Learning Objective 26-1: Chapter 26 Capital Investment Decisions

Horngren's Accounting, 10e, Global Edition (Nobles/Mattison/Matsumura)
Chapter 26 Capital Investment Decisions
Learning Objective 26-1
1) An operational asset used for a long period of time is known as a capital asset.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
AICPA Functional: Measurement
2) The acquisition or construction of a capital asset is known as a capital investment.

Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
3) A post-audit in capital budgeting is a comparison of actual results of capital investments with the
projected results.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
4) Capital rationing is a process adopted when a company has limited resources, and it must find ways to
reduce operating expenses in all of its divisions and units.
Answer: FALSE
Diff: 1
LO: 26-1
AACSB: Concept
5) Two methods of analyzing potential capital investments—payback and accounting rate of return—
ignore the time value of money.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
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6) The accounting rate of return method uses accrual-based accounting income.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
7) To determine the investment's net cash inflows, the inflows are netted against the investment's initial
cash outflow.
Answer: FALSE
Diff: 1
LO: 26-1
AACSB: Concept
8) The payback period and accounting rate of return (ARR) methods are suitable to investments with a
short time span.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
9) The payback method and the accounting rate of return method are often used to perform an initial
screening of investments, rather than a detailed, in-depth analysis.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
10) Most capital budgeting methods focus on cash flows rather than book income.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
11) Payback provides management with valuable information about the time period within which the
cash invested will be recouped.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
2
12) Net present value and internal rate of return consider the time value of money, so they are
appropriate for longer-term capital investments
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
13) Which of the following best describes a post-audit in capital budgeting?

A) an audit of an operating unit of a company
B) an audit performed after financial statements have been issued
C) an analysis of an investment's cash flows prior to committing to the initial investment
D) a comparison of actual results of capital investments with projected results
Answer: D
Diff: 1
LO: 26-1
AACSB: Concept
14) Which of the following best describes the term "capital rationing"?
A) a method of determining the period within which the cash invested is recouped
B) a process of ranking and choosing among alternative capital investments based on the availability of
funds
C) a method which shows the effect of the investment on the company's accrual-based income
D) a process of controlling operating costs when adequate funds are not available
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
15) The last step in the capital budgeting process is control which compares the actual results with the
projected results. These comparisons are known as:
A) cash inflows.
B) post-audits.
C) ranks.
D) cash outflows
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
3
16) Which of the following describes the word "capital budgeting"?
A) It involves budgeting for yearly operational expenses.
B) It involves preparing the sales budget for the coming year.
C) It involves deciding among various long-term investment decisions.
D) It involves analyzing various alternatives of financing available to a company.
Answer: C
Diff: 1
LO: 26-1
AACSB: Concept
17) Which of the following is a capital budgeting method?

A) return on assets
B) net present value
C) inventory turnover
D) return on equity
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
18) Which of the following is a capital budgeting method that is used to screen potential investments?
A) return on assets
B) acid test ratio
C) accounting rate of return
D) debt-to-equity ratio
Answer: C
Diff: 1
LO: 26-1
AACSB: Concept
19) Which of the following two methods are typically used for initial screening of investments, rather
than for detailed, in-depth analysis?
A) payback and accounting rate of return
B) net present value and payback
C) internal rate of return and net present value
D) accounting rate of return and net present value
Answer: A
Diff: 1
LO: 26-1
AACSB: Concept
4
20) Which of the following is true of projecting future cash flows of an investment?
A) Information on cash flow will also include non-cash transactions like depreciation.
B) Cash inflows and cash outflows are treated separately, rather than being netted together.
C) Cash flows are projected by accounting personnel without considering input from other business
functions.
D) The initial investment is always treated separately from all other cash flows.
Answer: D
Diff: 2
LO: 26-1
AACSB: Concept
21) Capital budgeting is:

A) the process of planning the investment in long-term assets.
B) preparing the budget for operating expenses.
C) the process of evaluating the profitability of a business.
D) the process of making pricing decisions for products.
Answer: A
Diff: 1
LO: 26-1
AACSB: Concept
1) The accounting rate of return method and the payback method are often used as preliminary screening
measures, but are insufficient to fully evaluate a capital investment.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
2) All else being equal, investments with longer payback periods are preferable.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
3) Net cash inflows from a capital investment arise from an increase in revenues, a decrease in expenses,
or both.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
5
4) A major criticism of the payback method is that it focuses only on time to recover the investment, and
ignores profitability.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
5) The payback considers only those cash flows that occur during the payback period and ignores any
cash flows that occur after that period.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
6) The payback method can only be used when the net cash inflows from a capital investment are the
same for each period.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
7) The accounting rate of return method of analyzing a potential capital investment considers the time
value of money.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
8) The payback method is the most thorough and comprehensive way to choose the best investment
among alternatives, than any other capital budgeting methods.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
9) The payback method uses discounted cash flows to make investment decisions.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
6
10) The payback method ignores cash flows that an asset generates, whereas the accounting rate of return
includes them.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
11) The accounting rate of return method focuses on net operating income instead of net cash inflow
generated by an asset.
Answer: TRUE
Diff: 2
LO: 26-2
AACSB: Concept
12) The accounting rate of return is also known as average rate of return or annual rate of return.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
13) The accounting rate of return method evaluates the lifetime return of an asset, whereas return on
investment evaluates an annual return.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
14) The accounting rate of return is calculated by dividing the average annual operating income by the
average amount invested.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
7
15) Which of the following is a capital budgeting method that ignores the time value of money?
A) payback
B) internal rate of return
C) return on assets
D) net present value
Answer: A
Diff: 1
LO: 26-2
AACSB: Concept
16) Which capital budgeting method uses accrual accounting, rather than net cash flows, as a basis for
calculations?
A) payback
B) accounting rate of return
C) net present value
D) internal rate of return
Answer: B
Diff: 2
LO: 26-2
AACSB: Concept
17) Flip Flop company is considering investing in production-management software that costs $600,000,
has $60,000 residual value, and should lead to cost savings of $150,000 per year for its five-year life.
Calculate the average amount invested in the asset that should be used for calculating the accounting rate
of return?
A) $660,000
B) $600,000
C) $330,000
D) $60,000
Answer: C
Diff: 1
LO: 26-2
AACSB: Application
8
18) Cortes Company is considering three investment opportunities with the following payback periods:
Project X Project Y Project Z

