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Chapter 10
Planning for Capital Investments
Multiple Choice Questions
1. All of the following are capital investment decisions except:
A. acquiring $100,000 of common stock.

B. buying a $5,000,000 manufacturing plant.
C. purchasing equipment for $80,000.
D. paying $600,000 to renovate a restaurant.
2. Which of the following is not a factor in explaining why the present value of a future dollar is less
than one dollar?
A. Inflation
B. Interest
C. Risk of failure to receive expected cash inflows
D. Historic cost
10-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
3. Which statement characterizes the time value of money concept?
A. The future value of a present dollar is greater than one dollar.

B. The present value of a future dollar is greater than one dollar.
C. The timing of cash flows is not relevant to decision making.
D. None of these answers is correct.
4. Evergreen Company has two investment opportunities. Both investments cost $5,000 and will
provide the same total future cash inflows. The cash receipt schedule for each investment is
given below:
Select the correct statement.
A. Evergreen should choose Investment I because of the time value of money.

B. Evergreen should choose Investment II because it generates more immediate cash inflows.
C. Evergreen should be indifferent between the two investments because they provide the same
total cash inflows.
D. Time value of money techniques are not useful for comparing these investments.
5. Which of the following statements describes the cost of capital?
A. The internal rate of return on investments

B. The maximum acceptable rate of return on investments
C. The return that a company must pay its investors and creditors
D. The interest rate the bank charges its best customers
6. The cost of capital is called all of the following except:
A. cutoff rate.
B. discount rate.
C. hurdle rate.
D. All of these are terms for the cost of capital.
10-2
7. For a capital investment project to be acceptable, it must generate a rate of return:
A. less than the hurdle rate.

B. equal to or greater than the cost of capital.
C. equal to the conversion rate.
D. none of these answers is correct.
8. What amount of cash must be invested today in order to have $60,000 at the end of one year
assuming the rate of return is 9%? (Do not round your PV factors.)
A. $45,454.56
B. $54,000.00
C. $55,045.88
D. $54,600.00
9. What amount of cash would result at the end of one year, if $15,000 is invested today and the
rate of return is 8%? (Do not round your PV factors.)
A. $16,200
B. $13,889
C. $15,000
D. $1,200
10. Ashley projects that she can get $100,000 cash per year for 5 years on a real estate investment
project. If Ashley wants to earn a rate of return of 12%, what is the maximum that she should pay
for the investment? (rounded to the nearest dollar)
A. $56,743
B. $446,429
C. $360,478
D. $560,000
11. Connor has $300,000 to invest in a 5 year annuity. Assuming the time value of money is 10%,
what amount will Connor receive in cash each year? (Do not round your PV factors. Round your
answer to the nearest dollar.)
A. $79,139
B. $60,000
C. $96,631
10-3
12. A cash flow that only occurs in equal amounts each year is referred to as:
A. a lump sum.
B. a perpetuity.
C. an annuity.
D. None of these.
13. Which of the following cash flow patterns represents of an annuity?
A. A
B. B
C. C
D. Any of the answers can represent an annuity.
14. Which one of the following statements describes an ordinary annuity?
A. Series of cash inflows of varying amounts collected at the end of each period
B. Series of cash flows of equal amounts collected at the end of each period
C. Series of cash flows of varying amounts collected at the beginning of each period
D. Series of cash flows of equal amounts collected at the beginning of each period
15. Which of the following is not a major cash inflow from a capital investment?
A. Incremental revenue
B. Increase in working capital
C. Cost savings
D. Salvage value
16. When calculating the present value of an ordinary annuity, it is assumed that:
A. cash flows will be reinvested at the required rate of return.

B. cash flows are withdrawn at the end of each year.
C. the investor will wait until the end of the investment period to withdraw cash flows.
D. Both cash flows will be reinvested at the required rate of return and cash flows are withdrawn
at the end of each year are correct.
10-4
17. A customary assumption in capital budgeting analysis is that:
A. the desired rate of return includes the effects of compounding.

B. the cash inflows generated by the investment are not reinvestment.
C. annual cash flows occur at the beginning of each period.
D. the time value of money is ignored.
18. Jiminez Company has two investment opportunities. Both investments cost $5,000 and will
provide the following net cash flows:
The total present value of Investment A's cash flows assuming an 8% minimum rate of return is
(Do not round your PV factors and intermediate calculations. Round your answer to the nearest
whole dollar):
A. $14,936.
B. $4,936.
C. $7,000.
D. $12,000.
19. Harvey wants to determine the net present value for a proposed capital investment. He has
determined the desired rate of return, the expected investment time period, a series of cash
inflows of equal amount, the salvage value of the investment, and the required cash outflows.
Which of the following tables would most likely be used to calculate the net present value of the
investment?
A. Present value of annuity.

B. Future value of a lump sum.
C. Present value of annuity and present value of a lump sum.
D. Future value of annuity and future value of a lump sum.
10-5
20. Morrisey Company has two investment opportunities. Both investments cost $5,500 and will
given below:
The net present value of Investment II assuming an 8% minimum rate of return would be which of
the following amounts? (Do not round your PV factors and intermediate calculations. Round your
answer to nearest whole dollar.)
A. $6,492
B. $992
C. $5,880
D. $380
21. An investment that costs $40,000 will produce annual cash flows of $12,000 for a period of 4
years. Given a desired rate of return of 10%, the investment will generate a (Do not round your
PV factors and intermediate calculations. Round your answer to nearest whole dollar):
A. positive net present value of $38,038.

B. positive net present value of $1,962.
C. negative net present value of $38,038.
D. negative net present value of $1,962.
years. Further, the investment has an expected salvage value of $3,000. Given a desired rate of
return of 12%, the investment will generate a (Do not round your PV factors and intermediate
calculations. Round your answer to the nearest whole dollar.):

B. negative net present value of $2,077.
C. positive net present value of $22,077.
D. positive net present value of $557.
10-6
23. The rate of return that equates the present value of cash inflows and outflows is the:
A. minimum rate of return.

B. internal rate of return.
C. desired rate of return.
D. hurdle rate.
24. An investment that cost $30,000 provided annual cash inflows of $9,000 per year for five years.
The desired rate of return is 10%. The internal rate of return from the investment was (Do not
round your PV factors and intermediate calculations):
A. less than the desired rate of return.

B. equal to the desired rate of return.
C. greater than the desired rate of return.
D. the answer cannot be determined from the information provided.
25. Select the incorrect statement concerning the internal rate of return (IRR) method of evaluating
capital projects.
A. The higher the IRR the better.

B. The internal rate of return is that rate that makes the present value of the initial outlay equal to
zero.
C. If a project has a positive net present value then its IRR will exceed the hurdle rate.
D. A project whose IRR is less than the cost of capital should be rejected.
26. Which of the following is the approximate internal rate of return for an investment that costs
$33,550 and provides a $5,000 annuity for 10 years?
A. 5%
B. 6%
C. 8%
D. 10%
10-7
27. Theresa is considering starting a small business. She plans to purchase equipment costing
$145,000. Rent on the building used by the business will be $26,000 per year while other
operating costs will total $30,000 per year. A market research specialist estimates that Theresa's
annual sales from the business will amount to $80,000. Theresa plans to operate the business for
6 years. Disregarding the effects of taxes, what will be the amount of annual net cash flow
generated by the business?
A. $24,000
B. $56,000
C. $80,000
28. Cash outflows can be categorized into all of the following groups except:
A. opportunity costs associated with selecting a specific capital project.

B. outflows associated with the initial investment.
C. working capital commitments.
D. increases in operating expenses.
29. Which of the following would be considered a cash inflow in determining the value of a capital
investment?
A. Incremental revenues from increased productivity

B. Cost savings from a reduction in labor hours
C. An increase in working capital commitments
D. Both incremental revenues from increased productivity and cost savings from a reduction in
labor hours are correct.
30. A capital investment project may provide cash inflows from:
A. incremental revenues.
B. cost savings.
C. the salvage value of the investment.
D. all of these answers are correct.
31. Cash outflows from a capital investment project include:
A. increases in operating expenses.

B. the reduction in the amount of working capital.
C. terminal salvage value.
10-8
32. Select the incorrect statement concerning the present value index (PVI).
A. The PVI is computed by dividing the total present value of the cash inflows by the present
value of the cash outflows.
B. The PVI should be used to evaluate two or more projects whose initial investments differ.
C. The lower the PVI, the better.
D. A project whose PVI is positive will also have a positive net present value.
33. Garrison Company has two investment opportunities. A cash flow schedule for the investments is
provided below:
Considering the unequal investments, which of the following techniques would be most
appropriate for choosing between Investment A and Investment B?
A. Payback technique
B. Present value index
C. Net present value technique
34. Shenandoah Springs Company is considering two investment opportunities whose cash flows are
provided below:
The company's hurdle rate is 12%. What is the present value index of Investment B? (Do not
round your PV factors and intermediate calculations.)
A. 1.01
B. 1.16
C. 0.86
10-9
35. An investment that costs $5,000 will produce annual cash flows of $2,000 for a period of 4 years.
Given a desired rate of return of 8%, the investment will generate a present value index of (Do
not round your PV factors and intermediate calculations):
A. 0.755.
B. 1.600.
C. 2.500.
D. 1.325.
36. Weston Company is considering a capital project that delivers a $50,000 annual net cash flow
before tax. The investment will result in annual depreciation expense of $10,000 over the
project's four-year useful life. Assuming a tax rate of 40%, what amount of annual after-tax net
cash flow will be provided by this project?
A. $40,000
B. $16,000
C. $34,000
D. $24,000
37. Southport Company is considering the purchase of a piece of equipment that costs $100,000.
The equipment would be depreciated on a straight-line basis to its expected salvage value of
$10,000 over its 10-year useful life. Assuming a tax rate of 40%, what is the annual amount of the
depreciation tax shield provided by this investment?
A. $4,000
B. $9,000
C. $3,600
38. Newton Company is considering the purchase of an asset that will provide a depreciation tax
shield of $10,000 per year for 10 years. Assuming the company is subject to a 40% tax rate
during the period, and a zero salvage value, what is the depreciable cost of the new asset?
A. $100,000
B. $250,000
C. $400,000
D. Can't be determined from the information provided
10-10
39. Mendez Company is considering a capital project that costs $16,000. The project will deliver the
following cash flows:
Using the incremental approach, the payback period for the investment is:
A. 5 years.
B. 2 years.
C. 2.4 years.
D. 1.66 years.
40. George Company has the opportunity to purchase an asset that costs $40,000. The asset is
expected to increase net income by $10,000 per year. Depreciation expense will be $5,000 per
year. Based on this information the payback period is:
A. 4 years.
B. 2.5 years.
C. 2.67 years.
D. 8 years.
41. Mr. J's Bagels invested in a new oven for $14,000. The oven reduced the amount of time for
baking which increased production and sales for five years by the following amounts of cash
inflows:
Using the averaging method, the payback period for the investment in the oven would be:
A. 5.0 years.
B. 2.3 years.
C. 2.0 years.
D. 0.5 years.
10-11
42. Which of the following statements concerning payback analysis is true?
A. An investment with a shorter payback is preferable to an investment with a longer payback.

B. The payback method ignores the time value of money concept.
C. The payback method and the unadjusted rate of return are different approaches that will not
consistently lead to the same conclusion.
D. All of the other answers are correct.
43. Which of the following does not represent an advantage of the unadjusted rate of return over the
payback method for evaluating capital projects?
A. The unadjusted rate of return method considers the investment's profitability.

B. The unadjusted rate of return method considers the time value of money.
C. The unadjusted rate of return is a percentage that can be compared to a stated hurdle rate.
D. None of these represents an advantage.
44. Cash outflows generated by capital investments include all of the following except:
A. depreciation expense
B. transportation costs
C. increased operating expenses
D. increase in the required amount of working capital
45. Which capital budgeting technique defines returns in terms of income instead of cash flows?
A. The unadjusted rate of return method

B. The internal rate of return technique
C. The net present value technique
D. The payback period
46. Nguyen Company has an opportunity to purchase an asset that will cost the company $36,000.
The asset is expected to add $12,000 per year to the company's net income. Assuming the asset
has a five-year useful life and zero salvage value, the unadjusted rate of return based on the
average investment will be:
A. 60%.
B. 33%.
C. 15%.
10-12
47. Finnegan Company plans to invest in a new operating plant that is expected to cost $500,000.
The projected incremental income from the investment is as follows:
The unadjusted rate of return on the initial investment would be approximately:
A. 8.0%.
B. 6.0%.
C. 16.7%.
D. 48.0%.
48. Select the incorrect statement regarding postaudits of capital investment decisions.
A. A postaudit should be conducted at the end of the project.

