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Exam 11: Capital Budgeting and Investment Analysis

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Question 21

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The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

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Question 22

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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.

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Question 23

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The ________ is the rate that yields a net present value of zero for an investment.

The net cash flow of a particular investment project:

Soft capital rationing is imposed by external factors, such as debt covenants.

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

A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus straight-line depreciation of $4,000 per year. The company's after-tax net income, based on a tax rate of 40%, is $2,400. What is the approximate accounting rate of return for the machine?

Net cash flow can be calculated by adjusting the projected net income from a project for any non-cash revenues and expenses.

A project requires a $28,500 investment and is expected to generate end-of-period annual cash inflows of $12,000 for each of three years. Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $\begin{array} { c c c } = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\0.9091 & 0.8264 & 0.7513\end{array}$

If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be accepted.

Poe Company is considering the purchase of new equipment costing $80,000. The projected annual cash inflows are $30,200, 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. $\begin{array} { c c c } \text { Periods } & \text { Present Value } & \text { Present Value of ary } \\ & \text { of } \$ 1 \text { at } 10 \% & \text { Aruruity of } \$ 1 \text { at } 10 \% \\1 & 0.9091 & 0.9091 \\2 & 0.8264 & 1.7355 \\3 & 0.7514 & 2.4869 \\4& 0.6830 & 3.1699\end{array}$

If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

Three widely used methods of comparing investment alternatives are payback period, net present value, and rate of return on average investment.

When the amount invested differs substantially across projects, NPV is of limited value for comparison purposes. You have evaluated three projects of substantially different investment amounts using the net present value (NPV) method. How would you decide which one of the projects to select?

The process of restating future cash flows in today's dollars is known as:

Capital budgeting decisions that relate to investments in technology are not as risky as other types of capital budgeting decisions.

Restating future cash flows in terms of present values and then determining the payback period using these present values is known as:

Two investments with exactly the same payback periods are always equally valuable to an investor.

The hurdle rate is often set at:

For each of the capital budgeting methods listed below, place an X in the correct column, indicating the measurement basis of each, the ability to make comparison among projects, and whether each method reflects or ignores the time value of money.