Q: A company is considering two projects. Project A requires an initial investment of $$100,000 and is expected to generate net cash inflows of 25$$,000 per year for 5 years. What is the payback period for Project A? Use the formula $$ \text{Payback} = \frac{\text{Amount invested}}{\text{Expected annual net cash inflow}} .$$

$$ \frac{100,000}{25,000} = 4 \text{ years} $$

Q: A project requires an initial investment of $$500,000 and is expected to generate net cash inflows of 120$$,000 per year for 5 years. If the company’s minimum required rate of return is 10%, and the present value of an ordinary annuity of $$1 at 10% for 5 years is 3.791, what is the NPV? Use the formula $$ \text{NPV} = (\text{Net cash inflow} \times \text{PV factor}) - \text{Initial investment} $.

$$ (120,000 \times 3.791) - 500,000 = -46$$,080 $

Q: A company is considering a project with the following cash flows: Year 1: $$100,000, Year 2: 80$$,000, Year 3: $$50,000, Year 4: 50$$,000. The initial investment is $$240,000. What is the payback period? Use the formula $$ \text{Payback period} = \text{Years before full recovery} + \frac{\text{Amount needed to complete recovery}}{\text{Net cash inflow in year of recovery}} $.

$$ 3 + \frac{10,000}{50,000} = 3.2 \text{ years} $$

Question 1

Which of the following best describes the main purpose of capital budgeting in financial accounting?

Accepted Answer

To plan investments in long-term assets to maximize company profitability.

Question 2

A company is considering two projects. Project A requires an initial investment of $$100,000 and is expected to generate net cash inflows of 25$$,000 per year for 5 years. What is the payback period for Project A? Use the formula $$ 	ext{Payback} = \frac{	ext{Amount invested}}{	ext{Expected annual net cash inflow}} .$$

Accepted Answer

$$ \frac{100,000}{25,000} = 4 	ext{ years} $$

Question 3

Which of the following is a criticism of the payback method for evaluating capital investments?

Accepted Answer

It ignores cash flows that occur after the payback period.

Question 4

A company invests $$240,000 in a project that generates 60$$,000 in net cash inflows per year for 6 years. What is the accounting rate of return (ARR) if the asset has no residual value? Use the formulas: $$ 	ext{ARR} = \frac{	ext{Average annual operating income}}{	ext{Average amount invested}} $$ and $$ 	ext{Average amount invested} = \frac{	ext{Amount invested} + 	ext{Residual value}}{2} .$$

Accepted Answer

$$ \frac{20,000}{120,000} = 16.7\% $$

Question 5

Which of the following statements about the time value of money is correct?

Accepted Answer

A dollar received today is worth more than a dollar received in the future.

Question 6

If you invest $$10,000 at 6% compound interest for 5 years, what is the future value? Use the formula $$ 	ext{Future value} = 	ext{Present value} + 	ext{Interest earned} $ and refer to the compound interest calculation.

Accepted Answer

$$ 10,000 + 3,383 = 13,383 $$

Question 7

Which method incorporates the time value of money when evaluating capital investments?

Accepted Answer

Net present value (NPV)

Question 8

A project requires an initial investment of $$500,000 and is expected to generate net cash inflows of 120$$,000 per year for 5 years. If the company’s minimum required rate of return is 10%, and the present value of an ordinary annuity of $$1 at 10% for 5 years is 3.791, what is the NPV? Use the formula $$ 	ext{NPV} = (	ext{Net cash inflow} 	imes 	ext{PV factor}) - 	ext{Initial investment} $.

Accepted Answer

$$ (120,000 	imes 3.791) - 500,000 = -46$$,080 $

Question 9

Which of the following best describes the internal rate of return (IRR)?

Accepted Answer

The interest rate that makes the net present value (NPV) of an investment equal to zero.

Question 10

A company is comparing two projects with different initial investments. Which metric should it use to determine which project returns more value per dollar invested?

Accepted Answer

Profitability index

Question 11

Which of the following is NOT a cash inflow considered in capital budgeting decisions?

Accepted Answer

Additional operating costs

Question 12

A company is considering a project with the following cash flows: Year 1: $$100,000, Year 2: 80$$,000, Year 3: $$50,000, Year 4: 50$$,000. The initial investment is $$240,000. What is the payback period? Use the formula $$ 	ext{Payback period} = 	ext{Years before full recovery} + \frac{	ext{Amount needed to complete recovery}}{	ext{Net cash inflow in year of recovery}} $.

Accepted Answer

$$ 3 + \frac{10,000}{50,000} = 3.2 	ext{ years} $$

Question 13

Which of the following best describes capital rationing?

Accepted Answer

Ranking and choosing among alternative capital investments based on the availability of funds.

Question 14

If a project’s expected ARR is less than the required rate of return, what should management do according to the decision rule?

Accepted Answer

Do not invest

Question 15

Which of the following is a key difference between simple interest and compound interest?

Accepted Answer

Compound interest is calculated on both the principal and previously earned interest.

Question 16

A company is evaluating a project with the following cash flows: Initial investment: $$300,000; Net cash inflows: 80$$,000 per year for 5 years; Residual value: $$20,000. What is the average amount invested? Use the formula $$ 	ext{Average amount invested} = \frac{	ext{Amount invested} + 	ext{Residual value}}{2} $.

Accepted Answer

$$ \frac{300,000 + 20,000}{2} = 160,000 $$

Question 17

Which of the following is the correct formula for the profitability index?

Accepted Answer

$$ 	ext{Profitability index} = \frac{	ext{Present value of net cash inflows}}{	ext{Initial investment}} $$

Question 18

A company is considering a project with an initial investment of $$1,000,000 and five equal yearly cash inflows of 305$$,450. If the present value of an ordinary annuity of $1 for 5 years is 3.274, what is the IRR?

Accepted Answer

16%

Question 19

Which of the following best describes a post-audit in the capital budgeting process?

Accepted Answer

A comparison of the actual results of capital investments to the projected results.

(26) Capital Investment Decisions: Methods and Applications

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