Chapter 13 Test Bank for accounts 2402

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Chapter 13
Capital Budgeting Decisions


Multiple Choice Questions

15. If a company has computed the project profitability index of an investment project as 0.15,
then:
A. the project's internal rate of return is less than the discount rate.
B. the project's internal rate of return is greater than the discount rate.
C. the project's internal rate of return is equal to the discount rate.
D. the relation between the rate of return and the discount rate is impossible to determine from
the given data.

16. Spring Company has invested $20,000 in a project. Spring's discount rate is 12% and the
project profitability index on the project is zero. Which of the following statements would be
true?

I. The net present value of the project is $20,000.
II. The project's internal rate of return is equal to 12%.
A. Only I.
B. Only II.
C. Both I and II.
D. Neither I nor II.

17. If the internal rate of return is used as the discount rate in computing net present value, the
net present value will be:
A. positive.
B. negative.
C. zero.
D. unknown.

18. The discount rate must be specified in advance for which of the following methods?


A. Option A
B. Option B
C. Option C
D. Option D

19. An investment project for which the net present value is $300 would result in which of the
following conclusions?
A. The net present value is too small; the project should be rejected.
B. The rate of return of the investment project is greater than the required rate of return.
C. The net present value method is not suitable for evaluating this project; the internal rate of
return method should be used.
D. The investment project should only be accepted if net present value is zero; a positive net
present value indicates an error in the estimates associated with the analysis of this investment.

20. In capital budgeting, what will be the effect on the following if there is an increase in the
working capital needed for a project?


A. Option A
B. Option B
C. Option C
D. Option D
E. Option E

21. The capital budgeting method that recognizes the time value of money by discounting cash
flows over the life of the project, using the company's required rate of return as the discount rate
is called the:
A. simple rate of return method.
B. the net present value method.
C. the internal rate of return method.
D. the payback method.

22. The internal rate of return of an investment project is the:
A. discount rate that results in a zero net present value for the project.
B. minimum acceptable rate of return.
C. weighted average rate of return generated by internal funds.
D. company's cost of capital.

23. If an investment has a project profitability index of 0.15, then the:
A. project's internal rate of return is 15%.
B. discount rate is greater than the project's internal rate of return.
C. net present value of the project is positive.
D. the discount rate is 15%.

24. If investment A has a payback period of 3 years and investment B has a payback period of 4
years, then:
A. A has a higher net present value than B.
B. A has a lower net present value than B.
C. A and B have the same net present value.
D. the relation between investment A's net present value and investment B's net present value
cannot be determined from the given information.

25. Which one of the following statements about the payback method of capital budgeting is
correct?
A. The payback method does not consider the time value of money.
B. The payback method considers cash flows after the payback has been reached.
C. The payback method uses discounted cash flow techniques.
D. The payback method will lead to the same decision as other methods of capital budgeting.

26. The length of time required to recover the initial cash outlay for a project is determined by
using the:
A. discounted cash flow method.
B. the payback method.
C. the net present value method.
D. the simple rate of return method.

27. (Ignore income taxes in this problem.) An investment of P dollars now will yield cash
inflows of $3,000 at the end of the first year and $2,000 at the end of the fourth year. If the
internal rate of return for this investment is 20%, then the value of P is:
A. $3,463
B. $2,499
C. $964
D. $4,185

28. (Ignore income taxes in this problem.) The Baker Company purchased a piece of equipment
with the following expected results:



The initial cost of the equipment was:
A. $300,100
B. $180,250
C. $190,600
D. Cannot be determined from the given information.

29. (Ignore income taxes in this problem.) The Yates Company purchased a piece of equipment
which is expected to have a useful life of 7 years with no salvage value at the end of the 7-year
period. This equipment is expected to generate a cash inflow of $32,000 each year of its useful
life. If this investment has a internal rate of return of 14%, then the initial cost of the equipment
is:
A. $150,000
B. $137,216
C. $12,800
D. $343,360

30. (Ignore income taxes in this problem.) The following information is available on a new piece
of equipment:



The life of the equipment is approximately:
A. 6 years
B. 4.3 years
C. 8 years
D. It is impossible to determine from the data given.

