Title: Capital Budgeting Decisions
Course: Question Banks

Q: Two new product lines are being considered by Z-Corp. They all require capital outlay for equipment and restructuring of the manufacturing facility. What would your first step be in analyzing the two potential capital budgeting projects?
- Evaluate the two projects using one of the available methods and pick the one with the highest rate of return.
- Evaluate the projects based on cost and rank them from least to most costly to implement.
- Evaluate each one to insure that they meet the minimum return on investment as set by your company before proceeding to analyze them further.
A: Evaluate each one to insure that they meet the minimum return on investment as set by your company before proceeding to analyze them further.

Q: The fact that $10,000 now is worth more than $10,000 eight years from now is important because;
- We want to invest in the project that has the lowest up front costs.
- Since capital projects are typically short term projects, we want to spend our money wisely.
- Capital budgeting typically involves projects that will last for many years, so the time value of money is crucial to decisions.
A: Capital budgeting typically involves projects that will last for many years, so the time value of money is crucial to decisions.

Q: Your company is currently busting at the seams from a space standpoint. In evaluating purchasing the building next door to yours for expansion, what might you consider first?
- Can we create new jobs with additional space?
- Can we pay off the loan on the new space quickly with the additional revenues?
- Will the additional space allow us to increase our capacity and net income, meeting our minimum return on investment goals?
A: Will the additional space allow us to increase our capacity and net income, meeting our minimum return on investment goals?

Q: It can be cost effective to replace old equipment, even if new equipment is costly if:
- The old equipment can be traded in for the new equipment.
- The new equipment is automated so you no longer need employees to run it.
- There is an increase in efficiency and lower manufacturing costs that creates a good rate of return on the purchase.
A: There is an increase in efficiency and lower manufacturing costs that creates a good rate of return on the purchase.

Q: Capital budgeting decisions are reserved for:
- Day to day purchases of office supplies and equipment.
- Raw materials for production due to the high cost.
- Large purchases that involve projects or equipment that last for longer periods of time and have a high cost.
A: Large purchases that involve projects or equipment that last for longer periods of time and have a high cost.

Q: A dollar invested today at 4% interest will be worth how much in 20 years?
- $1.00
- $1.80
- $2.1911
A: $2.1911

Q: A friend borrowed $50 from you. They can’t pay you back for a two years. If you would like to get 10% return on your $50, how much should they pay you at the end of the second year?
- $55.00
- $100.00
- $60.50
A: $60.50

Q: A $10,000 investment in equipment today needs to be evaluated from a time value of money perspective so you can:
- Determine if you should take out a loan to purchase it or not.
- Spend wisely since a dollar today is worth less than a dollar in the future.
- Know how long it will take to get back your initial investment and at what interest rate.
A: Know how long it will take to get back your initial investment and at what interest rate.

Q: A new piece of equipment will payback the initial investment in 5 years at $10,000 per year in net cash flows and $28,000 per year in sales. The original purchase price of the equipment is:
- $140,000
- $90,000
- $50,000
A: $50,000

Q: Z-Printers is planning to invest in a new press. The press will generate $100,000 a year in sales with net annual cash flow of $12,500. The press is priced at $250,000. What is the payback period for this investment?
- 2.5 years
- 5 years
- 20 years
A: 20 years

Q: XYZ Bakery is looking at two new ovens. Using the payback method, which oven should they purchase: Oven A- $10,000 purchase price, annual sales increase of $5,000 and net cash flows of $2,500. Oven B-$25,000 purchase price, annual sales increase of $12,500 and net cash flows of $5,000.
- Oven B
- Either one will pay back in the same timeframe.
- Oven A
A: Oven A

Q: The time value of money is used by:
- The payback method to give a clearer picture of the true time it will take to recoup an investment.
- Both the IRR and the payback methods take the time value of money into account.
- The IRR method to give a clearer picture of the true time it will take to recoup an investment.
A: The IRR method to give a clearer picture of the true time it will take to recoup an investment.

Q: ABC Bakery requires a 10% rate of return on investments to consider them. They are looking at replacing their proofer with an initial cost of $5,000. This new proofer should save them $1,000 a year and will have a 15 year useful life. Should they make the investment?
- No, this is a 5% rate of return on the investment.
- Yes, this is an 11% rate of return on the investment.
- Yes. This is more than a 17% rate of return, so it is a great investment!
A: Yes. This is more than a 17% rate of return, so it is a great investment!

