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Exam 15: Capital Investment Analysis

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Question 41

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In net present value analysis for a proposed capital investment, the expected future net cash flows are reduced to their present values.

A) True
B) False

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Question 42

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For years one through five, a proposed expenditure of $400,000 for a fixed asset with a 5-year life has expected net income of $50,000, $40,000, $20,000, $20,000, and $20,000, respectively, and net cash flows of $130,000, $120,000, $100,000, $100,000, and $100,000, respectively. The cash payback period is 3.5years.

A) True
B) False

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Question 43

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Which of the following is a present value method of analyzing capital investment proposals?

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: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$ The cash payback period for this investment is:

A 5-year project is estimated to cost $700,000 and have no residual value. If the straight-line depreciation method is used and estimated total income is $231,000, determine the average rate of return giving effect to depreciation on the investment.

A present value index can be used to rank competing capital investment proposals when the net present value method is used.

The process by which management allocates available investment funds among competing capital investment proposals is termed capital rationing.

The payback period is determined using which of the following formulas?

If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected net cash flow and net income of $32,000 and $12,000, respectively, the cash payback period is 2.5 years.

Which of the following provisions of the Internal Revenue Code can be used to reduce the amount of the income tax expense arising from capital investment projects?

When evaluating two competing proposals with unequal lives, management should give greater consideration to the investment with the longer life because the asset will be useful to the company for a longer period of time.

The primary advantages of the average rate of return method of analyzing a capital investment proposal are its ease of computation and the fact that:

Internal rate of return is often called the payback rate of return.

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

June Co. is evaluating a project requiring a capital expenditure of $620,000. The project has an estimated life of four years and no salvage value. The estimated net income and net cash flow from the project are as follows: $\begin{array}{ll} \text {Net Cash Flow}& \text {Net Income}& \text { Year}\\\$ 200,000 & \$ 45,000 &1\\240,000 & 85,000 &2\\160,000 & 5,000&3 \\170,000 & 15,000 &4\\ 770,000 & \$ 150,000\end{array}$ The company's minimum desired rate of return 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: (a) the average rate of return on investment, giving effect to depreciation on the investment, and (b) the net present value.

Using the following partial table of present value of $1 at compound interest, determine the present value of $20,000 to be received four years hence with earnings at the rate of 12% a year: $\begin{array} { | l | l | l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0.890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$

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 discount period.

Qualitative considerations are best evaluated using present value methods such as internal rate of return.

Harris Co. is considering a 12-year project that is estimated to cost $900,000 and has no residual value. Harris seeks to earn an average rate of return of 15% on all capital projects. Determine the necessary average annual income (using straight-line depreciation) that must be achieved on this project for it to be acceptable to Harris Co.

Care must be taken while making capital investment decisions since it involves a long-term commitment of funds and affects operations for several years.