30,000
Straight-line
14%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

F54 Model
$ 240,000
8
$ 35,000
$ 10,000
Straight-line
10%

What is the net present value of the B14 Model?


A) $15,260 positive
B) $48,605 negative
C) $5,800 negative
D) $335,260 positive
Answer: A
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

61
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148) (Present value tables are needed.) Cleveland Cove Enterprises is evaluating the purchase of an
elaborate hydraulic lift system for all of its locations to use for the boats brought in for repair. The
company has narrowed their choices down to two: the B14 Model and the F54 Model. Financial data
about the two choices follows.
B14 Model
$ 320,000
8
$ 70,000
$ 30,000
Straight-line
14%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

F54 Model
$ 240,000
8
$ 35,000
$ 10,000
Straight-line
10%

Using the net present value model, which alternative should the company select?
A) Neither investment should be selected.
B) The F54 Model should be selected.
C) Both investments should be selected.
D) The B14 Model should be selected.
Answer: D
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

62
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149) (Present value tables are needed.) The Janus Vending Machine Company is looking to expand its
business by adding a new line of vending machines. The management team is considering expanding into
either soda machines or snack machines. Following is the relevant financial data relating to the decision:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Soda
Machines
Snack Machines
$75,000
$50,000
5
10
$30,000
$18,000
$30,000
$10,000
straight-line
straight-line
8%
12%

What is the present value of all future cash inflows from the snack machines?
A) $101,700
B) $104,920
C) $75,094
D) $54,920
Answer: B
Explanation: B)
Estimated annual net cash inflows for useful life

$18,000

Present value of an annuity factor


Cash flow present value

$101,700

Residual value

$10,000

Present value of $1 factor


Residual value present value

$3,220

Cash flow present value

$10,000

Residual value present value


Present value of future cash inflows from Snack Machine
Diff: 3
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

63
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150) (Present value tables are needed.) The Janus Vending Machine Company is looking to expand its
business by adding a new line of vending machines. The management team is considering expanding into
either soda machines or snack machines. Following is the relevant financial data relating to the decision:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Soda
Machines
Snack Machines
$75,000
$50,000
5
10
$30,000
$18,000
$30,000
$10,000
straight-line
straight-line
8%
12%

What is the total present value of future cash inflows from the soda machines?
A) $189,930
B) $104,920
C) $62,220
D) $140,220
Answer: D
Explanation: D)
Estimated annual net cash inflows for useful life
$30,000
Present value of an annuity factor
3.993
Cash flow present value
$119,790
Residual value
Present value of $1 factor
Residual value present value

$30,000
0.681
$20,430

Cash flow present value


Residual value present value
Present value of future cash inflows from Soda machine

$119,790
$20,430
$140,220

Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

64
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

151) (Present value tables are needed.) The Janus Vending Machine Company is looking to expand its
business by adding a new line of vending machines. The management team is considering expanding into
either soda machines or snack machines. Following is the relevant financial data relating to the decision:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Soda
Machines
Snack Machines
$75,000
$50,000
5
10
$30,000
$18,000
$30,000
$10,000
straight-line
straight-line
8%
12%

What is the net present value for the snack machines?


A) $(65,220)
B) $104,920
C) $54,920
D) $86,920
Answer: C
Explanation: C)
Estimated annual net cash inflows for useful life

$18,000

Present value of an annuity factor


Cash flow present value

$101,700

Residual value

$10,000

Present value of $1 factor


Residual value present value

$3,220

Cash flow present value


Residual value present value

$101,700
$3,220

Investment
Net present value for Snack Machine
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

65
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

152) (Present value tables are needed.) The Janus Vending Machine Company is looking to expand its
business by adding a new line of vending machines. The management team is considering expanding into
either soda machines or snack machines. Following is the relevant financial data relating to the decision:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Soda
Machines
Snack Machines
$75,000
$50,000
5
10
$30,000
$18,000
$30,000
$10,000
straight-line
straight-line
8%
12%

What is the net present value for the soda machines?


