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Exam 15: Capital Investment Analysis

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Question 1

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Which method of evaluating capital investment proposals uses the concept of present value to compute a rate of return?

A) Average rate of return
B) Internal rate of return
C) Cash payback period
D) Accounting rate of return

E) A) and C)
F) A) and D)

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Question 2

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The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a $40,000 residual value, is expected to yield total net income of $500,000 for 5 years. The expected average rate of return is 50%.

A) True
B) False

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Question 3

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The expected average rate of return for a proposed investment of $3,000,000 in a fixed asset giving effect to depreciation (straight-line method) with a useful life of 20 years, no residual value, and an expected total income of $6,000,000 is:

Which of the following can be used to place capital investment proposals involving different amounts of investment on a comparable basis for purposes of net present value analysis?

All of the following qualitative considerations may impact upon capital investments analysis except:

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

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. 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 in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 60,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$ The present value index for this investment is:

The net present value has been computed for Proposals A and B. Relevant data are as follows: $\begin{array}{lll}\text { Proposal B } & \text { Proposal A } & \\\hline \$125,000 & \$ 75,000 & \text { Amount to be invested } \\136,250 & 84,000 & \text { Total present value of net cash flow } \\11,250 & 9,000 & \text { Net present value }\end{array}$ Determine the present value index for each proposal.

The expected average rate of return for a proposed investment of $540,000 in a fixed asset, with a useful life of four years, recognition is given to the effect of straight-line depreciation on the investment, no residual value, and an expected total net income of $216,000 for the 4 years, is:

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. 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 in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 10,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$ The average rate of return for this investment is:

When evaluating a proposal by use of the net present value method, if the present value is less than the amount to be invested, the rate of return on the proposal is more than the rate used in the analysis.

All of the following qualitative considerations may influence capital investments analysis except:

Sommers Company is evaluating a project requiring a capital expenditure of $300,000. The project has an estimated life of 5 years and no salvage value. The estimated net income and net cash flow from the project are as follows: $\begin{array}{ccc} \text {Net Cash}& \text { Net Income Flow}&\text { Year }\\\$ 120,000 & \$ 60,000 & 1 \\110,000 & 50,000 & 2 \\105,000 & 45,000 & 4 \\90,000 & 30,000 & 4 \\80,000 & 20,000 &5\\\underline{\$ 505,000}&\underline{\$205,000}\end{array}$ The company's minimum desired rate of return for net present value analysis is 12%. The present value of $1 at compound interest of 12% is shown in the table below: $\begin{array} { | l | l | } \hline \text { Present } \text { Value } & \text { Year } \\\hline \text { of} \$ 1 \text { at } 12 \% & 1 \\\hline 0.893 & 2 \\\hline 0.797 & 3 \\\hline 0.712 & 4 \\\hline 0.636 & 5 \\\hline 0.567 & \\\hline &\end{array}$ Determine (a) the average rate of return on investment, giving effect to depreciation on the investment, and (b) the net present value.

Average rate of return equals estimated average annual income divided by average investment.

The expected period of time that will elapse between the date of a capital investment and the complete recovery in cash of the amount invested is called the cash payback period.

Both proposal M, and N cost $800,000, have a 6-year life, and have expected total cash flows of $1,200,000. Proposal M is expected to provide equal annual net cash flows of $200,000, while the net cash flows for Proposal N are as follows: $\begin{array}{ll}\$ 250,000 & \text { Year 1 } \\\$ 225,000 & \text { Year 2 } \\\$ 200,000 & \text { Year 3 } \\\$ 200,000 & \text { Year 4 } \\\$ 175,000 & \text { Year 5 } \\\$ 150,000 & \text { Year 6 }\end{array}$ Determine the cash payback period for each proposal.

A company should purchase an asset when the minimum rate of return exceeds its average rate of return.

The average rate of return method of capital investment analysis gives consideration to the present value of future cash flows.

Assume in analyzing alternative proposals that Proposal F has a useful life of six years and Proposal J has a useful life of nine years. What is one widely used method that makes the proposals comparable?

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed net discounted cash flow.