B. The postaudit helps management determine whether a project that had been accepted should
have been rejected.
C. A postaudit is only necessary for a capital investment selected using a technique that does not
consider the time value of money.
D. The goal of a postaudit is to provide feedback that can be used to improve the accuracy of
future capital investment decisions.
49. The purposes of the postaudit for capital investments include all of the following except:
A. continuous improvement.
B. rewarding managers for increasing idle cash.
C. determining whether the project generated the results expected.
D. encouraging managers to closely scrutinize capital investment decisions.
10-13
50. The review of a capital budgeting decision to determine whether a project was accepted that
should have been rejected is referred to as:
A. an audit.
B. a preaudit.
C. a postaudit.
D. a capital review.
51. Six years ago, Neighborhood Hardware paid a contractor $45,000 to expand the store. At that
time, the company calculated a net present value of about $6,000 for the expansion. Now, the
company believes that the investment increased annual cash inflows by $8,000 per year for each
of the six years. The company has a desired rate of return of 10%. What was the net present
value actually achieved for this capital investment? (Do not round your PV factors and
intermediate calculations. Round to the nearest dollar.)
A. ($10,158)
B. ($3,000)
C. $34,842
D. $(9,207)
52. Langdon Company is considering purchasing a capital investment that is expected to provide
annual cash inflows of $10,000 per year for 3 years. Assuming that Langdon's required rate of
return is 8%, what is the present value of these cash inflows? (Do not round PV factors and
intermediate calculations. Round your final answer to the nearest dollar.)
A. $24,018
B. $24,869
C. $33,121
D. $25,771
53. Paul Company is considering purchasing a capital investment that is expected to provide annual
cash inflows of $12,000 per year for 3 years. Assuming that the required rate of return is 10%,
what is the present value of these cash inflows? (Do not round PV factors and intermediate
calculations. Round your final answer to the nearest dollar.)
A. $9,016
B. $28,822
C. $29,842
D. $27,047
10-14
54. Saget Company is considering the purchase of equipment that would cost $35,000 and offer
annual cash inflows of $10,500 over its useful life of 5 years. Assuming a required rate of return
of 8%, what is the net present value of this investment opportunity?
A. $(6,923)
B. $17,500
C. $6,923
D. $41,923
55. Generro Company is considering the purchase of equipment that would cost $36,000 and offer
annual cash inflows of $10,500 over its useful life of 5 years. Assuming a desired rate of return of
12%, is the project acceptable?
A. No, since the negative net present value indicates the investment will yield a rate of return
below the desired rate of return.
B. Yes, since the investment will generate $52,500 in future cash flows, which is greater than the
purchase cost of $36,000.
C. Yes, since the positive net present value indicates the investment will earn a rate of return
greater than 12%.
D. The answer cannot be determined.
56. Kerwin Company is considering purchase of equipment that costs $50,000. If the useful life is
expected to be 5 years and Crown's required rate of return is 12%, what is the minimum annual
cash inflow that the equipment must offer for the investment to be acceptable? (Do not round
your PV factors and intermediate calculations. Round your final answer to the nearest dollar.)
A. $8,929
B. $13,870
C. $12,076
D. $17,623
57. Grayson Company is considering purchase of equipment that costs $49,000 and is expected to
offer annual cash inflows of $13,000. Grayson's minimum required rate of return is 10%. How
many years must the cash flows last, for the investment to be acceptable? (Do not round your PV
factors and intermediate calculations. Round to nearest whole year.)
A. 4
B. 5
C. 3
D. 6
10-15
58. Fenwick Company is considering purchase of equipment that costs $60,000 and is expected to
offer annual cash inflows of $16,000 for 5 years. Fenwick Company's required rate of return is
10%. What is the internal rate of return of this investment project?
A. 11.56%
B. 26.67%
C. 16.67%
D. 11.00%
59. Benson Corporation is considering an investment in equipment that would cost $50,000 and
provide annual cash inflows of $14,000. The company's required rate of return is 12%; the
internal rate of return for the investment is 10.5%. Should the company make this investment?
A. No, since the internal rate of return is more than the company's required rate of return.
B. Yes, since the internal rate of return is less than the company's required rate of return.
C. No, since the internal rate of return is less than the company's required rate of return.
60. Findell Corporation is considering two projects, A and B, and it has gathered the following
estimates for the projects:
What is the net present value for project B?
A. $7,360
B. $6,100
C. $1,260
10-16
estimates for the project
What is the present value index for project A?
A. 1.096
B. 1.124
C. 0.889
D. 0.913
62. Young Corporation is considering purchasing equipment that costs $80,000 and is expected to
provide the following cash inflows over its five-year useful life:
What is the payback period of this investment project (rounded to the nearest year)?
A. 2 years
B. 4 years
C. 3 years
D. 6 years
63. Capital investment decisions involve all of the following, except:
A. the acquisition of short-term operational assets.

B. projects requiring relatively long periods of time and large cash flows.
C. the acquisition of long-term operational assets.
10-17
64. A series of equal cash flows at fixed intervals is termed a(n):
A. net cash flow.

B. lump sum.
C. annuity.
D. return on investment.
65. Which method for evaluating capital investment proposals reduces the present value of cash
outflows from the present value of cash inflows?
A. Payback method
B. Internal rate of return
C. Net present value
D. Unadjusted rate of return
66. Which of the following are not present value methods of analyzing capital investment proposals?
A. Internal rate of return and payback

B. Unadjusted rate of return and net present value
C. Net present value and payback
D. Payback and unadjusted rate of return
67. Which of the following is not a criteria that is used to determine whether a project is acceptable
under the net present value method?
A. If the net present value is equal to zero

B. If the net present value is greater than zero
C. If the net present value is equal to the required rate of return
68. Joan Osborne is evaluating a potential capital investment. She has calculated the net present
value using a minimum rate of return of 10%. Using this rate, the net present value is negative.
What does this tell her about the rate of return expected for the project?
A. If the net present value is negative; the expected rate of return for the project is greater than
the 10% minimum or required rate of return.
B. If the net present value is negative; the expected rate of return for the project is less than the
10% minimum or required rate of return.
C. If the net present value is negative; the expected rate of return for the project is equal to the
10% minimum or required rate of return.
D. None of the other answers are correct.
10-18
69. Which method of evaluating capital investment decisions uses the concept of present value to
compute a rate of return?
A. Internal rate of return

B. Unadjusted rate of return
D. Payback
70. Cash inflows generated by capital investments include all of the following except:
B. cost savings.
C. reduction in the amount of required working capital.
D. increase in operating expenses.
A. annual depreciation of the capital asset.

B. initial investment in the capital asset.
C. increase in operating expenses.
D. increase in the amount of required working capital
72. Seth Morrison is considering alternative proposals that involve different amounts of investments.
To compare different size investment proposals, it may be helpful for Sarah to prepare a relative
ranking of the proposals by using a(n):
A. present value index.

B. net present value.
C. internal rate of return.
73. The present value index indicates:
A. the time it will take to recover the initial cash outflow of an investment.
B. the additional cash inflows from operating activities.
C. the rate of return per dollar invested in a capital project.
D. the ratio of the net present value of an investment to the initial investment.
10-19
74. The length of time required to recover the initial investment in a capital asset is known as the:
A. the rate of return.

B. investment period.
C. present value period.
D. payback period.
75. The time value of money concept recognizes that a dollar today is worth more than a dollar
tomorrow. Which of the following is not a factor in causing the present value of cash inflows to
diminish over time?
A. Current expenses.
B. Earning potential, such as interest.
C. Risk of uncollectability.
D. Inflation reduces future purchasing power.
76. The difference between an ordinary annuity and an annuity due is:
A. an ordinary annuity represents a present value and an annuity due represents a future value.
B. an ordinary annuity represents a future value and an annuity due represents a present value.
C. an ordinary annuity assumes the cash flows occur at the beginning of the period and an
annuity due assumes the cash flows occur at the end of the period.
D. an ordinary annuity assumes the cash flows occur at the end of the period and an annuity due
assumes the cash flows occur at the beginning of the period.
77. Butch's Barbecue thinks that offering delivery will increase their sales. Butch's is considering
whether to purchase a used delivery truck costing $12,000. Additional net income from the
delivery service will be $1,400 per year. The truck will last approximately 5 years. What is the
unadjusted rate of return based on the average investment?
A. About 58.3%
B. About 11.7%
C. About 23.3%
D. About 857.1%
10-20
78. Which of the following statements is incorrect?
A. The further into the future a cash receipt is expected to occur, the lower is its present value.
B. The return on investment measures the compensation a company expects to receive from
investing in capital assets.
C. Most companies use their cost of capital to estimate the minimum return on investment
required from capital investments.
D. When a company invests in capital assets, it sacrifices future dollars for the opportunity to
receive present dollars.
79. The process by which management evaluates long-term investment decisions involving long term
operational assets is called:
A. capital investment analysis.

B. activity based management.
C. strategic business analysis.
D. fixed cost analysis.
80. Which of the following statements is correct?
A. A postaudit should be conducted at the time a capital investment is purchased.

B. The postaudit of a capital investment project should be made using the same analytical
technique that was used in deciding to make the investment.
C. The purpose of postaudits is to improve a company's cost-volume-profit analysis.
D. The postaudit process uses expected cash flows and the company's cost of capital.
True / False Questions
81. Capital investment decisions involve investments in current assets.
True False
82. Capital investments differ from stock and bond investments in that stock and bond investments
can be sold in organized markets.
True False
10-21
83. A capital investment decision is essentially a decision to exchange current cash outflows for
future cash inflows.
True False
84. The time value of money concept recognizes the fact that the present value of a dollar to be
received in the future is worth more than a dollar.
True False
85. A dollar to be received in the future is subject to the effects of risk and inflation.
True False
86. The compensation a company receives for investing in capital assets is referred to as a return on
investment.
True False
87. The cost of capital represents the maximum acceptable rate of return that a capital investment
should earn.
True False
88. The cost of capital is sometimes referred to as the hurdle or discount rate.
True False
89. Mary needs to have $20,000 one year from today. The formula to compute the amount of money
that must be invested today is future value/(1 - interest rate).
True False
90. The future value of $1 table should be used to discount lump sum cash flows expected to occur in
the future.
True False
91. Matt needs to compute the present value of $5,000 to be received four years from now. He
should multiple $5,000 by the appropriate present value interest factor obtained from the present
value of $1 table.
True False
92. The present value of an annuity of $1 table could be constructed using the factors contained in
the present value of $1 table.
True False
10-22
93. An annuity is a series of equal payments over equal time intervals that earn a constant rate of
return.
True False
94. The instantaneous computation power of spreadsheet software makes it ideal for answering
"what-if" questions regarding present values.
True False
95. The assumption regarding ordinary annuities is that cash flows occur at the end of each period.
True False
96. In performing capital budgeting analysis that takes time value of money into account, cash flows
generated by a capital project are assumed to be reinvested at the project's rate of return.
True False
97. Because of the expense of applying multiple techniques, managers should use a single capital
budgeting technique to analyze potential capital investments.
True False
98. A project's net present value can be found by subtracting the cost of the project from the total
present value of the future cash flows generated by the project.
True False
99. If a project has a positive net present value, its internal rate of return will exceed the firm's hurdle
rate.
True False
100.Investment projects A and B offer equal cash inflows over their lives, but the cash inflows for
project A occur sooner than those for project B. The two projects are otherwise identical (the cost
is the same, for example) Based on this information, the internal rate of return for A is lower than
for B.
True False
101.If the net present value for a capital investment is equal to zero, the internal rate of return for the
investment is equal to the required rate of return.
True False
10-23
102.A capital investment with an internal rate of return equal to or greater than the required rate of
return is considered to be an acceptable investment.
True False
103.Sources of cash inflows from capital investments include incremental expenses and installation
costs.
True False
104.Cash inflows from a capital investment may include the terminal value of capital assets and
increases in revenues.
True False
105.When the effect of income taxes is considered in a capital budgeting analysis, the amount of
depreciation expense must be added back to after-tax income to calculate the annual cash
inflow.
True False
106.Depreciation on a capital investment (such as equipment) has the effect of decreasing the
amount of income taxes that the company owning the asset must pay.
True False
107.The amount of the depreciation tax shield can be calculated by multiplying the amount of
depreciation expense by the tax rate.
True False
108.Generally, a company should use the MACRS method to calculate depreciation on its income tax
return, due to the effects of the time value of money.
True False
109.If a company has to pay a given amount of income taxes over the life of a capital investment,
managers of the company should seek to pay the taxes as early as possible in the investment's
life.
True False
110.The payback method shows how long will be required to recover the cost of an investment in a
capital asset.
True False
10-24
111.The payback method of evaluating capital investments measures the recovery of the investment,
but it does not measure profitability.
True False
112.When a capital investment is expected to provide unequal annual cash inflows, the payback
period can be calculated by accumulating the incremental cash inflows until the sum equals the
amount of the original investment.
True False
113.When a capital investment is expected to provide unequal annual cash inflows, the payback
period cannot be calculated.
True False
114.The unadjusted rate of return is found by dividing the average incremental increase in annual
operating income by the cost of the investment.
True False
115.Generally, the unadjusted rate of return should be calculated based on the average investment
rather than the amount of the original investment in a depreciable asset such as equipment.
True False
116.A postaudit should be performed at the end of a capital investment project to determine whether
the expected results were actually achieved.
True False
Essay Questions
117.Why is the time value of money often taken into account in analyzing a capital investment?
10-25
118.Why does a company use its cost of capital as the minimum required rate of return for its capital
investment decisions?
119.Describe what is meant by the time value of money.
120.What is the reinvestment assumption, and how does the assumption affect capital investment
analyses?
10-26
121.How does depreciation serve as a tax shield? How is the amount of the annual tax shield
calculated?
122.Describe how the unadjusted rate of return for a capital investment is calculated. Should it be
based on the net cost of the investment or the average investment?
123.Describe the general approaches companies may use in evaluating potential capital
investments.
10-27
124.Describe the decision rules management should use for accepting and rejecting capital projects
under each of the following capital budgeting models: net present value model, internal rate of
return model, payback period, and the unadjusted rate of return model.
125.What is a postaudit of a capital investment decision, and how should the postaudit be
conducted?
126.How would an organization benefit from conducting postaudits of its capital investment
decisions?
10-28
127.Indicate whether each of the following statements is true or false.
A capital investment is a purchase of a long-term operational asset.