31. (Ignore income taxes in this problem.) Mercredi, Inc., is considering investing in automated
equipment with a ten-year useful life. Managers at Highpoint have estimated the cash flows
associated with the tangible costs and benefits of automation, but have been unable to estimate
the cash flows associated with the intangible benefits. Using the company's 14% required rate of
return, the net present value of the cash flows associated with just the tangible costs and benefits
is a negative $182,560. How large would the annual net cash inflows from the intangible benefits
have to be to make this a financially acceptable investment?
A. $18,256
B. $26,667
C. $35,000
D. $38,000

32. (Ignore income taxes in this problem.) A piece of new equipment will cost $70,000. The
equipment will provide a cost savings of $15,000 per year for ten years, after which it will have a
$3,000 salvage value. If the required rate of return is 14%, the equipment's net present value is:
A. $8,240
B. $(8,240)
C. $23,888
D. $9,050

33. (Ignore income taxes in this problem.) Sibble Corporation is considering the purchase of a
machine that would cost $330,000 and would last for 5 years. At the end of 5 years, the machine
would have a salvage value of $50,000. By reducing labor and other operating costs, the machine
would provide annual cost savings of $76,000. The company requires a minimum pretax return
of 12% on all investment projects. The net present value of the proposed project is closest to:
A. -$56,020
B. -$6,020
C. -$48,764
D. -$27,670

34. (Ignore income taxes in this problem.) Benz Company is considering the purchase of a
machine that costs $100,000, has a useful life of 18 years, and no salvage value. The company's
discount rate is 12%. If the machine's net present value is $5,850, then the annual cash inflows
associated with the machine must be (round to the nearest whole dollar):
A. $42,413
B. $14,600
C. $13,760
D. It is impossible to determine from the data given.

35. (Ignore income taxes in this problem.) Sam Weller is thinking of investing $70,000 to start a
bookstore. Sam plans to withdraw $15,000 from the business at the end of each year for the next
five years. At the end of the fifth year, Sam plans to sell the business for $110,000 cash. At a
12% discount rate, what is the net present value of the investment?
A. $54,075
B. $62,370
C. $46,445
D. $70,000

36. (Ignore income taxes in this problem.) The following data pertain to an investment proposal:



The net present value of the proposed investment is:
A. $1,720
B. $6,064
C. $2,154
D. $2,025

37. (Ignore income taxes in this problem) The management of Serpas Corporation is considering
the purchase of a machine that would cost $180,000, would last for 5 years, and would have no
salvage value. The machine would reduce labor and other costs by $46,000 per year. The
company requires a minimum pretax return of 13% on all investment projects. The net present
value of the proposed project is closest to:
A. $27,138
B. $50,000
C. -$18,218
D. -$33,565

38. (Ignore income taxes in this problem.) The Gage Company purchased a machine which will
be depreciated by the straight-line method over its estimated 6 year life. The machine will have
no salvage value. It will generate cash inflows of $7,000 each year over the next 6 years. Gage
Company's required rate of return is 14%. If the net present value of this investment is $12,016,
the purchase price of the machine was:
A. $30,016
B. $15,207
C. $17,916
D. $18,000

39. (Ignore income taxes in this problem.) Stutz Company purchased a machine with an
estimated useful life of seven years. The machine will generate cash inflows of $8,000 each year
over the next seven years. If the machine has no salvage value at the end of seven years, if Stutz's
discount rate is 12%, and if the net present value of this investment is $15,000, then the purchase
price of the machine was:
A. $17,888
B. $36,512
C. $15,000
D. $21,512

40. (Ignore income taxes in this problem.) Mcclam, Inc., is considering the purchase of a
machine that would cost $100,000 and would last for 9 years. At the end of 9 years, the machine
would have a salvage value of $23,000. The machine would reduce labor and other costs by
$19,000 per year. Additional working capital of $2,000 would be needed immediately. All of this
working capital would be recovered at the end of the life of the machine. The company requires a
minimum pretax return of 13% on all investment projects. The net present value of the proposed
project is closest to:
A. $3,833
B. $5,167
C. -$2,492
D. $11,514

41. (Ignore income taxes in this problem.) Charley has a typing service. He estimates that a new
computer will result in increased cash inflow $1,600 in Year 1, $2,000 in Year 2 and $3,000 in
Year 3. If Charley's required rate of return is 12%, the most that Charley would be willing to pay
for the new computer would be:
A. $4,623
B. $5,159
C. $3,294
D. $4,804