A) $(140,220)
B) $24,360
C) $65,220
D) $54,920
Answer: C
Explanation: C)
Estimated annual net cash inflows for useful life
Present value of an annuity factor
Cash flow present value

$30,000
$119,790

Residual value

$30,000

Present value of $1 factor


Residual value present value

$20,430

Cash flow present value


Residual value present value

$119,790
$20,430

Investment
Net present value for Soda Machine
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

66
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

153) (Present value tables are needed.) The Janus Vending Machine Company is looking to expand its
business by adding a new line of vending machines. The management team is considering expanding into
either soda machines or snack machines. Following is the relevant financial data relating to the decision:

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Soda
Machines
Snack Machines
$75,000
$50,000
5
10
$30,000
$18,000
$30,000
$10,000
straight-line
straight-line
8%
12%

Using the net present value model, which alternative should Janus Vending Machine Company select?
A) The snack machines should be selected.
B) The soda machines should be selected.
C) Both investments should be selected.
D) Neither investment should be selected.
Answer: B
Explanation: B) Decision Rule:
NPV Soda (65,220) > NPV snack (54,920)
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

67
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154) (Present value tables are needed.) Somerville Corporation is considering investing in specialized
equipment costing $618,000. The equipment has a useful life of 5 years and a residual value of $55,000.
Depreciation is calculated using the straight-line method. The expected net cash inflows from the
investment are:
Year 1
Year 2
Year 3
Year 4
Year 5

$ 250,000
$ 190,000
$ 152,000
$ 112,000
$ 95,000
$ 799,000

Somerville Corporation's required rate of return is 14%.


The net present value of the investment is closest to
A) $62,976 negative.
B) $5,886 negative.
C) $34,431 negative.
D) $181,000 positive.
Answer: B
Diff: 2
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

68
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

155) (Present value tables are needed.) Somerville Corporation is considering investing in specialized
equipment costing $618,000. The equipment has a useful life of 5 years and a residual value of $55,000.
Depreciation is calculated using the straight-line method. The expected net cash inflows from the
investment are:
Year 1
Year 2
Year 3
Year 4
Year 5

$ 250,000
$ 190,000
$ 152,000
$ 112,000
$ 95,000
$ 799,000

Somerville Corporation's required rate of return is 14%.


Is the internal rate of return of the investment equal to, higher than, or lower than 14%?
A) Equal to 14%
B) Higher than 14%
C) Lower than 14%
D) Cannot be determined from the given data
Answer: C
Diff: 2
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Calculate the NPV, internal rate of return, payback period, and accounting rate of
return and use to evaluate a potential investment

69
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

156) (Present value tables are needed.) Mulheim Corporation is deciding whether to automate one phase
of its production process. The equipment has a six-year life and will cost $410,000. Projected net cash
inflows from the equipment are as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6

$ 120,000
$ 100,000
$ 110,000
$ 100,000
$ 95,000
$ 90,000

Mulheim Corporation's hurdle rate is 12%. Assume the residual value is zero.
What is the net present value of the equipment?
A) $(18,275)
B) $3,046
C) $20,000
D) $18,275
Answer: D
Diff: 3
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

70
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

157) (Present value tables are needed.) Mulheim Corporation is deciding whether to automate one phase
of its production process. The equipment has a six-year life and will cost $410,000. Projected net cash
inflows from the equipment are as follows:
Year 1

$ 120,000
$ 100,000
$ 110,000
$ 100,000
$ 95,000
$ 90,000

Year 2
Year 3
Year 4
Year 5
Year 6

Mulheim Corporation's hurdle rate is 12%.


If Mulheim Corporation decides to refurbish the equipment at a cost of $60,000 at the end of year 6, it
could be used for one more year and would have a $30,000 residual value at the end of year 7. Assume the
cash inflow in year 7 is $65,000. What is the NPV of just the refurbishment?
A) ($1,040)
B) $12,520
C) $15,820
D) $46,240
Answer: B
Explanation: B)
Investment (end year 6)
$ 60,000
Present value of $1, n=6 r=12%
0.507
Present value of investment - Year 6
$ 30,420
Cash inflow - Year 7
Present value of $1, n=7 r=12%
Present value cash flows - Year 7

$ 65,000
0.452
$ 29,380

Residual value - Year 7


Present value of $1, n=7 r=12%
Present value of residual value - Year 7

$ 30,000
0.452
$ 13,560

Present value of investment - Year 6


Present value cash flows - Year 7
Present value of residual value - Year 7
Net present value of refurbishment

$ (30,420)
$ 29,380
$ 13,560
$ 12,520

Diff: 3
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
71
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

use to evaluate a potential investment.


