Managerial Accounting 2nd Edition

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 Chapter 9
Capital Budgeting

Chapter Learning Objectives

1. Identify the cash flows associated with capital budgeting decisions. (Unit 9.1)
Cash flows will differ depending on the project under consideration. Common cash flows
include the following:

• Purchase price of new assets – buildings, equipment, etc. (outflow)

• Revenues from new sales generated by the project (inflow)
• Operating costs generated by the project (outflow)
• Sale of old equipment (inflow)
• Savings on operating costs generated by the project (inflow)

2. Explain the time value of money and calculate present values of lump sums and
annuities. (Unit 9.2)
A dollar received today is worth more than a dollar received in the future because
today’s dollar can be invested to earn interest. To determine what an amount of money
to be received in the future is worth today, you need to know: (1) how much money is
to be received; (2) when the money is to be received; and (3) the relevant interest rate.
If the money to be received in the future is a lump sum (received once), the present
value is determined as follows:

If the money to be received in the future is an annuity (an equal series of identical
payments), the present value is determined as follows:

3. Use the net present value to determine the acceptability of a project. (Unit 9.3)
The net present value of a project is the present value of its cash inflows less the
present value of its cash outflows. If the net present value is greater than or equal to
zero, the project is acceptable. If the net present value is less than zero, the project
should be rejected.
4. Use the internal rate of return to determine the acceptability of a project. (Unit 9.3)
The internal rate of return of a project is the discount rate (interest rate) that returns a
net present value of zero. If the project includes both an investment (initial cash
outflow) and an annuity (series of equal cash inflows), the internal rate of return can be
found by (a) solving for the present value of an annuity factor (PVA n,i) in the following
equation and (b) locating that factor in the present value of an annuity table.

If the project returns a series of uneven cash flows, the internal rate of return can be
found either by trial and error or by using Microsoft Excel’s IRR function.

5. Calculate a project’s payback period. (Unit 9.4)

The payback period shows how quickly the initial investment in a project will be
recovered from the yearly cash flows. If the annual cash flows are even, the payback
period can be calculated as follows:

If the annual cash flows are uneven, then they must be added up until they equal the
net initial investment. The number of years it takes for the annual cash inflows to equal
the net initial investment is the payback period. The payback period has two flaws: It
ignores both time value of money and cash flows that occur after the payback period.

6. Calculate a project’s accounting rate of return. (Unit 9.4)

The accounting rate of return is the only capital budgeting technique that is based on
accounting income rather than cash flows. It can be calculated as follows:
 Chapter 9
Capital Budgeting

TRUE-FALSE STATEMENTS

1. The process of evaluating an organization’s investment in long-term assets is called investment

control.
Unit 9-1, LO1 – False – Capital budgeting is the process of evaluating an organization’s investment in
long-term assets.
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

2. Capital budgeting differs from cash budgeting in terms of its time horizon.
Unit 9-1, LO1 – True
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

3. Those assets that are expected to provide economic benefits for several years are called capital
assets.
Unit 9-1, LO1 – True
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

4. All capital assets are depreciable assets.

Unit 9-1, LO1 – False – Capital assets, with the exception of land, are depreciable assets.
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

5. Capital assets are also referred to as long-lived assets.

Unit 9-1, LO1 – True
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

6. Assets used by an organization to build products or deliver services are called investment assets.
Unit 9-1, LO1 – False – Assets used by an organization to build products or deliver services may be called
capital assets, long-lived assets, or depreciable assets.
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

7. When a company invests in a capital asset, recouping the original investment is called return on
investment.
Unit 9-1, LO1 – False – When a company invests in a capital asset, recouping the original investment is
called return of investment.
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 8. Any return a company receives over and above the original investment in a capital asset is called
return on investment.
Unit 9-1, LO1 – True
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

9. In a predictable decision, a proposed project is compared to a performance benchmark to

determine whether the project should be considered further.
Unit 9-1, LO1 – False – In a screening decision, a proposed project is compared to a performance
benchmark to determine whether the project should be considered further.
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

10. The goal of the screening decision is to narrow the list of capital proposals to include only those
that are expected to bring the desired level of return.
Unit 9-1, LO1 – True
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

11. The original purchase price of an old machine that is being replaced must be considered in
capital budgeting decisions.
Unit 9-1, LO1 – False – the original purchase price of an old machine that is being replaced is never
included in a capital budgeting decision.
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

12. Capital budgeting decisions involve both outflows of cash at one or more times and inflows of
cash at other times.
Unit 9-2, LO2 – True
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

13. The process of determining how much an amount of money to be received in the future is worth
today is called future value.
Unit 9-2, LO2 – False – The process of determining how much an amount of money to be received in the
future is worth today is called discounting.
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

14. The present value of a future amount may be smaller or larger than the future value.
Unit 9-2, LO2 – False – The present value of the future amount is always smaller than the future amount.
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

15. A stream of equal cash flows received at set time intervals is called an annuity.
Unit 9-2, LO2 – True
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 16. To calculate the present value of an annuity, divide the amount to be received each year by the
present value factor.
Unit 9-2, LO2 – False – To calculate the present value of an annuity, multiple the amount to be received
each year by the present value factor.
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