42. (Ignore income taxes in this problem.) A piece of equipment has a cost of $20,000. The
equipment will provide cost savings of $3,500 each year for ten years, after which time it will
have a salvage value of $2,500. If the company's discount rate is 12%, the equipment's net
present value is:
A. $580
B. $(225)
C. $17,500
D. $2,275

43. (Ignore income taxes in this problem.) The following data pertain to an investment in
equipment:



At the completion of the project, the working capital will be released for use elsewhere. Compute
the net present value of the project, using a discount rate of 10%:
A. $606
B. $8,271
C. $(1,729)
D. $1,729

44. (Ignore income taxes in this problem.) The following data pertain to an investment proposal:



The working capital would be released for use elsewhere when the project is completed. What is
the net present value of the project, using a discount rate of 8 percent?
A. $2,566
B. $(251)
C. $251
D. $5,251

45. (Ignore income taxes in this problem.) The Valentine Company has decided to buy a machine
costing $14,750. Estimated cash savings from using the new machine amount to $4,500 per year.
The machine will have no salvage value at the end of its useful life of five years. If Valentine's
required rate of return is 10%, the machine's internal rate of return is closest to:
A. 10%
B. 12%
C. 14%
D. 16%

46. (Ignore income taxes in this problem.) If an investment of $14,760 now will yield $18,000 at
the end of one year, then the internal rate of return for this investment to the nearest whole
percentage is:
A. 14%
B. 18%
C. 22%
D. 28%

47. (Ignore income taxes in this problem.) Duhl Long-Haul, Inc., is considering the purchase of a
tractor-trailer that would cost $126,175, would have a useful life of 5 years, and would have no
salvage value. The tractor-trailer would be used in the company's hauling business, resulting in
additional net cash inflows of $35,000 per year. The internal rate of return on the investment in
the tractor-trailer is closest to:
A. 10%
B. 15%
C. 13%
D. 12%

48. (Ignore income taxes in this problem.) Mongon Roofing is considering the purchase of a
crane that would cost $40,224, would have a useful life of 5 years, and would have no salvage
value. The use of the crane would result in labor savings of $12,000 per year. The internal rate of
return on the investment in the crane is closest to:
A. 17%
B. 14%
C. 15%
D. 18%

49. (Ignore income taxes in this problem) The management of Mazor Corporation is considering
the purchase of a machine that would cost $144,144 and would have a useful life of 5 years. The
machine would have no salvage value. The machine would reduce labor and other operating
costs by $39,000 per year. The internal rate of return on the investment in the new machine is
closest to:
A. 14%
B. 13%
C. 12%
D. 11%

50. (Ignore income taxes in this problem) Lett Corporation is investigating buying a small used
aircraft for the use of its executives. The aircraft would have a useful life of 7 years. The
company uses a discount rate of 15% in its capital budgeting. The net present value of the
investment, excluding the salvage value of the aircraft, is -$578,739. Management is having
difficulty estimating the salvage value of the aircraft. To the nearest whole dollar how large
would the salvage value of the aircraft have to be to make the investment in the aircraft
financially attractive?
A. $578,739
B. $86,811
C. $3,858,260
D. $1,539,199

51. (Ignore income taxes in this problem) The management of Hirsh Corporation is investigating
an investment in equipment that would have a useful life of 9 years. The company uses a
discount rate of 13% in its capital budgeting. The net present value of the investment, excluding
the annual cash inflow, is -$666,493. To the nearest whole dollar how large would the annual
cash inflow have to be to make the investment in the equipment financially attractive?
A. $86,644
B. $666,493
C. $74,055
D. $129,870

52. (Ignore income taxes in this problem) The management of Londo Corporation is
investigating buying a small used aircraft to use in making airborne inspections of its above-
ground pipelines. The aircraft would have a useful life of 6 years. The company uses a discount
rate of 15% in its capital budgeting. The net present value of the investment, excluding the
intangible benefits, is -$474,060. To the nearest whole dollar how large would the annual
intangible benefit have to be to make the investment in the aircraft financially attractive?
A. $474,060
B. $125,280
C. $79,010
D. $71,109

53. (Ignore income taxes in this problem.) Cottrell, Inc., is investigating an investment in
equipment that would have a useful life of 9 years. The company uses a discount rate of 15% in
its capital budgeting. The net present value of the investment, excluding the salvage value, is -
$230,392. To the nearest whole dollar how large would the salvage value of the equipment have
to be to make the investment in the equipment financially attractive?
A. $1,535,947
B. $34,559
C. $811,239
D. $230,392