Payback period 3 years 2.5 years 2.8 years
Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being
equal.
A) Y, Z, X
B) X, Y, Z
C) Z, Y, X
D) Y, X, Z
Answer: A
Diff: 1
LO: 26-2
AACSB: Application
19) Newman Automobiles Manufacturing is considering two alternative investment proposals with the
following data:
Proposal X Proposal Y
Investment $10,000,000 $500,000
Useful life 5 years 5 years
Estimated annual net cash inflows for 5 years $2,000,000 $95,000
Residual value $50,000 $20,000
Depreciation method Straight-line Straight-line
Required rate of return 12% 10%
Calculate the payback period for Proposal X.

A) 5 years
B) 4 years
C) 8 years
D) 10 years
Answer: A
Explanation: A)
Payback = Amount invested ÷ Expected annual net cash inflow
Payback for Proposal X = $10,000,000 ÷ $2,000,000 per year = 5 years
Diff: 2
LO: 26-2
AACSB: Application
9
20) Newman Automobiles Manufacturing is considering two alternative investment proposals with the
following data:
Investment $10,000,000 $500,000
Estimated annual net cash inflows for 5 years $2,000,000 $95,000
Residual value $50,000 $20,000
Calculate accounting rate of return for Proposal Y.

A) 8.95%
B) 10.21%
C) 7.50%
D) 6.57%
Answer: C
Explanation: C) Calculation of accounting rate of return:
Proposal Y
Total net cash inflows during operating life of the $475,000
asset ($95,000 per year × 5 years)
Less: Total depreciation during operating life of the
asset ($400,000 - $0) 400,000
Total operating income during operating life 75,000
Divide by: Asset's operating life in years ÷5
Average annual operating income from asset $15,000
Average amount invested [($400,000 + 0) ÷ 2] $200,000
ARR of Proposal Y = Average annual operating income ÷ Average amount invested

ARR = $15,000 ÷ $200,000 = 7.5% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
10
21) The following details are provided by a manufacturing company.
Product line
Investment $1,000,000
Useful life 12 years
Estimated annual net cash inflows for first year $400,000
Estimated annual net cash inflows for second year $350,000
Estimated annual net cash inflows for next ten years $300,000
Residual value $50,000
Depreciation method Straight-line
Required rate of return 12%
Calculate the payback period for the investment.

A) 2.5 years
B) 2.83 year
C) 3.0 years
D) 3.5 years
Answer: B
Explanation: B) Payback = 2 years + [($1,000,000 - $750,000)] ÷ $300,000 = 2.83 years or 2 years 10 months.
Diff: 2
LO: 26-2
AACSB: Application
22) Logy Inc. is evaluating two possible investments in depreciable plant assets. The company uses the
straight-line method of depreciation. The following information is available:
Investment A Investment B
Initial capital investment $100,000 $150,000
Estimated useful life 10 years 10 years
Estimated residual value 0 $20,000
Estimated annual net cash inflow for 10 years $20,000 $40,000
Calculate the payback period for Investment A.

A) 3 years
B) 4 years
C) 1 year
D) 5 years
Answer: D
Explanation: D) Payback for Investment A = $100,000/$20,000 = 5 years.
Diff: 2
LO: 26-2
AACSB: Application
11
23) Logy Inc. is evaluating two possible investments in depreciable plant assets. The company uses the
straight-line method of depreciation. The following information is available:
Investment A Investment B
Initial capital investment $100,000 $150,000
Estimated useful life 10 years 10 years
Estimated residual value 0 $20,000
Estimated annual net cash inflow for 10 years $20,000 $40,000
Calculate the payback period for Investment B.

A) 3 years
B) 2 years
C) 4 years
D) 5 years
Answer: A
Explanation: A) Payback for Investment B = $150,000/$50,000 = 3 years
Diff: 2
LO: 26-2
AACSB: Application
12
24) Dartis Company is considering investing in a specialized equipment costing $600,000. The equipment
has a useful life of 5 years and a residual value of $60,000. Depreciation is calculated using the straight-
line method. The expected net cash inflows from the investment are given below.
Year 1 $200,000
2 150,000
3 160,000
4 95,000
5 75,000
$680,000
What is the accounting rate of return on the investment?

A) 7.95%
B) 8.78%
C) 8.48%
D) 9.25%
Answer: C
Explanation: C)
Calculation of accounting rate of return:
Total net cash inflows during operating life of the asset $680,000
asset ($600,000 - $60,000) 540,000
Average amount invested [($600,000 + $60,000) ÷ 2] $330,000
ARR of Equipment = Average annual operating income ÷ Average amount invested

ARR = $28,000 ÷ $330,000 = 8.48% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
13
25) Landmark Company is considering an investment in new equipment costing $500,000. The equipment
will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash
inflows of $120,000 the first year, $140,000 the second year, and $150,000 every year thereafter until the
fifth year. What is the payback period for this investment? The residual value is zero.
A) 4.5 years
B) 3.6 years
C) 2.9 years
D) 3.2 years
Answer: B
Explanation: B)
Net cash outflows Net cash inflows
Year Amount invested Annual Accumulated
0 500,000
1 $120,000 $120,000
2 140,000 260,000
3 150,000 410,000
4 150,000 560,000
5 150,000 710,000
Payback = 3 years + [($500,000 - $410,000) ÷ $150,000] = 3.6 years

Diff: 2
LO: 26-2
AACSB: Application
26) Software Hub is deciding whether to purchase new accounting software. The cost of the software
package is $55,000, and its expected life is 10 years. The payback for this investment is four years.
Assuming equal yearly cash flows, what are the expected annual net cash savings from the new software?
(Assume the investment has zero salvage value.)
A) $5,500
B) $37,800
C) $13,750
D) $220,000
Answer: C
Explanation: C) Expected annual net cash savings from the software = $55,000 ÷ 4 years = $13,750
Diff: 2
LO: 26-2
AACSB: Application
14
27) Paramount Company is considering purchasing new equipment costing $700,000. The company's
management has estimated that the equipment will generate cash flows as follows:
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
Residual value is zero. What is the payback period?

