Chapter 12
Capital Budgeting Decisions
True/False
1. Both the net present value method and the internal rate of return method can be used as a screening tool
in capital budgeting decisions.
Level: Easy LO: 1 Ans: T
2. When considering a number of investment projects, the project that has the best payback period will
also always have the highest net present value.
Level: Medium LO: 1,3 Ans: F
3. When discounted cash flow methods of capital budgeting are used, the working capital required for a
project is ordinarily counted as a cash outflow at the beginning of the project and as a cash inflow at the
end of the project.
Level: Medium LO: 1 Ans: T
4. Discounted cash flow techniques automatically provide for recovery of initial investment.
Level: Medium LO: 1 Ans: T
5. When computing the project profitability index of an investment project, the investment required will
include any investment made in working capital at the beginning of the project.
Level: Medium LO: 2 Ans: T
6. If investment funds are limited, the net present value of one project should not be compared directly to
the net present value of another project unless the initial investments in these projects are equal.
Level: Medium LO: 2 Ans: T
7. In calculating payback where new equipment is replacing old equipment, any salvage value to be
received on disposal of the old equipment should be deducted from the cost of the new equipment.
Level: Medium LO: 3 Ans: T
8. In the payback method, depreciation is added back to net operating income when computing the net
annual cash flow.
Level: Medium LO: 3 Ans: T
9. The simple rate of return method is desirable because of its simplicity and the fact that it takes the time
value of money into account.
Level: Medium LO: 4 Ans: F
Brewer, Introduction to Managerial Accounting, 3/e 589
,10. The present value of a cash flow will never be greater than the future dollar amount of the cash flow.
Level: Easy LO: 5 Ans: T
Multiple Choice
11. Some investment projects require that a company increase its working capital. Under the net present
value method, the investment and eventual recovery of working capital should be treated as:
A) an initial cash outflow.
B) a future cash inflow.
C) both an initial cash outflow and a future cash inflow.
D) irrelevant to the net present value analysis.
Level: Medium LO: 1 Ans: C
12. The net present value (NPV) method of investment project analysis assumes that the project’s cash
flows are reinvested at the:
A) internal rate of return.
B) discount rate used in the NPV calculation.
C) firm’s simple rate of return.
D) firm’s average ROI.
Source: CMA, adapted
Level: Medium LO: 1 Ans: B
13. If taxes are ignored, all of the following items are included in a discounted cash flow analysis except:
A) future operating cash savings.
B) depreciation expense.
C) future salvage value.
D) investment in working capital.
Source: CMA, adapted
Level: Medium LO: 1 Ans: B
14. In capital budgeting computations, discounted cash flow methods:
A) automatically provide for recovery of initial investment.
B) can’t be used unless cash flows are uniform from year to year.
C) assume that all cash flows occur at the beginning of a period.
D) responses a, b, and c are all correct.
Level: Medium LO: 1 Ans: A
15. The investment required for the project profitability index should:
A) be reduced by the amount of any salvage recovered from the sale of old equipment.
B) be reduced by the amount of any salvage recovered from the sale of the new equipment at the end of
its useful life.
C) be reduced by the amount of any salvage recovered from the sale of both the old and new equipment.
D) none of the above is correct.
Level: Medium LO: 2 Ans: A
590 Brewer, Introduction to Managerial Accounting, 3/e
,16. A company wants to have $40,000 at the end of a five-year period through investment of a single sum
now. How much needs to be invested in order to have the desired sum in five years, if the money can be
invested at 10%:
A) $10,551
B) $8,000
C) $24,840
D) $12,882
Level: Easy LO: 1 Ans: C
17. The following data on a proposed investment project have been provided:
The net present value of the project would be:
A) $3,730
B) $0
C) $32,450
D) $88,370
Level: Medium LO: 1 Ans: A
18. Stratford Company purchased a machine with an estimated useful life of seven years. The machine
will generate cash inflows of $9,000 each year over the next seven years. If the machine has no salvage
value at the end of seven years, and assuming the company's discount rate is 10%, what is the purchase
price of the machine if the net present value of the investment is $17,000?