Investments in capital assets normally are recovered by selling the assets.
The profitability of a business is greatly influenced by the quality of its capital investment
decisions.
A capital investment decision exchanges current cash inflows for future cash outflows.
The time value of money concept is often used in making capital investment decisions.
The further into the future a cash receipt is expected to occur, the higher is its present value.
The return on investment measures the compensation a company expects to receive from
Most companies use their cost of capital to estimate the minimum return on investment required
from capital investments.
When a company invests in capital assets, it sacrifices present dollars for the opportunity to
receive future dollars.
The required rate of return on a capital investment is also referred to as the hurdle rate or
discount rate.
10-29
An ordinary annuity assumes that cash flows occur at the beginning of each period.
To say that an investment earns the desired rate of return assumes that all cash flows generated
by the investment are reinvested at the desired rate of return.
Managers should not use two different methods in evaluating capital investment decisions
because different methods generally give different results.
Copley Corporation uses a required rate of return of 10% for its capital investment decisions. A
particular project had a negative net present value. For this project, the actual rate of return was
expected to be more than 10%.
The net present value of a capital investment project is calculated by subtracting the present
value of expected cash inflows from the cost of the investment.
If two capital investments both have positive net present values, both offer an actual rate of
return that is higher than the required rate of return.
Company M has two potential capital investments, each of which has a positive net present
value. M can only accept one of the investments. In this situation, it should always accept the
project that has the higher net present value.
Net present value is calculated by dividing the present value of cash inflows by the present value
of cash outflows associated with a capital investment.
The present value index can be used to compare different capital investment projects.
The higher the present value index, the lower the rate of return per dollar invested in the project.
10-30
The net present value method provides a direct measure of the rate of return to be expected from
a capital investment project.
Managers who want to know the rate of return to expect from a capital investment project should
calculate the net present value.
The internal rate of return for a capital investment is the rate that would produce a net present
value of zero.
For a capital investment project to be acceptable, the internal rate of return should be higher than
the hurdle rate.
A capital investment project that has a positive net present value may have an internal rate of
return that is lower than the hurdle or required rate of return.
In analysis of a capital investment, a cost saving is treated as a cash inflow.

The expected salvage value of an asset is a source of a cash outflow that should be considered
in capital investment analyses.
Many capital investments require an increase in the amount of a company's working capital.
Incremental revenues are treated as cash outflows in capital investment analyses.
An increase in working capital, which may occur near the beginning of a capital investment
project, is treated as a cash outflow.
10-31
Internal rate of return measures the difference between an investment's rate of return and the
company's required rate of return.
A spreadsheet program is useful in doing internal rate of return analyses.
Capital investment analyses should take tax consequences into account.
Depreciation on equipment or a building has the effect of sheltering some of a corporation's
income from income taxes.
The amount of a depreciation tax shield is calculated by multiplying the amount of depreciation
by (1 - the tax rate).
The payback method does not take the time value of money into account.
The unadjusted rate of return indicates the length of time required to recover the initial cost of an
investment.
The payback period can only be calculated for capital investments that are expected to provide
equal annual cash inflows over their useful lives.
Generally, investments with shorter payback periods are preferred.
Use of the payback method to analyze capital investments is the best way of identifying the
projects that will make the greatest contribution to a company's profits.
10-32
When unequal cash inflows are expected from a capital investment, the payback period can be
calculated by accumulating incremental cash inflows or by using average annual cash inflows.
The unadjusted rate of return is also called the simple rate of return.
The unadjusted rate of return can be calculated as average increase in cash inflows divided by
net cost of the original investment.
The unadjusted rate of return does not take the time value of money into account.
The unadjusted rate of return should be calculated using the initial cost of the investment, rather
than the average invested capital.
136.Indicate whether each of the following statements is true or false:
A postaudit should be conducted at the time a capital investment is purchased.

The postaudit of a capital investment project should be made using the same analytical
The purpose of postaudits is to improve a company's capital investment decision process.
The postaudit process uses expected cash flows and the company's cost of capital.
Making good estimates of future cash flows is important in making capital investment decisions.
10-33
137.Select the term from the list provided that best matches each of the following definitions or
descriptions. Put the number of the term in the answer column.
10-34
138.Redmond Company is considering investing in one of the following two projects:
Required:
1) Which project is more desirable strictly in terms of cash inflows? Why?

2) Compute the present value of each project's cash inflows assuming the company's required
rate of return is 12%.
3) What is the maximum amount Redmond should be willing to pay for each project?
4) Suppose each project costs $7,000. Which project(s) should be accepted? Note that only one
project can be accepted.
10-35
139.Chichester Company is considering investing in the following two mutually exclusive projects:
Required:

3) What is the maximum amount Chichester should be willing to pay for each project?
4) Suppose each project costs $10,000. Which project(s) should be accepted?
10-36
140.Chico Company is considering the purchase of a new high-speed machine for its factory. The
machine will cost $160,000 and will save the company $45,000 per year in cash operating costs.
The machine has an estimated useful life of five years and no expected salvage value. The
company's cost of capital is 12%.
Required:
1) Compute the net present value of this investment.

2) What is the maximum amount that Chico should be willing to pay for the machine?
3) What are the minimum annual cash savings that will make the machine acceptable on a net
present value basis if the purchase price is $160,000?
141.Neighbors Company is considering the purchase of new equipment that will cost $130,000. The
equipment will save the company $38,000 per year in cash operating costs. The equipment has
an estimated useful life of five years and a zero expected salvage value. The company's cost of
capital is 10%.
Required:
1) Ignoring income taxes, compute the net present value and internal rate of return. Round net
present value to the nearest dollar and round internal rate of return to the nearest whole percent.
2) Should the equipment be purchased? Why or why not?
10-37
142.Pierce Company is considering the purchase of new equipment that will cost $150,000. The
equipment will save the company $48,000 per year in cash operating costs. The equipment has
an estimated useful life of five years and no expected salvage value. The company's cost of
capital is 12%.
Required:
1) Assuming the company is subject to a 40% tax rate, compute the net present value.
2) Compute the amount of the annual depreciation tax shield provided by the new equipment.
143.Alcorn Company is considering purchasing equipment that costs $400,000. The equipment has
an estimated useful life of 8 years and no salvage value. Alcorn believes that the annual cash
inflows from using the equipment will be $80,000.
Required:
1) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is 12%.
Is the equipment an acceptable investment?
2) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is 10%.
Is the equipment an acceptable investment?
3) What general conclusion can you reach from your results to parts 1) and 2)?
10-38
144.Burgess Corporation is considering purchasing equipment that costs $235,000. The equipment
has an estimated useful life of 5 years and no salvage value. Burgess believes that the annual
cash inflows from using the equipment will be $65,000.
Required:
1) Calculate the net present value of the equipment assuming that Burgess's cost of capital is
12%. Is the equipment an acceptable investment?
3) Based on your results to parts 1) and 2), estimate the internal rate of return for the investment
in the equipment.
10-39
145.Montana Company is evaluating two different capital investments, Project X and Y. Either X or Y
would cost $210,000, and the company cannot afford to do both. The company expects that
Project X would provide net cash inflows of $62,000 per year for 5 years. For Project Y, the net
cash inflows are expected to be as follows:
Montana's cost of capital is 12%.
Required:
1) Calculate the present value index for Project X and for Project Y. Round your answer to three
decimal places.
2) Indicate whether each of the projects is an acceptable investment.
3) Based on present value index, which of the two projects should Montana implement?
10-40
146.Janelle Bates has just inherited $250,000 from her uncle's estate. She is considering opening a
small sewing and fabric shop. She would need to purchase inventory costing $50,000. Janelle
plans to rent a shop in a local shopping center for $12,000 per year. Fixtures, display equipment,
and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years to its expected
salvage value of $3,000. Operating costs will amount to $25,000 per year. Janelle estimates her
revenues from sales and sewing services will total $65,000. Because Janelle believes she can
earn a 10% return by investing in mutual funds, she does not want to start the business unless
she can earn at least this rate. Ignore income taxes.
Required:
1) Prepare a schedule of expected cash flows for the proposed investment by completing the
table provided below. In column 1 enter a brief description of the cash flow. In column 2 indicate
whether the cash flow is an inflow (I) or an outflow (O). In column 3 enter the years in which the
cash flow will occur. For example, if the cash flow occurs immediately enter a 0. If the cash flow
occurs each year enter 1-5, etc. In column 4 enter the cash flow amount.
2) What is the initial outlay for this capital investment (the amount of the cash flow at time = 0)?
3) What is the amount of the annual net cash flow for this capital investment?
4) What is the net present value of the proposed venture? Should Janelle proceed?
10-41
147.Omicron Company is considering purchasing equipment that would cost $60,000 and have a
useful life of 5 years. The equipment is expected to provide net cash inflows of $16,000 per year.
Omicron's cost of capital is 12%.
Required:
Estimate the internal rate of return for this capital investment. Is this an acceptable investment?
10-42
148.Columbus Company is considering a project that requires an initial investment of $400,000. Its
incremental cash flows are expected to be $150,000 per year for five years. The project would be
depreciated on a straight-line basis over 5 years with no expected salvage value. The company
has a stated policy that all projects must return their required investment dollars within the first
75% of the project's life. The company is subject to a 40% income tax rate, and its cost of capital
is 10%.
Required:
1) Compute the project's after-tax net cash flows (NCF) by completing the following table:
2) Compute the project's net present value by completing the following table:
3) Compute the project's payback period.