A) 4.5 years
B) 3.2 years
C) 3.5 years
D) 3.8 years
Answer: B
Explanation: B)
Net cash outflows Net cash inflows
Year Amount invested Annual Accumulated
0 700,000
1 $200,000 $200,000
2 200,000 400,000
3 250,000 650,000
4 250,000 900,000
5 150,000 1,050,000
Payback = 3 years + [($700,000 - $650,000) ÷ $250,000] = 3.2 years

Diff: 2
LO: 26-2
AACSB: Application
28) Caliber Company is considering the purchase of a new machine costing $800,000. The company's
management is estimating that the new machine will generate additional cash flows of $180,000 a year for
ten years and have a salvage value of $50,000 at the end of ten years. What is the machine's payback
period?
A) 4.44 years
B) 6.77 years
C) 3.33 years
D) 5.33 years
Answer: A
Explanation: A) Payback period =$800,000/$180,000 = 4.44 years
Diff: 2
LO: 26-2
AACSB: Application
15
29) Nylan Company is considering an investment in new equipment costing $850,000. The equipment
will be depreciated on a straight-line basis over a five-year life and is expected to have a salvage value of
$50,000. The equipment is expected to generate net cash inflows of $1,000,000 in total during the five
years life. What is the accounting rate of return associated with the equipment investment?
A) 9.99%
B) 8.89%
C) 7.56%
D) 9.32%
Answer: B
Explanation: B)
Total net cash inflows during operating life of the asset $1,000,000
asset ($850,000 - $50,000) 800,000

ARR = $40,000 ÷ $450,000 = 8.89% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
16
30) Clapton Corporation is considering an investment in new equipment costing $900,000. The equipment
will be depreciated on a straight-line basis over a ten-year life and is expected to have a salvage value of
$90,000. The equipment is expected to generate net cash flows of $140,000 for each of the first five years
and $100,000 for each of the last five years. What is the accounting rate of return associated with the
equipment investment?
A) 8.89%
B) 9.23%
C) 8.52%
D) 7.88%
Answer: D
Explanation: D)
Total net cash inflows during operating life of the
asset [($140,000 × 5) + ($100,000 × 5)] $1,200,000
asset ($900,000 - $90,000) 810,000
Divide by: Asset's operating life in years ÷ 10

ARR = $39,000 ÷ $495,000 = 7.88% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
17
31) A company is evaluating three possible investments. Following information is provided by the
company.
Project A Project B Project C

Investment $200,000 $50,000 $200,000
Salvage value 0 5,000 10,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the payback period for Project A? (Assume that the company uses the straight-line depreciation
method.)
A) 3.0 years
B) 2.0 years
C) 4.0 years
D) 5.0 years
Answer: C
Explanation: C) Payback = $200,000 ÷ $50,000 = 4 years
Diff: 1
LO: 26-2
AACSB: Application
18
32) A company is evaluating three possible investments. Each uses straight-line method of depreciation.
Following information is provided by the company.

Investment $200,000 $50,000 $200,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the accounting rate of return for Project B?

A) 15.08%
B) 10.214%
C) 15.45%
D) 14.54%
Answer: C
Explanation: C)
asset ($25,000 + $16,000 + $12,000 +$9,000)
asset ($50,000 - $5,000) 45,000
ARR of Project B = Average annual operating income ÷ Average amount invested

ARR = $4,250 ÷ $27,500 = 15.45% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
19
33) A company is evaluating three possible investments. Each uses straight-line method of depreciation.
Following information is provided by the company.

Investment 200,000 $50,000 $200,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the accounting rate of return for Project C?

A) 15%
B) 12%
C) 18%
D) 10%
Answer: B
Explanation: B)
asset ($80,000 + $50,000 + $60,000 +$20,000)
asset ($200,000 - $50,000) 150,000
ARR of Project C = Average annual operating income ÷ Average amount invested

ARR = $15,000 ÷ $125,000 = 12% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
34) Which of the following capital budgeting methods uses accrual accounting information?
A) payback
B) accounting rate of return
C) net present value
D) internal rate of return
Answer: B
Diff: 1
LO: 26-2
AACSB: Concept
20
1) The fact that invested cash earns income over time is called the time value of money.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
2) An annuity refers to a series of equal cash flows received or paid annually.

Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
3) All else being equal, the shorter the investment period, the higher the total amount of interest earned.
Answer: FALSE
Diff: 1
LO: 26-3
AACSB: Concept
4) Compound interest means that interest is calculated only on the principal amount.
Answer: FALSE
Diff: 1
LO: 26-3
AACSB: Concept
5) Compound interest assumes that all interest earned will be reinvested at the same rate of interest at
which the investment was originally made.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
6) The only difference between present value and future value is the amount of interest that is earned in
the intervening time span.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
21
7) Paramount Company is considering purchasing new equipment costing $700,000. The management
has estimated that the equipment will generate cash flows as follows:
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
Present value of $1:
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
The company's required rate of return is 8%. Using the factors in the table, calculate the present value of
the cash inflows. (Round all calculations to the nearest whole dollar)
A) $890,000
B) $750,000
C) $850,000
D) $841,000
Answer: D
Explanation: D)
Calculation of present value of cash inflows:
Cash inflows PV factors at 8% Present value

$200,000 0.926 $185,200
200,000 0.857 171,400
250,000 0.794 198,500
250,000 0.735 183,750
150,000 0.681 102,150
$841,000
Diff: 3
LO: 26-3
AACSB: Application
22
8) Paramount Company is considering purchasing new equipment costing $700,000. Company's
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
The company's required rate of return is 9%. Using the factors in the table, calculate the present value of
the cash flows.
A) $850,000
B) $819,300
C) $820,500
D) $852,000
Answer: B
Explanation: B)
Calculation of present value of cash inflows:
Cash Inflows PV factors at 9% Present Value

$200,000 0.917 $183,400
200,000 0.842 168,400
250,000 0.772 193,000
250,000 0.708 177,000
150,000 0.650 97,500
$819,300
Diff: 3
LO: 26-3
AACSB: Application
23
9) Paramount Company is considering purchasing new equipment costing $700,000. Company's
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
The company's required rate of return is 10%. Using the factors in the table below, calculate the present
value of the cash inflows. Present value of $1:
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
A) $765,000
B) $768,921
C) $798,650
D) $780,000
Answer: C
Explanation: C)
Cash Inflows PV factors at 10% Present Value
$200,000 0.909 $181,800
200,000 0.826 165200
250,000 0.751 187750
250,000 0.683 170750
150,000 0.621 93150
$798,650
Diff: 3
LO: 26-3
AACSB: Application
10) Which of the following describes the term time value of money?
A) Money can be used only at certain times and only for certain purposes.
B) Money loses its purchasing power over time through inflation.
C) Wasted time can result in wasted money.
D) Value of a dollar received today will be higher than that received after some time.
Answer: D
Diff: 1
LO: 26-3
AACSB: Concept
24
11) Which of the following most accurately describes the term annuity?
A) an investment which produces increasing cash flows overtime
B) an installment loan with amortizing principal payments
C) a stream of equal installments of cash flows made at equal time intervals
D) a term life insurance policy
Answer: C
Diff: 1
LO: 26-3
AACSB: Concept
12) Lara is going to receive $10,000 a year at the end of each of the next five years from her insurer to meet
her education cost. Using a discount rate of 14%, the present value of the receipts can be stated as:
A) PV = $10,000 (Annuity FV factor, i = 14%, n = 5).
B) PV = $10,000 (PV factor, i = 14%, n = 5).
C) PV = $10,000 (Annuity PV factor, i = 14%, n = 5).
D) PV = $10,000 (FV factor, i = 14%, n = 5).
Answer: C
Diff: 1
LO: 26-3
AACSB: Application
25
13) If $10,000 is invested annually in an account with 7% interest compounded yearly, what will the
balance of the account be after six years? Refer to the following Future Value table:
Future value of annuity of $1:
5% 6% 7% 8%
1 1 1 1 1
2 2.05 2.06 2.07 2.08
3 3.153 3.184 3.215 3.246
4 4.31 4.375 4.44 4.506
5 5.526 5.637 5.751 5.867
6 6.802 6.975 7.153 7.336
7 8.142 8.394 8.654 8.923
A) $79,050
B) $71,530
C) $18,020
D) $83,290
Answer: B
Explanation: B)
Balance in the account after six years:
Net Cash Annuity

Time Inflow FV Factor Future Value
1-6 years Cash flow $10,000 7.153 $71,530
Diff: 1
LO: 26-3
AACSB: Application
26
14) If $15,000 is invested annually in an account with 9% interest compounding yearly, what will the
balance of the account be after five years? Refer to the following Future Value table:
Future value of annuity of $1:
7% 8% 9%
1 0.935 0.926 0.917
2 1.808 1.783 1.759
3 2.624 2.577 2.531
4 3.387 3.312 3.24
5 4.1 3.993 3.89
6 4.767 4.623 4.486
7 5.389 5.206 5.033
A) $26,180
B) $26,211
C) $58,350
D) $25,125
Answer: C
Explanation: C) Balance in the account after five years:
Net cash Annuity

Time inflow FV Factor Future Value
1-5 years Cash flow $15,000 3.89 $58,350
Diff: 1
LO: 26-3
AACSB: Application
27
15) John wins the lottery and has the following three payout options for after-tax prize money:
1. $150,000 per year at the end of each of the next six years
2. $300,000 (lump sum) now
3. $500,000 (lump sum) six years from now
The required rate of return is 9%. What is the present value if he selects the first option? Round to nearest
whole dollar.
Present value of annuity of $1:
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $750,000
B) $672,900
C) $450,000
D) $450,050
Answer: B
Explanation: B) Present value of lottery receipt under first option:
Net cash Annuity

Time inflow PV Factor Present Value
1-6 years Cash flow $150,000 4.486 $672,900
Diff: 1
LO: 26-3
AACSB: Application
28
2. $300,000 (lump sum) now
The required rate of return is 9%. What is the present value if he selects the second option? Round to
nearest whole dollar.
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $650,000
B) $100,000
C) $400,000
D) $300,000
Answer: D
Diff: 1
LO: 26-3
AACSB: Application
29
2. $300,000 (lump sum) now
The required rate of return is 9%. What is the present value if he selects the third option? Round to
nearest whole dollar.
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $250,000
B) $230,000
C) $238,400
D) $298,000
Answer: D
Explanation: D) Present value of lottery receipt under third option:
Net Cash Annuity

Time Inflow PV Factor Present Value
6th year Cash flow $500,000 0.596 $298,000
Diff: 1
LO: 26-3
AACSB: Application
30
18) Nylan Manufacturing is considering two alternative investment proposals with the following details:
Investment $720,000 $500,000
Estimated annual net cash inflows $150,000 $90,000
Residual value $50,000 $0
Discount rate 10% 9%
What is the total present value of future cash inflows from Proposal Y?
8% 9% 10%
1 0.926 $0.92 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
A) $266,750
B) $291,600
C) $290,000
D) $250,000
Answer: B
Explanation: B) Present value of future cash inflows from proposal Y:
Net cash Annuity

1-4 years Cash flow $90,000 3.24 $291,600
Diff: 2
LO: 26-3
AACSB: Application
31
32
19) Nylan Manufacturing is considering two alternative investment proposals with the following details:
Investment $720,000 $500,000
Estimated annual net cash inflows $150,000 $90,000
Residual value $50,000 $0
Discount rate 10% 9%
What is the total present value of future cash inflows from Proposal X?
8% 9% 10%
1 0.926 $0.92 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
A) $742,340
B) $650,070
C) $568,650
D) $599,700
Answer: D
Explanation: D) Present value of cash inflows from Proposal X:
Net cash Annuity Present

Time inflow PV Factor Value
1-5 years Present value of annuity $150,000 3.791 $568,650
5th year Present value of residual value 50,000 0.621 31,050
Total present value of cash flows $599,700
Diff: 1
LO: 26-3
AACSB: Application
33
20) Arriyana has just received an inheritance of $100,000, and she would like to put it into an investment
portfolio for 20 years. Which of the following would be useful to calculate the value of the investment at
the end of 20 years?
A) Present Value of $1
B) Present Value of an Annuity of $1
C) Future Value of $1
D) Future Value of an Annuity of $1
Answer: C
Diff: 1
LO: 26-3
AACSB: Concept
21) Zane has received a prize which entitles him to receive annual payments of $10,000 for the next 10
years. Which of the following is to be referred to in order to calculate the total value of the prize today?
A) Present Value of $1
B) Present Value of an Annuity of $1
C) Future Value of $1
D) Future Value of an Annuity of $1
Answer: B
Diff: 1
LO: 26-3
AACSB: Concept
34
22) James has just won the lottery after purchasing one $10 lottery ticket. The state offers him the
following three payout options for after-tax prize money:
2. $300,000 (lump sum) now
Calculate the present value of each scenario using an 8% discount rate. Round to nearest whole dollar.
7% 8% 9%
1 0.935 0.926 0.917
2 1.808 1.783 1.759
3 2.624 2.577 2.531
4 3.387 3.312 3.24
5 4.1 3.993 3.89
6 4.767 4.623 4.486
7% 8% 9%
1 0.935 0.926 0.917
2 0.873 0.857 0.842
3 0.816 0.794 0.772
4 0.763 0.735 0.708
5 0.713 0.681 0.65
6 0.666 0.63 0.596
Answer:
Scenario 1: Present value of lottery receipt:
Net cash Annuity

1-6 years Cash flow $50,000 4.623 $231,150
Scenario 2: Present value of lottery receipt = $300,000
Scenario 3: Present value of lottery receipt:
Net cash
6th year Cash flow $400,000 0.63 $252,000
Diff: 2
LO: 26-3
AACSB: Application
35
1) Net present value is defined as the difference between the present value of the project's net cash
inflows and the cost of investment.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
2) Management's minimum desired rate of return on a capital investment is known as the return on
investment.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
3) The residual value is discounted as a single lump sum because it will be received only once at the end
of life of the asset.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
4) When the internal rate of return is the same as the required rate of return, the net present value of an
investment will be positive.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
5) The NPV method of evaluating capital investments suggests that a project with positive net cash
inflows that exceed the cost of the investment should be accepted.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
36
6) When calculating the net present value of future cash flows, dollars that are received in earlier years
are worth more than dollars received in later years.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
7) The internal rate of return (IRR) is the rate of return, based on discounted cash flows, that a company
can expect to earn by investing in a capital asset.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
8) The benefit foregone by not choosing an alternative course of action is known as an opportunity cost.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
9) Out of all methods of evaluating capital investments, the discounted cash flow methods are superior
because they consider both the time value of money and the profitability of the investment.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
10) When evaluating a potential investment, managers should use more than one measure for making a
sound investment decision.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
11) When a company is evaluating an investment proposal with high risk, a low discount rate should be
used, and vice versa.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
37
12) Compound interest used in discounted cash flow calculations assumes that companies will reinvest
future cash flows whenever they are received.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
13) If an investment project's IRR is higher than the company's required rate of return, the company
should reject the investment.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
14) Discounted cash flow methods consider the time value of money while evaluating an investment
proposal.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
15) Which of the following is true of discounted cash flow methods like NPV and IRR?
A) They use simple interest calculations.
B) They use net income amounts rather than cash flows.
C) They focus on the payback period.
D) They consider discounted cash flows.
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept
16) Which of the following is true of discounted cash flow methods like NPV and IRR?
A) They use simple interest calculations.
B) They assume that cash flows will be reinvested when received.
C) They focus on the payback period.
D) They comply with the requirements of GAAP.
Answer: B
Diff: 1
LO: 26-4
AACSB: Concept
38
17) Cash flows used in NPV and IRR analysis ignore:
A) future increased sales.
B) future cost savings.
C) depreciation expense.
D) residual value.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
18) Which of the following situations suggests the acceptance of an investment proposal?
A) The present value of the net cash inflows exceeds the initial investment.
B) The IRR is lower than the hurdle rate.
C) The cash inflows are lesser than the initial investment.
D) The investment will have a residual value.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
19) The term net present value means the difference between:
A) the total net income of the project and the initial investment.
B) the initial investment and the residual value.
C) the future value of the cash flows and the present value of the cash flows.
D) the present value of the net cash inflows and the investment's cost.
Answer: D
Diff: 2
LO: 26-4
AACSB: Concept
20) Which of the following most accurately describes the discount rate used in NPV analysis?
A) the rate of inflation
B) the rate of interest earned on a savings account
C) the required rate of return or the hurdle rate
D) the rate of interest charged for debt financing of an investment
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
39
21) Gamma Company is considering an investment of $500,000 in a land development project. It will
yield cash flows of $200,000 for 5 years. The company uses a discount rate of 9%. What is the net present
value of the investment?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
A) $230,000
B) $278,000
C) $330,000
D) $200,000
Answer: B
Explanation: B)
1-5 years Cash flow $200,000 3.89 $778,000
0 Initial investment (500,000)
Net present value $278,000
Diff: 2
LO: 26-4
AACSB: Application
40
22) Gamma Company is considering an investment proposal that would require an initial outlay of
$800,000, and would yield yearly cash flows of $200,000 for 9 years. The company uses a discount rate of
10%. What is the NPV of the investment?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8 5.747 5.535 5.335
9 6.247 5.995 5.759
A) $350,000
B) $400,000
C) $351,800
D) $250,000
Answer: C
Explanation: C)
1-9 years Cash flow $200,000 5.759 $1,151,800
0 Initial Investment (800,000)
Net present value $351,800
Diff: 2
LO: 26-4
AACSB: Application
41
23) A company is considering an iron ore extraction project which requires an initial investment of
$500,000 and will yield annual cash flows of $150,000 for 4 years. The company's hurdle rate is 9%. What
is the NPV of the project?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8 5.747 5.535 5.335
9 6.247 5.995 5.759
10 6.71 6.418 6.145
A) positive $14,000
B) negative $100,000
C) positive $100,000
D) negative $14,000
Answer: D
Explanation: D)
1-4 years Cash flow 150,000 3.24 $486,000
Net present value ($14,000)
Diff: 2
LO: 26-4
AACSB: Application
24) Which of the following would be the best basis on whether to accept an investment opportunity or
not?
A) if it has positive total cash inflows
B) if it has a payback period in less than 10 years
C) if the investment's rate of return is higher than the company's current year required rate of return
D) if the net present value is positive
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept
42
25) Following details are provided by Dopler Company.
Initial investment $2,000,000

