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Exam 25: Capital Investment Analysis

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Question 61

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The management of Charlton Corporation is considering the purchase of a new machine costing $380,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability of this investment: $\begin{array} { l l l } & \text { Income from } & \text { Net Cash } \\\text { Year } & \text { Operations } & \text { Flow } \\1 & \$ 20,000 & \$ 95,000 \\2 & 20,000 & 95,000 \\3 & 20,000 & 95,000 \\4 & 20,000 & 95,000 \\5 & 20,000 & 95,000\end{array}$ The cash payback period for this investment is

A) 4 years
B) 5 years
C) 19 years
D) 3.3 years

E) A) and B)
F) All of the above

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Question 62

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If in evaluating a proposal by use of the net present value method there is a deficiency of the present value of future cash inflows over the amount to be invested, the proposal should be rejected.

A) True
B) False

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Question 63

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Which method for evaluating capital investment proposals reduces the expected future net cash flows originating from the proposals to their present values and computes a net present value?

If in evaluating a proposal by use of the net present value method there is an excess of the present value of future cash inflows over the amount to be invested, the rate of return on the proposal is less than the rate used in the analysis.

The management of River Corporation is considering the purchase of a new machine costing $380,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability of this investment: $\begin{array} { l l l } & \text { Income from } & \text { Net Cash } \\\text { Year } & \text { Operations } & \text { Flow } \\1 & \$ 20,000 & \$ 95,000 \\2 & 20,000 & 95,000 \\3 & 20,000 & 95,000 \\4 & 20,000 & 95,000 \\5 & 20,000 & 95,000\end{array}$ -The net present value for this investment is

The methods of evaluating capital investment proposals can be grouped into two general categories that can be referred to as 1) average rate of return and 2) cash payback methods.

The management of Arkansas Corporation is considering the purchase of a new machine costing $490,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability of this investment: $\begin{array}{lll}& \text { Income from } & \text { Net Cash } \\\text { Year } & \text { Operations } & \text { Flow }\\1 & \$ 100,000 & \$ 180,000 \\2 & 40,000 & 120,000 \\3 & 40,000 & 100,000 \\4 & 10,000 & 90,000 \\5 & 10,000 & 120,000\end{array}$ The net present value for this investment is

Methods that ignore present value in capital investment analysis include the cash payback method.

The average rate of return is a measure of profitability computed by dividing the average annual cash inflows from an asset by the average amount invested in the asset.

A project has estimated annual net cash flows of $80,000. It is estimated to cost $600,000. Determine the cash payback period.

A project is estimated to cost $273,840 and provide annual net cash flows of $60,000 for 7 years. Determine the internal rate of return for this project, using the following present value of an annuity table. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 1.833 & 1.736 & 1.690 \\3 & 2.673 & 2.487 & 2.402 \\4 & 3.465 & 3.170 & 3.037 \\5 & 4.212 & 3.791 & 3.605 \\6 & 4.917 & 4.355 & 4.111 \\7 & 5.582 & 4.868 & 4.564 \\8 & 6.210 & 5.335 & 4.968 \\9 & 6.802 & 5.759 & 5.328 \\10 & 7.360 & 6.145 & 5.650\end{array}$

In calculating the net present value of an investment in equipment, the required investment and its residual value should be subtracted from the present value of all future cash inflows.

A $400,000 capital investment proposal has an estimated life of 4 years and no residual value. The estimated net cash flows are as follows: $\begin{array} { l l } \text { Year } & \text { Net Cash Flow } \\1 & \$ 200,000 \\2 & 150,000 \\3 & 90,000 \\4 & 80,000\end{array}$ The minimum desired rate of return for net present value analysis is 12%. The present value of $1 at compound interest of 12% for 1, 2, 3, and 4 years is 0.893, 0.797, 0.712, and 0.636, respectively. Determine the net present value.

A company is contemplating investing in a new piece of manufacturing machinery. The amount to be invested is $210,000. The present value of the future cash flows is $225,000. The company's desired rate of return used in the present value calculations was 12%. Which of the following statements is true?

In capital rationing, alternative proposals that survive initial and secondary screening are normally evaluated in terms of:

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $200,000 for the 5 years. The expected average rate of return on investment is 50%.

Project A requires an original investment of $65,000. The project will yield cash flows of $15,000 per year for 7 years. Project B has a calculated net present value of $5,500 over a 5-year life. Project A could be sold at the end of 5 years for a price of $30,000. a) Using the table below, determine the net present value of Project A over a 5- year life with salvage value assuming a minimum rate of return of 12%. b) Which project provides the greatest net present value? Below is a table for the present value of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 0.890 & 0.826 & 0.797 \\3 & 0.840 & 0.751 & 0.712 \\4 & 0.792 & 0.683 & 0.636 \\5 & 0.747 & 0.621 & 0.567\end{array}$ Below is a table for the present value of an annuity of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 1.833 & 1.736 & 1.690 \\3 & 2.673 & 2.487 & 2.402 \\4 & 3.465 & 3.170 & 3.037 \\5 & 4.212 & 3.791 & 3.605\end{array}$

If in evaluating a proposal by use of the net present value method there is an excess of the present value of future cash inflows over the amount to be invested, the rate of return on the proposal exceeds the rate used in the analysis.

A qualitative characteristic that may impact upon capital investment analysis is employee morale.

Match each definition that follows with the term a-e) it defines. -Often referred to as the discounted cash flow method