4) Should the project be accepted? Why or why not?
10-43
149.Bruce Company is considering replacing one of its delivery trucks. The truck in question was
purchased two years ago at a cost of $41,000. At the time of purchase the truck was expected to
have a $5,000 salvage value at the end of its six-year life. Given the use of straight-line
depreciation, the truck has a current book value of $29,000. If sold today, the company could get
$22,000 for the truck. It costs $20,000 per year to operate the existing truck. The new truck would
cost $46,000 and would cost only $14,000 per year to operate. The new truck would be
depreciated on a straight-line basis over its four-year useful life to its expected salvage value of
$10,000. The company's required rate of return is 14%. Ignore income taxes.
Required:
1) Identify the cash flows for each alternative by completing the following table:
2) The company's objective is to minimize costs. Complete the following table to determine
whether the existing truck should be replaced. Ignore income taxes. What is your
recommendation?
10-44
150.Levin Company is considering two new machines that should produce considerable cost savings
in its assembly operations. The cost of each machine is $14,000 and neither is expected to have
a salvage value at the end of a 4-year useful life. Levin's required rate of return is 12% and the
company prefers that a project return its initial outlay within the first half of the project's life. The
annual after-tax cash savings for each machine are provided in the following table:
Required:
1) Compute the payback period for each machine using the incremental approach and comment
on the results.
2) Compute the unadjusted rate of return based on average investment for each machine. The
machines will be depreciated on a straight-line basis.
3) Compute the net present value for each machine.
4) Which machine would you recommend? Explain your reasoning.
5) Use the present value table to compute the approximate internal rate of return for Machine.
10-45
151.Bristles Hair Salon is considering installing spray tanning booths. The booths cost $220,000 and
have an estimated five-year useful life. Ignore income taxes. The following pro forma income
statement is provided:
Required:
1) Bristles would like to recoup its original investment in less than four years. Compute the
payback period for the tanning booth investment. Would you recommend that the booths be
purchased? Why or why not?
2) Bristles' minimum acceptable unadjusted rate of return is 11%. Compute the unadjusted rate
of return on the original investment. Would you recommend that the booths be purchased? Why
or why not?
10-46
152.Seven Day Mini Mart is considering installing video games in its stores. The machines cost
$300,000 and have an estimated six-year useful life. Ignore income taxes. The following
projected income statement is provided:
Required:
1) Seven Day Mini Mart would like to recoup its original investment in less than five years.
Compute the payback period for the video game machine investment. Would you recommend
that the machines be purchased? Why or why not?
2) Seven Day Mini Mart's target unadjusted rate of return is 12%. Compute the unadjusted rate of
return on the original investment. Would you recommend that the machines be purchased? Why
or why not?
10-47
153.Gordon Company is considering a three-year capital investment that will return $150,000 per
year. The present value of this annuity at the company's required rate of return of 12% is
$360,275.
Required:
Complete the table that has been started below to show the return on investment at 12% and the
amount of investment recovered each year. Remember that the investment balance should be
zero at the end of the three years.
10-48
154.In 2008, Burton Company purchased equipment with an expected useful life of 5 years. The
initial cost of the equipment was $160,000. Burton's cost of capital is 12%; when it purchased the
equipment, Burton computed a net present value of $15,824 for the investment. In 2013, the
equipment reached the end of its useful life. Burton determined that, over the 5-year life, the
equipment had generated annual cash inflows of $46,000.
Required:
Conduct a post-audit to determine whether the equipment achieved the net present value the
company had expected. Based on the results actually achieved, was the asset in fact an
acceptable investment?
10-49
155.In 2008, Chandler Company purchased equipment with an expected useful life of 5 years. The
initial cost of the equipment was $85,000. Chandler's cost of capital is 12%. At the time it
purchased the equipment, Chandler projected the following cash inflows from use of the
equipment:
In 2013, the equipment had reached the end of its useful life. Chandler determined that it had
actually generated the following cash flows:
Required:
1) What was the net present value that Chandler calculated for the equipment when the company
purchased the asset?
2) Calculate the net present value that the equipment achieved, based on the actual cash
inflows.
3) Comment on the pattern of actual cash inflows, compared to the cash flows that had been
projected.
4) Was the equipment in fact an acceptable investment, based on the cash flows actually
achieved?
10-50
Chapter 10 Planning for Capital Investments Answer Key
Multiple Choice Questions
1. All of the following are capital investment decisions except:
A. acquiring $100,000 of common stock.

B. buying a $5,000,000 manufacturing plant.
C. purchasing equipment for $80,000.
D. paying $600,000 to renovate a restaurant.
AACSB: Reflective Thinking

AICPA FN: Decision Making
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Explain the time value of money concept.
2. Which of the following is not a factor in explaining why the present value of a future dollar is
less than one dollar?
A. Inflation
B. Interest
C. Risk of failure to receive expected cash inflows
D. Historic cost
AACSB: Analytic
AICPA BB: Critical Thinking
Blooms: Understand
Difficulty: 1 Easy
10-51
3. Which statement characterizes the time value of money concept?
A. The future value of a present dollar is greater than one dollar.

B. The present value of a future dollar is greater than one dollar.
C. The timing of cash flows is not relevant to decision making.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
4. Evergreen Company has two investment opportunities. Both investments cost $5,000 and will
given below:
Select the correct statement.
A. Evergreen should choose Investment I because of the time value of money.

B. Evergreen should choose Investment II because it generates more immediate cash
inflows.
C. Evergreen should be indifferent between the two investments because they provide the
same total cash inflows.
D. Time value of money techniques are not useful for comparing these investments.
AACSB: Analytic
AICPA BB: Resource Management
Blooms: Understand
Difficulty: 1 Easy
10-52
5. Which of the following statements describes the cost of capital?
A. The internal rate of return on investments

B. The maximum acceptable rate of return on investments
C. The return that a company must pay its investors and creditors
D. The interest rate the bank charges its best customers

Blooms: Remember
Difficulty: 1 Easy
6. The cost of capital is called all of the following except:
A. cutoff rate.
B. discount rate.
C. hurdle rate.
D. All of these are terms for the cost of capital.

Blooms: Remember
Difficulty: 1 Easy
7. For a capital investment project to be acceptable, it must generate a rate of return:
A. less than the hurdle rate.

B. equal to or greater than the cost of capital.
C. equal to the conversion rate.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-53
8. What amount of cash must be invested today in order to have $60,000 at the end of one year
assuming the rate of return is 9%? (Do not round your PV factors.)
A. $45,454.56
B. $54,000.00
C. $55,045.88
D. $54,600.00
AACSB: Analytic
AICPA FN: Measurement
Blooms: Apply
Difficulty: 2 Medium
9. What amount of cash would result at the end of one year, if $15,000 is invested today and the
rate of return is 8%? (Do not round your PV factors.)
A. $16,200
B. $13,889
C. $15,000
D. $1,200
AACSB: Analytic
Blooms: Apply
Learning Objective: 10-02 Determine and interpret the net present value of an investment opportunity.
10. Ashley projects that she can get $100,000 cash per year for 5 years on a real estate
investment project. If Ashley wants to earn a rate of return of 12%, what is the maximum that
she should pay for the investment? (rounded to the nearest dollar)
A. $56,743
B. $446,429
C. $360,478
D. $560,000
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
10-54
11. Connor has $300,000 to invest in a 5 year annuity. Assuming the time value of money is 10%,
what amount will Connor receive in cash each year? (Do not round your PV factors. Round
your answer to the nearest dollar.)
A. $79,139
B. $60,000
C. $96,631
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
12. A cash flow that only occurs in equal amounts each year is referred to as:
A. a lump sum.
B. a perpetuity.
C. an annuity.
D. None of these.

Blooms: Remember
Difficulty: 1 Easy
13. Which of the following cash flow patterns represents of an annuity?
A. A
B. B
C. C
D. Any of the answers can represent an annuity.
AACSB: Analytic
Blooms: Understand
10-55
14. Which one of the following statements describes an ordinary annuity?
A. Series of cash inflows of varying amounts collected at the end of each period
B. Series of cash flows of equal amounts collected at the end of each period
C. Series of cash flows of varying amounts collected at the beginning of each period
D. Series of cash flows of equal amounts collected at the beginning of each period

Blooms: Remember
Difficulty: 1 Easy
15. Which of the following is not a major cash inflow from a capital investment?
A. Incremental revenue
B. Increase in working capital
C. Cost savings
D. Salvage value

AACSB: Technology
Blooms: Remember
Difficulty: 1 Easy
16. When calculating the present value of an ordinary annuity, it is assumed that:
A. cash flows will be reinvested at the required rate of return.

B. cash flows are withdrawn at the end of each year.
C. the investor will wait until the end of the investment period to withdraw cash flows.
D. Both cash flows will be reinvested at the required rate of return and cash flows are
withdrawn at the end of each year are correct.

Blooms: Understand
10-56
17. A customary assumption in capital budgeting analysis is that:
A. the desired rate of return includes the effects of compounding.

B. the cash inflows generated by the investment are not reinvestment.
C. annual cash flows occur at the beginning of each period.
D. the time value of money is ignored.
AACSB: Analytic
Blooms: Understand
18. Jiminez Company has two investment opportunities. Both investments cost $5,000 and will
provide the following net cash flows:
The total present value of Investment A's cash flows assuming an 8% minimum rate of return
is (Do not round your PV factors and intermediate calculations. Round your answer to the
nearest whole dollar):
A. $14,936.
B. $4,936.
C. $7,000.
D. $12,000.
AACSB: Analytic
Blooms: Apply
10-57
19. Harvey wants to determine the net present value for a proposed capital investment. He has
determined the desired rate of return, the expected investment time period, a series of cash
inflows of equal amount, the salvage value of the investment, and the required cash outflows.
Which of the following tables would most likely be used to calculate the net present value of
the investment?
A. Present value of annuity.

B. Future value of a lump sum.
C. Present value of annuity and present value of a lump sum.
D. Future value of annuity and future value of a lump sum.
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
20. Morrisey Company has two investment opportunities. Both investments cost $5,500 and will
given below:
The net present value of Investment II assuming an 8% minimum rate of return would be
which of the following amounts? (Do not round your PV factors and intermediate calculations.
Round your answer to nearest whole dollar.)
A. $6,492
B. $992
C. $5,880
D. $380
AACSB: Analytic
Blooms: Apply
10-58
years. Given a desired rate of return of 10%, the investment will generate a (Do not round your
PV factors and intermediate calculations. Round your answer to nearest whole dollar):

B. positive net present value of $1,962.
C. negative net present value of $38,038.
D. negative net present value of $1,962.
AACSB: Analytic
Blooms: Apply
years. Further, the investment has an expected salvage value of $3,000. Given a desired rate
of return of 12%, the investment will generate a (Do not round your PV factors and
intermediate calculations. Round your answer to the nearest whole dollar.):

B. negative net present value of $2,077.
C. positive net present value of $22,077.
D. positive net present value of $557.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
23. The rate of return that equates the present value of cash inflows and outflows is the:
A. minimum rate of return.

B. internal rate of return.
C. desired rate of return.
D. hurdle rate.

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Determine and interpret the internal rate of return of an investment opportunity.
10-59
24. An investment that cost $30,000 provided annual cash inflows of $9,000 per year for five
years. The desired rate of return is 10%. The internal rate of return from the investment was
(Do not round your PV factors and intermediate calculations):
A. less than the desired rate of return.

B. equal to the desired rate of return.
C. greater than the desired rate of return.
D. the answer cannot be determined from the information provided.
AACSB: Analytic
Blooms: Understand
25. Select the incorrect statement concerning the internal rate of return (IRR) method of
evaluating capital projects.
A. The higher the IRR the better.

B. The internal rate of return is that rate that makes the present value of the initial outlay
equal to zero.
C. If a project has a positive net present value then its IRR will exceed the hurdle rate.
D. A project whose IRR is less than the cost of capital should be rejected.
AACSB: Analytic
Blooms: Understand
26. Which of the following is the approximate internal rate of return for an investment that costs
$33,550 and provides a $5,000 annuity for 10 years?
A. 5%
B. 6%
C. 8%
D. 10%
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
10-60
27. Theresa is considering starting a small business. She plans to purchase equipment costing
$145,000. Rent on the building used by the business will be $26,000 per year while other
operating costs will total $30,000 per year. A market research specialist estimates that
Theresa's annual sales from the business will amount to $80,000. Theresa plans to operate
the business for 6 years. Disregarding the effects of taxes, what will be the amount of annual
net cash flow generated by the business?
A. $24,000
B. $56,000
C. $80,000
AACSB: Analytic
Blooms: Apply
28. Cash outflows can be categorized into all of the following groups except:
A. opportunity costs associated with selecting a specific capital project.

B. outflows associated with the initial investment.
C. working capital commitments.
D. increases in operating expenses.
AACSB: Analytic
Blooms: Understand
29. Which of the following would be considered a cash inflow in determining the value of a capital
investment?
A. Incremental revenues from increased productivity

B. Cost savings from a reduction in labor hours
C. An increase in working capital commitments
D. Both incremental revenues from increased productivity and cost savings from a reduction
in labor hours are correct.
AACSB: Analytic
Blooms: Understand
10-61
30. A capital investment project may provide cash inflows from:
B. cost savings.
C. the salvage value of the investment.

Blooms: Remember
Difficulty: 1 Easy
31. Cash outflows from a capital investment project include:
A. increases in operating expenses.

