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Exam 15: Capital Investment Analysis

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Question 1

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If the average rate of return on an asset exceeds the minimum rate of return for investments, the asset should be purchased.

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B) False

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Question 2

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

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B) False

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Question 3

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Which of the following is a qualitative consideration that influences capital investments analysis?

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: ​ $\begin{array} { c r r } \text { Year } & \text { Net Income } & \text { Net Cash Flow } \\1 & \$ 60,000 & \$ 120,000 \\2 & 50,000 & 110,000 \\3 & 45,000 & 105,000 \\4 & 30,000 & 90,000 \\5 & 20,000 & 80,000 \\& \mathbf { \$ 2 0 5 , 0 0 0 } & \mathbf { \$ 5 0 5 , 0 0 0 }\end{array}$ ​ 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: ​ $\begin{array} { | c | c | } \hline \text { Year } & \begin{array} { c } \text { Present Value } \\\text { of } \$ 1 \text { at } 12 \%\end{array} \\\hline 1 & 0.893 \\\hline 2 & 0.797 \\\hline 3 & 0.712 \\\hline 4 & 0.636 \\\hline 5 & 0.567 \\\hline\end{array}$ ​ Determine (a) the average rate of return on investment, giving effect to depreciation on the investment, and (b) the net present value.

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%.

In capital rationing, an initial screening of alternative proposals is usually performed by establishing minimum standards.Which of the following evaluation methods are normally used?

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

Qualitative considerations in capital investment decisions are most appropriate for strategic investments or those that are designed to affect a company's long-term ability to generate profits.

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.

Using the following partial table of present value of $1 at compound interest, determine the present value of $35,000 to be received three years hence, with earnings at the rate of 10% a year. $\begin{array} { c c c c } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 0.890 & 0.826 & 0.797 \\3 & 0.840 & 0.751 & 0.712 \\4 & 0.792 & 0.683 & 0.636\end{array}$

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.

Proposals L and K each cost $500,000, have 6-year lives, and have expected total cash flows of $750,000.Proposal L is expected to provide equal annual net cash flows of $125,000, while the net cash flows for Proposal K are as follows: ​ $\begin{array} { l r } \text { Year 1 } & \$ 250,000 \\\text { Year 2 } & 200,000 \\\text { Year 3 } & 100,000 \\\text { Year 4 } & 90,000 \\\text { Year 5 } & 60,000 \\\text { Year 6 } & 50,000 \\& \underline { \mathbf { \$ 75 } 0,000 } \\\hline\end{array}$ ​ Determine the cash payback period for each proposal.

Cash payment for monthly rent is an example of _____.

The process by which management plans, evaluates, and controls long-term investment decisions involving fixed assets is called capital investment analysis.

The management of London Corporation is considering the purchase of a new machine costing $750,000.The company's desired rate of return is 6%.The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively.In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array} { c c c } \text { Year } & \text { Income from Operations } & \text { Net Cash Flow } \\\hline 1 & \$ 37,500 & \$ 187,500 \\2 & 37,500 & 187,500 \\3 & 37,500 & 187,500 \\4 & 37,500 & 187,500 \\5 & 37,500 & 187,500\end{array}$ ? The net present value for this investment is:

Project A as well as project B require an initial investment of $1,050,000, have a 6-year life, and have expected total cash inflows of $1,680,000.Proposal A is expected to provide an annual net cash inflow of $280,000, while the annual net cash inflows for Proposal B are as follows: ​ $\begin{array} { l l } \text { Year 1 } & \$ 350,000 \\\text { Year 2 } & \$ 315,000 \\\text { Year 3 } & \$ 280,000 \\\text { Year 4 } & \$ 280,000 \\\text { Year 5 } & \$ 245,000 \\\text { Year 6 } & \$ 210,000\end{array}$ ​ 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.

Which of the following capital investment evaluation methods uses present values while evaluating different projects?

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

The management of Retz Corporation is considering the purchase of a new machine costing $500,000.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: $\begin{array} { c c c } \text { Year } & \text { Income from Operations } & \text { Net Cash Flow } \\\hline 1 & \$ 100,000 & \$ 200,000 \\2 & 80,000 & 170,000 \\3 & 50,000 & 130,000 \\4 & 10,000 & 80,000 \\5 & 10,000 & 80,000\end{array}$ ? The net present value for this investment is: