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Exam 16: Planning for Capital Investments

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Question 61

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The difference between an ordinary annuity and an annuity due is:

A) an ordinary annuity represents a present value and an annuity due represents a future value.
B) an ordinary annuity represents a future value and an annuity due represents a present value.
C) an ordinary annuity assumes the cash flows occur at the beginning of the period and an annuity due assumes the cash flows occur at the end of the period.
D) an ordinary annuity assumes the cash flows occur at the end of the period and an annuity due assumes the cash flows occur at the beginning of the period.

E) A) and D)
F) None of the above

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Question 62

Multiple Choice

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Which of the following are not present value methods of analyzing capital investment proposals?

A) Internal rate of return and payback
B) Unadjusted rate of return and net present value
C) Net present value and payback
D) Payback and unadjusted rate of return

E) None of the above
F) A) and D)

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Question 63

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A dollar to be received in the future is subject to the effects of risk and inflation.

Janelle Bates has just inherited $250,000 from her uncle's estate. She is considering opening a small sewing and fabric shop. She would need to purchase inventory costing $50,000. Janelle plans to rent a shop in a local shopping center for $12,000 per year. Fixtures, display equipment, and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years to its expected salvage value of $3,000. Operating costs will amount to $25,000 per year. Janelle estimates her revenues from sales and sewing services will total $65,000. Because Janelle believes she can earn a 10% return by investing in mutual funds, she does not want to start the business unless she can earn at least this rate. Ignore income taxes.(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)Required:Prepare a schedule of expected cash flows for the proposed investment by completing the table provided below. In Column 1 enter a brief description of the cash flow. In Column 2 indicate whether the cash flow is an inflow (I) or an outflow (O). In Column 3 enter the years in which the cash flow will occur. For example, if the cash flow occurs immediately enter a 0. If the cash flow occurs each year, enter 1 to 5, etc. In Column 4 enter the cash flow amount.

The future value of $1 table should be used to discount lump sum cash flows expected to occur in the future.

Findell Corporation is considering two projects, A and B, and it has gathered the following estimates for the projects: $\begin{array}{lcc}&\text {Project A}&\text {Project B}\\\text { Useful life } & 5 \text { Years } & 5 \text { Years } \\\text { Present value of cash inflows } & \$ 84,360 & \$ 55,100 \\\text { Present value of cash outflows } & \$ 77,000 & \$ 49.000\end{array}$ What is the net present value of cash flows for project B?

Weston Company is considering a capital project that delivers a $50,000 annual net cash flow before tax. The investment will result in annual depreciation expense of $10,000 over the project's four-year useful life. Assuming a tax rate of 40%, what amount of annual after-tax net cash flow will be provided by this project?

Which capital budgeting technique defines returns in terms of income instead of cash flows?

An annuity is a series of equal payments over equal time intervals that earn a constant rate of return.

Matt needs to compute the present value of $5,000 to be received four years from now. He should multiply $5,000 by the appropriate present value interest factor obtained from the present value of $1 table.

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: $\begin{array}{ccc}\text { Year } & \text { Investment A} &\text { Investment B} \\0 & \$(5,000) & \$(6,000) \\1 & 2,000 & 3,000 \\2 & 2,000 & 2,000 \\3 & 2,000 & 2,000 \\4 & 2,000 & 1,000\end{array}$ Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

Indicate whether each of the following statements is true or false. Internal rate of return measures the difference between an investment's rate of return and the company's required rate of return. ______A spreadsheet program is useful in doing internal rate of return analyses. ______Capital investment analyses should take tax consequences into account. ______Depreciation on equipment or a building has the effect of sheltering some of a corporation's income from income taxes. ______The amount of a depreciation tax shield is calculated by multiplying the amount of depreciation by (1 - the tax rate). ______

What amount of cash must be invested today in order to have $33,000 at the end of one year assuming the rate of return is 9%? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

Montana Company is evaluating two different capital investments, Project X and Y. Either X or Y would cost $210,000, and the company cannot afford to do both. The company expects that Project X would provide net cash inflows of $62,000 per year for 5 years. For Project Y, the net cash inflows are expected to be as follows: $\begin{array}{crr}\text { Year}&\text { Cash inflows trom Project } Y\\1 & \$ 44,000 \\2 & 48,000 \\3 & 60,000 \\4 & 76,000 \\5 & 80,000 \\\text { Total }& \$ 308,000\end{array}$ Montana's cost of capital is 12%. (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)Required:Calculate the present value index for Project X and for Project Y. Round your answer to three decimal places.Indicate whether each of the projects is an acceptable investment.Based on present value index, which of the two projects should Montana implement?

Connor has $490,000 to invest in a 5-year annuity. Assuming the time value of money is 12%, what amount will Connor receive in cash each year?(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

What is the reinvestment assumption, and how does the assumption affect capital investment analyses?

Evergreen Company has two investment opportunities. Both investments cost $5,000 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{crc}&\text { Investment I }&\text {Investment II }\\\text { Period 1 } & \$ 1,000 & \$ 3,000 \\\text { Period 2 } & 1,000 & 3,000 \\\text { Period 3 } & 2,000 & 2,000 \\\text { Period } 4 & \underline{4,000} &\underline{ 1,000}\\\text { Total } &\underline{\$ 8,000}&\underline{\$8,000}\end{array}$ Select the correct statement.

Indicate whether each of the following statements is true or false. An ordinary annuity assumes that cash flows occur at the beginning of each period. ______To say that an investment earns the desired rate of return assumes that all cash flows generated by the investment are reinvested at the desired rate of return. ______Managers should not use two different methods in evaluating capital investment decisions because different methods generally give different results. ______Copley Corporation uses a required rate of return of 10% for its capital investment decisions. A particular project had a negative net present value. For this project, the actual rate of return was expected to be more than 10%. ______The net present value of a capital investment project is calculated by subtracting the present value of expected cash inflows from the cost of the investment. ______

Which of the following does not represent an advantage of the unadjusted rate of return over the payback method for evaluating capital projects?

An investment that costs $33,000 will produce annual cash flows of $11,020 for a period of 4 years. Given a desired rate of return of 9%, what will the investment generate?(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to the nearest dollar.)