54. (Ignore income taxes in this problem.) Girman Corporation is considering three investment
projects: K, L, and M. Project K would require an investment of $27,000, Project L of $59,000,
and Project M of $88,000. No other cash outflows would be involved. The present value of the
cash inflows would be $31,860 for Project K, $66,080 for Project L, and $95,040 for Project M.
Rank the projects according to the profitability index, from most profitable to least profitable.
A. K, M, L
B. K, L, M
C. L, M, K
D. L, K, M

55. Logan Company is considering two projects, A and B. The following information has been
gathered on these projects:



Based on this information, which of the following statements is (are) true?

I. Project A has the highest ranking according to the project profitability index criterion.
II. Project B has the highest ranking according to the net present value criterion.
A. Only I
B. Only II
C. Both I and II
D. Neither I nor II

56. (Ignore income taxes in this problem.) The management of Dewitz Corporation is
considering a project that would require an initial investment of $65,000. No other cash outflows
would be required. The present value of the cash inflows would be $72,800. The profitability
index of the project is closest to:
A. 0.12
B. 1.12
C. 0.88
D. 0.11

57. (Ignore income taxes in this problem.) The management of Dittrick Corporation is
considering the following three investment projects:



Rank the projects according to the profitability index, from most profitable to least profitable.
A. I, J, K
B. K, J, I
C. J, K, I
D. I, K, J

58. A project requires an initial investment of $60,000 and has a project profitability index of
0.329. The present value of the future cash inflows from this investment is:
A. $79,740
B. $45,147
C. $60,000
D. Cannot be determined with available data.

59. Blanding Company is considering several investment proposals, as shown below:



Using the project profitability index, the ranking would be:
A. D, B, A, C
B. D, C, A, B
C. C, D, A, B
D. C, A, D, B

60. (Ignore income taxes in this problem.) Deibel Corporation is considering a project that would
require an investment of $59,000. No other cash outflows would be involved. The present value
of the cash inflows would be $66,080. The profitability index of the project is closest to:
A. 0.88
B. 0.12
C. 1.12
D. 0.11

61. Perkins Company is considering several investment proposals, as shown below:



Rank the proposals in terms of preference using the project profitability index:
A. D, B, C, A
B. B, D, C, A
C. B, D, A, C
D. A, C, B, D

62. (Ignore income taxes in this problem.) The Jackson Company has invested in a machine that
cost $70,000, that has a useful life of seven years, and that has no salvage value at the end of its
useful life. The machine is being depreciated by the straight-line method, based on its useful life.
It will have a payback period of four years. Given these data, the simple rate of return on the
machine is closest to:
A. 7.1%
B. 8.2%
C. 10.7%
D. 39.3%

63. (Ignore income taxes in this problem.) Czaplinski Corporation is considering a project that
would require an investment of $323,000 and would last for 7 years. The incremental annual
revenues and expenses generated by the project during those 7 years would be as follows:



The scrap value of the project's assets at the end of the project would be $22,000. The payback
period of the project is closest to:
A. 9.7 years
B. 4.4 years
C. 4.1 years
D. 10.4 years

64. (Ignore income taxes in this problem.) Buy-Rite Pharmacy has purchased a small auto for
delivering prescriptions. The auto was purchased for $9,000 and will have a 6-year useful life
and a $3,000 salvage value. Delivering prescriptions (which the pharmacy has never done
before) should increase gross revenues by at least $5,000 per year. The cost of these
prescriptions to the pharmacy will be about $2,000 per year. The pharmacy depreciates all assets
using the straight-line method. The payback period for the auto is:
A. 3.0 years
B. 1.8 years
C. 2.0 years
D. 1.2 years

65. (Ignore income taxes in this problem.) The Higgins Company has just purchased a piece of
equipment at a cost of $120,000. This equipment will reduce operating costs by $40,000 each
year for the next eight years. This equipment replaces old equipment which was sold for $8,000
cash. The new equipment has a payback period of:
A. 8.0 years
B. 2.8 years
C. 10.0 years
D. 3.0 years