B. the reduction in the amount of working capital.
C. terminal salvage value.

Blooms: Remember
32. Select the incorrect statement concerning the present value index (PVI).
A. The PVI is computed by dividing the total present value of the cash inflows by the present
value of the cash outflows.
B. The PVI should be used to evaluate two or more projects whose initial investments differ.
C. The lower the PVI, the better.
D. A project whose PVI is positive will also have a positive net present value.
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
10-62
33. Garrison Company has two investment opportunities. A cash flow schedule for the
investments is provided below:
Considering the unequal investments, which of the following techniques would be most
appropriate for choosing between Investment A and Investment B?
A. Payback technique
B. Present value index
C. Net present value technique
AACSB: Analytic
Blooms: Understand
10-63
34. Shenandoah Springs Company is considering two investment opportunities whose cash flows
are provided below:
The company's hurdle rate is 12%. What is the present value index of Investment B? (Do not
round your PV factors and intermediate calculations.)
A. 1.01
B. 1.16
C. 0.86
AACSB: Analytic
Blooms: Apply
years. Given a desired rate of return of 8%, the investment will generate a present value index
of (Do not round your PV factors and intermediate calculations):
A. 0.755.
B. 1.600.
C. 2.500.
D. 1.325.
AACSB: Analytic
Blooms: Apply
10-64
36. Weston Company is considering a capital project that delivers a $50,000 annual net cash flow
before tax. The investment will result in annual depreciation expense of $10,000 over the
project's four-year useful life. Assuming a tax rate of 40%, what amount of annual after-tax net
cash flow will be provided by this project?
A. $40,000
B. $16,000
C. $34,000
D. $24,000
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
37. Southport Company is considering the purchase of a piece of equipment that costs $100,000.
The equipment would be depreciated on a straight-line basis to its expected salvage value of
$10,000 over its 10-year useful life. Assuming a tax rate of 40%, what is the annual amount of
the depreciation tax shield provided by this investment?
A. $4,000
B. $9,000
C. $3,600
AACSB: Analytic
Blooms: Apply
38. Newton Company is considering the purchase of an asset that will provide a depreciation tax
shield of $10,000 per year for 10 years. Assuming the company is subject to a 40% tax rate
during the period, and a zero salvage value, what is the depreciable cost of the new asset?
A. $100,000
B. $250,000
C. $400,000
D. Can't be determined from the information provided
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-65
39. Mendez Company is considering a capital project that costs $16,000. The project will deliver
the following cash flows:
Using the incremental approach, the payback period for the investment is:
A. 5 years.
B. 2 years.
C. 2.4 years.
D. 1.66 years.
AACSB: Analytic
Blooms: Apply
Learning Objective: 10-04 Evaluate investment opportunities using the payback method and the unadjusted rate of return.
40. George Company has the opportunity to purchase an asset that costs $40,000. The asset is
expected to increase net income by $10,000 per year. Depreciation expense will be $5,000
per year. Based on this information the payback period is:
A. 4 years.
B. 2.5 years.
C. 2.67 years.
D. 8 years.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
10-66
41. Mr. J's Bagels invested in a new oven for $14,000. The oven reduced the amount of time for
baking which increased production and sales for five years by the following amounts of cash
inflows:
Using the averaging method, the payback period for the investment in the oven would be:
A. 5.0 years.
B. 2.3 years.
C. 2.0 years.
D. 0.5 years.
AACSB: Analytic
Blooms: Apply
42. Which of the following statements concerning payback analysis is true?
A. An investment with a shorter payback is preferable to an investment with a longer payback.

B. The payback method ignores the time value of money concept.
C. The payback method and the unadjusted rate of return are different approaches that will
not consistently lead to the same conclusion.
D. All of the other answers are correct.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
43. Which of the following does not represent an advantage of the unadjusted rate of return over
the payback method for evaluating capital projects?
A. The unadjusted rate of return method considers the investment's profitability.

B. The unadjusted rate of return method considers the time value of money.
C. The unadjusted rate of return is a percentage that can be compared to a stated hurdle rate.
D. None of these represents an advantage.
AACSB: Analytic
Blooms: Understand
10-67
A. depreciation expense
B. transportation costs
C. increased operating expenses
D. increase in the required amount of working capital
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
45. Which capital budgeting technique defines returns in terms of income instead of cash flows?
A. The unadjusted rate of return method

B. The internal rate of return technique
C. The net present value technique
D. The payback period
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
46. Nguyen Company has an opportunity to purchase an asset that will cost the company
$36,000. The asset is expected to add $12,000 per year to the company's net income.
Assuming the asset has a five-year useful life and zero salvage value, the unadjusted rate of
return based on the average investment will be:
A. 60%.
B. 33%.
C. 15%.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
10-68
47. Finnegan Company plans to invest in a new operating plant that is expected to cost $500,000.
The projected incremental income from the investment is as follows:
The unadjusted rate of return on the initial investment would be approximately:
A. 8.0%.
B. 6.0%.
C. 16.7%.
D. 48.0%.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
48. Select the incorrect statement regarding postaudits of capital investment decisions.
A. A postaudit should be conducted at the end of the project.

B. The postaudit helps management determine whether a project that had been accepted
should have been rejected.
C. A postaudit is only necessary for a capital investment selected using a technique that does
not consider the time value of money.
D. The goal of a postaudit is to provide feedback that can be used to improve the accuracy of
future capital investment decisions.
AACSB: Analytic
Blooms: Understand
10-69
49. The purposes of the postaudit for capital investments include all of the following except:
A. continuous improvement.
B. rewarding managers for increasing idle cash.
C. determining whether the project generated the results expected.
D. encouraging managers to closely scrutinize capital investment decisions.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
50. The review of a capital budgeting decision to determine whether a project was accepted that
should have been rejected is referred to as:
A. an audit.
B. a preaudit.
C. a postaudit.
D. a capital review.

Blooms: Remember
Difficulty: 1 Easy
51. Six years ago, Neighborhood Hardware paid a contractor $45,000 to expand the store. At that
time, the company calculated a net present value of about $6,000 for the expansion. Now, the
company believes that the investment increased annual cash inflows by $8,000 per year for
each of the six years. The company has a desired rate of return of 10%. What was the net
present value actually achieved for this capital investment? (Do not round your PV factors and
intermediate calculations. Round to the nearest dollar.)
A. ($10,158)
B. ($3,000)
C. $34,842
D. $(9,207)
AACSB: Analytic
Blooms: Analyze
10-70
52. Langdon Company is considering purchasing a capital investment that is expected to provide
annual cash inflows of $10,000 per year for 3 years. Assuming that Langdon's required rate of
return is 8%, what is the present value of these cash inflows? (Do not round PV factors and
A. $24,018
B. $24,869
C. $33,121
D. $25,771
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
53. Paul Company is considering purchasing a capital investment that is expected to provide
annual cash inflows of $12,000 per year for 3 years. Assuming that the required rate of return
is 10%, what is the present value of these cash inflows? (Do not round PV factors and
A. $9,016
B. $28,822
C. $29,842
D. $27,047
AACSB: Analytic
Blooms: Analyze
54. Saget Company is considering the purchase of equipment that would cost $35,000 and offer
annual cash inflows of $10,500 over its useful life of 5 years. Assuming a required rate of
return of 8%, what is the net present value of this investment opportunity?
A. $(6,923)
B. $17,500
C. $6,923
D. $41,923
AACSB: Analytic
Blooms: Apply
10-71
55. Generro Company is considering the purchase of equipment that would cost $36,000 and offer
annual cash inflows of $10,500 over its useful life of 5 years. Assuming a desired rate of return
of 12%, is the project acceptable?
A. No, since the negative net present value indicates the investment will yield a rate of return
below the desired rate of return.
B. Yes, since the investment will generate $52,500 in future cash flows, which is greater than
the purchase cost of $36,000.
C. Yes, since the positive net present value indicates the investment will earn a rate of return
greater than 12%.
AACSB: Analytic
Blooms: Analyze
56. Kerwin Company is considering purchase of equipment that costs $50,000. If the useful life is
expected to be 5 years and Crown's required rate of return is 12%, what is the minimum
annual cash inflow that the equipment must offer for the investment to be acceptable? (Do not
round your PV factors and intermediate calculations. Round your final answer to the nearest
dollar.)
A. $8,929
B. $13,870
C. $12,076
D. $17,623
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-72
57. Grayson Company is considering purchase of equipment that costs $49,000 and is expected
to offer annual cash inflows of $13,000. Grayson's minimum required rate of return is 10%.
How many years must the cash flows last, for the investment to be acceptable? (Do not round
your PV factors and intermediate calculations. Round to nearest whole year.)
A. 4
B. 5
C. 3
D. 6
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
58. Fenwick Company is considering purchase of equipment that costs $60,000 and is expected
to offer annual cash inflows of $16,000 for 5 years. Fenwick Company's required rate of return
is 10%. What is the internal rate of return of this investment project?
A. 11.56%
B. 26.67%
C. 16.67%
D. 11.00%
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
10-73
59. Benson Corporation is considering an investment in equipment that would cost $50,000 and
provide annual cash inflows of $14,000. The company's required rate of return is 12%; the
internal rate of return for the investment is 10.5%. Should the company make this investment?
A. No, since the internal rate of return is more than the company's required rate of return.
B. Yes, since the internal rate of return is less than the company's required rate of return.
C. No, since the internal rate of return is less than the company's required rate of return.
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
estimates for the projects:
What is the net present value for project B?
A. $7,360
B. $6,100
C. $1,260
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
10-74
estimates for the project
What is the present value index for project A?
A. 1.096
B. 1.124
C. 0.889
D. 0.913
AACSB: Analytic
Blooms: Analyze
62. Young Corporation is considering purchasing equipment that costs $80,000 and is expected to
provide the following cash inflows over its five-year useful life:
What is the payback period of this investment project (rounded to the nearest year)?
A. 2 years
B. 4 years
C. 3 years
D. 6 years
AACSB: Analytic
Blooms: Analyze
10-75
63. Capital investment decisions involve all of the following, except:
A. the acquisition of short-term operational assets.

B. projects requiring relatively long periods of time and large cash flows.
C. the acquisition of long-term operational assets.
AACSB: Analytic
AACSB: Communication
Blooms: Understand
Difficulty: 1 Easy
64. A series of equal cash flows at fixed intervals is termed a(n):
A. net cash flow.

B. lump sum.
C. annuity.
D. return on investment.

Blooms: Remember
Difficulty: 1 Easy
65. Which method for evaluating capital investment proposals reduces the present value of cash
outflows from the present value of cash inflows?
A. Payback method
B. Internal rate of return
D. Unadjusted rate of return
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
10-76
66. Which of the following are not present value methods of analyzing capital investment
proposals?
A. Internal rate of return and payback

B. Unadjusted rate of return and net present value
C. Net present value and payback
D. Payback and unadjusted rate of return
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
67. Which of the following is not a criteria that is used to determine whether a project is
acceptable under the net present value method?
A. If the net present value is equal to zero

B. If the net present value is greater than zero
C. If the net present value is equal to the required rate of return
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
68. Joan Osborne is evaluating a potential capital investment. She has calculated the net present
value using a minimum rate of return of 10%. Using this rate, the net present value is negative.
What does this tell her about the rate of return expected for the project?
A. If the net present value is negative; the expected rate of return for the project is greater
than the 10% minimum or required rate of return.
B. If the net present value is negative; the expected rate of return for the project is less than
C. If the net present value is negative; the expected rate of return for the project is equal to
D. None of the other answers are correct.
AACSB: Analytic
Blooms: Analyze
10-77
69. Which method of evaluating capital investment decisions uses the concept of present value to
compute a rate of return?
A. Internal rate of return

B. Unadjusted rate of return
D. Payback
AACSB: Analytic
Blooms: Understand
70. Cash inflows generated by capital investments include all of the following except:
B. cost savings.
C. reduction in the amount of required working capital.
D. increase in operating expenses.

Blooms: Remember
A. annual depreciation of the capital asset.

B. initial investment in the capital asset.
C. increase in operating expenses.
D. increase in the amount of required working capital

Blooms: Remember
10-78
72. Seth Morrison is considering alternative proposals that involve different amounts of
investments. To compare different size investment proposals, it may be helpful for Sarah to
prepare a relative ranking of the proposals by using a(n):
A. present value index.

B. net present value.
C. internal rate of return.
AACSB: Analytic
Blooms: Analyze
73. The present value index indicates:
A. the time it will take to recover the initial cash outflow of an investment.
B. the additional cash inflows from operating activities.
C. the rate of return per dollar invested in a capital project.
D. the ratio of the net present value of an investment to the initial investment.
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
74. The length of time required to recover the initial investment in a capital asset is known as the:
A. the rate of return.

