Capital Budgeting Test Bank Compress

Capital Budgeting Test Bank
Accountancy
CHAPTER 21: CAPITAL BUDGETING AND COST ANALYSIS
TRUE/FALSE
1. Capital budgeting focuses on projects over their entire lives in order to consider all the
cash flows or cash savings from investing in a single project.
Answer: True Difficulty: 2 Objective: 1
2. The identification stage of capital budgeting explores alternative capital investments

that will achieve the objectives of the organization.
Answer: False Difficulty: 1 Objective: 2

This is the definition of the search stage.
3. The information-acquisition stage of capital budgeting considers the expected costs and
the expected benefits of alternative capital investments.
4. The selection stage of the capital budgeting process consists of choosing projects for
possible implementation.
5. Discounted cash flow methods measure all the expected future cash inflows and
outflows of a project as if they occurred at equal intervals over the life of the project.

As if they occurred at a single point in time.
6. Discounted cash flow methods focus on operating income.

Discounted cash flow method focus on cash inflows and cash outflows.
7. The net present value method calculates the expected monetary gain or loss from a
project by discounting all expected future cash inflows and outflows to the present
point in time using the hurdle rate.
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8. Internal rate of return is a method of calculating the expected net monetary gain or loss
from a project by discounting all expected future cash inflows and outflows to the
present point in time.

The internal rate of return calculates the discount rate at which the present value of
expected cash inflows from a project equals the present value of expected cash
outflows.
9. A capital budgeting project is accepted if the required rate of return equals or exceeds
the internal rate of return.

A capital budgeting project is accepted if the internal rate of return equals or exceeds
the required internal rate of return.
10. The net present value method can be used in situations where the required rate of return
varies over the life of the project.
11. Relevant cash flows are expected future cash flows that differ among the alternative
uses of investment funds.
12. Deducting depreciation from operating cash flows would result in counting the initial
investment twice, in the discounted cash flow analysis.
13. Unlike the net present value method and the internal rate-of-return method, the payback
method does not distinguish between the origins of the cash flows.

None of the three capital budgeting methods distinguish between the origins of the cash
flows.
14. The payback method is only useful when the expected cash flows in the later years of
the project are highly uncertain.

The payback method is only useful when the expected cash flows in the later years are
highly certain.
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15. The accrual accounting rate-of-return method is similar to the internal rate-of-return
method in that both methods calculate a rate-of-return percentage.
16. A manager who uses discounted cash flow methods to make capital budgeting
decisions does not face goal-congruence issues if the accrual accounting rate of return
is used for performance evaluation.

The manager does face goal-congruence issues.
17. Depreciation tax deductions result in tax savings that partially offset the cost of
acquiring the capital asset.
18. The use of an accelerated method of depreciation for tax purposes would usually
increase the present value of the investment.
19. An example of an intangible asset would be a corporation’s customer base.
20. The nominal approach to incorporating inflation into the net present value method
predicts cash inflows in real monetary units and uses a real rate as the required rate of
return.
Answer: False Difficulty: 2 Objective: A

This is the definition of the real approach.
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MULTIPLE CHOICE
21. Which of the following involves significant financial investments in projects to develop
new products, expand production capacity, or remodel current production facilities?
a. Capital budgeting
b. Working capital
c. Master budgeting
d. Project-cost budgeting
Answer: a Difficulty: 1 Objective: 1
22. The accounting system that corresponds to the project dimension in capital budgeting is
the
a. net present value method.
b. internal rate of return.
c. accrual accounting rate of return.
d. life-cycle costing.
Answer: d Difficulty: 1 Objective: 1
23. The stage of the capital budgeting process which distinguishes which types of capital
expenditure projects are necessary to accomplish organization objectives is the
a. identification stage.
b. search stage.
c. information-acquisition stage.
d. selection stage.
24. The stage of the capital budgeting process which explores alternative capital
investments that will achieve organization objectives is the
b. search stage.
d. selection stage.
Answer: b Difficulty: 1 Objective: 2
25. The stage of the capital budgeting process which considers the expected costs and the
expected benefits of alternative capital investments is the
b. search stage.
d. selection stage.
Answer: c Difficulty: 1 Objective: 2
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26. The stage of the capital budgeting process which chooses projects for implementation is
the
a. selection stage.
b. search stage.
c. identification stage.
d. management-control stage.
27. The stage of the capital-budgeting process in which projects get underway and
performance is monitored is the
a. implementation and control stage.
b. search stage.
c. identification stage.
d. management-control stage.
28. Capital budgeting emphasizes two factors