158) (Present value tables are needed.) O'Mally Department Stores is considering two possible expansion
plans. One proposal involves opening 5 stores in Indiana at the cost of $1,920,000. Under the other
proposal, the company would focus on Kentucky and open 6 stores at a cost of $2,500,000. The following
information is available:
Indiana proposal
Kentucky proposal
Required investment
$1,920,000
$2,500,000
Estimated life
10 years
10 years
Estimated residual value
$50,000
$80,000
Estimated annual cash inflows over the next 10 years
$400,000
$500,000
Required rate of return
10%
10%
The net present value of the Indiana proposal is closest to
A) $538,000.
B) $557,300.
C) $461,650.
D) $1,171,800.
Answer: B
Explanation: B)
Cash flow
$400,000 (PVA 10yr @ 10%) 6.145 = 2,458,000
Residual
50,000 (PV 10 yr @ 10%) .386 = 19,300
Less Cost
-1,920,000
NPV
557,300
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

72
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

159) (Present value tables are needed.) O'Mally Department Stores is considering two possible expansion
plans. One proposal involves opening 5 stores in Indiana at the cost of $1,920,000. Under the other
proposal, the company would focus on Kentucky and open 6 stores at a cost of $2,500,000. The following
information is available:

Required investment
Estimated life
Estimated residual value
Estimated annual cash inflows over the next 10 years
Required rate of return

Indiana proposal
Kentucky proposal
$1,920,000
$2,500,000
10 years
10 years
$50,000
$80,000
$400,000
$500,000
10%
10%

The net present value of the Kentucky proposal is closest to


A) $557,300.
B) $572,500.
C) $603,380.
D) $684,600.
Answer: C
Explanation: C)
Cash flow
$500,000 (PVA 10yr @ 10%) 6.145 = 3,072,500
Residual
80,000 (PV 10 yr @ 10%) .386 = 30,880
Less Cost
-2,500,000
NPV
603,380
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

73
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

160) (Present value tables are needed.) Family Fun Park is evaluating the purchase of a new game to be
located on its Midway. Family Fun has narrowed their choices down to two: the Wacky Water Race game
and the Whack-A-Mole game. Financial data about the two choices follows.
Wacky Water
Race
$ 32,000
5
$ 8,000
$ 2,000
straight-line
8%

Investment
Useful life
Estimated annual net cash inflows for 5 years
Residual value
Depreciation method
Required rate of return

Whack-AMole
$ 22,000
5
$ 6,000
$ 1,000
straight-line
10%

What is the total present value of future cash inflows from the Whack-A-Mole game?
A) $22,746
B) $24,579
C) $23,367
D) $45,367
Answer: C
Explanation: C)
Cash flow
$ 6,000 (PVA 5yr @ 10%) 3.791 = 22,746
Residual
1,000 (PV 5 yr @ 10%) .621 = 621
Total
23,367
Diff: 3
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss standard costing and variance analysis. Discuss and calculate direct material,
direct labor and overhead variances.