B. investment period.
C. present value period.
D. payback period.

Blooms: Remember
Difficulty: 1 Easy
10-79
75. The time value of money concept recognizes that a dollar today is worth more than a dollar
tomorrow. Which of the following is not a factor in causing the present value of cash inflows to
diminish over time?
A. Current expenses.
B. Earning potential, such as interest.
C. Risk of uncollectability.
D. Inflation reduces future purchasing power.
AACSB: Analytic
Blooms: Understand
76. The difference between an ordinary annuity and an annuity due is:
A. an ordinary annuity represents a present value and an annuity due represents a future
value.
B. an ordinary annuity represents a future value and an annuity due represents a present
value.
C. an ordinary annuity assumes the cash flows occur at the beginning of the period and an
annuity due assumes the cash flows occur at the end of the period.
D. an ordinary annuity assumes the cash flows occur at the end of the period and an annuity
due assumes the cash flows occur at the beginning of the period.
AACSB: Analytic
Blooms: Understand
10-80
77. Butch's Barbecue thinks that offering delivery will increase their sales. Butch's is considering
whether to purchase a used delivery truck costing $12,000. Additional net income from the
delivery service will be $1,400 per year. The truck will last approximately 5 years. What is the
unadjusted rate of return based on the average investment?
A. About 58.3%
B. About 11.7%
C. About 23.3%
D. About 857.1%
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
78. Which of the following statements is incorrect?
A. The further into the future a cash receipt is expected to occur, the lower is its present
value.
B. The return on investment measures the compensation a company expects to receive from
C. Most companies use their cost of capital to estimate the minimum return on investment
D. When a company invests in capital assets, it sacrifices future dollars for the opportunity to
receive present dollars.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
79. The process by which management evaluates long-term investment decisions involving long
term operational assets is called:
A. capital investment analysis.

B. activity based management.
C. strategic business analysis.
D. fixed cost analysis.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-81
80. Which of the following statements is correct?
A. A postaudit should be conducted at the time a capital investment is purchased.

B. The postaudit of a capital investment project should be made using the same analytical
C. The purpose of postaudits is to improve a company's cost-volume-profit analysis.
D. The postaudit process uses expected cash flows and the company's cost of capital.
AACSB: Analytic
Blooms: Understand
True / False Questions
81. Capital investment decisions involve investments in current assets.
FALSE

Blooms: Remember
Difficulty: 1 Easy
82. Capital investments differ from stock and bond investments in that stock and bond
investments can be sold in organized markets.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-82
83. A capital investment decision is essentially a decision to exchange current cash outflows for
future cash inflows.
TRUE
AACSB: Analytic
Blooms: Understand
84. The time value of money concept recognizes the fact that the present value of a dollar to be
received in the future is worth more than a dollar.
FALSE

Blooms: Remember
Difficulty: 1 Easy
85. A dollar to be received in the future is subject to the effects of risk and inflation.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
86. The compensation a company receives for investing in capital assets is referred to as a return
on investment.
TRUE

Blooms: Remember
87. The cost of capital represents the maximum acceptable rate of return that a capital investment
should earn.
FALSE
AACSB: Analytic
Blooms: Understand
10-83
88. The cost of capital is sometimes referred to as the hurdle or discount rate.
TRUE

Blooms: Remember
Difficulty: 1 Easy
89. Mary needs to have $20,000 one year from today. The formula to compute the amount of
money that must be invested today is future value/(1 - interest rate).
FALSE
AACSB: Analytic
Blooms: Understand
90. The future value of $1 table should be used to discount lump sum cash flows expected to
occur in the future.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
91. Matt needs to compute the present value of $5,000 to be received four years from now. He
should multiple $5,000 by the appropriate present value interest factor obtained from the
present value of $1 table.
TRUE
AACSB: Analytic
Blooms: Understand
10-84
92. The present value of an annuity of $1 table could be constructed using the factors contained in
the present value of $1 table.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
93. An annuity is a series of equal payments over equal time intervals that earn a constant rate of
return.
TRUE

Blooms: Remember
94. The instantaneous computation power of spreadsheet software makes it ideal for answering
"what-if" questions regarding present values.
TRUE

AACSB: Technology
Blooms: Remember
Difficulty: 1 Easy
95. The assumption regarding ordinary annuities is that cash flows occur at the end of each
period.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
10-85
96. In performing capital budgeting analysis that takes time value of money into account, cash
flows generated by a capital project are assumed to be reinvested at the project's rate of
return.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
97. Because of the expense of applying multiple techniques, managers should use a single capital
budgeting technique to analyze potential capital investments.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
98. A project's net present value can be found by subtracting the cost of the project from the total
present value of the future cash flows generated by the project.
TRUE
AACSB: Analytic
Blooms: Understand
99. If a project has a positive net present value, its internal rate of return will exceed the firm's
hurdle rate.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-86
100. Investment projects A and B offer equal cash inflows over their lives, but the cash inflows for
project A occur sooner than those for project B. The two projects are otherwise identical (the
cost is the same, for example) Based on this information, the internal rate of return for A is
lower than for B.
FALSE
AACSB: Analytic
Blooms: Understand
101. If the net present value for a capital investment is equal to zero, the internal rate of return for
the investment is equal to the required rate of return.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
102. A capital investment with an internal rate of return equal to or greater than the required rate of
return is considered to be an acceptable investment.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
103. Sources of cash inflows from capital investments include incremental expenses and
installation costs.
TRUE

Blooms: Remember
Difficulty: 1 Easy
10-87
104. Cash inflows from a capital investment may include the terminal value of capital assets and
increases in revenues.
TRUE

Blooms: Remember
Difficulty: 1 Easy
105. When the effect of income taxes is considered in a capital budgeting analysis, the amount of
depreciation expense must be added back to after-tax income to calculate the annual cash
inflow.
TRUE
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
106. Depreciation on a capital investment (such as equipment) has the effect of decreasing the
amount of income taxes that the company owning the asset must pay.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
107. The amount of the depreciation tax shield can be calculated by multiplying the amount of
depreciation expense by the tax rate.
TRUE
AACSB: Analytic
Blooms: Apply
10-88
108. Generally, a company should use the MACRS method to calculate depreciation on its income
tax return, due to the effects of the time value of money.
TRUE
AACSB: Analytic
Blooms: Apply
109. If a company has to pay a given amount of income taxes over the life of a capital investment,
managers of the company should seek to pay the taxes as early as possible in the
investment's life.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
110. The payback method shows how long will be required to recover the cost of an investment in a
capital asset.
TRUE

Blooms: Remember
111. The payback method of evaluating capital investments measures the recovery of the
investment, but it does not measure profitability.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-89
112. When a capital investment is expected to provide unequal annual cash inflows, the payback
period can be calculated by accumulating the incremental cash inflows until the sum equals
the amount of the original investment.
TRUE
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
113. When a capital investment is expected to provide unequal annual cash inflows, the payback
period cannot be calculated.
FALSE
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
114. The unadjusted rate of return is found by dividing the average incremental increase in annual
operating income by the cost of the investment.
TRUE
AACSB: Analytic
Blooms: Apply
115. Generally, the unadjusted rate of return should be calculated based on the average
investment rather than the amount of the original investment in a depreciable asset such as
equipment.
TRUE
AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
10-90
116. A postaudit should be performed at the end of a capital investment project to determine
whether the expected results were actually achieved.
TRUE

Blooms: Remember
Difficulty: 1 Easy
Essay Questions
117. Why is the time value of money often taken into account in analyzing a capital investment?
Answers will vary
Feedback: Capital investments involve expected cash flows occurring over long periods of
time. Therefore, taking the timing of cash flows into account can improve the quality of
decision making. After all, a cash flow occurring many years into the future has a lower
present value than the same cash flow occurring sooner.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-91
118. Why does a company use its cost of capital as the minimum required rate of return for its
capital investment decisions?
Answers will vary
Feedback: The cost of capital measures the return expected by stockholders and creditors on
their investment in the company. A company that cannot generate at least this rate of return
on its capital investments will eventually go bankrupt.
AACSB: Analytic
Blooms: Understand
119. Describe what is meant by the time value of money.
Answers will vary
Feedback: The time value of money concept recognizes the fact that the present value of a
dollar received in the future is less than a dollar. The further into the future the receipt is
expected to occur, the smaller is its present value. There are several reasons why the present
value of cash flows diminishes as the time until receipt increases. The first is cash's
investment potential. Cash available today can be invested to earn a return. The second
reason is the risk associated with future dollars. Conditions may change and the promise to
pay the future dollar may be broken. Finally, inflation diminishes the buying power of the
dollar.
AACSB: Analytic
Blooms: Understand
10-92
120. What is the reinvestment assumption, and how does the assumption affect capital investment
analyses?
Answers will vary
Feedback: The reinvestment assumption is that cash inflows from a capital project are
reinvested at the required rate of return. This assumption is implied in capital investment
methods that take the time value of money into account - net present value and internal rate of
return methods. If cash inflows cannot be reinvested at the required rate of return, the project
would not achieve the expected rate of return.
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
121. How does depreciation serve as a tax shield? How is the amount of the annual tax shield
calculated?
Answers will vary
Feedback: Recording depreciation on a tax return reduces taxable income and thus reduces
the amount of income tax a company must pay. The tax shield effect of depreciation increases
net cash inflows from a capital investment. The amount of the annual tax shield equals the
annual depreciation multiplied by the tax rate. A company benefits by maximizing the
depreciation deduction early in an asset's life.
AACSB: Analytic
Blooms: Analyze
10-93
122. Describe how the unadjusted rate of return for a capital investment is calculated. Should it be
based on the net cost of the investment or the average investment?
Answers will vary
Feedback: Unadjusted rate of return is calculated by dividing the average incremental

increase in annual net income by the investment. It can be calculated using the initial
investment or the average amount of investment over the project's life. Using the net cost of
the investment fails to take into account the gradual recovery of investment over the project's
life. Thus, the average investment probably should be used.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
123. Describe the general approaches companies may use in evaluating potential capital
investments.
Answers will vary
Feedback: The basic approach to making capital budgeting decisions is to compare the
expected future returns generated by a project to the cost required to purchase those future
returns. If the returns exceed the cost, then the project should be accepted. Most capital
budgeting models define returns in terms of cash; however the unadjusted rate of return model
defines returns in terms of some measure of accrual based income. One problem associated
with the comparison of returns to cost is that the returns occur in the future while the cost
occurs today. Thus, some capital budgeting models (e.g., the net present value model and the
internal rate of return model) compute the present value of the future returns in order to make
apples-to-apples comparisons (i.e., they compare both returns and costs as if they all occurred
today).
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
10-94
124. Describe the decision rules management should use for accepting and rejecting capital
projects under each of the following capital budgeting models: net present value model,
internal rate of return model, payback period, and the unadjusted rate of return model.
Answers will vary
Feedback: Management should accept projects whose net present values (NPV) are equal to
or greater than zero. Projects with zero net present values are earning exactly the minimum
required rate of return while projects with positive NPVs are earning more than the minimum
rate. Thus, the higher the net present value the better. When selecting projects on the basis of
the internal rate of return (IRR), management should accept projects whose internal rate of
return is equal to or greater than the hurdle rate. The higher the IRR is, the better. When
selecting projects on the basis of payback, the payback must be compared to a threshold set
by management. For example, management might stipulate that a project of a certain risk
level must recoup its initial investment during the first half of the project's life. The shorter the
payback period the better. Finally, when using the unadjusted rate of return (URR) model, a
project should be accepted if its unadjusted rate of return is equal to or greater than the
specified hurdle rate. The larger the URR, the better.
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
125. What is a postaudit of a capital investment decision, and how should the postaudit be
conducted?
Answers will vary
Feedback: A postaudit is a review of a capital investment project at the end of its life,
performed to determine whether the project lived up to expectations for it. The postaudit
should be conducted using the same analysis technique(s) used in making the investment
decision.
AACSB: Analytic
Blooms: Understand
10-95
126. How would an organization benefit from conducting postaudits of its capital investment
decisions?
Answers will vary
Feedback: The purpose of postaudits is to focus on continuous improvement of the

organization's decision making processes. The company should learn whether it made
reasonable estimates of cash flows and whether it accepted projects that should not have
been accepted. The feedback to managers is intended to improve future capital investment
decisions.
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
127. Indicate whether each of the following statements is true or false.
A capital investment is a purchase of a long-term operational asset.