Discount rate 12%
Yearly cash flows
1 $200,000
2 $400,000
3 $400,000
4 $400,000
5 $200,000
Refer to the following table for PV factors:
10% 11% 12% 13%

1 0.909 0.901 0.893 0.885
2 0.826 0.812 0.797 0.783
3 0.751 0.731 0.712 0.693
4 0.683 0.659 0.636 0.613
5 0.621 0.593 0.567 0.543
Calculate the NPV of the project.

A) $950,000 negative
B) $850,000 negative
C) $1,005,000 positive
D) $250,000 positive
Answer: B
Explanation: B)
Net cash Annuity
Present value of each year's inflow
1 $200,000 0.893 $178,600
2 400,000 0.797 318,800
3 400,000 0.712 284,800
4 00,000 0.636 254,400
5 00,000 0.567 113,400
Total PV of cash inflows $1,150,000
0 Total Investment (2,000,000)
Net present value of the project ($850,000)
Diff: 2
LO: 26-4
AACSB: Concept
43
26) Following details are provided by VPN Company.

Discount rate 15%
Yearly cash flows
1 $1,250,000
2 $1,350,000
3 $2,400,000
4 $1,150,000
Refer to the following table for PV factors:

13% 14% 15%
1 0.885 0.877 0.87
2 0.783 0.769 0.756
3 0.693 0.675 0.658
4 0.613 0.592 0.572
What is the NPV of the project?

A) $654,900 negative
B) $590,000 positive
C) $615,455 positive
D) $590,850 negative
Answer: A
Explanation: A)
Net cash Annuity
Present value of each year's inflow
1 $1,250,000 0.87 $1,087,500
2 1,350,000 0.756 1,020,600
3 2,400,000 0.658 1,579,200
4 1,150,000 0.572 657,800
Total PV of cash inflows $4,345,100
0 Total Investment 5,000,000
Net present value of the project ($654,900)
Diff: 2
LO: 26-4
AACSB: Application
44
27) When comparing several investments with the same initial outlay, the decision should be made on the
basis of:
A) highest total cash inflows.
B) longest payback period.
C) highest NPV.
D) highest ARR.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
28) Under conditions of limited resources, when a company is comparing several investments with
different amounts of initial outlay, the decision should be made on the basis of:
A) highest total cash inflows.
B) shortest payback period.
C) highest profitability index.
D) highest NPV.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
29) Which of the following best describes the profitability index?

A) an index of projects based on their net income
B) the ratio of present value of net cash inflows to initial investment
C) the ratio of total cash inflows to initial investment
D) an array of possible investment outcomes at different discount rates
Answer: B
Diff: 1
LO: 26-4
AACSB: Concept
45
30) A company seeking investment opportunities has collected the following information.
Project A Project B Project C Project D

Initial investment $400,000 $250,000 $150,000 $270,000
PV of cash inflows $570,000 $295,000 $210,000 $282,000
Payback period (years) 3.6 3.0 4.75 3.5
NPV of project $170,000 $45,000 $60,000 $12,000
Profitability index 1.43 1.18 1.40 1.04
If the company makes a decision based on the NPV, the most preferable project would be:
A) Project A.
B) Project B.
C) Project C.
D) Project D.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
31) The following details are provided by Dopler Company:

NPV of project $150,000 $180,000 $250,000 ($110,000)
Calculate the profitability index for Project A.

A) 0.98
B) 1.08
C) 1.36
D) 1.66
Answer: C
Explanation: C)
Calculation of Profitability Index:
Project A
Present value of cash inflows $570,000
Initial Investment 420,000
Profitability Index($570,000 ÷ $420,000) 1.36
Diff: 2
LO: 26-4
AACSB: Application
46

NPV of project $150,000 $180,000 $250,000 ($110,000)
What is the profitability index for Project B?