a. qualitative and nonfinancial.
b. quantitative and nonfinancial.
c. quantitative and financial
d. qualitative and financial.
29. Which of the following are NOT included in the formal financial analysis of a capital
budgeting program?
a. Quality of the output
b. Safety of employees
c. Cash flow
d. Neither (a) nor (b) are included
30. Which capital budgeting technique(s) measure all expected future cash inflows and
outflows as if they occurred at a single point in time?
a. Net present value
b. Internal rate of return
c. Payback
d. Both (a) and (b).
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31. Discounted cash flow methods for capital budgeting focus on
a. cash inflows.
b. operating income.
c. cash outflows.
d. both (a) and (c).
32. Net present value is calculated using

a. the internal rate of return.
b. the required rate of return.
c. the rate of return required by the investment bankers.
d. none of the above.
33. All of the following are methods that aid management in analyzing the expected results
of capital budgeting decisions EXCEPT
a. accrual accounting rate-of-return method.
b. discounted cash-flow method.
c. future-value cash-flow method.
d. payback method.
34. The capital budgeting method which calculates the expected monetary gain or loss from
a project by discounting all expected future cash inflows and outflows to the present
point in time using the required rate of return is the
a. payback method.
b. accrual accounting rate-of-return method.
c. sensitivity method.
d. net present value method.
35. Assume your goal in life is to retire with one million dollars. How much would you
need to save at the end of each year if interest rates average 6% and you have a 20-year
work life?
a. $14,565
b. $27,184
c. $120,102
d. $376,476

S (36.786) = $1,000,000
S = $ 27,184.25
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36. Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning
machine. The existing machine is operable for three more years and will have a zero
disposal price. If the machine is disposed of now, it may be sold for $60,000. The new
machine will cost $200,000 and an additional cash investment in working capital of
$60,000 will be required. The new machine will reduce the average amount of time
required to wash clothing and will decrease labor costs. The investment is expected to
net $50,000 in additional cash inflows during the year of acquisition and $150,000 each
additional year of use. The new machine has a three-year life, and zero disposal value.
These cash flows will generally occur throughout the year and are recognized at the end
of each year. Income taxes are not considered in this problem. The working capital
investment will not be recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is
10%? Would the company want to purchase the new machine?
a. $82,000; yes
b. $50,000; no
c. $(50,000); yes
d. $(82,000); no

Yr. 0 ($60,000 - $200,000 - $60,000) x 1.000 = $(200,000)
Yr. 1 $50,000 x 0.909 = 45,450
Yr. 2 $150,000 x 0.826 = 123,900
Yr. 3 $150,000 x 0.751 = 112,650
$ 82,000
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37. Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning
machine. The existing machine is operable for three more years and will have a zero
disposal price. If the machine is disposed of now, it may be sold for $60,000. The new
machine will cost $200,000 and an additional cash investment in working capital of
$60,000 will be required. The new machine will reduce the average amount of time
required to wash clothing and will decrease labor costs. The investment is expected to
net $50,000 in additional cash inflows during the year of acquisition and $150,000 each
additional year of use. The new machine has a three-year life. These cash flows will
generally occur throughout the year and are recognized at the end of each year. Income
taxes are not considered in this problem. The working capital investment will not be
recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is
24%? Would the company want to purchase the new machine?
a. $(32,800); yes
b. $(16,400); no
c. $16,400; yes
d. $32,800; no