17. The net present value approach to capital budgeting requires you to calculate the present value
of each cash flow and then add those present values to arrive at the capital project’s net present
value.
Unit 9-3, LO3 – True
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

18. The first step in calculating the net present value of a product is to determine the appropriate
discount rate.
Unit 9-3, LO3 – False – The first step in calculating the net present value of a product is to identify the
amount and timing of each cash flow.
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

19. In calculating the net present value of a project, the appropriate discount rate should be similar
across companies.
Unit 9-3, LO3 – False – In calculating the net present value of a project, the appropriate discount rate
varies from company to company.
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

20. Once the cash flows and discount rate have been determined, calculate the present value of
each cash flow by multiplying each one by the appropriate present value factor.
Unit 9-3, LO3 – True
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

21. If the net present value of a project is greater than or equal to zero, the project has achieved the
required rate of return and should be accepted.
Unit 9-3, LO3 – True
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

22. The decision to replace an old automobile with a new one must be analyzed using incremental
analysis.
Unit 9-3, LO3 – False – The decision to replace an old automobile with a new one may be analyzed in
two ways: calculate the cost of each decision separately (keep or replace) or use incremental analysis
focusing only on relevant cost.
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Difficult, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 23. Like net present value, the internal rate of return considers the amount and timing of future
cash flows.
Unit 9-3, LO3 – True
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

24. When the annual cash flows are uneven, you must use the annuity table method to calculate
the internal rate of return.
Unit 9-3, LO3 – False – When the annual cash flows are uneven, you cannot use the annuity table
method to calculate the internal rate of return.
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

25. The payback period is the time it takes, in years, for an investment to return the original amount
of invested capital.
Unit 9-4, LO5 – True
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

26. The payback period is used most often as a screening tool, by companies that have established a
maximum acceptable payback period.
Unit 9-4, LO5 – True
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

27. The payback period is a simple technique using the time value of money as its basis.
Unit 9-4, LO5 – False – While the payback period is a simple technique it is subject to limitations. First,
this method ignores the time value of money.
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

28. The accounting rate of return differs from the internal rate of return and the payback period in
that the accounting rate of return does not focus on cash flows.
Unit 9-4, LO5 – True
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

29. The accounting rate of return is also known as the unadjusted rate of return.
Unit 9-4, LO5 – True
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

30. Two major weaknesses of the accounting rate of return are that it does not consider cash flows
and it is the least accurate capital budgeting technique.
Unit 9-4, LO5 – False – Two major weaknesses of the accounting rate of return are that it does not
consider cash flows or the time value of money.
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
Answers to True-False Questions
Item Ans Item Ans Item Ans Item Ans
1. F 9. F 17. T 25. T
2. T 10. T 18. F 26. T
3. T 11. F 19. F 27. F
4. F 12. T 20. T 28. T
5. T 13. F 21. T 29. T
6. F 14. F 22. F 30. F
7. F 15. T 23. T
8. T 16. F 24. F
 MULTIPLE-CHOICE QUESTIONS
31. The process of evaluating an organization’s investment in long-term assets is called
a. Activity-based evaluation.
b. Capital budgeting.
c. Investment control.
d. None of these answer choices are correct.
Unit 9-1, LO1 – B
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

32. Capital budgeting differs from cash budgeting in that

a. Cash budgeting focuses on short-term results while capital budgeting focuses on five,
ten, or even twenty years in the future.
b. Cash budgeting focuses on the balance sheet while capital budgeting focuses on the
income statement.
c. Cash budget does not contain cash outflows for capital assets while capital budgeting
does.
d. All of these answer choices are correct.
Unit 9-1, LO1 – A
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

33. A capital asset is

a. A variable cost
b. An item on the income statement.
c. A long-term asset.
d. None of these answer choices are correct.
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

34. Assets that are expected to provide economic benefits for several years are referred to as
a. Cash assets.
b. Short-term assets.
c. Capital assets.
d. Balance sheet assets.
Unit 9-1, LO1 – C
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

35. Which of the following capital assets is not a depreciable asset?

a. Building
b. Equipment
c. Automobiles
d. Land
Unit 9-1, LO1 – D
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions
 36. Capital assets are also referred to as
a. Long-lived assets.
b. Balance sheet asset.
c. Cash assets.
d. Investment assets.
Unit 9-1, LO1 – A
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

37. Capital assets are

a. Used to promote the company.
b. Used to build products or deliver services.
c. Always depreciable.
d. All of these answer choices are correct.
Unit 9-1, LO1 – B
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

38. Which of the following is a reason organizations invest in capital assets?

a. Expectation that they will generate a future return
b. Expectation that they will be used to build products
c. Both the expectation that they will generate a future return and the expectation that
they will be used to build products.
d. Neither the expectation that they will generate a future return nor the expectation that
they will be used to build products
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

39. Two types of return can be expected from investment in long-term assets:
a. Positive contribution margin and positive segment margin.
b. Interest and dividends.
c. Return of investment and return on investment.
d. None of these answer choices are correct.
Unit 9-1, LO1 – C
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

40. Any return a company receives over and above the original investment is referred to as
a. Return on investment.
b. Return of investment.
c. Return of contribution.
d. None of these answer choices are correct.
Unit 9-1, LO1 – A
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 41. When a company recoups its original investment – that is, gets its money back, the company has
received a
a. Return on investment.
b. Return of investment.
c. Return of contribution.
d. None of these answer choices are correct.
Unit 9-1, LO1 – B
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