A) 1.98
B) 1.38
C) 1.26
D) 1.90
Answer: D
Explanation: D) Project B
Initial Investment 200,000
Profitability Index ($380,000 ÷ $200,000) 1.90
Diff: 2
LO: 26-4
AACSB: Application

NPV of project $150,000 $180,000 $250,000 ($110,000)
What is the profitability index for Project C?

A) 1.45
B) 1.38
C) 1.26
D) 1.23
Answer: A
Explanation: A) Project C
Initial investment 550,000
Profitability index ($800,000 ÷ $550,000) 1.45
Diff: 2
LO: 26-4
AACSB: Application
47

NPV of project $150,000 $180,000 $250,000 ($110,000)
Which project has the highest profitability index?

A) Project A
B) Project B
C) Project C
D) Project D
Answer: B
Explanation: B)
Present value of cash inflows $570,000 $380,000 $800,000 $390,000
Profitability index 1.36 1.90 1.45 0.78
Diff: 3
LO: 26-4
AACSB: Application
35) Which of the following best describes the term sensitivity analysis?
A) setting the budgets of an investment
B) analyzing the effect of an investment on workers' morale
C) evaluating different investment options
D) testing the results of an investment analysis with varying assumptions
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept/Application
36) Which of the following is the rate of return, based on discounted cash flows, that a company can
expect to earn by investing in a capital asset?
A) accounting rate of return (ARR)
B) bank interest rate
C) internal rate of return (IRR)
D) return on investment
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
48
37) Which of the following best describes the internal rate of return?
A) discount rate at which the cost of the investment equals the present value of the net cash inflows from
the investment
B) discount rate that is used to evaluate funds borrowed from a lender for profitability
C) the ratio of average annual income to average amount invested
D) the rate at which the profitability of an investment increases
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
38) At the internal rate of return (IRR), the present value of cash inflows will be equal to:
A) initial investment.
B) residual value.
C) average operating income.
D) profit from the project.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
49
39) A company is considering an iron ore extraction project which requires an initial investment of
$1,000,000 and will yield annual cash flows of $350,263 for 4 years. The company's hurdle rate is 9%.
Calculate IRR.
A) 15%
B) 18%
C) 12%
D) 10%
Answer: A
Explanation: A) Calculation of IRR:

Present value of cash inflows 350,263
Annuity PV factor ($1,000,000 ÷ $350,263) 2.855
Net cash Annuity

1-4 years Cash flow $350,263 2.855 $1,000,000
0 Initial Investment 1,000,000
Net present value 0
15%
1 0.87
2 1.626
3 2.283
4 2.855
At IRR, NPV = 0
Diff: 2
LO: 26-4
AACSB: Application
50
40) Nobell Company is evaluating an investment of $1,000,000 which will yield net cash inflows of
$142,369 per year for 10 years with no residual value. What is the internal rate of return?
5% 6% 7% 8%
1 0.952 0.943 0.935 0.926
2 1.859 1.833 1.808 1.783
3 2.723 2.673 2.624 2.577
4 3.546 3.465 3.387 3.312
5 4.329 4.212 4.1 3.993
6 5.076 4.917 4.767 4.623
7 5.786 5.582 5.389 5.206
8 6.463 6.21 5.971 5.747
9 7.108 6.802 6.515 6.247
10 7.722 7.36 7.024 6.71
A) 6%
B) 7%
C) 8%
D) 9%
Answer: B
Explanation: B)
Present value of cash inflows 142,369
Annuity PV factor ($1,000,000 ÷ $142,369) 7.024

1-10 years Cash flow 142,369 7.024 $1,000,000
0 Initial Investment 1,000,000
Net present value 0
Diff: 2
LO: 26-4
AACSB: Application
51
41) Gamma Company is considering an investment opportunity with the following expected net cash
inflows: Year 1, $250,000; Year 2, $350,000; Year 3, $395,000. The company uses a discount rate of 12% and
the initial investment is $750,000.
The following table is available:

Present Value of $1:
10% 12% 14% 15%

1 0.909 0.893 0.877 0.870
2 0.826 0.797 0.769 0.756
3 0.751 0.712 0.675 0.658
4 0.683 0.636 0.592 0.572
5 0.621 0.567 0.519 0.497
The IRR of the project will be:

A) less than 12%.
B) between 12% and 13%.
C) between 14% and 15%.
D) more than 12%.
Answer: C
Explanation: C)
At 10% $250,000 0.909 $227,250
$350,000 0.826 289,100
$395,000 0.751 296,645
(750,000)
Net Present Value 62,995
At 14% $250,000 0.877 219,250

$350,000 0.769 269,150
$395,000 0.675 266,625
(750,000)
Net Present Value 5,025
At 15% $250,000 0.87 217,500

$350,000 0.756 264,600
$395,000 0.658 259,910
(750,000)
Net Present Value ($7,990)
Diff: 3
LO: 26-4
AACSB: Application
52
42) Gladeer Company is evaluating an investment that will cost $520,000 and will yield cash flows of
$300,000 in the first year, $200,000 in the second year, and $100,000 in the third and final year. Use the
tables below and determine the internal rate of return.
8% 9% 10% 11%
1 0.926 0.917 0.909 0.901
2 0.857 0.842 0.826 0.812
3 0.794 0.772 0.751 0.731
4 0.735 0.708 0.683 0.659
5 0.681 0.65 0.621 0.593
The IRR of the project will be:

A) between 9% and 10%.
B) less than 8%
C) less than 9%, more than 8%
D) more than 10%
Answer: A
Explanation: A) At 8% $300,000 0.926 $277,800
$200,000 0.857 171,400
$100,000 0.794 79,400
(520,000)
Net Present Value $8,600
At 9% $300,000 0.917 $275,100