74
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161) (Present value tables are needed.) Family Fun Park is evaluating the purchase of a new game to be
located on its Midway. Family Fun has narrowed their choices down to two: the Wacky Water Race game
and the Whack-A-Mole game. Financial data about the two choices follows.
Wacky Water
Race
$ 32,000
5
$ 8,000
$ 2,000
straight-line
8%

Investment
Useful life
Estimated annual net cash inflows for 5 years
Residual value
Depreciation method
Required rate of return

Whack-AMole
$ 22,000
5
$ 6,000
$ 1,000
straight-line
10%

What is the total present value of future cash inflows from the Wacky Water Race game?
A) $1,306
B) $23,367
C) $33,306
D) $31,690
Answer: C
Explanation: C)
Cash flow
$ 8,000 x (PVA 5yr @ 8%) 3.993 = 31,944
Residual
2,000 x (PV 5 yr @ 8%) .681 = 1,362
Total
33,306
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

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162) (Present value tables are needed.) Family Fun Park is evaluating the purchase of a new game to be
located on its Midway. Family Fun has narrowed their choices down to two: the Wacky Water Race game
and the Whack-A-Mole game. Financial data about the two choices follows.
Wacky Water
Race
$ 32,000
5
$ 8,000
$ 2,000
straight-line
8%

Investment
Useful life
Estimated annual net cash inflows for 5 years
Residual value
Depreciation method
Required rate of return

Whack-AMole
$ 22,000
5
$ 6,000
$ 1,000
straight-line
10%

What is the net present value of the Whack-A-Mole game?


A) $1,367
B) ($56)
C) $56
D) ($1,367)
Answer: A
Explanation: A)
Cash flow
$ 6,000 (PVA 5yr @ 10%) 3.791 = 22,746
Residual
1,000 (PV 5 yr @ 10%) 621 = 621
Total
23,367
Cost
-22,000
NPV
1,367
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

76
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163) (Present value tables are needed.) Family Fun Park is evaluating the purchase of a new game to be
located on its Midway. Family Fun has narrowed their choices down to two: the Wacky Water Race game
and the Whack-A-Mole game. Financial data about the two choices follows.
Wacky Water
Race
$ 32,000
5
$ 8,000
$ 2,000
straight-line
8%

Investment
Useful life
Estimated annual net cash inflows for 5 years
Residual value
Depreciation method
Required rate of return

Whack-AMole
$ 22,000
5
$ 6,000
$ 1,000
straight-line
10%

What is the net present value of the Wacky Water Race game?
A) $(746)
B) $(1,306)
C) $1,306
D) $746
Answer: C
Explanation: C)
Cash flow
$ 8,000 (PVA 5yr @ 8% ) 3.993 = 31,944
Residual
2,000 (PV 5 yr @ 8% ) .681 = 1,362
Total
33,306
Cost
-32,000
NPV
1,306
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

77
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164) (Present value tables are needed.) Family Fun Park is evaluating the purchase of a new game to be
located on its Midway. Family Fun has narrowed their choices down to two: the Wacky Water Race game
and the Whack-A-Mole game. Financial data about the two choices follows.
Wacky Water
Race
$ 32,000
5
$ 8,000
$ 2,000
straight-line
8%

Investment
Useful life
Estimated annual net cash inflows for 5 years
Residual value
Depreciation method
Required rate of return

Whack-AMole
$ 22,000
5
$ 6,000
$ 1,000
straight-line
10%

Using the net present value model, which alternative(s) should Family Fun Park select?
A) The Wacky Water Race game should be selected.
B) Neither investment should be selected.
C) Both investments should be selected.
D) The Whack-A-Mole game should be selected.
Answer: D
Diff: 2
LO: 12-4
EOC: E12-26
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
165) Icy Peaks Sports makes snowboards. The company wants to add a new machine that would cost
$80,000 and have a useful life of 5 years and no residual value. The company expects the machine will
generate $24,000 annual cash inflows for 5 years. The discount rate is 10%. What is the net present value
of the investment?
Answer: ($24,000 3.791) - $80,000 = $10,984
Diff: 2
LO: 12-4
EOC: E12-27
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

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166) Louise owns a golf course and wants to add some computers to the lounge. The computers would
cost $14,000 and would have a 3 year life and no residual value. Louise expects the computers to generate
$4,000 annual cash inflows for 3 years. The discount rate is 8%. What is the net present value of the
investment?
Answer: ($4,000 2.577) - 14,000 = ($3,692)
Diff: 2
LO: 12-4
EOC: E12-27
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
167) Spinelli Company is deciding whether to automate one phase of its production process. The
equipment has a six year life and will cost $450,000. The interest rate is 12%. Net cash inflows per year:
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6