42. Within the organization, which of the following groups reviews capital project requests?
a. Audit committee
b. Financial expenditures committee
c. Capital budgeting committee
d. Investment committee
Unit 9-1, LO1 – C
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

43. Which of the following is a reason capital budget requests should be reviewed and approved by
executive management?
a. These investments are made for the long-term
b. These investments will likely have a significant impact on the company’s future financial
health
c. Both because these investments are made for the long-term and because these
investments will likely have a significant impact on the company’s future financial health
d. Neither because these investments are made for the long-term nor because these
investments will likely have a significant impact on the company’s future financial health
Unit 9-1, LO1 – C
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

44. Managers use the capital budgeting techniques to make which of the following two types of
capital budgeting decisions?
a. Screening decisions and preference decisions.
b. Screening decisions and pricing decisions.
c. Preference decisions and pricing decisions.
d. None of these answer choices are correct.
Unit 9-1, LO1 – A
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 45. In which of the following decisions is a proposed project compared to a performance benchmark
to determine whether the project should be considered further?
a. Hurdle
b. Screening
c. Performance
d. Benchmark
Unit 9-1, LO1 – B
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

46. When a company compares a proposed project to a performance benchmark, which of the
following benchmarks might the company use?
a. Minimum required return on investment
b. Minimum number of years in which the project must return the original investment
c. Both the minimum required return on invest and the minimum number of years in
which the project must return the original investment
d. Neither the minimum required return on invest nor the minimum number of years in
which the project must return the original investment
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

47. The goal of the screening decision process is to

a. Narrow the list of capital proposals to those expected to bring the desired level of
return.
b. Select the project with the best level of return.
c. Arrange for the completion of the proposed project.
d. None of these answer choices are correct.
Unit 9-1, LO1 – A
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

48. The minimum required rate of return is often referred to as the

a. Benchmark rate.
b. Hurdle rate.
c. Project rate.
d. Activity rate.
Unit 9-1, LO1 – B
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

49. In which of the following decisions do managers determine which projects will actually receive
funds by rank-ordering them based on selected criteria?
a. Hurdle
b. Screening
c. Capital
d. Preference
Unit 9-1, LO1 – D
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 50. In a preference decision, which of the following criteria might be used to rank-order the
projects?
a. Rate of return
b. Return on investment
c. Expected opportunities in new market niche
d. All of these answer choices are correct.
Unit 9-1, LO1 – D
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

51. While most accounting decisions focus on income, most capital budgeting decisions focus on
a. Expenses
b. Costs
c. Need
d. Cash flows
Unit 9-1, LO1 – D
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

52. Which of the following items is not included in the decision to purchase a new capital asset to
replace an old one?
a. The price of the new machine
b. Shipping
c. The original purchase price of the old machine
d. Installation costs
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

53. Which of the following items is not included in the decision to purchase a new capital asset to
replace an old one?
a. Depreciation on the new machine
b. Sales tax
c. Installation cost of the new machine
d. Scrap value of the old machine
Unit 9-1, LO1 – A
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

54. Why is the original purchase price of an old machine that is being replaced never included in
capital budgeting decisions?
a. It is an opportunity cost, and thus not relevant
b. No future cash flows are associated with its purchase
c. It will affect future costs
d. None of these answer choices are correct
Unit 9-1, LO1 – B
LO: 1, Bloom: K, Unit: 9-1, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 55. Which of the following is a cash flow that might occur when new equipment is purchased?
a. Cash outflow in the form of cash payments
b. Cash inflow in the form of cost savings
c. Both a cash outflow in the form of cash payments and a cash inflow in the form of cost
savings
d. Neither a cash outflow in the form of cash payments nor a cash inflow in the form of
cost savings
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

56. When a new piece of equipment is purchased, which of the following would be considered a
cash inflow?
a. Cost savings
b. Salvage value of the new equipment
c. Additional revenue generated
d. All of these answer choices are correct.
Unit 9-1, LO1 – D
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

57. Mauldin Welding Shop is considering the purchase of new high-tech welding equipment. If the
equipment is purchased, Mauldin can avoid the cost of updating the old equipment estimated
to be $3,000. In determining the cash flows associated with the new equipment, the cost of
updating the old equipment will be
a. A cash outflow
b. A cash inflow
c. A sunk cost
d. Not relevant
Unit 9-1, LO1 – B
LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

58. Mauldin Welding Shop is considering the purchase of new high-tech welding equipment. If the
equipment is purchased, Mauldin will have to incur $2,000 to install the equipment and pay a
technician to adjust the computer settings. In determining the cash flows associated with the
new equipment, the $2,000 payment will be
a. A cash outflow
b. A cash inflow
c. An opportunity cost
d. Not relevant
Unit 9-1, LO1 – A
LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 59. Mauldin Welding Shop is considering the purchase of new high-tech welding equipment. If the
equipment is purchased, Mauldin will incur an additional $8,000 in annual depreciation expense
for the next five years. In determining the cash flows associated with the new equipment, the
$8,000 of annual depreciation expense will be
a. A cash outflow
b. A cash inflow
c. A sunk cost
d. Ignored in the cash flow analysis
Unit 9-1, LO1 – D
LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

