Chapter 21 Capital Budgeting and Cost Analysis
Objective 21.1
1) Which of the following involves significant financial investments in projects to develop new
products, expand production capacity, or remodel current production facilities?
A) capital budgeting
B) working capital
C) master budgeting
D) project-cost budgeting
Answer: A
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
2) The accounting system that corresponds to the project dimension in capital budgeting is the:
A) net present value method
B) internal rate of return
C) accrual accounting rate of return
D) life-cycle costing
Answer: D
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
3) Capital budgeting is the process of making long-run planning decisions for investments in
projects.
Answer: TRUE
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
4) A capital budget spans only a one-year period.
Answer: FALSE
Explanation: A capital budget normally is for a period of time greater than one year.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
1
Copyright © 2012 Pearson Education, Inc.
,5) The identify projects stage of capital budgeting gathers information from all parts of the value chain
to evaluate alternative projects.
Answer: FALSE
Explanation: This is the definition of the obtain information stage.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
6) The obtain information stage of capital budgeting gathers information from all parts of the value
chain to evaluate alternative projects.
Answer: TRUE
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
7) The make decisions by choosing among alternatives stage of the capital budgeting process consists of
determining which investment yields the greatest benefit and the least cost to the organization.
Answer: TRUE
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
8) The make predictions stage of the capital budgeting process consists of forecasting all potential net
income additions that are attributable to the alternative projects.
Answer: FALSE
Explanation: The make predictions stage of the capital budgeting process consists of forecasting all
potential cash flows attributable to the alternative projects.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
9) The final activity in the capital budgeting process is to obtain funding and make the investments
identified in the make decisions by choosing among alternatives stage of the process.
Answer: FALSE
Explanation: The implement decision, evaluate performance, and learn stage requires that after the
funding is obtained and the investment is made, there is a follow-up wherin the realized cash flows are
tracked, compared against the estimates, and plans are revised if necessary.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
2
Copyright © 2012 Pearson Education, Inc.
,10) Match each one of the examples below with one of the stages of the capital budgeting decision
model.
Stages:
1. Identify Projects
2. Obtain Information
3. Make Predictions
4. Make Decisions by Choosing Among Alternatives
5. Implement the Decision, Evaluate Performance, and Learn
________ a. Issuing corporate stock for the funds to purchase new equipment
________ b. Learning how to effectively operate Machine #8 only takes 15 minutes
________ c. The need to reduce the costs to process the vegetables used in producing goulash
________ d. Monitoring the costs to operate a new machine
________ e. Percentage of defective merchandise considered too high
________ f. Will introducing the new product substantially upgrade our image as
a producer of quality products?
________ g. Research indicates there are five machines on the market capable of producing
our product at a competitive cost.
________ h. Use of the internal rate of return for each alternative
Answer:
a. 5. Implement the Decision, Evaluate Performance, and Learn
b. 2. Obtain Information
c. 1. Identify Projects
d. 5. Implement the Decision, Evaluate Performance, and Learn
e. 1. Identify Projects
f. 2. Obtain Information
g. 2. Obtain Information
h. 4. Make Decisions by Choosing Among Alternatives
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
11) Explain why a corporation's customer base is considered an intangible asset.
Answer: A corporation's customer base is considered an intangible asset because if it is handled
properly, a corporation's existing customers will be a source of revenues for an indefinite time period.
One could make the case that the customer base is like an annuity a steady source of revenues and
earnings. Thus it is an asset, although an intangible one.
An existing customer usually will stay with a corporation if he or she is handled properly. Usually there
is minimal marginal cost in retaining a customer other than producing a satisfactory product. In contrast,
attracting new customers takes time, effort, and most times substantial marketing dollars. Thus, it is
much easier to retain a current customer than to obtain a new one. This is why the existing customer
base is considered an asset.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
3
Copyright © 2012 Pearson Education, Inc.
, 12) Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting
project?
Answer: Capital budgeting is long-run planning for investment projects that usually have a life that is
greater than one year.
Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which
types of capital investments are necessary to accomplish organization objectives and strategies. Stage 2
is the obtain information stage in which a firm gathers information from all parts of the value chain to
analyze alternative projects. Stage 3 is the make predictions stage in which the firm forecasts all
potential cash flows attributable to the alternative projects. Stage 4 is the make decisions by choosing
among alternatives stage in which the firm determines which investment yields the greatest benefit and
the least cost to the organization. Stage 5 is the implement the decision, evaluate performance, and learn
stage that is further separated into two sub stages: (1) obtain funding and make the investments selected
in the stage 4 process, and (2) track the realized cash flows, compare against the forecast numbers, and
revise plans if necessary.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
13) Cast Iron Stove Company wants to buy a molding machine that can be integrated into its
computerized manufacturing process. It has received three bids for the machine and related
manufacturer's specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual
savings of the machines range from $260,000 to $270,000. The payback periods are almost identical and
the net present values are all within $8,000 of each other. The president just doesn't know what to do
about which vendor to choose since all of the selection criteria are so close together.
Required:
What suggestions do you have for the president?
Answer: The president needs to consider nonfinancial and qualitative factors between the three vendors.
Quality of output units, manufacturing flexibility, and cycle time are all additional factors that can be
considered about the machines. Other items might include worker safety, ease of learning and using, and
ease of maintenance.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
4
Copyright © 2012 Pearson Education, Inc.
