Module 24
Capital Budgeting Decisions
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Explain the role of
capital budgeting in long- 1-3 1-4 1, 2
range planning.
LO2 – Apply capital
budgeting models, such as
net present value and internal 4, 5 5-34 1-7
rate of return, that consider
the time value of money.
LO3 – Apply capital
budgeting models, such as
payback period and
6, 7 35-49 1-7
accounting rate of return, that
do not consider the time
value of money.
LO4 – Evaluate the strengths
and weaknesses of
8, 9 46, 49-57 3
alternative capital budgeting
models.
LO5 – Discuss the
importance of judgment,
attitudes toward risk, and
10, 11 59 8-11 4, 5
relevant cash flow information
for capital budgeting
decisions.
LO6 – Determine the net
present value of investment
12, 13 58, 60-64 12-15
proposals with consideration
of taxes.
Appendix 24A: Time Value
1, 2 1-16 1, 2
of Money
©Cambridge Business Publishers, 2015
Test Bank, Module 24 24-1
,Module 24: Capital Budgeting Decisions
True/False
Topic: Post-Audits
LO: 1
1. A well run organization should perform an evaluation, called a post audit, of its investment projects
before their completion.
Answer: False
Rationale: After completion of the project, the post-audit is conducted for comparison with project
expectations.
Topic: Post-Audits
LO: 1
2. Post-audits create an incentive for managers to make accurate estimates, since managers know their
results will be evaluated.
Answer: True
Rationale: When managers know they will be held accountable for the results of the projects they
initiate, they are likely to put more care into the development of capital expenditure proposals and
take a greater interest in approved projects.
Topic: Post-Audits
LO: 1
3. A post audit is an evaluation of how well a project’s actual performance matches the projections made
when the project was proposed.
Answer: True
Rationale: A post-audit involves the development of project performance reports comparing planned
and actual results.
Topic: Cost of Capital
LO: 2
4. The cost of capital is the average cost an organization pays to obtain the resources (i.e., borrowed
funds, as well as on funds provided by investors in the company’s stock) necessary to make
investments.
Answer: True
Rationale: The average rate considers such items as the effective interest rate on debt (notes or
bonds), the effective dividend rate on preferred stock, and the discount rate that equates the present
value of all dividends expected on common stock over the life of the organization to the current
market value of the organization’s common stock.
©Cambridge Business Publishers, 2015
24-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Net Present Value
LO: 2
5. The net present value method can only be used in capital budgeting if the expected cash flows from
the project are an equal amount each year.
Answer: False
Rationale: The net present value method will accommodate unequally sized cash flows by using
individual present value factors for annual cash flows.
Topic: Payback Period
LO: 3
6. The payback period method is frequently used as a screening tool, but it does not take into
consideration the profitability of a project.
Answer: True
Rationale: The payback period method tells how many periods it will take to recover the initial
investment. It does not consider additional cash inflows or the time value of the cash inflows.
Topic: Accounting Rate of Return
LO: 3
7. The accounting rate of return method requires dividing a project’s annual cash inflows by the
economic life of the project.
Answer: False
Rationale: The accounting rate of return is found by dividing the average annual increase in net
income by the dollar amount of the investment.
Topic: Evaluation of Payback and Accounting Rate of Return
LO: 4
8. The payback period and the accounting rate of return methods are inferior to the net present value
method because neither considers cash flows.
Answer: False
Rationale: The payback period method uses cash flows. However, neither payback nor accounting
rate of return considers the time value of money.
Topic: Evaluation of Internal Rate of Return and Net Present Value Methods
LO: 4
9. The net present value method and internal rate of return method are both deficient to the extent that
neither method considers investment size.
Answer: False
Rationale: The net present value method gives explicit consideration to investment size. Internal rate
of return does not.
©Cambridge Business Publishers, 2015
Test Bank, Module 24 24-3
, Topic: Judgment, Attitudes, and Risk
LO: 5
10. To avoid accepting projects that actually should be rejected, a company should ignore all
nonquantitative benefits in evaluating net present value.
Answer: False
Rationale: Non quantitative factors such as market position, operational performance, and strategy
implementation often play a decisive role in management’s final decision to accept or reject a project.
Topic: Judgment, Attitudes, and Risk
LO: 5
11. The objective of capital budgeting models is to eliminate risk.
Answer: False
Rationale: All capital budgeting models involve risk, including risk related to cost of the initial
investment, time required to complete the initial investment and begin operations, whether the new
facilities will operate as planned, life of the facilities, customers’ demand for the product or service,
final selling price, operating costs, and disposal values.
Topic: Taxes in Capital Budgeting Decisions
LO: 6
12. The depreciation tax shield is calculated as depreciation divided by tax rate.
Answer: False
Rationale: The depreciation tax shield is calculated as depreciation times tax rate.
Topic: Taxes in Capital Budgeting Decisions
LO: 6
13. Taxes have the effect of reducing both cash inflows from taxable revenues and cash outflows for tax
deductible expenses.
Answer: True
Rationale: Taxes are paid on revenues, resulting in a reduction of after-tax revenues. Taxes are
saved on tax deductible expenses such as depreciation.