Investments in capital assets normally are recovered by selling the assets.
decisions.
A capital investment decision exchanges current cash inflows for future cash outflows.
The time value of money concept is often used in making capital investment decisions.
A capital investment is a purchase of a long-term operational asset. T

Investments in capital assets normally are recovered by selling the assets. F
decisions. T
A capital investment decision exchanges current cash inflows for future cash outflows. F
The time value of money concept is often used in making capital investment decisions. T
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-96
The further into the future a cash receipt is expected to occur, the higher is its present value.
Most companies use their cost of capital to estimate the minimum return on investment
receive future dollars.
discount rate.
The further into the future a cash receipt is expected to occur, the higher is its present value. F
investing in capital assets. T
Most companies use their cost of capital to estimate the minimum return on investment
required from capital investments. T
receive future dollars. T
discount rate. T
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-97
An ordinary annuity assumes that cash flows occur at the beginning of each period.
To say that an investment earns the desired rate of return assumes that all cash flows
generated by the investment are reinvested at the desired rate of return.
because different methods generally give different results.
Copley Corporation uses a required rate of return of 10% for its capital investment decisions.
A particular project had a negative net present value. For this project, the actual rate of return
was expected to be more than 10%.
value of expected cash inflows from the cost of the investment.
An ordinary annuity assumes that cash flows occur at the beginning of each period. F
To say that an investment earns the desired rate of return assumes that all cash flows
generated by the investment are reinvested at the desired rate of return. T
because different methods generally give different results. F
Copley Corporation uses a required rate of return of 10% for its capital investment decisions.
A particular project had a negative net present value. For this project, the actual rate of return
was expected to be more than 10%. F
value of expected cash inflows from the cost of the investment. F
AACSB: Analytic
Blooms: Understand
10-98
return that is higher than the required rate of return.
project that has the higher net present value.
Net present value is calculated by dividing the present value of cash inflows by the present
value of cash outflows associated with a capital investment.
The present value index can be used to compare different capital investment projects.
The higher the present value index, the lower the rate of return per dollar invested in the
project.
return that is higher than the required rate of return. T
project that has the higher net present value. F
Net present value is calculated by dividing the present value of cash inflows by the present
value of cash outflows associated with a capital investment. F
The present value index can be used to compare different capital investment projects. T
The higher the present value index, the lower the rate of return per dollar invested in the
project. F
AACSB: Analytic
Blooms: Understand
10-99
The net present value method provides a direct measure of the rate of return to be expected
from a capital investment project.
Managers who want to know the rate of return to expect from a capital investment project
should calculate the net present value.
value of zero.
For a capital investment project to be acceptable, the internal rate of return should be higher
than the hurdle rate.
return that is lower than the hurdle or required rate of return.
The net present value method provides a direct measure of the rate of return to be expected
from a capital investment project. F
Managers who want to know the rate of return to expect from a capital investment project
should calculate the net present value. F
value of zero. T
For a capital investment project to be acceptable, the internal rate of return should be higher
than the hurdle rate. T
return that is lower than the hurdle or required rate of return. F
AACSB: Analytic
Blooms: Understand
10-100
In analysis of a capital investment, a cost saving is treated as a cash inflow.

The expected salvage value of an asset is a source of a cash outflow that should be
considered in capital investment analyses.
Many capital investments require an increase in the amount of a company's working capital.
Incremental revenues are treated as cash outflows in capital investment analyses.
project, is treated as a cash outflow.
In analysis of a capital investment, a cost saving is treated as a cash inflow. T

The expected salvage value of an asset is a source of a cash outflow that should be
considered in capital investment analyses. F
Many capital investments require an increase in the amount of a company's working capital. T
Incremental revenues are treated as cash outflows in capital investment analyses. F
project, is treated as a cash outflow. T
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-101
company's required rate of return.
A spreadsheet program is useful in doing internal rate of return analyses.
Capital investment analyses should take tax consequences into account.
income from income taxes.
by (1 - the tax rate).
company's required rate of return. F
A spreadsheet program is useful in doing internal rate of return analyses. T
Capital investment analyses should take tax consequences into account. T
income from income taxes. T
by (1 - the tax rate). F
AACSB: Analytic
Blooms: Understand
10-102
The payback method does not take the time value of money into account.
The unadjusted rate of return indicates the length of time required to recover the initial cost of
an investment.
The payback period can only be calculated for capital investments that are expected to
provide equal annual cash inflows over their useful lives.
Generally, investments with shorter payback periods are preferred.
projects that will make the greatest contribution to a company's profits.
The payback method does not take the time value of money into account. T
The unadjusted rate of return indicates the length of time required to recover the initial cost of
an investment. F
The payback period can only be calculated for capital investments that are expected to
provide equal annual cash inflows over their useful lives. F
Generally, investments with shorter payback periods are preferred. T
projects that will make the greatest contribution to a company's profits. F
AACSB: Analytic
Blooms: Understand
Difficulty: 1 Easy
10-103
When unequal cash inflows are expected from a capital investment, the payback period can
be calculated by accumulating incremental cash inflows or by using average annual cash
inflows.
The unadjusted rate of return is also called the simple rate of return.
net cost of the original investment.
The unadjusted rate of return does not take the time value of money into account.
The unadjusted rate of return should be calculated using the initial cost of the investment,
rather than the average invested capital.
When unequal cash inflows are expected from a capital investment, the payback period can
be calculated by accumulating incremental cash inflows or by using average annual cash
inflows. T
The unadjusted rate of return is also called the simple rate of return. T
net cost of the original investment. F
The unadjusted rate of return does not take the time value of money into account. T
The unadjusted rate of return should be calculated using the initial cost of the investment,
rather than the average invested capital. F
AACSB: Analytic
Blooms: Understand
10-104
136. Indicate whether each of the following statements is true or false:
A postaudit should be conducted at the time a capital investment is purchased.

The purpose of postaudits is to improve a company's capital investment decision process.
The postaudit process uses expected cash flows and the company's cost of capital.
Making good estimates of future cash flows is important in making capital investment
decisions.
A postaudit should be conducted at the time a capital investment is purchased. F

technique that was used in deciding to make the investment. T
The purpose of postaudits is to improve a company's capital investment decision process. T
The postaudit process uses expected cash flows and the company's cost of capital. F
Making good estimates of future cash flows is important in making capital investment
decisions. T
AACSB: Analytic
Blooms: Understand
10-105
10-106
137 Select the term from the list provided that best matches each of the following definitions or
. descriptions. Put the number of the term in the answer column.
Answers will vary
10-107
Feedback:
AACSB: Analytic
Blooms: Understand
10-108
138. Redmond Company is considering investing in one of the following two projects:
Required:

3) What is the maximum amount Redmond should be willing to pay for each project?
4) Suppose each project costs $7,000. Which project(s) should be accepted? Note that only
one project can be accepted.
Answers will vary
Feedback: 1) Project B is more desirable because the majority of the cash flows occur earlier.
The timing of the cash flows is important because of the concept of the time value of money
which recognizes the fact that the present value of a dollar received in the future is worth less
than a dollar.
2) Present values:
3) Maximum that should be paid: Project A = $6,948.15; Project B = $7,654.36

4) Redmond should accept Project B because its NPV is positive, while Project A's is negative.
10-109
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
10-110
139. Chichester Company is considering investing in the following two mutually exclusive projects:
Required:

3) What is the maximum amount Chichester should be willing to pay for each project?
4) Suppose each project costs $10,000. Which project(s) should be accepted?
Answers will vary
Feedback: 1) Project A is more desirable because the majority of the cash flows occur earlier.
The timing of the cash flows is important because of the concept of the time value of money
which recognizes the fact that the present value of a dollar to be received in the future is worth
less than a dollar.
2) Present values:
Project B: $3,500 per year for four years × PV annuity factor for 10 percent (3.169865) =
$11,095.
3) Maximum that should be paid: Project A = $11,471; Project B = $11,095.

4) Both Project A and Project B have a positive net present value. If possible, Chichester
should accept both projects. If resources are only available for one project, the company
should select Project A.
10-111
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
140. Chico Company is considering the purchase of a new high-speed machine for its factory. The
machine will cost $160,000 and will save the company $45,000 per year in cash operating
costs. The machine has an estimated useful life of five years and no expected salvage value.
The company's cost of capital is 12%.
Required:
1) Compute the net present value of this investment.

2) What is the maximum amount that Chico should be willing to pay for the machine?
3) What are the minimum annual cash savings that will make the machine acceptable on a net
present value basis if the purchase price is $160,000?
Answers will vary
Feedback: 1) Net present value:
2) To earn at least the minimum rate of return of 12%, the company should pay no more than
$162,215.
3) Minimum annual savings:
Savings × 3.604776 = $160,000; Therefore, annual savings = $44,385.56
AACSB: Analytic
Blooms: Analyze
Difficulty: 1 Easy
10-112
141. Neighbors Company is considering the purchase of new equipment that will cost $130,000.
The equipment will save the company $38,000 per year in cash operating costs. The
equipment has an estimated useful life of five years and a zero expected salvage value. The
company's cost of capital is 10%.
Required:
1) Ignoring income taxes, compute the net present value and internal rate of return. Round net
present value to the nearest dollar and round internal rate of return to the nearest whole
percent.
Answers will vary
Feedback: 1) Ignoring income taxes:
Present value factor for internal rate of return = $130,000/$38,000 = 3.421. Looking up this
interest factor in the present value of an annuity of $1 table, 5 periods, the internal rate of
return is slightly greater than 14%.
2) The equipment should be purchased. Net present value is positive, and the internal rate of
return is higher than the required rate of return.
AACSB: Analytic
Blooms: Analyze
10-113
142. Pierce Company is considering the purchase of new equipment that will cost $150,000. The
equipment will save the company $48,000 per year in cash operating costs. The equipment
has an estimated useful life of five years and no expected salvage value. The company's cost
of capital is 12%.
Required:
1) Assuming the company is subject to a 40% tax rate, compute the net present value.
2) Compute the amount of the annual depreciation tax shield provided by the new equipment.
Answers will vary
Feedback: 1) Annual cash taxable income = $48,000 - $30,000 depreciation = $18,000

Annual income tax = $18,000 × 0.40 = $7,200
Income after taxes = $18,000 - $7,200 = $10,800
Annual net cash inflow = $10,800 + $30,000 = $40,800
Net present value = ($40,800 × 3.604776) - 150,000 = $(2,925)
2) Annual depreciation tax shield = $30,000 × 0.40 = $12,000
3) Because net present value is negative, the project is unacceptable.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-114
143. Alcorn Company is considering purchasing equipment that costs $400,000. The equipment
has an estimated useful life of 8 years and no salvage value. Alcorn believes that the annual
cash inflows from using the equipment will be $80,000.
Required:
1) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is
2) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is
3) What general conclusion can you reach from your results to parts 1) and 2)?
Answers will vary
Feedback: 1) Net present value = $80,000 × 4.967640 - $400,000 = $(2,589). Because net
present value is negative, the equipment is not an acceptable investment.
2) Net present value = $80,000 × 5.334926 - $400,000 = $26,794. Because net present value
is positive, the equipment is an acceptable investment.
3) The net present value of a project depends on what the required rate of return is. A project
that is acceptable with a relatively low required rate of return may not be acceptable at a
higher rate of return.
AACSB: Analytic
Blooms: Analyze
10-115
144. Burgess Corporation is considering purchasing equipment that costs $235,000. The
equipment has an estimated useful life of 5 years and no salvage value. Burgess believes that
the annual cash inflows from using the equipment will be $65,000.
Required:
3) Based on your results to parts 1) and 2), estimate the internal rate of return for the
investment in the equipment.
Answers will vary
Feedback: 1) Net present value = ($65,000 × 3.604776) - $235,000 = $(690). Because net
present value is negative, the equipment is not an acceptable investment at a required rate of
return of 12%.
2) Net present value = ($65,000 × 3.790787) - $235,000 = $11,401. Because net present
value is positive, the equipment is an acceptable investment at a required rate of return of
10%.
3) The internal rate of return must be between 10% and 12%. Based on parts 1) and 2),
internal rate of return appears to be somewhat below 12%.
AACSB: Analytic
Blooms: Apply
10-116
145. Montana Company is evaluating two different capital investments, Project X and Y. Either X or
Y would cost $210,000, and the company cannot afford to do both. The company expects that
Project X would provide net cash inflows of $62,000 per year for 5 years. For Project Y, the
net cash inflows are expected to be as follows:
Montana's cost of capital is 12%.
Required:
1) Calculate the present value index for Project X and for Project Y. Round your answer to
three decimal places.
2) Indicate whether each of the projects is an acceptable investment.
3) Based on present value index, which of the two projects should Montana implement?
Answers will vary
Feedback: 1) Present value index for X: $62,000 × 3.604776/$210,000 = 1.064