Q: The steps involved in the IRR method include:
- Divide the net initial investment by the annual cash flows to equal the number of years to recoup the investment.
- Divide the net initial investment by the useful life to equal the number of years to recoup the investment.
- First: Net initial investment/annual cash flows , then in the present value table of an ordinary annuity, find your factor based on the useful life of the equipment to determine the IRR.
A: First: Net initial investment/annual cash flows , then in the present value table of an ordinary annuity, find your factor based on the useful life of the equipment to determine the IRR.

Q: If a project has a negative NPV a company should:
- Proceed with the project because the inflows will exceed the outflows.
- Proceed with the project as it will show a return on your initial investment.
- Pass on the project because the outflows will exceed the inflows.
A: Pass on the project because the outflows will exceed the inflows.

Q: NPV uses the value of future cash flows which may include:
- Total sales, and interest on the cash investment.
- Labor and utility costs and the salvage value of the equipment.
- Labor savings, utility savings and additional potential net revenues.
A: Labor savings, utility savings and additional potential net revenues.

Q: Using your present value of an annuity in arrears table,compute the NPV for the following potential investment: Initial cost $10,000, life of equipment 10 years, annual cash inflow $5,000, salvage value: 0, required rate of return 15%.
- The NPV for this investment is negative, so we should pass on it.
- We do not have enough information to calculate the NPV.
- The NPV for this investment is positive, so we should go ahead with it.
A: The NPV for this investment is positive, so we should go ahead with it.

Q: Incremental net operating income would be $25,000 after depreciation. If the initial investment in a new piece of equipment is $75,000, what is the simple rate of return?
- 25%
- 15%
- 33.33%*
A: 33.33%*

Q: The incremental net operating income is calculated by:
- Incremental revenue-incremental operating expense
- Incremental revenue- initial investment
- Incremental revenue-incremental operating expense-annual depreciation
A: Incremental revenue-incremental operating expense-annual depreciation

Q: A person’s level of risk aversion may depend on;
- The guaranteed return on the investment.
- When a particular investment will be obsolete.
- A variety of factors including length of investment or available funds.
A: A variety of factors including length of investment or available funds.

Q: When choosing between a $5,000 investment that will recover in 1 year at 5% or in 10 years at 31%, with the risk of losing principal, an investor who wishes to retire in 3 years would most likely choose:
- The 31% investment and hope for the best.
- Neither. They would probably put the money in a drawer so as to not lose any principal at all.
- The 5% rate of return and then reinvest in another safe investment.
A: The 5% rate of return and then reinvest in another safe investment.

Q: Z-Corp has narrowed down their options to two pieces of equipment. Both will produce additional profits for the company based on analysis. Equipment A has an initial cost of $50,000 and a profitability index of 25%, while Equipment B has an initial cost of $30,000 and a profitability index of 18%. Which is the better investment?
- Equipment B has a lower initial cost so is a better investment.
- Either piece of equipment is a good option.
- Equipment A has a higher profitability index so is a better investment.
A: Equipment A has a higher profitability index so is a better investment.

Q: You can only choose one investment, but two have shown to meet company minimum requirements. If investment A has a higher NPV, but Investment B has a higher IRR, which investment should you choose?
- IRR is more reliable so choose B.
- If they conflict you can choose the investment you prefer.
- NPV is more reliable so choose A.
A: NPV is more reliable so choose A.

Q: The project profitability index is used when:
- You want to average out the initial investments to determine which one has the higher NPV.
- You need to determine which investment is the lowest cost choice.
- You are looking at two projects with different initial costs, so you can compare them side by side.
A: You are looking at two projects with different initial costs, so you can compare them side by side.

Q: When comparing the actual results to the preliminary analysis managers should:
- Use a different method than was used in the preliminary analysis to get a better picture of why the project succeeded or failed.
- Use different methods so you can show the manager who prepared the initial analysis what he or she did wrong.
- Use the same methods as were used in the preliminary analysis to compare apples to apples.
A: Use the same methods as were used in the preliminary analysis to compare apples to apples.

Q: Accountability is important because:
- Managers know they can be fired or reprimanded if they make a mistake in analysis.
- It allows management to use alternative methods to prove why a proposal should not have been accepted.
- It can be tempting to exaggerate the potential benefits of a proposal that is important to a manager. The postaudit process helps with the accountability.
A: It can be tempting to exaggerate the potential benefits of a proposal that is important to a manager. The postaudit process helps with the accountability.

Q: Actual results are analyzed using the same method as the original project proposal in order to:
- Reprimand managers who did not correctly analyze projects.
- Use the analysis to show the manager who did the original proposal what he or she did in error.
- Compare the final results of a capital budget project to what the anticipated results were in the initial analysis.
A: Compare the final results of a capital budget project to what the anticipated results were in the initial analysis.