©Cambridge Business Publishers, 2015
24-4 Financial & Managerial Accounting for MBAs, 4th Edition
Capital Budgeting Decisions
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Explain the role of
capital budgeting in long- 1-3 1-4 1, 2
range planning.
LO2 – Apply capital
budgeting models, such as
net present value and internal 4, 5 5-34 1-7
rate of return, that consider
the time value of money.
LO3 – Apply capital
budgeting models, such as
payback period and
6, 7 35-49 1-7
accounting rate of return, that
do not consider the time
value of money.
LO4 – Evaluate the strengths
and weaknesses of
8, 9 46, 49-57 3
alternative capital budgeting
models.
LO5 – Discuss the
importance of judgment,
attitudes toward risk, and
10, 11 59 8-11 4, 5
relevant cash flow information
for capital budgeting
decisions.
LO6 – Determine the net
present value of investment
12, 13 58, 60-64 12-15
proposals with consideration
of taxes.
Appendix 24A: Time Value
1, 2 1-16 1, 2
of Money
©Cambridge Business Publishers, 2015
Test Bank, Module 24 24-1
,Module 24: Capital Budgeting Decisions
True/False
Topic: Post-Audits
LO: 1
1. A well run organization should perform an evaluation, called a post audit, of its investment projects
before their completion.
Answer: False
Rationale: After completion of the project, the post-audit is conducted for comparison with project
expectations.
Topic: Post-Audits
LO: 1
2. Post-audits create an incentive for managers to make accurate estimates, since managers know their
results will be evaluated.
Answer: True
Rationale: When managers know they will be held accountable for the results of the projects they
initiate, they are likely to put more care into the development of capital expenditure proposals and
take a greater interest in approved projects.
Topic: Post-Audits
LO: 1
3. A post audit is an evaluation of how well a project’s actual performance matches the projections made
when the project was proposed.
Answer: True
Rationale: A post-audit involves the development of project performance reports comparing planned
and actual results.
Topic: Cost of Capital
LO: 2
4. The cost of capital is the average cost an organization pays to obtain the resources (i.e., borrowed
funds, as well as on funds provided by investors in the company’s stock) necessary to make
investments.
Answer: True
Rationale: The average rate considers such items as the effective interest rate on debt (notes or
bonds), the effective dividend rate on preferred stock, and the discount rate that equates the present
value of all dividends expected on common stock over the life of the organization to the current
market value of the organization’s common stock.
©Cambridge Business Publishers, 2015
24-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Net Present Value
LO: 2
5. The net present value method can only be used in capital budgeting if the expected cash flows from
the project are an equal amount each year.
Answer: False
Rationale: The net present value method will accommodate unequally sized cash flows by using
individual present value factors for annual cash flows.
Topic: Payback Period
LO: 3
6. The payback period method is frequently used as a screening tool, but it does not take into
consideration the profitability of a project.
Answer: True
Rationale: The payback period method tells how many periods it will take to recover the initial
investment. It does not consider additional cash inflows or the time value of the cash inflows.
Topic: Accounting Rate of Return
LO: 3
7. The accounting rate of return method requires dividing a project’s annual cash inflows by the
economic life of the project.
Answer: False
Rationale: The accounting rate of return is found by dividing the average annual increase in net
income by the dollar amount of the investment.
Topic: Evaluation of Payback and Accounting Rate of Return
LO: 4
8. The payback period and the accounting rate of return methods are inferior to the net present value
method because neither considers cash flows.
Answer: False
Rationale: The payback period method uses cash flows. However, neither payback nor accounting
rate of return considers the time value of money.
Topic: Evaluation of Internal Rate of Return and Net Present Value Methods
LO: 4
9. The net present value method and internal rate of return method are both deficient to the extent that
neither method considers investment size.
Answer: False
Rationale: The net present value method gives explicit consideration to investment size. Internal rate
of return does not.
©Cambridge Business Publishers, 2015
Test Bank, Module 24 24-3
, Topic: Judgment, Attitudes, and Risk
LO: 5
10. To avoid accepting projects that actually should be rejected, a company should ignore all
nonquantitative benefits in evaluating net present value.
Answer: False
Rationale: Non quantitative factors such as market position, operational performance, and strategy
implementation often play a decisive role in management’s final decision to accept or reject a project.
Topic: Judgment, Attitudes, and Risk
LO: 5
11. The objective of capital budgeting models is to eliminate risk.
Answer: False
Rationale: All capital budgeting models involve risk, including risk related to cost of the initial
investment, time required to complete the initial investment and begin operations, whether the new
facilities will operate as planned, life of the facilities, customers’ demand for the product or service,
final selling price, operating costs, and disposal values.
Topic: Taxes in Capital Budgeting Decisions
LO: 6
12. The depreciation tax shield is calculated as depreciation divided by tax rate.
Answer: False
Rationale: The depreciation tax shield is calculated as depreciation times tax rate.
Topic: Taxes in Capital Budgeting Decisions
LO: 6
13. Taxes have the effect of reducing both cash inflows from taxable revenues and cash outflows for tax
deductible expenses.
Answer: True
Rationale: Taxes are paid on revenues, resulting in a reduction of after-tax revenues. Taxes are
saved on tax deductible expenses such as depreciation.
©Cambridge Business Publishers, 2015
24-4 Financial & Managerial Accounting for MBAs, 4th Edition