Yr. 0 ($60,000 - $200,000 - $60,000) x 1.000 = $(200,000)
Yr. 1 $ 50,000 x 0.806 = 40,300
Yr. 2 $150,000 x 0.650 = 97,500
Yr. 3 $150,000 x 0.524 = 78,600
$ 16,400
38. In using the net present value method, only projects with a zero or positive net present
value are acceptable because
a. the return from these projects equals or exceeds the cost of capital.
b. a positive net present value on a particular project guarantees company
profitability.
c. the company will be able to pay the necessary payments on any loans secured to
finance the project.
d. of both (a) and (b).
39. Which of the following is NOT an appropriate term for the required rate of return?
a. Discount rate
b. Hurdle rate
c. Cost of capital
d. All of the above are appropriate terms
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40. Which of the following results of the net present value method in capital budgeting is
the LEAST acceptable?
a. $(10,000)
b. $(7,000)
c. $(18,000)
d. $0
41. The definition of an annuity is

a. similar to the definition of a life insurance policy.
b. a series of equal cash flows at intervals.
c. an investment product whose funds are invested in the stock market.
d. both (a) and (b) are correct.
42. The net present value method focuses on

a. cash inflows.
b. accrual-accounting net income.
c. cash outflows.
43. If the net present value for a project is zero or positive, this means
a. the project should be accepted.
b. the project should not be accepted.
c. the expected rate of return is below the required rate of return.
44. Shirt Company wants to purchase a new cutting machine for its sewing plant. The
investment is expected to generate annual cash inflows of $300,000. The required rate
of return is 12% and the current machine is expected to last for four years. What is the
maximum dollar amount Shirt Company would be willing to spend for the machine,
assuming its life is also four years? Income taxes are not considered.
a. $507,000
b. $720,600
c. $791,740
d. $911,100

X = $300,000 x PV Ann 4 (12%) = $300,000 x 3.037
X= $911,100
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45. The Zeron Corporation wants to purchase a new machine for its factory operations at a
cost of $950,000. The investment is expected to generate $350,000 in annual cash flows
for a period of four years. The required rate of return is 14%. The old machine can be
sold for $50,000. The machine is expected to have zero value at the end of the four-year
period. What is the net present value of the investment? Would the company want to
purchase the new machine? Income taxes are not considered.
a. $119,550; yes
b. $69,550; no
c. $1,019,550; yes
d. $326,750; no

Year 0 = ($50,000 - $950,000) = $(900,000)
Year 1 = $350,000 x 0.877 = 306,950
Year 2 = $350,000 x 0.769 = 269,150
Year 3 = $350,000 x 0.675 = 236,250
Year 4 = $350,000 x 0.592 = 207,200
$ 119,550
46. Wet and Wild Water Company drills small commercial water wells. The company is in
the process of analyzing the purchase of a new drill. Information on the proposal is
provided below.
Initial investment:
Asset $160,000
Working capital $ 32,000
Operations (per year for four years):
Cash receipts $160,000
Cash expenditures $ 88,000
Disinvestment:
Salvage value of drill (existing) $ 16,000
Discount rate 20%
What is the net present value of the investment? Assume there is no recovery of
working capital.
a. $(62,140)
b. $10,336
c. $42,362
d. $186,336

- $32,000 - $160,000 + $16,000= $(176,000)
Yr 1 = $72,000 x 0.833= 59,976
Yr 2 = $72,000 x 0.694= 49,968
Yr 3 = $72,000 x 0.579= 41,688
Yr 4 = $72,000 x 0.482= 34,704
$ 10,336
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47. The capital budgeting method that calculates the discount rate at which the present
value of expected cash inflows from a project equals the present value of expected cash
outflows is the
a. net present value method.
b. accrual accounting rate-of-return method.
c. payback method.
d. internal rate of return.
48. In capital budgeting, a project is accepted only if the internal rate of return
a. equals or exceeds the required rate of return.
b. equals or is less than the required rate of return.
c. equals or exceeds the net present value.
d. equals or exceeds the accrual accounting rate of return.
49. The Zeron Corporation recently purchased a new machine for its factory operations at a
cost of $921,250. The investment is expected to generate $250,000 in annual cash flows
for a period of six years. The required rate of return is 14%. The old machine has a
remaining life of six years. The new machine is expected to have zero value at the end
of the six-year period. The disposal value of the old machine at the time of replacement
is zero. What is the internal rate of return?
a. 15%
b. 16%
c. 17%
d. 18%