$ 85,000
$ 70,000
$ 95,000
$ 75,000
$ 85,000
$ 96,000

a. What is the present value of the net inflow for year 1?


b. What is the present value of the net inflow for year 5?
Answer:
a. $85,000 .893 = $75,905
b. $85,000 .567 = $48,195
Diff: 3
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

79
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168) (Present value tables are needed.) Georgia Peach Farms is upgrading its fruit washing/separating
machine. Georgia has narrowed the decision down to two machines: Machine A and Machine B.Pertinent
information for each machine follows:
Machine A
$450,000
10
$75,000
$25,000
straight-line
10%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Machine B
$650,000
10
$120,000
$35,000
straight-line
12%

Required:
a. Calculate the net present value of Machine A.
b. Calculate the net present value of Machine B.
c. Using the net present value method, which machine should Georgia select if it can select only one
investment?
Answer: SOLUTION part a.
Estimated annual net cash inflows for useful life
Present value of an annuity factor
Cash flow present value

$75,000
6.145
$460,875

Residual value
Present value of $1 factor
Residual value present value

$25,000
0.386
$9,650

Cash flow present value


Residual value present value
Investment
Net present value for Machine A

$460,875
$9,650
$(450,000)
$20,525

SOLUTION part b.
Estimated annual net cash inflows for useful life
Present value of an annuity factor
Cash flow present value

$120,000
5.650
$678,000

Residual value
Present value of $1 factor
Residual value present value

$35,000
0.322
$11,270

Cash flow present value


Residual value present value
Investment
Net present value for Machine B

$678,000
$11,270
$(650,000)
$39,270

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SOLUTION part c.
NPV Machine B (39,270) > NPV Machine A (20,525); therefore select Machine B.
Diff: 3
LO: 12-4
EOC: E12-28
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
169) (Present value tables are needed.) Shaker Investments, a private investment holding company, is
searching for a new investment opportunity. Shaker Investments has identified two potential investment
opportunities: an upstart fast food chain and a growing organic grocery chain. Information for each
investment follows:
Fast Food
Chain
$975,000
15
$120,000
$50,000
straight-line
8%

Investment
Useful life (years)
Estimated annual net cash inflows for useful life
Residual value
Depreciation method
Required rate of return

Organic Grocery
Chain
$1,500,000
15
$210,000
$100,000
straight-line
10%

Required:
a. Calculate the net present value of the Fast Food Chain.
b. Calculate the net present value of the Organic Grocery Chain.
c. Using the net present value method, which investment should Shaker select if it can select only one
investment?

81
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Answer:
SOLUTION part a.
Estimated annual net cash inflows for useful life
Present value of an annuity factor
Cash flow present value

$120,000
8.559
$1,027,080

Residual value
Present value of $1 factor
Residual value present value

$50,000
0.315
$15,750

Cash flow present value


Residual value present value
Investment
Net present value for Fast Food Chain

$1,027,080
$15,750
$(975,000)
$67,830

SOLUTION part b.
Estimated annual net cash inflows for useful life
Present value of an annuity factor
Cash flow present value

$210,000
7.606
$1,597,260

Residual value
Present value of $1 factor
Residual value present value

$100,000
0.239
$23,900

Cash flow present value


Residual value present value
Investment
Net present value for Organic Grocery Chain

$1,597,260
$23,900
$(1,500,000)
$121,160

SOLUTION part c.
NPV Organic Grocery (121,160) > NPV Fast Food (67,830); therefore choose Organic Grocery
Diff: 2
LO: 12-4
EOC: E12-21
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

82
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170) The ARR is the only method that uses accrual accounting figures and thus making it important to
financial statement users.
Answer: TRUE
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
171) Neither the payback period nor the IRR capital budgeting method recognizes the time value of
money.
Answer: FALSE
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
172) The payback and accounting rate of return models are conceptually better than the discounted cash
flow models because they are based on cash flows, and they consider both profitability and the time value
of money.
Answer: FALSE
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
173) The net present value model differs from the IRR model in that it does NOT show the project's
unique rate of return.
Answer: TRUE
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

