Seat Work—Capital Investment Decisions

TRUE/FALSE

1. False
2. True
3. True
4. True
5. True
6. False
7. False
8. False
9. True
10. True
11. False
12. False
13. True
14. True
15. True

COMPLETION

1. Capital investment decisions

2. Capital budgeting
3. Independent projects, Mutually exclusive projects
4. Independent projects
5. Discounting models
6. Nondiscounting models
7. Payback period
8. Accounting rate of return
9. Discounted cash flow
10. Net present value
11. Required rate of return
12. Internal rate of return
13. Acceptable
14. Rejected
15. Post audit

MULTIPLE CHOICE
 1. E
2. C
3. E
4. A
5. A
6. A
7. A
8. E
9. E
10. A
11. B
12. B
13. E
14. C
15. C

TRUE/FALSE

1. Projects that do not affect the cash flows of other projects are called mutually exclusive projects.

2. The process of planning, setting goals and priorities, arranging financing, and using certain criteria to
select long-term assets is called capital investment decisions.

3. Projects that if accepted preclude the acceptance of all other competing projects are called mutually
exclusive projects.

4. In capital investment decision making, it is usually assumed that managers should select projects that
attempt to maximize the wealth of the owners of the firm.

5. Taxes are important consideration in forecasting cash flows.

6. Before-tax cash flows must be forecasted and used in capital investment decision making.

7. The two major categories of capital investment decision models are independent and mutually exclusive.

8. In order to use the payback period model, the proposed investment must have even cash inflows.

9. If cash flows are uneven, the payback period assumes that the inflows during the last fraction of a year
occur evenly.

10. One way to use the payback period is to set a maximum payback period for all projects and to reject any
project that exceeds this level.

11. Sometimes firms require riskier projects to have longer payback periods.

12. Companies considering projects with shorter lives are interested in longer payback periods.
 13. A disadvantage of the payback period is that it ignores a project's total profitability.

14. A disadvantage of the payback period is that it ignores the time value of money.

15. Only accounting rate of return ignores the time value of money.

COMPLETION

1. _______________________ are concerned with the process of planning, setting goals and priorities,
arranging financing, and using certain criteria to select long-term assets.

2. The process of making capital investment decisions often is referred to as ________________.

3. The two types of capital budgeting projects are ________________ and _______________.

4. ______________________ are projects that, if accepted or rejected, do not affect the cash flows of other
projects.

5. _____________________ explicitly consider the time value of money.

6. _______________________ ignore the time value of money.

7. The ______________ is the time required for a firm to recover its original investment.

8. The _________________________ measures the return on a project in terms of income.

9. _______________________ are the future cash flows expressed in terms of their present value.

10. The difference between the present value of the cash inflows and the outflows associated with a project is
known as the ___________________.

11. The ___________________ is the minimum acceptable rate of return.

12. The _______________________ is defined as the interest rate that sets the present value of a project’s
cash inflows equal to the present value of the project’s cost.

13. If the internal rate of return (IRR) is greater than the required rate, the project is deemed ___________.

14. If the internal rate of return (IRR) is less than the required rate of return, the project is __________.

15. A key element in the capital investment process is a follow-up analysis of a capital project once it is
implemented; this analysis is a called a _____
TERMS

Rejected payback period

Acceptable Non discounting models
internal rate of return Discounting models
required rate of return Independent projects
Net present value independent projects, mutually exclusive projects
Discounted cash flows capital budgeting
accounting rate of return Capital investment decisions
post audit

MULTIPLE CHOICE

1. Which of the following is true of capital investment decision making?

a. It is used only for independent projects.
b. It is used only for mutually exclusive projects.
c. It requires that funding for a project must come from sources with the same opportunity
cost of funds.
d. It is used to determine whether or not a firm should accept a special order.
e. None of these.
2. In general terms, a sound capital investment will earn
a. back its original capital outlay.
b. a return greater than existing capital investments.
c. back its original capital outlay and provide a reasonable return on the original investment.
d. back its original capital outlay by the midpoint of its useful life.
e. None of these.
3. To make a capital investment decision, a manager must estimate the
a. quantity of cash flows.
b. timing of cash flows.
c. risk of the investment.
d. impact of the investment on the firm's profitability.
e. All of these.
4. If the cash flows of a project are received evenly over the life of the project, the formula for the
calculating the payback period is
a. original investment/annual cash flow.
b. original investment  annual cash flow.
c. original investment + annual cash flow.
d. original investment  annual cash flow.
e. (original investment + annual cash flow)/annual cash flow.
5. The payback period provides information to managers that can be used to help
a. control the risks associated with the uncertainty of future cash flows.
b. minimize the impact of an investment on a firm's liquidity problems.
 c. control the risk of obsolescence.
d. control the effect of the investment on performance measures.
e. All of these.
6. Which of the following is a drawback of the payback period?
a. It ignores a project's total profitability.
b. It uses a set discount rate.
c. It considers total profitability, requiring the forecasting of all future cash flows.
d. It uses before-tax cash flows rather than after-tax cash flows.
e. It uses operating income rather than cash flows.

7.A formula for the accounting rate of return is

a. average income/initial investment.
b. initial investment/annual cash flow.
c. annual cash flow/initial investment.
d. initial investment/average income.
e. (average income + initial investment)/initial investment.
8. Managers may use the accounting rate of return to evaluate potential investment projects because
a. debt contracts require that a firm maintain certain ratios that are affected by income and
long-term asset levels.
b. it serves as a screening measure to insure that new investments do not affect key financial
ratios.
c. bonuses to managers may be based on accounting income and/or return on assets.
d. it can be tied to the manager's personal income.
e. All of these.
9. The time required for a firm to recover its original investment is the
a. internal rate of return.
b. net present value.
c. life of the project.
d. accounting rate of return.
e. payback period.
10. When the risk of obsolescence is high, managers will want
a. a shorter payback period.
b. a longer payback period.
c. a payback period equal to the life of the investment.
d. All of these.
e. None of these.
11. One disadvantage of the payback period is that
a. it is sometimes used as a crude measure of risk.
b. managers may choose investments with quick payback periods to maximize short term
criteria on which their own bonuses, etc. may be based.
c. it cannot be used for investments with unequal cash inflows.
d. it cannot be used if the entire cost of the investment does not occur immediately.
e. All of these.
 12. A division manager was considering a project that required a significant initial investment. If accepted,
the project could have a negative impact on certain financial ratios that the firm was required to maintain
to satisfy debt contracts. To ensure that the ratios would not be adversely affected by the investment, the
manager would use which of the following capital investment models?
a. payback period
b. accounting rate of return
c. net present value
d. internal rate of return
e. None of these.

13.Greg Moss has just invested $120,000 in a coffee shop. He expects to receive cash income of $15,000 a year.
What is the payback period?
a. 5 years
b. 7.7 years
c. 4.5 years
d. 6.5 years
e. 8 years

14. Carol Harrison is considering an investment in a retail shopping mall. The initial investment is $400,000.
She expects to receive cash income of $80,000 a year. What is the payback period?
a. 4 year
b. 3.5 years
c. 5 years
d. 2.5 years
e. 6 years
15. Elena Wallace invested $150,000 in a project that pays her an even amount per year for 10 years. The
payback period is 6 years. What are Elena's yearly cash inflows from the project?
a. $150,000
b. $15,000
c. $25,000
d. $90,000
e. Cannot be determined from this information.