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Exam 15: Capital Investment Analysis

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Question 51

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The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$ The present value index for this investment is:

A) 1.00.
B) 0.95.
C) 1.25.
D) 1.05.

E) A) and B)
F) C) and D)

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Question 52

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The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$ The average rate of return for this investment is:

A) 5%.
B) 10%.
C) 25%.
D) 15%.

E) A) and B)
F) B) and D)

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Question 53

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Using the following partial table of present value of $1 at compound interest, determine the present value of $20,000 to be received three years hence, with earnings at the rate of 10% a year. $\begin{array} { | l | l| l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0 .890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$

A series of unequal cash flows at fixed intervals is termed an annuity.

All of the following are factors that may complicate capital investment analysis except:

If the average rate of return on an asset exceeds the minimum rate of return for investments, the asset should be purchased.

When evaluating a proposal by use of the cash payback method, if net cash flows exceed the capital investment within the time deemed acceptable by management, the proposal should be accepted.

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $200,000 for 5 years. The expected average rate of return on investment computed is 20%.

In capital rationing, alternative proposals that survive initial screening and further analysis using present value methods are normally evaluated in terms of:

One issue to consider when investing in assets in foreign countries is:

The amount of the estimated average income for a proposed investment of $60,000 in a fixed asset, giving effect to depreciation (straight-line method) , with a useful life of four years, no residual value, and an expected total income yield of $22,300, is:

Assuming that the desired rate of return is 6%, determine the present value of $10,000 to be received in one year, using the following partial table of present value of $1 at compound interest. $\begin{array} { | l | l| l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 &0 .890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$

The anticipated purchase of a fixed asset for $400,000 with a useful life of 5 years and no residual value is expected to yield total income of $150,000 (recognition is given to the effect of straight-line depreciation on the investment). The expected average rate of return is 15%.

Methods that ignore present value in capital investment analysis include the cash payback method.

Mars Corp. is choosing between two different capital investment proposals. Machine A has a useful life of 4 years, and Machine B has a useful life of 6 years. Each proposal requires an initial investment of $200,000, and the company desires a rate of return of 10%. Although Machine B has a useful life of 6 years, it could be sold at the end of 4 years for $35,000. $\begin{array}{|l|l|}\hline \begin{array}{l}\text { Present Value } \\\text { of } \$ 1 \text { at } 10 \%\end{array} & \text { Year } \\\hline 0.909 & 1 \\\hline 0.826 & 2 \\\hline 0.751 & 3 \\\hline 0.683 & 4 \\\hline 0.621 & 5 \\\hline 0.513 & 6 \\\hline\end{array}$ Machine A will generate net cash flow of $70,000 in each of the four years. Machine B will generate $80,000 in year 1, $70,000 in year 2, $60,000 in year 3, and $40,000 per year for the remaining 3 years of its useful life. Which of the following statements portrays the most accurate analysis between the two proposals?

Which of the following are present value methods of analyzing capital investment proposals?

In general, present value methods of analyzing capital investments are more desirable than methods ignoring present values because:

Using the following partial table of present value of $1 at compound interest, compute the present value of $20,000 (rounded to nearest dollar) to be received one year from today, assuming an earnings rate of 15%. $\begin{array} { |l | l | l | l | } \hline 20 \% & 15 \% & 10 \% & \text { Year } \\\hline 0.833 & 0.870 & 0.909 & 1 \\\hline 0.694 & 0.756 & 0.826 & 2 \\\hline 0.579 & 0.659 & 0.751 & 3 \\\hline 0.482 & 0.572 & 0.683 & 4 \\\hline 0.402 & 0.497 & 0.621 & 5 \\\hline 0.335 & 0.473 & 0.564 & 6 \\\hline 0.279 & 0.376 & 0.513 & 7 \\\hline & & & \\\hline\end{array}$

The process by which management allocates available investment funds among competing capital investment proposals is termed present value analysis.

When evaluating a proposal by use of the net present value method, if there is an excess of the present value of future cash inflows over the amount to be invested, the rate of return on the proposal is less than the rate used in the analysis.