$921,250= $250,000 F
F = 3.685
Chart criteria for six years is 3.685 = 16%
50. Brown Corporation recently purchased a new machine for $339,013.20 with a ten-year
life. The old equipment has a remaining life of ten years and no disposal value at the
time of replacement. Net cash flows will be $60,000 per year. What is the internal rate
of return?
a. 12%
b. 16%
c. 20%
d. 24%

$339,013.20 = $60,000F
F = 5.65022
Chart criteria for 10 years is 5.65022 = 12%
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51. Soda Manufacturing Company provides vending machines for soft-drink
manufacturers. The company has been investigating a new piece of machinery for its
production department. The old equipment has a remaining life of three years and the
new equipment has a value of $52,650 with a three-year life. The expected additional
cash inflows are $25,000 per year. What is the internal rate of return?
a. 20%
b. 16%
c. 10%
d. 8%

$52,650 = $25,000F
F = 2.106
Chart criteria for 3 years is 2.106 = 20%
52. An important advantage of the net present value method of capital budgeting over the
internal rate-of-return method is
a. the net present value method is expressed as a percentage.
b. the net present values of individual projects can be added to determine the effects
of accepting a combination of projects.
c. no advantage.
d. both (a) and (b).
53. In situations where the required rate of return is not constant for each year of the
project, it is advantageous to use
a. the adjusted rate-of-return method.
b. the internal rate-of-return method.
c. the net present value method.
d. sensitivity analysis.
54. A "what-if" technique that examines how a result will change if the original predicted
data are not achieved or if an underlying assumption changes is called
a. sensitivity analysis.
b. net present value analysis.
c. internal rate-of-return analysis.
d. adjusted rate-of-return analysis.
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55. Investment A requires a net investment of $800,000. The required rate of return is 12%
for the four-year annuity. What are the annual cash inflows if the net present value
equals 0? (rounded)
a. $189,483
b. $263,418
c. $274,848
d. $ 295,733

3.037 x ACI - $800,000 = $0
= $ 263,418
56. The focus in capital budgeting should be on

a. the tax consequences of different investment strategies.
b. the internal rate of return of different strategies.
c. expected future cash flows that differ between alternatives.
57. All of the following are major categories of cash flows in capital investment decisions
EXCEPT
a. the initial investment in machines and working capital.
b. recurring operating cash flows.
c. the initial working capital investment
d. depreciation expense reported on the income statement.
58. An example of a sunk cost in a capital budgeting decision for new equipment is
a. increase in working capital required by a particular investment choice.
b. the book value of the old equipment.
c. the necessary transportation costs on the new equipment.
d. all of the above are examples of sunk costs.
59. Depreciation is usually not considered an operating cash flow in capital budgeting
because
a. depreciation is usually a constant amount each year over the life of the capital
investment.
b. deducting depreciation from operating cash flows would be counting the lump-
sum amount twice.
c. depreciation usually does not result in an increase in working capital.
d. depreciation usually has no effect on the disposal price of the machine.
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60. The relevant terminal disposal price of a machine equals
a. the difference between the salvage value of the old machine and the ultimate
salvage value of the new machine.
b. the total of the salvage values of the old machine and the new machine.
c. the salvage value of the old machine.
d. the salvage value of the new machine.
61. The method that measures the time it will take to recoup, in the form of future cash
inflows, the total dollars invested in a project is called
a. the accrued accounting rate-of-return method.
b. payback method.
c. internal rate-of-return method.
d. the book-value method.
62. The net initial investment for a piece of construction equipment is $1,000,000. Annual
cash inflows are expected to increase by $200,000 per year. The equipment has an 8-
year useful life. What is the payback period?
a. 8.00 years
b. 7.00 years
c. 6.00 years
d. 5.00 years