A) $43,812
B) $26,812
C) $17,000
D) $22,195
Level: Hard LO: 1 Ans: B
19. Anthony operates a part time auto repair service. He estimates that a new diagnostic computer system
will result in increased cash inflows of $1,500 in Year 1, $2,100 in Year 2, and $3,200 in Year 3. If
Anthony's required rate of return is 10%, then the most he would be willing to pay for the new computer
system would be:
A) $4,599
B) $5,501
C) $5,638
D) $5,107
Level: Medium LO: 1 Ans: B
Brewer, Introduction to Managerial Accounting, 3/e 591
, 20. Fossa Road Paving Company is considering an investment in a curb-forming machine. The machine
will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The
machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa's
discount rate is 18%. What is the net present value of this machine?
A) $5,840
B) $37,280
C) $(48,780)
D) $69,640
Level: Medium LO: 1 Ans: B
21. Apnea Video Rental Store is considering the purchase of an almost new minivan to use as a vehicle to
deliver and pick up video tapes for customers. The minivan will cost $18,000 and is expected to last 8
years but only if the engine is overhauled at a cost of $3,000 at the end of year 3. The minivan is expected
to have a $1,000 salvage value at the end of 8 years. This delivery service is expected to generate net cash
inflows of $6,000 per year in each of the 8 years. Apnea's discount rate is 14%. What is the net present
value of this investment opportunity?
A) $(2,826)
B) $(3,801)
C) $7,185
D) $8,160
Level: Medium LO: 1 Ans: D
22. In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in
equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life
of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. Pontic's discount
rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10
years in order for it to be an acceptable project?
A) $50,690 or more
B) $41,315 or more
C) $105,315 or more
D) $94,316 or more
Level: Hard LO: 1 Ans: C
23. Naomi Corporation has a capital budgeting project that has a negative net present value of $36,000.
The life of this project is 6 years. Naomi's discount rate is 20%. By how much would the annual cash
inflows from this project have to increase in order to have a positive net present value?
A) $1,200 or more
B) $2,412 or more
C) $6,000 or more
D) $10,824 or more
Level: Hard LO: 1 Ans: D
592 Brewer, Introduction to Managerial Accounting, 3/e
Capital Budgeting Decisions
True/False
1. Both the net present value method and the internal rate of return method can be used as a screening tool
in capital budgeting decisions.
Level: Easy LO: 1 Ans: T
2. When considering a number of investment projects, the project that has the best payback period will
also always have the highest net present value.
Level: Medium LO: 1,3 Ans: F
3. When discounted cash flow methods of capital budgeting are used, the working capital required for a
project is ordinarily counted as a cash outflow at the beginning of the project and as a cash inflow at the
end of the project.
Level: Medium LO: 1 Ans: T
4. Discounted cash flow techniques automatically provide for recovery of initial investment.
Level: Medium LO: 1 Ans: T
5. When computing the project profitability index of an investment project, the investment required will
include any investment made in working capital at the beginning of the project.
Level: Medium LO: 2 Ans: T
6. If investment funds are limited, the net present value of one project should not be compared directly to
the net present value of another project unless the initial investments in these projects are equal.
Level: Medium LO: 2 Ans: T
7. In calculating payback where new equipment is replacing old equipment, any salvage value to be
received on disposal of the old equipment should be deducted from the cost of the new equipment.
Level: Medium LO: 3 Ans: T
8. In the payback method, depreciation is added back to net operating income when computing the net
annual cash flow.
Level: Medium LO: 3 Ans: T
9. The simple rate of return method is desirable because of its simplicity and the fact that it takes the time
value of money into account.
Level: Medium LO: 4 Ans: F
Brewer, Introduction to Managerial Accounting, 3/e 589
,10. The present value of a cash flow will never be greater than the future dollar amount of the cash flow.
Level: Easy LO: 5 Ans: T
Multiple Choice
11. Some investment projects require that a company increase its working capital. Under the net present
value method, the investment and eventual recovery of working capital should be treated as:
A) an initial cash outflow.
B) a future cash inflow.
C) both an initial cash outflow and a future cash inflow.
D) irrelevant to the net present value analysis.
Level: Medium LO: 1 Ans: C
12. The net present value (NPV) method of investment project analysis assumes that the project’s cash
flows are reinvested at the:
A) internal rate of return.
