Krajewski Om9 Tif SuppF

Supplement F  Financial Analysis
Supplement
F Financial Analysis
TRUE/FALSE
1. The time value of money implies that a dollar in hand today is worth more than a dollar
to be received in the future.
Answer: True
Reference: Time Value of Money
Difficulty: Easy
Keywords: time value of money
2. Discounting is the process by which interest on an investment accumulates, and then

earns interest itself for the remainder of the investment period.
Answer: False
Difficulty: Moderate
Keywords: compounding interest
3. The value of an investment at the end of the period over which interest is compounded is
called the future value of the investment.
Answer: True
Difficulty: Easy
Keywords: future value
4. The present value of an investment is the amount that must be invested now to
accumulate to a certain amount in the future at a specific interest rate.
Answer: True
Keywords: present value
5. The interest rate is also called the discount rate.

Answer: True
Keywords: interest rate, discount rate
6. An annuity is a series of payments of a fixed amount for a specified number of years.

Answer: True
Difficulty: Easy
Keywords: annuity payment
753
Copyright ©2010 Pearson Education
7. Cash flow is the cash that will flow into and out of the organization.
Answer: True
Reference: Techniques of Analysis
Difficulty: Easy
Keywords: cash flow
8. Depreciation is not a legitimate cash flow.

Answer: True
Keywords: depreciation, cash flow
9. Straight-line depreciation is an accelerated depreciation method.

Answer: False
Keywords: depreciation, accelerated depreciation, straight-line depreciation
10. The advantage of using the modified accelerated cost recovery system (MACRS) for
depreciation is that it extends the lives of investments, giving a firm a longer period of
time before the item must be replaced.
Answer: False
Keywords: depreciation, accelerated, cost recovery, MACRS
11. The net present value (NPV) method evaluates an investment by calculating the present
values of all after-tax total cash flows and then subtracting the original investment
amount from their total.
Answer: True
Keywords: NPV, net present value, after-tax cash flow
12. The hurdle rate is the interest rate that is the highest desired return on an investment.
Answer: False
Difficulty: Easy
Keywords: hurdle rate
754
MULTIPLE CHOICE
called the:
a. time value of money.
b. present value of an investment.
c. future value of an investment.
d. None of the above.
Answer: c
Difficulty: Easy
Keywords: future value, investment
14. The amount to be invested now to accumulate to a certain amount in the future at a
specified interest rate is called the:
a. time value of money.
b. present value of an investment.
c. future value of an investment.
d. None of the above.
Answer: b
Difficulty: Easy
Keywords: present value, investment
15. An investor puts $10,000 in an account earning 4 percent compounded interest. At the
end of three years, the account will have a value of:
a. less than $11,000.
b. between $11,000 and $11,200.
c. between $11,200 and $11,400.
d. more than $11,400.
Answer: c
Difficulty: Easy
16. It is estimated that the cost for the first year of college at Massive University, the state
school with the best operations management program, will be $60,000 by the time your
son is ready to enroll as a student. If prevailing interest rates will average 5 percent, what
amount should you invest now to pay his first year’s tuition eight years from now?
a. Less than $35,000
b. Between $35,000 and $38,000
c. Between $38,000 and $41,000
d. More than $41,000
Answer: c
Keywords: present value
755
17. Depreciation:
a. is not an allowance for the consumption of capital.
b. is not a legitimate cash flow.
c. does not act as a tax shield.
d. does not consider the salvage value of an item.
Answer: b
Keywords: depreciation
18. Which method of analysis does not consider the time value of money?
a. Net present value (NPV)
b. Internal rate of return (IRR)
c. Payback
d. Future Value of an Investment (FVI).
Answer: c
Keywords: time value, payback, NPV, IRR
19. A poultry farmer is interested in purchasing an egg tester that can measure weight,
albumin height, yolk color, and Haugh units all at the touch of a button. The unit will cost
$6900 and is expected to last 10 years at which point it can be sold for $500 to a farmer
in a less stringently controlled egg market. What is the annual depreciation under the
straight line method?
a. $640
b. $690
c. $50
d. $740
Answer: a
Difficulty: Easy
Keywords: straight-line depreciation
20. A poultry farmer is interested in purchasing an industrial egg tester that can measure
weight, albumin height, yolk color, and Haugh units all at the touch of a button. The unit
will cost $6900 and is expected to last 10 years at which point it can be sold for $1000 to
a farmer in a less stringently controlled egg market. What is the annual depreciation for
year 4 under the MACRS method? A copy of Table F.3 is appended to your exam.
a. $862
b. $795
c. $737
d. $680
Answer: b
Keywords: MACRS, depreciation, modified accelerated cost recovery
756
21. Which of the following is an accelerated depreciation method?

a. Straight-line depreciation
b. MACRS
c. Net present value
d. After-tax cash flow
Answer: b
Keywords: depreciation, accelerated depreciation
22. A flexible manufacturing system is expected to cost $25,000,000 but has present values
of after-tax cash flow as shown in the table. The interest rate used is 10 percent. What is
the payback of this investment?
Year -After-Tax Net Present Value of