60. Bend Manufacturers is considering investing in a new truck that will be used to deliver its
custom-made furniture. The truck currently used by Bend cost the company $72,000 eight years
ago. Two years from now the company anticipates spending $20,000 to overhaul the old truck,
at which time the truck could be used for an additional 10 years. The old truck costs $8,000 per
month in gas, insurance, and other costs to operate. Ron Shop, Controller of Bend
Manufacturers, is considering the purchase of a new truck which will cost $100,000 and which
has a useful life of 10 years. The new truck will only cost $4,800 per month to operate, but will
require an overhaul 8 years from now that is expected to cost $8,000. Ron believes the old
truck could be sold for $16,000. If the new truck is purchased, he estimates that the new truck
could be sold for $28,000 at the end of its useful life. Which of the following is not a relevant
cash flow in the decision to replace the truck?
a. $3,200 per month in operating cost savings
b. $20,000 overhaul avoided on old truck
c. $72,000 purchase price of old truck
d. $16,000 salvage value of old truck
Unit 9-1, LO1 – C
LO: 1, Bloom: C, Unit: 9-1, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: The purchase price of the old truck is not relevant to the present decision.

61. Capital budgeting decisions involve all of the following except

a. Outflows of cash at one or more times
b. Inflows of cash at one or more times
c. Consideration of depreciation expense
d. A review and approval process
Unit 9-2, LO2 – C
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 62. In making a capital budgeting decision, one needs to compare cash flows in terms of
a. Their amounts
b. When they occur
c. Both their amounts and when they occur
d. Neither their amounts nor when they occur
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

63. In making a capital budgeting decision, one needs to compare cash flows in terms of their
amounts and when they occur. One way to do so is to determine the
a. Future value
b. Present value
c. Average cash outflows
d. Opportunity costs
Unit 9-2, LO2 – B
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

64. The value today of the dollars to be paid or received in the future is referred to as
a. Present value
b. Future value
c. Either a or b
d. Neither a nor b
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

65. The process of determining how much an amount of money to be received in the future is worth
today is called
a. Present value
b. Hurdling
c. Discounting
d. None of these answer choices are correct
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

66. The interest rate used in present value calculations is called the
a. Discount rate
b. Hurdle rate
c. Compound rate
d. None of these answer choices are correct
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 67. To determine the present value of any future amount, you need to know
a. The future amount to be received
b. The interest rate
c. When the future amount will be received
d. All of these answer choices are correct
Unit 9-2, LO2 – D
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

68. To determine the present value of any future amount, you need to know all of the following
except?
a. The interest rate
b. The future amount to be received
c. Screening rate
d. When the future amount will be received
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

69. To determine the present value of any future amount, you need to know
a. The opportunity cost
b. The stated maximum rate of return
c. The future amount to be received
d. All of these answer choices are correct
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

70. To calculate the present value of any future amount, you can use which of the following tables?
a. Present value of $1 received in n periods
b. Future value of $1 received in n periods
c. Present value of an annuity
d. Future value of an annuity
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

71. In looking at the “Present Value of $1 Received in n Periods” the columns represent
a. Different interest rates
b. Number of periods in the future
c. Discount factor
d. None of these answer choices are correct
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 72. In looking at the “Present Value of $1 Received in n Periods” the rows represent
a. Different interest rates
b. Number of periods in the future
c. Discount factor
d. None of these answer choices are correct
Unit 9-2, LO2 – B
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

73. When the interest from year one is built into the principal balance, the interest is referred to as
a. Differential interest
b. Discounted interest
c. Compound interest
d. None of these answer choices are correct
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

74. Compounding interest more frequently than annually changes the

a. Number of periods
b. The discount rate
c. Both the number of periods and the discount rate.
d. Neither the number of periods nor the discount rate
Unit 9-2, LO2 – C
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

75. The relationship between the discount rate and the present value is
a. Inverse
b. Proportionate
c. Constant
d. Sporadic
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

76. A stream of equal cash flows received at set time intervals is called a (an)
a. Annuity
b. Present cash flow
c. Discounted cash flow
d. None of these answer choices are correct
Unit 9-2, LO2 – A
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 77. To calculate the present value of an annuity, multiply
a. The principal amount by the present value factor
b. The amount to be received each year by the present value factor
c. The principal by the discounted interest rate
d. The amount to be received each year by the discounted interest rate
Unit 9-2, LO2 – B
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

78. To calculate the present value of an annuity, multiply

a. The total dollars to be received by the present value factor
b. The total dollars to be received by the discounted interest rate
c. The amount to be received each year by the present value factor
d. The amount to be received each year by the discounted interest rate
Unit 9-2, LO2 – C
LO: 2, Bloom: K, Unit: 9-2, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

79. A dollar received today is

a. Worth less than a dollar received in the future discounted at 12% interest.
b. Worth more than a dollar received at any time in the future.
c. Worth less than a dollar received in the future if the current interest rate is lower than
the anticipated future interest rate.
d. None of these answer choices are correct.
Unit 9-2, LO2 – B
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

80. Given a present value factor of 0.7921, assuming a 6% discount rate, the present value of
$16,000 payment received in 4 years is
a. $3,168
b. $12,674
c. $20,199
d. None of these answer choices are correct
Unit 9-2, LO2 – B
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
Solution: $16,000 x 0.7921 = $12,674