66. (Ignore income taxes in this problem.) The management of Rusell Corporation is considering
a project that would require an investment of $282,000 and would last for 6 years. The annual
net operating income from the project would be $107,000, which includes depreciation of
$43,000. The scrap value of the project's assets at the end of the project would be $24,000. The
payback period of the project is closest to:
A. 1.9 years
B. 2.4 years
C. 1.7 years
D. 2.6 years

67. (Ignore income taxes in this problem.) Rogers Company is studying a project that would
have a ten-year life and would require an $800,000 investment in equipment which has no
salvage value. The project would provide net operating income each year as follows for the life
of the project:



The company's required rate of return is 8%. What is the payback period for this project?
A. 3 years
B. 6.67 years
C. 2 years
D. 4 years

68. (Ignore income taxes in this problem.) The Jason Company is considering the purchase of a
machine that will increase revenues by $32,000 each year. Cash outflows for operating this
machine will be $6,000 each year. The cost of the machine is $65,000. It is expected to have a
useful life of five years with no salvage value. For this machine, the simple rate of return is:
A. 20%
B. 40%
C. 49.2%
D. 9.2%

69. (Ignore income taxes in this problem.) Blaine Corporation is considering replacing a
technologically obsolete machine with a new state-of-the-art numerically controlled machine.
The new machine would cost $180,000 and would have a ten-year useful life. Unfortunately, the
new machine would have no salvage value. The new machine would cost $12,000 per year to
operate and maintain, but would save $48,000 per year in labor and other costs. The old machine
can be sold now for scrap for $20,000. What is the simple rate of return on the new machine
(round off your answer to the nearest one-hundredth of a percent)?
A. 10.00%
B. 26.67%
C. 22.50%
D. 11.25%

70. (Ignore income taxes in this problem.) The management of Burney Corporation is
investigating purchasing equipment that would increase sales revenues by $74,000 per year and
cash operating expenses by $32,000 per year. The equipment would cost $115,000 and have a 5
year life with no salvage value. The simple rate of return on the investment is closest to:
A. 36.5%
B. 25.7%
C. 20.0%
D. 16.5%

71. (Ignore income taxes in this problem.) Tu Corporation is investigating automating a process
by purchasing a machine for $423,000 that would have a 9 year useful life and no salvage value.
By automating the process, the company would save $112,000 per year in cash operating costs.
The new machine would replace some old equipment that would be sold for scrap now, yielding
$27,000. The annual depreciation on the new machine would be $47,000. The simple rate of
return on the investment is closest to:
A. 15.4%
B. 16.4%
C. 26.5%
D. 11.1%

72. (Ignore income taxes in this problem.) Hartong Corporation is contemplating purchasing
equipment that would increase sales revenues by $185,000 per year and cash operating expenses
by $89,000 per year. The equipment would cost $416,000 and have a 8 year life with no salvage
value. The annual depreciation would be $52,000. The simple rate of return on the investment is
closest to:
A. 23.8%
B. 12.5%
C. 10.6%
D. 23.1%

73. (Ignore income taxes in this problem.) An expansion at Fenstermacher, Inc., would increase
sales revenues by $315,000 per year and cash operating expenses by $186,000 per year. The
initial investment would be for equipment that would cost $405,000 and have a 5 year life with
no salvage value. The annual depreciation on the equipment would be $81,000. The simple rate
of return on the investment is closest to:
A. 31.9%
B. 15.2%
C. 20.0%
D. 11.9%

74. (Ignore income taxes in this problem.) The management of Rouleau Corporation is
investigating automating a process. Old equipment, with a current salvage value of $10,000,
would be replaced by a new machine. The new machine would be purchased for $240,000 and
would have a 6 year useful life and no salvage value. By automating the process, the company
would save $64,000 per year in cash operating costs. The simple rate of return on the investment
is closest to:
A. 10.0%
B. 26.7%
C. 10.4%
D. 16.7%

(Ignore income taxes in this problem.) Shields Company has gathered the following data on a
proposed investment project:



75. The payback period for the investment is closest to:
A. 0.2 years
B. 1.0 years
C. 3.0 years
D. 5.0 years

76. The simple rate of return on the investment is closest to:
A. 5%
B. 10%
C. 15%
D. 20%

77. The net present value on this investment is closest to:
A. $400,000
B. $80,000
C. $91,600
D. $76,750

78. The internal rate of return on the investment is closest to:
A. 11%
B. 13%
C. 15%
D. 17%


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