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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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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%

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%

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:

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%

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

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%

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

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%

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

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%

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

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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:

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%

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:

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

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

$1,920,000

$2,500,000

10 years

10 years

$50,000

$80,000

$400,000

$500,000

10%

10%

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

$1,920,000

$2,500,000

10 years

10 years

$50,000

$80,000

$400,000

$500,000

10%

10%

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

$1,920,000

$2,500,000

10 years

10 years

$50,000

$80,000

$400,000

$500,000

10%

10%

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:

Estimated life

Estimated residual value

Estimated annual cash inflows over the next 10 years

Required rate of return

$1,920,000

$2,500,000

10 years

10 years

$50,000

$80,000

$400,000

$500,000

10%

10%

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

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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%

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%

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%

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%

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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:

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

Cash flow present value

$101,700

Residual value

$10,000

Residual value present value

$3,220

$10,000

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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:

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

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:

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%

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

Cash flow present value

$101,700

Residual value

$10,000

Residual value present value

$3,220

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:

Useful life (years)

Estimated annual net cash inflows for useful life

Residual value

Depreciation method

Required rate of return

Machines

Snack Machines

$75,000

$50,000

5

10

$30,000

$18,000

$30,000

$10,000

straight-line

straight-line

8%

12%

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

Residual value present value

$20,430

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:

Useful life (years)

Estimated annual net cash inflows for useful life

Residual value

Depreciation method

Required rate of return

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

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

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

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

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

Present value of residual value - Year 7

$ 30,000

0.452

$ 13,560

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

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:

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

75

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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.

78

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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

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

Residual value present value

Investment

Net present value for Machine B

$678,000

$11,270

$(650,000)

$39,270

80

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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%

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

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

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

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