$1,000,000/$200,000 = 5.0 years
63. The payback method of capital budgeting approach to the investment decision
highlights
a. cash flow over the life of the investment.
b. the liquidity of the investment.
c. the tax savings of the depreciation amounts.
d. having as lengthy payback time as possible.
64. The approach to capital budgeting which divides an accounting measure of income by
an accounting measure of investment is
a. net present value.
b. internal rate of return.
c. payback method.
d. accrual accounting rate of return.
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65. For capital budgeting decisions, the use of the accrual accounting rate of return for
evaluating performance is often a stumbling block to the implementation of the
a. net cash flow.
b. most effective goal-congruence choice.
c. discounted cash flow method for capital budgeting.
d. most effective tax strategy.
66. In the analysis of a capital budgeting proposal, for which of the following items are
there no after-tax consequences?
a. Cash flow from operations
b. Gain or loss on the disposal of the asset
c. Reduction of working capital balances at the end of the useful life of the capital
asset
d. There are no after-tax consequences of any of the above.
67. The Alpha Beta Corporation disposes of a capital asset with an original cost of $85,000
and accumulated depreciation of $54,500 for $25,000. Alpha Beta's tax rate is 40%.
Calculate the after-tax cash inflow from the disposal of the capital asset.
a. $2,200
b. ($2,200)
c. $27,200
d. $31,500

($85,000 - 54,500) = $30,500 - $25,000 = $5,500 loss x 0.4 = $2,200 tax savings from
loss plus $25,000 proceeds = $27,200.
68. The Phenom Corporation has an annual cash inflow from operations from its
investment in a capital asset of $50,000 for five years. The corporation's income tax
rate is 40%. Calculate the five years total after-tax cash inflow from operations.
a. $250,000
b. $175,000
c. $150,000
d. $50,000

$50,000 x 5 = $250,000 x (1- 0.4) = $150,000 net cash flow
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69. Comparison of the actual results for a project to the costs and benefits expected at the
time the project was selected is referred to as
a. the audit trail.
b. management control.
c. a postinvestment audit.
d. a cost-benefit analysis.
70. A capital budgeting tool management can use to summarize the difference in the future
net cash inflows from an intangible asset at two different points in time is referred to as
a. the accrual accounting rate-of-return method.
b. the net present value method.
c. sensitivity analysis
d. the payback method.
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EXERCISES AND PROBLEMS
71. Match each one of the examples below with one of the stages of the capital budgeting
decision model.
Stages:
1. Identification
2. Search
3. Information-acquisition
4. Selection
5. Financing
6. Implementation and control
______ a. Issuing corporate stock in order to supply the funds to purchase new
equipment
______ b. Learning how to effectively operate Machine #8 only takes 15 minutes
______ c. The need to reduce the costs to process the vegetables used in
producing goulash
______ d. Monitoring the costs to operate a new machine
______ e. Percentage of defective merchandise considered too high
______ f. Will introducing the new product substantially upgrade our image as a
producer of quality products
______ g. Research indicates there are five machines on the market capable of
producing our product at a competitive cost
______ h. Utilization of the internal rate of return for each alternative
Answer:
a. Financing
b. Information-acquisition
c. Identification
d. Implementation and control
e. Identification
f. Information-acquisition
g. Search
h. Selection
Difficulty: 2 Objective: 2
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72. The Zero Machine Company is evaluating a capital expenditure proposal that requires
an initial investment of $20,960 and has predicted cash inflows of $5,000 per year for
10 years. It will have no salvage value.
Required:
a. Using a required rate of return of 16%, determine the net present value of the
investment proposal.
b. Determine the proposal's internal rate of return.
Answer:
a.
Predicted PV of Cash
Cash Flows Year(s) PV Factor Flows
Initial investment $(20,960) 0 1.000 $(20,960)
Annual operations 5,000 10 4.833 24,165
Net present value $ 3,205
b. Present value factor of an annuity of $1.00 = $20,960/$5,000 = 4.192.
From annuity table, the 4.192 factor is closest to the 10-year row at the 20%
column. Therefore, the IRR is 20%.
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73. Network Service Center is considering purchasing a new computer network for
$82,000. It will require additional working capital of $13,000. Its anticipated eight-year
life will generate additional client revenue of $33,000 annually with operating costs,
excluding depreciation, of $15,000. At the end of eight years, it will have a salvage
value of $9,500 and return $5,000 in working capital. Taxes are not considered.
Required:
a. If the company has a required rate of return of 14%, what is the net present value
of the proposed investment?
b. What is the internal rate of return?
Answer:
a.
Predicted PV of
Cash Flows Year(s) PV Factor Cash Flows
Annual operations, net 18,000 1-8 4.639 83,502
Salvage value, work cap 14,500 8 0.351 5,090
Net present value $ (6,408)
b. Trial and error is necessary. You know it is below 14% because the answer to Part
A was negative and, therefore, less than the discount rate. Therefore, let's try
12%.
Predicted PV Of
Cash Flows Year(s) PV Factor Cash Flows
Annual operations, net 18,000 1-8 4.968 89,424
Salvage value, work cap 14,500 8 0.404 5,858
Net present value $ 282
The (almost) zero net present value indicates an internal rate of return of approximately
12%.
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74. EIF Manufacturing Company needs to overhaul its drill press or buy a new one. The
facts have been gathered, and are as follows:
Current Machine New Machine