83
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174) The discounted cash flow methods for capital budgeting are generally considered inferior to the
payback period and the ARR because they consider the time value of money.
Answer: FALSE
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
175) The Internal Rate of Return, the Accounting Rate of Return, Net Present Value and Payback Period
are four recognized capital budgeting methods.
Answer: TRUE
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
176) Capital budgeting methods will not work with unequal cash flows during the capital asset's life.
Other methods must be utilized in those cases.
Answer: FALSE
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss standard costing and variance analysis. Discuss and calculate direct material,
direct labor and overhead variances.
177) Capital budgeting techniques such as payback method and net present value are based upon
Generally Accepted Accounting Principles (GAAP) and accrual accounting.
Answer: FALSE
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss standard costing and variance analysis. Discuss and calculate direct material,
direct labor and overhead variances.

84
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178) A manager wants to know which investment decision will affect the bottom line of the financial
statements according to Generally Accepted Accounting Principles. Which capital budgeting method
would he choose?
A) Payback method
B) Accounting rate of return method
C) Net present value method
D) Profitability index
Answer: B
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
179) A company is evaluating a variety of different capital investment opportunities. Due to limited funds,
the company can only choose one project. What would be the best capital budgeting method for this
company to use to select a project?
A) Payback method
B) Accounting rate of return method
C) Profitability index
D) Net present value method
Answer: C
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
180) The ________ capital budgeting method uses accrual accounting income.
A) accounting rate of return
B) payback
C) net present value
D) internal rate of return
Answer: A
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts

85
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181) Which of the following is not an advantage of post-audits of capital investments?


A) They indicate whether project should continue or should be abandoned.
B) They help managers make better estimates for future projects.
C) They encourage managers to submit realistic net cash inflows with their project proposals.
D) They help managers to decide which project should be selected.
Answer: D
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
182) The ________ capital budgeting model considers both profitability and the time value of money.
A) payback
B) net present value
C) accounting rate of return
D) Both a and c are correct
Answer: B
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
183) The ________ capital budgeting model is generally the simplest to compute.
A) accounting rate of return
B) net present value
C) internal rate of return
D) payback
Answer: D
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

86
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184) Which of the capital budgeting methods is the best?


A) Payback period
B) Net present value
C) Internal rate of return
D) No single method is best.
Answer: D
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
185) The ________ capital budgeting methods are based on cash flows, profitability, and the time value of
money.
A) payback and accounting rate of return
B) payback and net present value
C) net present value and internal rate of return
D) accounting rate of return and internal rate of return
Answer: C
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
186) The ________ is generally considered to be the most superior method for making capital budgeting
decisions.
A) accounting rate of return method
B) net present value method
C) payback method
D) incremental method
Answer: B
Diff: 2
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

87
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187) "Management's minimum desired rate of return on an investment" is best described by which of the
following terms?
A) Payback return
B) Internal rate of return
C) Discount rate
D) Net present value
Answer: C
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Analytical Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts
188) "A measure of profitability computed by dividing the average annual operating income by the
amount of the investment" is best described by which of the following terms?
A) Net present value
B) Discount rate
C) Internal rate of return
D) Accounting rate of return
Answer: D
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.
189) The "rate of return that makes the NPV of a capital project equal to zero" is best described by which
of the following terms?
A) Accounting rate of return
B) Internal rate of return
C) Discount rate
D) Net present value
Answer: B
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

88
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190) The "decision model that computes the difference between the present value of the investment's net
cash inflows, using a desired rate of return, and the cost of the initial investment" is best described by
which of the following terms?
A) Accounting rate of return
B) Discount rate
C) Net present value
D) Internal rate of return
Answer: C
Diff: 1
LO: 12-5
EOC: E12-35
AACSB: Reflective Thinking
Learning Outcome: Discuss the basics of capital investments and illustrate the time value of money
concepts. Calculate the NPV, internal rate of return, payback period, and accounting rate of return and
use to evaluate a potential investment.

89
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