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Exam 11: Capital Budgeting and Investment Analysis

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Question 71

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In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.

A) True
B) False

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Question 72

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Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

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B) False

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Question 73

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Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

The process of restating cash flows in terms of their present values is called discounting.

Accounting rate of return is the simplest capital budgeting method. It gives managers an estimate of how soon they will recover their initial investment.

The net present value decision rule requires that when an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the project should be ________.

A company is planning to purchase a machine that will cost $24,000 with a six-year life and no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine? Sales………………………………………… $90,000 Costs: Manufacturing……………………………… $52,000 Depreciation on machine…………………… 4,000 Selling and administrative expenses……….. 30,000 (86,000) Income before taxes………………………... $ 4,000 Income tax (50%) …………………………... ( 2,000 ) Net income…………………………………. $ 2,000

The ________ is computed by dividing a project's annual after-tax net income by the annual average amount invested.

The break-even time (BET) method is a variation of the:

The time value of money is considered when calculating the payback period of an investment.

________ is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

A company can buy a machine that is expected to have a three-year life and a $30,000 salvage value. The machine will cost $1,800,000 and is expected to produce a $200,000 after-tax net income to be received at the end of each year. If a table of present values of $1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and 0.7118 for three years, what is the net present value of the cash flows from the investment, discounted at 12%?

Poe Company is considering the purchase of new equipment costing $80,000. The projected net cash flows are $35,000 for the first two years and $30,000 for years three and four. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine. $\begin{array} { c c c } \text { Periods } & \text { Present Value } & \text { Presert Value of arl } \\ & \text { of } \$ 1 \text { at } 10 \% & \text { Arunuity of } \$ 1 \text { at } 10 \% \\1& 0.9091 & 0.9091 \\2 & 0.8264 & 1.7355 \\3 & 0.7514 & 2.4869 \\4 & 0.6830 & 3.1699\end{array}$

A shorter payback period reduces the company's ability to respond to unanticipated changes and increases the risk of having to keep an unprofitable investment.

Capital budgeting decisions are not affected by return on investment considerations.

A company buys a machine for $76,000 that has an expected life of 6 years and no salvage value. The company anticipates a yearly after tax net income of $1,805. What is the accounting rate of return?

If net present values are used to evaluate two investments that have equal costs and equal total cash flows, the one with more cash flows in the early years has the higher net present value.

In calculating the rate of return on average investment, average investment should be calculated as (beginning book value + ending book value)/2.

When computing payback period, the year in which a capital investment is made is year 1.

Briefly describe both the payback period method and the net present value method of comparing investment alternatives.