Purchase Price, New $80,000 $100,000
Current book value 30,000
Overhaul needed now 40,000
Annual cash operating costs 70,000 40,000
Current salvage value 20,000
Salvage value in five years 5,000 20,000
Required:
Which alternative is the most desirable with a current required rate of return of 20%?
Show computations, and assume no taxes.
Answer:
Present value of keeping current system:
Predicted PV PV of
Cash Flows Year(s) Factor Cash Flows
Overhaul $(40,000) 0 1.000 $ (40,000)
Annual operations (70,000) 1-5 2.991 (209,370)
Salvage value 5,000 5 0.402 2,010
Net present value $(247,360)
Present value of new system:
Predicted PV PV of
Cash Flows Year(s) Factor Cash Flows
Investment $(100,000) 0 1.000 $(100,000)
Salvage value, old 20,000 0 1.000 20,000
Annual operations (40,000) 1-5 2.991 (119,640)
Salvage value 20,000 5 0.402 8,040
Net present value $(191,600)
Buying the new equipment is the most desirable by $55,760 ($247,360 - $191,600).
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55. Investment A requires a net investment of $800,000. The required rate of return is 12%
for the four-year annuity. What are the annual cash inflows if the net present value
equals 0? (rounded)
a. $189,483
b. $263,418
c. $274,848
d. $ 295,733

3.037 x ACI - $800,000 = $0
= $ 263,418
56. The focus in capital budgeting should be on

a. the tax consequences of different investment strategies.
b. the internal rate of return of different strategies.
c. expected future cash flows that differ between alternatives.
57. All of the following are major categories of cash flows in capital investment decisions
EXCEPT
a. the initial investment in machines and working capital.
b. recurring operating cash flows.
c. the initial working capital investment
d. depreciation expense reported 0 on the
0 income statement.