B) discount rate used in the NPV calculation.
C) firm’s simple rate of return.
D) firm’s average ROI.
Source: CMA, adapted
Level: Medium LO: 1 Ans: B
13. If taxes are ignored, all of the following items are included in a discounted cash flow analysis except:
A) future operating cash savings.
B) depreciation expense.
C) future salvage value.
D) investment in working capital.
Source: CMA, adapted
Level: Medium LO: 1 Ans: B
14. In capital budgeting computations, discounted cash flow methods:
A) automatically provide for recovery of initial investment.
B) can’t be used unless cash flows are uniform from year to year.
C) assume that all cash flows occur at the beginning of a period.
D) responses a, b, and c are all correct.
Level: Medium LO: 1 Ans: A
15. The investment required for the project profitability index should:
A) be reduced by the amount of any salvage recovered from the sale of old equipment.
B) be reduced by the amount of any salvage recovered from the sale of the new equipment at the end of
its useful life.
C) be reduced by the amount of any salvage recovered from the sale of both the old and new equipment.
D) none of the above is correct.
Level: Medium LO: 2 Ans: A
590 Brewer, Introduction to Managerial Accounting, 3/e
,16. A company wants to have $40,000 at the end of a five-year period through investment of a single sum
now. How much needs to be invested in order to have the desired sum in five years, if the money can be
invested at 10%:
A) $10,551
B) $8,000
C) $24,840
D) $12,882
Level: Easy LO: 1 Ans: C
17. The following data on a proposed investment project have been provided:
The net present value of the project would be:
A) $3,730
B) $0
C) $32,450
D) $88,370
Level: Medium LO: 1 Ans: A
18. Stratford Company purchased a machine with an estimated useful life of seven years. The machine
will generate cash inflows of $9,000 each year over the next seven years. If the machine has no salvage
value at the end of seven years, and assuming the company's discount rate is 10%, what is the purchase
price of the machine if the net present value of the investment is $17,000?
A) $43,812
B) $26,812
C) $17,000
D) $22,195
Level: Hard LO: 1 Ans: B
19. Anthony operates a part time auto repair service. He estimates that a new diagnostic computer system
will result in increased cash inflows of $1,500 in Year 1, $2,100 in Year 2, and $3,200 in Year 3. If
Anthony's required rate of return is 10%, then the most he would be willing to pay for the new computer
system would be:
A) $4,599
B) $5,501
C) $5,638
D) $5,107
Level: Medium LO: 1 Ans: B
Brewer, Introduction to Managerial Accounting, 3/e 591
, 20. Fossa Road Paving Company is considering an investment in a curb-forming machine. The machine
will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The
machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa's
discount rate is 18%. What is the net present value of this machine?
A) $5,840
B) $37,280
C) $(48,780)
D) $69,640
Level: Medium LO: 1 Ans: B
21. Apnea Video Rental Store is considering the purchase of an almost new minivan to use as a vehicle to
deliver and pick up video tapes for customers. The minivan will cost $18,000 and is expected to last 8
years but only if the engine is overhauled at a cost of $3,000 at the end of year 3. The minivan is expected
to have a $1,000 salvage value at the end of 8 years. This delivery service is expected to generate net cash
inflows of $6,000 per year in each of the 8 years. Apnea's discount rate is 14%. What is the net present
value of this investment opportunity?
A) $(2,826)
B) $(3,801)
C) $7,185
D) $8,160
Level: Medium LO: 1 Ans: D
22. In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in
equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life
of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. Pontic's discount
rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10
years in order for it to be an acceptable project?
A) $50,690 or more
B) $41,315 or more
C) $105,315 or more
D) $94,316 or more
Level: Hard LO: 1 Ans: C
23. Naomi Corporation has a capital budgeting project that has a negative net present value of $36,000.
The life of this project is 6 years. Naomi's discount rate is 20%. By how much would the annual cash
inflows from this project have to increase in order to have a positive net present value?
A) $1,200 or more
B) $2,412 or more
C) $6,000 or more
D) $10,824 or more
Level: Hard LO: 1 Ans: D
592 Brewer, Introduction to Managerial Accounting, 3/e