$200,000 0.842 168,400
$100,000 0.772 77,200
(520,000)
Net Present Value $700
At 10% $300,000 0.909 $272,700

$200,000 0.826 165,200
$100,000 0.751 75,100
(520,000)
Diff: 3
LO: 26-4
AACSB: Application
53
43) Canbera Company is considering investing $450,000 in telecommunications equipment which would
have an estimated life of 5 years with zero residual value. The cash flows are as shown below:
Year 1 $120,000
2 $235,000
3 $140,000
4 $98,000
The present value of $1 factors are given below:
10% 12% 13% 14%

1 0.909 0.893 0.885 0.877
2 0.826 0.797 0.783 0.769
3 0.751 0.712 0.693 0.675
4 0.683 0.636 0.613 0.592
5 0.621 0.567 0.543 0.519
The IRR of the project would be:

A) between 12% and 13%
B) more than 13%
C) less than 10%
D) between 8% and 10%
Answer: A
Explanation: A) At 10%$120,000 0.909 $109,080
$235,000 0.826 194,110
$140,000 0.751 105,140
$98,000 0.683 66,934
(450,000)
At 12% $120,000 0.893 $107,160

$235,000 0.797 187,295
$140,000 0.712 99,680
$98,000 0.636 62,328
(450,000)
At 13% $120,000 0.885 $106,200

$235,000 0.783 184,005
$140,000 0.693 97,020
$98,000 0.613 60,074
(450,000)
Diff: 3
LO: 26-4
AACSB: Application
54
44) Gamma Company is considering an investment opportunity with the following expected net cash
inflows: Year 1, $250,000; Year 2, $350,000; Year 3, $395,000. Residual value of the investment would be
$50,000. The company uses a discount rate of 12% and the initial investment is $400,000. Calculate the
NPV of the investment.
11% 12% 13% 14%

1 0.901 0.893 0.885 0.877
2 0.812 0.797 0.783 0.769
3 0.731 0.712 0.693 0.675
4 0.659 0.636 0.613 0.592
5 0.593 0.567 0.543 0.519
Answer: Net cash Present

Time inflow PV factor Value
Present value of each year's cash flow
1 $250,000 0.893 $223,250
2 350,000 0.797 278,950
3 395,000 0.712 281,240
3 Present value of residual value 50,000 0.712 35,600
Net Present value $419,040
Diff: 3
LO: 26-4
AACSB: Application
55
45) Gamma Company is considering an investment opportunity with the expected net cash inflows of
$300,000 for four years. Residual value of the investment would be $70,000. The company uses a discount
rate of 14% and the initial investment is $290,000. Calculate the NPV of the investment.
12% 13% 14% 15%

1 0.893 0.885 0.877 0.87
2 1.69 1.668 1.647 1.626
3 2.402 2.361 2.322 2.283
4 3.037 2.974 2.914 2.855
5 3.605 3.517 3.433 3.352
12% 13% 14% 15%

1 0.893 0.885 0.877 0.87
2 0.797 0.783 0.769 0.756
3 0.712 0.693 0.675 0.658
4 0.636 0.613 0.592 0.572
5 0.567 0.543 0.519 0.497
Answer: Net cash Annuity Present

1-4 years Present value of annuity $300,000 2.914 $874,200
4th year Present value of residual value 70,000 0.592 41,440
0 Initial Investment 290,000
Net Present value $625,640
Diff: 3
LO: 26-4
AACSB: Application
56

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Learning Objective 26-1: Chapter 26 Capital Investment Decisions

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Horngren's Accounting, 10e, Global Edition (Nobles/Mattison/Matsumura)

Chapter 26 Capital Investment Decisions

Learning Objective 26-1

2) The acquisition or construction of a capital asset is known as a capital investment.

13) Which of the following best describes a post-audit in capital budgeting?

17) Which of the following is a capital budgeting method?

21) Capital budgeting is:

Learning Objective 26-2

Project X Project Y Project Z

Calculate the payback period for Proposal X.

Calculate accounting rate of return for Proposal Y.

ARR of Proposal Y = Average annual operating income ÷ Average amount invested

Calculate the payback period for the investment.

Calculate the payback period for Investment A.

Calculate the payback period for Investment B.

What is the accounting rate of return on the investment?

ARR of Equipment = Average annual operating income ÷ Average amount invested

Payback = 3 years + [($500,000 - $410,000) ÷ $150,000] = 3.6 years

Residual value is zero. What is the payback period?

Payback = 3 years + [($700,000 - $650,000) ÷ $250,000] = 3.2 years

ARR of Equipment = Average annual operating income ÷ Average amount invested

ARR of Equipment = Average annual operating income ÷ Average amount invested

Project A Project B Project C

Project A Project B Project C

What is the accounting rate of return for Project B?

ARR of Project B = Average annual operating income ÷ Average amount invested

Project A Project B Project C

What is the accounting rate of return for Project C?

ARR of Project C = Average annual operating income ÷ Average amount invested

2) An annuity refers to a series of equal cash flows received or paid annually.

Present value of $1:

Cash inflows PV factors at 8% Present value

Present value of $1:

Cash Inflows PV factors at 9% Present Value

Net Cash Annuity

Net cash Annuity

Present value of $1:

Net cash Annuity

Net Cash Annuity

Net cash Annuity

Present value of $1:

Net cash Annuity Present

Present value of $1:

Net cash Annuity

Scenario 2: Present value of lottery receipt = $300,000

Scenario 3: Present value of lottery receipt:

Initial investment $2,000,000

Refer to the following table for PV factors:

10% 11% 12% 13%

Calculate the NPV of the project.

Initial investment $5,000,000

Refer to the following table for PV factors:

What is the NPV of the project?

29) Which of the following best describes the profitability index?

Project A Project B Project C Project D

31) The following details are provided by Dopler Company:

Project A Project B Project C Project D

Calculate the profitability index for Project A.