81. Assuming an 6% discount rate, the present value of a $22,000 payment received in 3 years is
a. $18,472
b. $23,812
c. $25,123
d. $32,947
Unit 9-2, LO2 – A
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $22,000 x 0.83964 = $18,472
 82. Given a present value factor of 3.7907, assuming a 10% discount rate, the present value of an
annuity of $20,000 payment each year for five years is
a. $5,276
b. $26,380
c. $75,814
d. $379,070
Unit 9-2, LO2 – C
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
$20,000 x 3.7907 = $75,814

83. Dina Jones just learned that she received an inheritance from her grandmother. The inheritance
provides for Dina to receive $5,000 per year at the end of the year for each of the next 5 years.
Using the following factors, what is the value of this inheritance to Dina today?

Type of cash flow (n) Periods (i) Interest rate Factor

PV of $1 5 10% .62092
FV of $1 5 10% 1.61051
PV ordinary annuity 5 10% 3.79079
FV ordinary annuity 5 10% 6.10510
PV annuity due 5 10% 4.16986

a. $15,523
b. $20,849
c. $18,954
d. $30,526
Unit 9-2, LO2 – C
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $5,000 x 3.79079 = $18,954
84. Chris Mann will deposit $22,400 into an account today that earns 10% per year compounded
annually. Using the following factors, what is the amount that will be in the account at the end
of the 5 years?

Type of cash flow (n) Periods (i) Interest rate Factor

PV of $1 5 10% .62092
FV of $1 5 10% 1.61051
PV ordinary annuity 5 10% 3.79079
FV ordinary annuity 5 10% 6.10510
PV annuity due 5 10% 4.16986

a. $36,075
b. $13,909
c. $27,351
d. $18,681
Unit 9-2, LO2 – A
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $22,400 x 1.61051 = $36,075

85. Stacey Trail has just won the Lotto. Her prize pays $40,000 at the end of each year for 5 years.
In addition, she will receive a one-time payment of $240,000 at the end of 5 years. Using the
following factors at 10%, what amount has Stacey really won in the Lotto?

Type of cash flow (n) Periods (i) Interest rate Factor

PV of $1 5 10% .62092
FV of $1 5 10% 1.61051
PV ordinary annuity 5 10% 3.79079
FV ordinary annuity 5 10% 6.10510
PV annuity due 5 10% 4.16986

a. $440,000
b. $300,653
c. $553,317
d. $484,204
Unit 9-2, LO2 – B
LO: 2, Bloom: C, Unit: 9-2, Difficulty: Moderate, Min: 4, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: 240,000 x 0.62092 = $149,021; $40,000 x 3.79079 = $151,632;
$149,021 + $151,632 = $300,653
 86. Which of the following is not a step in the net present value approach to capital budgeting?
a. Identify the amount and timing of each cash flow
b. Determine the appropriate discount rate
c. Compare the discount rate to the hurdle rate
d. Calculate the net present value of the project
Unit 9-3, LO3 – C
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

87. Which of the following is not a step in the net present value approach to capital budgeting?
a. Identify the amount and timing of each cash flow
b. Determine the payback period
c. Calculate the present value of each cash flow
d. Calculate the net present value of the project
Unit 9-3, LO3 – B
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

88. Before you can calculate the present value of a cash flow, you must
a. Identify the amount and timing of each cash flow
b. Determine the appropriate discount rate
c. Both identify the amount and timing of each cash flow and determine the appropriate
discount rate
d. Neither identify the amount and timing of each cash flow nor determine the appropriate
discount rate
Unit 9-3, LO3 – C
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

89. Which of the following is a factor that influences the discount rate?
a. Level of risk
b. Inflation
c. Both the level of risk and inflation
d. Neither the level of risk nor inflation
Unit 9-3, LO3 – C
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

90. Which of the following is not a factor that influences the discount rate?
a. Level of risk
b. Inflation
c. Investor’s expected rate of return
d. All of these answer choices are factors that influence the discount rate
Unit 9-3, LO3 – D
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 91. Which of the following is not a factor that influences the discount rate?
a. Amount of the cash flows
b. Inflation
c. Investor’s expected rate of return
d. All of these answer choices are factors that influence the discount rate
Unit 9-3, LO3 – A
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

92. Discount rates are used to value which of the following items?
a. Future earnings
b. A partnership’s property when a new partner is being admitted
c. Distributions of estate assets
d. All of these answer choices are correct
Unit 9-3, LO3 – D
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

93. Once you have determined the net present value of a project, if the net present value is less
than zero, the project should be
a. Accepted
b. Rejected
c. Before making a decision, calculate the future value of the project
d. Before making a decision, recalculate the present value using another discount rate
Unit 9-3, LO3 – B
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

94. The decision to replace old equipment with new equipment can be analyzed by
a. Incremental analysis
b. Calculating the cost of each decision separately – keep or replace
c. Both incremental analysis and calculating the cost of each decision separately – keep or
replace
d. Neither incremental analysis nor calculating the cost of each decision separately – keep
or replace
Unit 9-3, LO3 – C
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