Objective 21.1
1) Which of the following involves significant financial investments in projects to develop new
products, expand production capacity, or remodel current production facilities?
A) capital budgeting
B) working capital
C) master budgeting
D) project-cost budgeting
Answer: A
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
2) The accounting system that corresponds to the project dimension in capital budgeting is the:
A) net present value method
B) internal rate of return
C) accrual accounting rate of return
D) life-cycle costing
Answer: D
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
3) Capital budgeting is the process of making long-run planning decisions for investments in
projects.
Answer: TRUE
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
4) A capital budget spans only a one-year period.
Answer: FALSE
Explanation: A capital budget normally is for a period of time greater than one year.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
1
Copyright © 2012 Pearson Education, Inc.
,5) The identify projects stage of capital budgeting gathers information from all parts of the value chain
to evaluate alternative projects.
Answer: FALSE
Explanation: This is the definition of the obtain information stage.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
6) The obtain information stage of capital budgeting gathers information from all parts of the value
chain to evaluate alternative projects.
Answer: TRUE
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
7) The make decisions by choosing among alternatives stage of the capital budgeting process consists of
determining which investment yields the greatest benefit and the least cost to the organization.
Answer: TRUE
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
8) The make predictions stage of the capital budgeting process consists of forecasting all potential net
income additions that are attributable to the alternative projects.
Answer: FALSE
Explanation: The make predictions stage of the capital budgeting process consists of forecasting all
potential cash flows attributable to the alternative projects.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
9) The final activity in the capital budgeting process is to obtain funding and make the investments
identified in the make decisions by choosing among alternatives stage of the process.
Answer: FALSE
Explanation: The implement decision, evaluate performance, and learn stage requires that after the
funding is obtained and the investment is made, there is a follow-up wherin the realized cash flows are
tracked, compared against the estimates, and plans are revised if necessary.
Diff: 1
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
2
Copyright © 2012 Pearson Education, Inc.
,10) Match each one of the examples below with one of the stages of the capital budgeting decision
model.
Stages:
1. Identify Projects
2. Obtain Information
3. Make Predictions
4. Make Decisions by Choosing Among Alternatives
5. Implement the Decision, Evaluate Performance, and Learn
________ a. Issuing corporate stock for the funds to purchase new equipment
________ b. Learning how to effectively operate Machine #8 only takes 15 minutes
________ c. The need to reduce the costs to process the vegetables used in producing goulash
________ d. Monitoring the costs to operate a new machine
________ e. Percentage of defective merchandise considered too high
________ f. Will introducing the new product substantially upgrade our image as
a producer of quality products?
________ g. Research indicates there are five machines on the market capable of producing
our product at a competitive cost.
________ h. Use of the internal rate of return for each alternative
Answer:
a. 5. Implement the Decision, Evaluate Performance, and Learn
b. 2. Obtain Information
c. 1. Identify Projects
d. 5. Implement the Decision, Evaluate Performance, and Learn
e. 1. Identify Projects
f. 2. Obtain Information
g. 2. Obtain Information
h. 4. Make Decisions by Choosing Among Alternatives
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
11) Explain why a corporation's customer base is considered an intangible asset.
Answer: A corporation's customer base is considered an intangible asset because if it is handled
properly, a corporation's existing customers will be a source of revenues for an indefinite time period.
One could make the case that the customer base is like an annuity a steady source of revenues and
earnings. Thus it is an asset, although an intangible one.
An existing customer usually will stay with a corporation if he or she is handled properly. Usually there
is minimal marginal cost in retaining a customer other than producing a satisfactory product. In contrast,
attracting new customers takes time, effort, and most times substantial marketing dollars. Thus, it is
much easier to retain a current customer than to obtain a new one. This is why the existing customer
base is considered an asset.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Analytical skills
3
Copyright © 2012 Pearson Education, Inc.
, 12) Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting
project?
Answer: Capital budgeting is long-run planning for investment projects that usually have a life that is
greater than one year.
Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which
types of capital investments are necessary to accomplish organization objectives and strategies. Stage 2
is the obtain information stage in which a firm gathers information from all parts of the value chain to
analyze alternative projects. Stage 3 is the make predictions stage in which the firm forecasts all
potential cash flows attributable to the alternative projects. Stage 4 is the make decisions by choosing
among alternatives stage in which the firm determines which investment yields the greatest benefit and
the least cost to the organization. Stage 5 is the implement the decision, evaluate performance, and learn
stage that is further separated into two sub stages: (1) obtain funding and make the investments selected
in the stage 4 process, and (2) track the realized cash flows, compare against the forecast numbers, and
revise plans if necessary.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
13) Cast Iron Stove Company wants to buy a molding machine that can be integrated into its
computerized manufacturing process. It has received three bids for the machine and related
manufacturer's specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual
savings of the machines range from $260,000 to $270,000. The payback periods are almost identical and
the net present values are all within $8,000 of each other. The president just doesn't know what to do
about which vendor to choose since all of the selection criteria are so close together.
Required:
What suggestions do you have for the president?
Answer: The president needs to consider nonfinancial and qualitative factors between the three vendors.
Quality of output units, manufacturing flexibility, and cycle time are all additional factors that can be
considered about the machines. Other items might include worker safety, ease of learning and using, and
ease of maintenance.
Diff: 2
Terms: capital budgeting
Objective: 1
AACSB: Reflective thinking
4
Copyright © 2012 Pearson Education, Inc.