Cash Flow After-Tax Cash Flow
1 $11,000,000 $10,000,100
2 $9,000,000 $7,437,600
3 $7,000,000 $5,259,800
4 $5,000,000 $3,415,000
5 $3,000,000 $1,862,700
a. Less than two years

b. Between two and three years
c. Between three and four years
d. More than four years
Answer: b
Keywords: payback
FILL IN THE BLANK
23. The ____________ is the concept that a dollar in hand today is worth more than a dollar
to be received in the future.
Answer: time value of money
Difficulty: Easy
24. The process by which interest on an investment accumulates and then earns interest itself
for the remainder of the investment period is called ____________.
Answer: compounding interest
Keywords: compounding interest
757
called the ____________.
Answer: future value of an investment
26. The amount that must be invested now to accumulate to a certain amount in the future at
a specified interest rate is called the ____________.
Answer: present value of an investment
Keywords: present value, investment
27. A(n) ____________ is a series of payments of a fixed amount for a specified number of
years.
Answer: annuity
Keywords: annuity payments
28. Cash flows should be converted to ____________ amounts before applying the net
present value, payback, or internal rate of return method to them.
Answer: after-tax
Keywords: cash flow, after-tax cash flow
29. ____________ is the cash that will flow into and out of the organization.
Answer: Cash flow
Keywords: cash flow
30. ____________ is an allowance for the consumption of capital.

Answer: Depreciation
Keywords: depreciation, allowance
31. The ____________ method of calculating annual depreciation is the simplest, and usually
is adequate for internal planning purposes.
Answer: straight-line
Keywords: straight-line depreciation
758
32. Since 1986, the only acceptable accelerated depreciation method is the ____________.
Answer: Modified Accelerated Cost Recovery System (MACRS)
Keywords: accelerated depreciation, Modified Accelerated Recovery, MACRS
33. The cash flow from the sale or disposal of plant and equipment at the end of a project’s
life is its ____________.
Answer: salvage value
Keywords: salvage value
34. The ____________ is the interest rate that is the lowest desired return on an investment.
Answer: hurdle rate
Keywords: hurdle rate
35. The ____________ is the discount rate that makes the NPV of a project zero.
Answer: internal rate of return, IRR
Keywords: internal rate of return, IRR
36. The ____________ is used to evaluate projects by calculating the amount of time that
will elapse before the total of after-tax cash flows will equal the initial investment.
Answer: payback method
Keywords: payback method
37. The term ____________ is often used to describe the common U.S. business practice of
focusing on short-term results from low-risk projects via analysis by NPV or IRR
calculations.
Answer: managing by the numbers
Keywords: managing by the numbers
SHORT ANSWERS
38. Explain the time-value-of-money concept.

Answer: Basically, a dollar in hand today is worth more than a dollar to be received in
the future.
Difficulty: Easy
759
39. Describe the basic techniques of financial analysis.

Answer: The three techniques discussed in this textbook are net present value, internal
rate of return, and payback. Net present value (NPV) calculates the present value of all
future after-tax cash flows and then subtracts the original investment amount from their
total. The internal rate of return (IRR) is the discount rate that makes the NPV of a
project zero. Payback determines how much time will elapse before the total of after-tax
cash flows will equal, or pay back, the initial investment.
Keywords: financial analysis, NPV, IRR, payback, net present value, internal rate of
return
40. What are the problems and advantages of managing by the numbers?
Answer: Financial analysis provides tools to objectively weigh decisions involving the
deployment of capital. As such, it allows managers within a firm to make direct
comparisons and standardize investment analysis. Managing by the numbers tends to
favor short-term, low-risk projects that provide quick paybacks in favor of more strategic,
long-term investments.
Keywords: managing by the numbers
Table F.3
Class of Investment
Year 3-Year 5-Year 7-Year 10-Year
1 33.33 20.00 14.29 10.00
2 44.45 32.00 24.49 18.00
3 14.81 19.20 17.49 14.40
4 7.41 11.52 12.49 11.52
5 11.52 8.93 9.22
6 5.76 8.93 7.37
7 8.93 6.55
8 4.45 6.55
9 6.55
10 6.55
11 3.29
760

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Supplement F  Financial Analysis

2. Discounting is the process by which interest on an investment accumulates, and then

5. The interest rate is also called the discount rate.

6. An annuity is a series of payments of a fixed amount for a specified number of years.

8. Depreciation is not a legitimate cash flow.

9. Straight-line depreciation is an accelerated depreciation method.

21. Which of the following is an accelerated depreciation method?

Year -After-Tax Net Present Value of

a. Less than two years

FILL IN THE BLANK

30. ____________ is an allowance for the consumption of capital.

38. Explain the time-value-of-money concept.

39. Describe the basic techniques of financial analysis.

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