95. The actual return earned on a project is called the

a. Internal rate of return
b. Net future value
c. Payback amount
d. None of these answer choices are correct
Unit 9-3, LO3 – A
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 96. In which of the following situations should a project not be accepted?
a. Internal rate of return is less than the discount rate
b. Internal rate of return is equal to the discount rate
c. Internal rate of return is greater than the discount rate
d. When the internal rate of return is greater than zero
Unit 9-3, LO3 – A
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

97. When a project’s internal rate of return equals the discount rate,
a. A manager has probably manipulated the analysis
b. The net present value is zero
c. The discount rate is equal to the industry average
d. None of these answer choices are correct
Unit 9-3, LO3 – B
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

98. The net initial investment is the

a. Net cash outflow in year 0
b. Net cash outflow for all years combined
c. Net cash outflow as computed at the initial discount rate
d. None of these answer choices are correct
Unit 9-3, LO3 – A
LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

99. You cannot easily use the annuity table method to calculate
a. The return on investment
b. The internal rate of return with uneven cash flows
c. Analyzing the purchase of a capital asset
d. You can use the annuity table method for all of these answer choices
Unit 9-3, LO3 – B
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

100. Which of the following is not an assumption of the internal rate of return model?
a. The amount and timing of all cash flows is known exactly
b. All cash flows occur at the end of the year
c. Cash inflows from the project are reinvested in another project earning a return equal
to the internal rate of return
d. All of these answer choices are assumptions of the internal rate of return model.
Unit 9-3, LO3 – D
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 101. Which of the following uses interest expense in its computations?
a. Net present value
b. Internal rate of return
c. Both net present value and internal rate of return
d. Neither net present value nor internal rate of return
Unit 9-3, LO3 – D
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

Problems 102 - 107 require the use of Present Value Tables

102. Braxton Manufacturing is considering the purchase of new computerized equipment. The
machine costs $85,000 and would generate $22,000 in annual cost savings over its 5-year life. At
the end of 5 years, the equipment would have a $5,000 salvage value. Braxton’s required rate of
return is 12%. The machine’s net present value is nearest
a. ($2,857)
b. ($5,694)
c. $79,306
d. $110,000
Unit 9-3, LO3 – A
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $22,000 x 3.60478 = $79,305 - $85,000 + ($5,000 x 0.5675) = ($2,857)

103. Braxton Manufacturing is considering the purchase of new computerized equipment. The
machine costs $75,000 and would generate $22,000 in annual cost savings over its 5-year life. At
the end of 5 years, the equipment would have a $5,000 salvage value. Braxton’s required rate of
return is 12%. The machine’s net present value is
a. $695
b. $4,305
c. $7,143
d. $79,306
Unit 9-3, LO3 – C
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $22,000 x 3.60478 = $79,305 - $75,000 + ($5,000 x 0.5675) = $7,143

104. Logan, Inc. is considering the purchase of a warehouse directly across the street from its
manufacturing plant. Logan currently warehouses its inventory in a public warehouse across
town. Rent on the warehouse and delivering and picking up inventory cost Logan $48,000 per
year. The building will cost Logan $450,000. Logan will depreciate the building for 20 years. At
the end of 20 years, the building will have a $125,000 salvage value. Logan’s required rate of
return is 10%. The building’s net present value is
a. ($41,347)
b. ($22,772)
c. $427,228
d. $960,000
Unit 9-3, LO3 – B
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $48,000 x 8.5136 = $408,653 - $450,000 + ($125,000 x 0.1486) = ($22,772)
 105. Logan, Inc. is considering the purchase of a warehouse directly across the street from its
manufacturing plant. Logan currently warehouses its inventory in a public warehouse across
town. Rent on the warehouse and delivering and picking up inventory cost Logan $48,000 per
year. The building will cost Logan $400,000. Logan will depreciate the building for 20 years. At
the end of 20 years, the building will have a $125,000 salvage value. Logan’s required rate of
return is 10%. The building’s net present value is
a. ($41,347)
b. $27,228
c. $427,228
d. $960,000
Unit 9-3, LO3 – B
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $48,000 x 8.5136 = $408,653 - $400,000 + ($125,000 x 0.1486) = $27,228

106. Woods Manufacturing is considering the purchase of a new sewing machine that costs
$18,000. The machine, because of its efficiency, will save about $4,000 in cost each year. The
machine is expected to have a salvage value of $3,000 and a life of 6 years. Woods’ required
rate of return is 12%. What is the machine’s net present value?
a. ($34)
b. $1,520
c. $15,000
d. $24,000
Unit 9-3, LO3 – A
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $4,000 x 4.1114 = $16,446 - $18,000 + ($3,000 x 0.5066) = ($34)

107. Woods Manufacturing is considering the purchase of a new sewing machine that costs
$16,000. The machine, because of its efficiency, will save about $4,000 in cost each year. The
machine is expected to have a salvage value of $3,000 and a life of 6 years. Woods’ required
rate of return is 12%. What is the machine’s net present value?
a. ($34)
b. $1,966
c. $15,000
d. $24,000
Unit 9-3, LO3 – B
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $4,000 x 4.1114 = $16,446 - $16,000 + ($3,000 x 0.5066) = $1,966
108. Bend Manufacturers is considering investing in a new truck that will be used to deliver
its custom-made furniture. Ron Shop, Controller of Bend Manufacturers, is considering a truck
which will cost $80,000 and which has a useful life of 5 years. The new truck will save $9,600
per year in operating costs which are realized at the end of each year. Ron believes if the new
truck is purchased it could be sold for $64,500 at the end of its useful life. Bend’s required rate
of return is 10%. What is the new truck’s net present value?