58. An example of a sunk cost in a capital budgeting decision for new equipment is
a. increase in working capital required by a particular investment choice.
b. the book value of the old equipment.
c. the necessary transportation costs on the new equipment.
d. all of the above are examples of sunk costs.
59. Depreciation is usually not considered an operating cash flow in capital budgeting
because
a. depreciation is usually a constant amount each year over the life of the capital
investment.
b. deducting depreciation from operating cash flows would be counting the lump-
sum amount twice.
c. depreciation usually does not result in an increase in working capital.
d. depreciation usually has no effect on the disposal price of the machine.
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60. The relevant terminal disposal price of a machine equals
a. the difference between the salvage value of the old machine and the ultimate
salvage value of the new machine.
b. the total of the salvage values of the old machine and the new machine.
c. the salvage value of the old machine.
d. the salvage value of the new machine.
61. The method that measures the time it will take to recoup, in the form of future cash
inflows, the total dollars invested in a project is called
a. the accrued accounting rate-of-return method.
b. payback method.
c. internal rate-of-return method.
d. the book-value method.
62. The net initial investment for a piece of construction equipment is $1,000,000. Annual
cash inflows are expected to increase by $200,000 per year. The equipment has an 8-
year useful life. What is the payback period?
a. 8.00 years
b. 7.00 years
c. 6.00 years
d. 5.00 years

$1,000,000/$200,000 = 5.0 years
63. The payback method of capital budgeting approach to the investment decision
highlights
a. cash flow over the life of the investment.
b. the liquidity of the investment.
c. the tax savings of the depreciation amounts.
d. having as lengthy payback time as possible.
64. The approach to capital budgeting which divides an accounting measure of income by
an accounting measure of investment is
a. net present value.
b. internal rate of return. 0 0
c. payback method.
d. accrual accounting rate of return.
Chapter 21 Page 14
65. For capital budgeting decisions, the use of the accrual accounting rate of return for
evaluating performance is often a 0stumbling
0 block to the implementation of the
a. net cash flow.
b. most effective goal-congruence choice.
c. discounted cash flow method for capital budgeting.
d. most effective tax strategy.
66. In the analysis of a capital budgeting proposal, for which of the following items are
there no after-tax consequences?
a. Cash flow from operations
b. Gain or loss on the disposal of the asset
c. Reduction of working capital balances at the end of the useful life of the capital
asset
d. There are no after-tax consequences of any of the above.
67. The Alpha Beta Corporation disposes of a capital asset with an original cost of $85,000
and accumulated depreciation of $54,500 for $25,000. Alpha Beta's tax rate is 40%.
Calculate the after-tax cash inflow from the disposal of the capital asset.
a. $2,200
b. ($2,200)
c. $27,200
d. $31,500

($85,000 - 54,500) = $30,500 - $25,000 = $5,500 loss x 0.4 = $2,200 tax savings from
loss plus $25,000 proceeds = $27,200.
68. The Phenom Corporation has an annual cash inflow from operations from its
investment in a capital asset of $50,000 for five years. The corporation's income tax
rate is 40%. Calculate the five years total after-tax cash inflow from operations.
a. $250,000
b. $175,000
c. $150,000
d. $50,000

$50,000 x 5 = $250,000 x (1- 0.4) = $150,000 net cash flow
Chapter 21 Page 15
0 0
69. Comparison of the actual results for a project to the costs and benefits expected at the
time the project was selected is referred to as
a. the audit trail.
b. management control.
c. a postinvestment audit.
d. a cost-benefit analysis.
70. A capital budgeting tool management can use to summarize the difference in the future
net cash inflows from an intangible asset at two different points in time is referred to as
a. the accrual accounting rate-of-return method.
b. the net present value method.
c. sensitivity analysis
d. the payback method.
0 0
Chapter 21 Page 16
0 0
EXERCISES AND PROBLEMS
71. Match each one of the examples below with one of the stages of the capital budgeting
decision model.
Stages:
1. Identification
2. Search
3. Information-acquisition
4. Selection
5. Financing
6. Implementation and control
______ a. Issuing corporate stock in order to supply the funds to purchase new
equipment
______ b. Learning how to effectively operate Machine #8 only takes 15 minutes
______ c. The need to reduce the costs to process the vegetables used in
producing goulash
______ d. Monitoring the costs to operate a new machine
______ e. Percentage of defective merchandise considered too high
______ f. Will introducing the new product substantially upgrade our image as a
producer of quality products
______ g. Research indicates there are five machines on the market capable of
producing our product at a competitive cost
______ h. Utilization of the internal rate of return for each alternative
Answer:
a. Financing
b. Information-acquisition
c. Identification
d. Implementation and control
e. Identification
f. Information-acquisition
g. Search
0 0
h. Selection
Chapter 21 Page 17
0 0
72. The Zero Machine Company is evaluating a capital expenditure proposal that requires
an initial investment of $20,960 and has predicted cash inflows of $5,000 per year for
10 years. It will have no salvage value.
Required:
a. Using a required rate of return of 16%, determine the net present value of the
investment proposal.
b. Determine the proposal's internal rate of return.
Answer:
a.
Predicted PV of Cash
Cash Flows Year(s) PV Factor Flows
Annual operations 5,000 10 4.833 24,165
Net present value $ 3,205
b. Present value factor of an annuity of $1.00 = $20,960/$5,000 = 4.192.
From annuity table, the 4.192 factor is closest to the 10-year row at the 20%
column. Therefore, the IRR is 20%.
Chapter 21 Page 18
0 0