Present value index for Y:
[($44,000 × 0.892857) + ($48,000 × 0.797194) + ($60,000 × 0.711780) + ($76,000 ×
0.635518) + ($80,000 × 0.567427)]/$210,000 = 1.019
2) Both Project X and Project Y represent acceptable investments because the present value
index is greater than 1 (net present value would be greater than zero for each).
3) Project X is preferred because the present value index is higher than for Y.
AACSB: Analytic
Blooms: Analyze
10-117
10-118
146. Janelle Bates has just inherited $250,000 from her uncle's estate. She is considering opening
a small sewing and fabric shop. She would need to purchase inventory costing $50,000.
Janelle plans to rent a shop in a local shopping center for $12,000 per year. Fixtures, display
equipment, and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years
to its expected salvage value of $3,000. Operating costs will amount to $25,000 per year.
Janelle estimates her revenues from sales and sewing services will total $65,000. Because
Janelle believes she can earn a 10% return by investing in mutual funds, she does not want to
start the business unless she can earn at least this rate. Ignore income taxes.
Required:
1) Prepare a schedule of expected cash flows for the proposed investment by completing the
table provided below. In column 1 enter a brief description of the cash flow. In column 2
indicate whether the cash flow is an inflow (I) or an outflow (O). In column 3 enter the years in
which the cash flow will occur. For example, if the cash flow occurs immediately enter a 0. If
the cash flow occurs each year enter 1-5, etc. In column 4 enter the cash flow amount.
2) What is the initial outlay for this capital investment (the amount of the cash flow at time =
0)?
3) What is the amount of the annual net cash flow for this capital investment?
4) What is the net present value of the proposed venture? Should Janelle proceed?
Answers will vary
Feedback: 1) Schedule of cash flows:
10-119
2) Initial investment = $50,000 + $18,000 = $68,000
3) Annual net cash flow amount: ($65,000 - $12,000 - $25,000) = $28,000
4)
Yes, Janelle should proceed. Her sewing shop is expected to generate a return considerably
greater than 10%.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-120
147. Omicron Company is considering purchasing equipment that would cost $60,000 and have a
useful life of 5 years. The equipment is expected to provide net cash inflows of $16,000 per
year. Omicron's cost of capital is 12%.
Required:
Estimate the internal rate of return for this capital investment. Is this an acceptable
investment?
Answers will vary
Feedback: $60,000/$16,000 = 3.750 = present value annuity factor

The internal rate of return appears to be slightly above 10%, but clearly less than 12% (for
which the factor would be 3.604776). Therefore, the investment is not acceptable.
AACSB: Analytic
Blooms: Analyze
10-121
10-122
148. Columbus Company is considering a project that requires an initial investment of $400,000. Its
incremental cash flows are expected to be $150,000 per year for five years. The project would
be depreciated on a straight-line basis over 5 years with no expected salvage value. The
company has a stated policy that all projects must return their required investment dollars
within the first 75% of the project's life. The company is subject to a 40% income tax rate, and
its cost of capital is 10%.
Required:
1) Compute the project's after-tax net cash flows (NCF) by completing the following table:
2) Compute the project's net present value by completing the following table:
3) Compute the project's payback period.

4) Should the project be accepted? Why or why not?
Answers will vary
Feedback: 1) After-tax net cash flow:
2) Net present value:
10-123
3) Payback = $400,000/150,000 = 2.67 years
4) The project should be accepted because it will earn more than 10% and it does recover its
initial investment within the first 75% of the project life. (2.67 years is 53.3% of the project life.)
AACSB: Analytic
Blooms: Analyze
10-124
10-125
149. Bruce Company is considering replacing one of its delivery trucks. The truck in question was
purchased two years ago at a cost of $41,000. At the time of purchase the truck was expected
to have a $5,000 salvage value at the end of its six-year life. Given the use of straight-line
depreciation, the truck has a current book value of $29,000. If sold today, the company could
get $22,000 for the truck. It costs $20,000 per year to operate the existing truck. The new truck
would cost $46,000 and would cost only $14,000 per year to operate. The new truck would be
depreciated on a straight-line basis over its four-year useful life to its expected salvage value
of $10,000. The company's required rate of return is 14%. Ignore income taxes.
Required:
1) Identify the cash flows for each alternative by completing the following table:
2) The company's objective is to minimize costs. Complete the following table to determine
whether the existing truck should be replaced. Ignore income taxes. What is your
recommendation?
Answers will vary
Feedback: 1) Cash flows for each alternative:
10-126
The company should keep its existing truck. The net present value of the cash outflows
associated with the existing truck is $6,518 less than net present value of the cash outflows
associated with the new truck.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-127
10-128
150. Levin Company is considering two new machines that should produce considerable cost
savings in its assembly operations. The cost of each machine is $14,000 and neither is
expected to have a salvage value at the end of a 4-year useful life. Levin's required rate of
return is 12% and the company prefers that a project return its initial outlay within the first half
of the project's life. The annual after-tax cash savings for each machine are provided in the
following table:
Required:
1) Compute the payback period for each machine using the incremental approach and
comment on the results.
2) Compute the unadjusted rate of return based on average investment for each machine. The
machines will be depreciated on a straight-line basis.
3) Compute the net present value for each machine.
4) Which machine would you recommend? Explain your reasoning.
5) Use the present value table to compute the approximate internal rate of return for Machine.
Answers will vary
1) Machine A: $14,000/$5,000 = 2.8 years; Machine B: $8,000 + $6,000 = $14,000 - Machine

B achieves payback in 2 years, and thus achieves the objective.
2) Unadjusted rate of return:
Depreciation expense = $14,000/4 = $3,500 per year
Average incremental increase in annual net income:
Machine A = $5,000 - $3,500 = $1,500
Machine B = ($8,000 + $6,000 + $4,000 + $2,000)/4 = $5,000; $5,000 - $3,500 = $1,500
Average investment = $14,000/2 = $7,000
Machine A: $1,500/$7,000 = 21.4%
Machine B: $1,500/$7,000 = 21.4%
10-129
4) Machine B is preferred. It has a higher net present value and a shorter payback period.
5) Machine A's internal rate of return is found by first calculating the PVIF a (investment cost
and annuity = PVIFa $14,000 ÷ $5,000 = 2.800). Look up PVIFa of 3.000 in the present value
of an annuity of $1 table for 4 years. The project is earning just below 16%.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-130
151. Bristles Hair Salon is considering installing spray tanning booths. The booths cost $220,000
and have an estimated five-year useful life. Ignore income taxes. The following pro forma
income statement is provided:
Required:
1) Bristles would like to recoup its original investment in less than four years. Compute the
payback period for the tanning booth investment. Would you recommend that the booths be
2) Bristles' minimum acceptable unadjusted rate of return is 11%. Compute the unadjusted
rate of return on the original investment. Would you recommend that the booths be
Answers will vary
Feedback: 1) Payback = $220,000/($25,000 + $44,000) = 3.19 years. Yes, the beds should be
purchased because the company will recover its initial investment in well under five years.
2) Unadjusted rate of return = ($25,000/$220,000) = 11.4%. Yes, the beds should be
purchased. The expected unadjusted rate of return exceeds the company's cost of capital.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-131
152. Seven Day Mini Mart is considering installing video games in its stores. The machines cost
$300,000 and have an estimated six-year useful life. Ignore income taxes. The following
projected income statement is provided:
Required:
1) Seven Day Mini Mart would like to recoup its original investment in less than five years.
Compute the payback period for the video game machine investment. Would you recommend
that the machines be purchased? Why or why not?
2) Seven Day Mini Mart's target unadjusted rate of return is 12%. Compute the unadjusted
rate of return on the original investment. Would you recommend that the machines be
Answers will vary
Feedback: 1) Payback = $300,000/($40,000 + $50,000) = 3.33 years. Yes, the machines

should be purchased because the company will recover its initial investment in less than five
years.
2) Unadjusted rate of return = ($40,000/$300,000) = 13.3%. If this rate is compared to the
target rate, the machines should be purchased. The expected unadjusted rate of return is
greater than the company's target unadjusted rate of return.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-132
153.Gordon Company is considering a three-year capital investment that will return $150,000 per
year. The present value of this annuity at the company's required rate of return of 12% is
$360,275.
Required:
Complete the table that has been started below to show the return on investment at 12% and the
amount of investment recovered each year. Remember that the investment balance should be
zero at the end of the three years.
Answers will vary
Feedback:
AACSB: Analytic
Blooms: Apply
10-133
154. In 2008, Burton Company purchased equipment with an expected useful life of 5 years. The
initial cost of the equipment was $160,000. Burton's cost of capital is 12%; when it purchased
the equipment, Burton computed a net present value of $15,824 for the investment. In 2013,
the equipment reached the end of its useful life. Burton determined that, over the 5-year life,
the equipment had generated annual cash inflows of $46,000.
Required:
Conduct a post-audit to determine whether the equipment achieved the net present value the
company had expected. Based on the results actually achieved, was the asset in fact an
acceptable investment?
Answers will vary
Feedback: Net present value = (Present value of annuity factor × $46,000) - $160,000
= (3.604776 × $46,000) - $160,000 = $5,820
The equipment did not achieve the net present value the company had expected. However, its
net present value was positive, so it turned out to be an acceptable investment.
AACSB: Analytic
Blooms: Analyze
10-134
10-135
155. In 2008, Chandler Company purchased equipment with an expected useful life of 5 years. The
initial cost of the equipment was $85,000. Chandler's cost of capital is 12%. At the time it
purchased the equipment, Chandler projected the following cash inflows from use of the
equipment:
In 2013, the equipment had reached the end of its useful life. Chandler determined that it had
actually generated the following cash flows:
Required:
1) What was the net present value that Chandler calculated for the equipment when the
company purchased the asset?
2) Calculate the net present value that the equipment achieved, based on the actual cash
inflows.
3) Comment on the pattern of actual cash inflows, compared to the cash flows that had been
projected.
4) Was the equipment in fact an acceptable investment, based on the cash flows actually
achieved?
Answers will vary
Feedback: 1) Projected NPV
10-136
Net present value = $91,085 - $85,000 = $6,085
2) Net present value actually achieved
Actual NPV
Net present value = $82,314 - $85,000 = $(2,686)

3) Total cash flows were projected to be $125,000; actual cash inflows were $120,000, so the
actual cash flows fell short of what had been projected. In addition, the cash flows tended to
come later in the equipment's life than had been projected, reducing the present value of cash
inflows due to the effects of the time value of money.
4) The equipment did not achieve the net present value that had been projected. The actual
net present value was negative. Therefore, the investment in equipment turned out to be an
unacceptable investment.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
10-137

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Planning for Capital Investments

Multiple Choice Questions

1. All of the following are capital investment decisions except:

A. acquiring $100,000 of common stock.

A. The future value of a present dollar is greater than one dollar.

Select the correct statement.

A. Evergreen should choose Investment I because of the time value of money.

5. Which of the following statements describes the cost of capital?

A. The internal rate of return on investments

6. The cost of capital is called all of the following except:

A. less than the hurdle rate.

13. Which of the following cash flow patterns represents of an annuity?

14. Which one of the following statements describes an ordinary annuity?

A. cash flows will be reinvested at the required rate of return.

A. the desired rate of return includes the effects of compounding.

A. Present value of annuity.

A. positive net present value of $38,038.

A. positive net present value of $2,077.

A. minimum rate of return.

A. less than the desired rate of return.

A. The higher the IRR the better.

A. opportunity costs associated with selecting a specific capital project.

A. Incremental revenues from increased productivity

30. A capital investment project may provide cash inflows from:

31. Cash outflows from a capital investment project include:

A. increases in operating expenses.

A. An investment with a shorter payback is preferable to an investment with a longer payback.

A. The unadjusted rate of return method considers the investment's profitability.

A. The unadjusted rate of return method

The unadjusted rate of return on the initial investment would be approximately:

A. A postaudit should be conducted at the end of the project.

What is the net present value for project B?

What is the present value index for project A?

63. Capital investment decisions involve all of the following, except:

A. the acquisition of short-term operational assets.

A. net cash flow.

A. Internal rate of return and payback

A. If the net present value is equal to zero

A. Internal rate of return

A. annual depreciation of the capital asset.

A. present value index.

73. The present value index indicates:

A. the rate of return.

A. capital investment analysis.

80. Which of the following statements is correct?

A. A postaudit should be conducted at the time a capital investment is purchased.

True / False Questions

81. Capital investment decisions involve investments in current assets.

119.Describe what is meant by the time value of money.

A capital investment is a purchase of a long-term operational asset.

128.Indicate whether each of the following statements is true or false.

130.Indicate whether each of the following statements is true or false.

132.Indicate whether each of the following statements is true or false.

In analysis of a capital investment, a cost saving is treated as a cash inflow.

134.Indicate whether each of the following statements is true or false.

136.Indicate whether each of the following statements is true or false:

A postaudit should be conducted at the time a capital investment is purchased.

1) Which project is more desirable strictly in terms of cash inflows? Why?

1) Which project is more desirable strictly in terms of cash inflows? Why?

1) Compute the net present value of this investment.