Type of cash flow (n) Periods (i) Interest rate Factor

PV of $1 5 10% .62092
FV of $1 5 10% 1.61051
PV ordinary annuity 5 10% 3.79079
FV ordinary annuity 5 10% 6.10510
PV annuity due 5 10% 4.16986

a. ($80)
b. ($8,049)
c. ($3,559)
d. $18,658
Unit 9-3, LO3 – C
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $9,600 x 3.79079 = $36,392 - $80,000 + ($64,500 x 0.62092) = ($3,559)

109. Keltner Enterprises is considering investing in a new packing machine. The new machine
will provide annual cash operating inflows of $12,300 for 5 years. The cost of the machine is
$42,300 and it can be sold at the end of its 5-year useful life for $6,800. Keltner’s required rate
of return is 10%. What is the machine’s net present value?

Type of cash flow (n) Periods (i) Interest rate Factor

PV of $1 5 10% .62092
FV of $1 5 10% 1.61051
PV ordinary annuity 5 10% 3.79079
FV ordinary annuity 5 10% 6.10510
PV annuity due 5 10% 4.16986

a. ($105)
b. $13,211
c. $8,549
d. $15,278
Unit 9-3, LO3 – C
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $12,300 x 3.79079 = $46,627 - $42,300 + ($6,800 x 0.62092) = $8,549
110. Keltner Enterprises is considering investing in a new packing machine. The new machine
will provide annual cash operating inflows of $12,300 for 5 years. The cost of the machine is
$50,430. The machine currently being used is 3 years old and could be sold for $1,320. What is
the machine’s internal rate of return?

Type of cash flow (n) Periods (i) Interest rate Factor

PV ordinary annuity 5 6% 4.21236
PV ordinary annuity 5 8% 3.99271
PV ordinary annuity 5 10% 3.79079
PV ordinary annuity 5 12% 3.60478
PV ordinary annuity 5 15% 3.35216

a. 6%
b. 8%
c. 10%
d. 12%
Unit 9-3, LO3 – B
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 4, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: ($50,430 – 1,320) ÷ $12,300 = 3.9927, which is the PV factor for 8%

111. James Bruce is the CEO of Bruce Industries. James is interested in purchasing new
pollution abatement equipment because the current equipment is outdated and not efficient.
The controller of the company has identified equipment that costs $104,110 and will provide
annual cash operating inflows of $28,290 for 5 years. The equipment currently being used is 3
years old and could be sold for $2,130. What is the equipment’s internal rate of return?

Type of cash flow (n) Periods (i) Interest rate Factor

PV ordinary annuity 5 6% 4.21236
PV ordinary annuity 5 8% 3.99271
PV ordinary annuity 5 10% 3.79079
PV ordinary annuity 5 12% 3.60478
PV ordinary annuity 5 15% 3.35216

a. 8%
b. 10%
c. 12%
d. 15%
Unit 9-3, LO3 – C
LO: 3, Bloom: C, Unit: 9-3, Difficulty: Moderate, Min: 4, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: ($104,110 – 2,130) ÷ $28,290 = 3.6048, which is the PV factor for 12%
 112. The time it takes, in years, for an investment to return the original amount of invested
capital is referred to as
a. Payback period.
b. Period of return.
c. Investment return period.
d. Capital return period.
Unit 9-4, LO5 – A
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

113. The payback period is defined as

a. The amount of time, in years, that it takes the company to provide investors a return on
the capital.
b. The amount of time, in years, that it takes for an investment to return the original
amount of the capital plus the required internal rate of return.
c. The amount of time, in years, that it takes the company to earn enough profit generated
from the capital asset to pay for it.
d. The amount of time, in years, that it takes for an investment to return the original
amount of invested capital.
Unit 9-4, LO5 – D
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

114. The payback period is most often used as which of the following tools?
a. Preference
b. Screening
c. Budgeting
d. Evaluation
Unit 9-4, LO5 – B
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

115. The payback period of a project that produces even cash flows each year is calculated by
dividing
a. Net initial investment by the projected annual cash flow.
b. Gross initial investment by the projected annual cash flow.
c. Net initial investment by the projected annual cash inflows.
d. Gross initial investment by the projected annual cash inflows.
Unit 9-4, LO5 – A
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 116. Lorman Manufacturing purchases equipment with an expected life of 10 years for
$50,000. The equipment has an estimated salvage value of $2,000. Lorman expects the new
equipment to generate cost savings of $8,000. What is the payback period for the equipment?
a. 6 years
b. 6.25 years
c. 6.50 years
d. 10 years
Unit 9-4, LO5 – B
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Easy, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
Solution: $50,000 ÷ $8,000 = 6.25 years

117. Welcher, Inc. plans to purchase equipment with a cost of $142,500. The company
expects annual cash inflows from the equipment of $30,000. The equipment has an estimated
life of 8 years, no estimated salvage life, and a required rate of return is 6%. The payback period
for the equipment is closest to
a. 1 year.
b. 1.5 years.
c. 5 years.
d. 8 years.
Unit 9-4, LO5 – C
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Easy, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
Solution: $142,500 ÷ $30,000 = 4.75 years (closest to 5 years)