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CHAPTER 21: CAPITAL BUDGETING AND COST ANALYSIS

Answer: True Difficulty: 2 Objective: 1

2. The identification stage of capital budgeting explores alternative capital investments

Answer: False Difficulty: 1 Objective: 2

Answer: True Difficulty: 1 Objective: 2

Answer: True Difficulty: 1 Objective: 2

Answer: False Difficulty: 2 Objective: 3

6. Discounted cash flow methods focus on operating income.

Answer: False Difficulty: 2 Objective: 3

Answer: True Difficulty: 2 Objective: 3

Answer: False Difficulty: 2 Objective: 3

Answer: False Difficulty: 2 Objective: 3

Answer: True Difficulty: 2 Objective: 3

Answer: True Difficulty: 2 Objective: 4

Answer: True Difficulty: 2 Objective: 4

Answer: False Difficulty: 2 Objective: 5

Answer: False Difficulty: 3 Objective: 5

Answer: True Difficulty: 2 Objective: 6

Answer: False Difficulty: 2 Objective: 7

Answer: True Difficulty: 2 Objective: 8

Answer: True Difficulty: 3 Objective: 8

19. An example of an intangible asset would be a corporation’s customer base.

Answer: True Difficulty: 2 Objective: 8

Answer: False Difficulty: 2 Objective: A

Answer: a Difficulty: 1 Objective: 1

Answer: d Difficulty: 1 Objective: 1

Answer: a Difficulty: 1 Objective: 2

Answer: b Difficulty: 1 Objective: 2

Answer: c Difficulty: 1 Objective: 2

Answer: a Difficulty: 1 Objective: 2

Answer: a Difficulty: 1 Objective: 2

28. Capital budgeting emphasizes two factors

Answer: c Difficulty: 1 Objective: 2

Answer: d Difficulty: 2 Objective: 2

Answer: d Difficulty: 2 Objective: 3

Answer: d Difficulty: 2 Objective: 3

32. Net present value is calculated using

Answer: b Difficulty: 2 Objective: 3

Answer: c Difficulty: 2 Objective: 3

Answer: d Difficulty: 2 Objective: 3

Answer: b Difficulty: 3 Objective: 3

Answer: a Difficulty: 3 Objective: 3

Answer: c Difficulty: 3 Objective: 3

Answer: a Difficulty: 2 Objective: 3

Answer: d Difficulty: 2 Objective: 3

Answer: c Difficulty: 2 Objective: 3

41. The definition of an annuity is

Answer: b Difficulty: 2 Objective: 3

42. The net present value method focuses on

Answer: d Difficulty: 2 Objective: 3

Answer: a Difficulty: 2 Objective: 3

Answer: d Difficulty: 3 Objective: 3

Answer: a Difficulty: 3 Objective: 3

Answer: b Difficulty: 3 Objective: 3

Answer: d Difficulty: 2 Objective: 3

Answer: a Difficulty: 2 Objective: 3

Answer: b Difficulty: 3 Objective: 3

Answer: a Difficulty: 2 Objective: 3

Answer: a Difficulty: 2 Objective: 3