118. Minor Company is going to invest in a new product line. Minor estimates that the net
cash flows from the new line will be $25,000 per year. The initial investment required to
implement the new line will be $500,000. The company requires a rate of return of 8% and the
new product line is expected to span a time period of 15 years. What is the payback period for
the new product line?
a. 1.6 years
b. 12.5 years
c. 20 years
d. 25 years
Unit 9-4, LO5 – C
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Easy, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
Solution: $500,000 ÷ $25,000 = 20 years

119. Which of the following is a limitation of the payback period?

a. This method is complex to calculate.
b. The cash flows after the payback period needed for the calculation are difficult to
determine.
c. This method ignores the time value of money.
d. The discount rate used in the calculation may change before the end of the payback.
Unit 9-4, LO5 – C
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 120. Which of the following is a limitation of the payback period method?
a. It ignores the time value of money
b. It ignores cash flows that occur after the payback period
c. It both ignores the time value of money and it ignores cash flows that occur after the
payback period
d. Neither that it ignores the time value of money nor that it ignores cash flows that occur
after the payback period
Unit 9-4, LO5 – C
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

121. The return generated by an investment based on its operating income is the
a. Internal rate of return.
b. Discounted rate of return.
c. Accounting rate of return.
d. Payback period.
Unit 9-4, LO5 – C
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

122. The accounting rate of return differs from other methods in that it
a. Does not focus on cash flows.
b. The calculation is complex.
c. It ignores the time value of money.
d. None of these answer choices are correct.
Unit 9-4, LO5 – A
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

123. The accounting rate of return is also known as the

a. Simple rate of return.
b. Internal rate of return.
c. Present value of an investment.
d. None of these answer choices are correct.
Unit 9-4, LO5 – A
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

124. The accounting rate of return is also known as the

a. Internal rate of return.
b. Unadjusted rate of return.
c. Return on investment.
d. None of these answer choices are correct.
Unit 9-4, LO5 – B
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 125. Which of the following is not used in the calculation of the accounting rate of return?
a. Additional revenues generated by the investment
b. All additional operating expenses
c. Amount of the initial investment
d. Present value of an annuity factor.
Unit 9-4, LO5 – D
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

126. Which of the following is the formula for the accounting rate of return?

Net initial investment

a. Annual cash flow

Project revenue – project operating expenses

b. Initial investment – salvage of old asset

Present value of future cash flows

c. Net initial investment

d. None of these answer choices are correct

Unit 9-4, LO5 – B
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

127. Which of the following is a weakness of the accounting rate of return?

a. It does not consider cash flows
b. It does not consider the time value of money
c. Both that it does not consider cash flows and that it does not consider the time value of
money
d. Neither that it does not consider cash flows nor that it does not consider the time value
of money
Unit 9-4, LO5 – C
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

128. Which of the following is not a weakness of the accounting rate of return?
a. It does not consider cash flows
b. It does not consider the time value of money
c. The discount rate used in the calculation may change over the life of the investment
d. All of these answer choices are weaknesses of the accounting rate of return
Unit 9-4, LO5 – C
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 129. Which of the following is an advantage of the accounting rate of return?
a. It is easy to determine the time value of money used in the calculation
b. Accounting records are generally not based on cash flow, so the information for the
calculation is readily available.
c. Since depreciation is not included in the calculation, the result is not distorted.
d. None of these answer choices are correct.
Unit 9-4, LO5 – B
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Difficult, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

130. The payback period measures

a. The present value of an investment.
b. The actual cost of an investment.
c. The time, in years, for an investment to return the original amount of invested capital.
d. None of these answer choices are correct.
Unit 9-4, LO5 – C
LO: 5, Bloom: K, Unit: 9-4, Difficulty: Easy, Min: 2, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

131. Which of the following is an advantage of the payback period?

a. It is a simple technique
b. Accounting records are generally not based on cash flow, so the information for the
calculation is readily available.
c. Since depreciation is not included in the calculation, the result is not distorted.
d. None of these answer choices are correct.
Unit 9-4, LO5 – A
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 2, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

132. Bowen is considering the purchase of equipment costing $150,000. The equipment has a 12-
year useful life and will generate $25,000 in annual cash flows. The company has a 10% required
rate of return and uses the straight-line depreciation method. The accounting rate of return on
this equipment is closest to
a. 1.6%
b. 8.3%
c. 10%
d. 25%
Unit 9-4, LO5 – B
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $25,000 – ($150,000 ÷ 12) = $12,500
$12,500 ÷ $150,000 = 8.3%

133. Morrow Company has invested in equipment that cost $70,000. The equipment has a 7-year
life and no salvage value. Morrow uses straight-line depreciation. The equipment has a payback
period of 4 years. The accounting rate of return is closest to
a. 3.5%
b. 10.7%
c. 25%
d. 39%
Unit 9-4, LO5 – B
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solutions: ($70,000 ÷ 4) – ($70,000 ÷ 7) = $7,500
$7,500 ÷ $70,000 = 10.7%

134. Pilot Corporation is considering the purchase of equipment costing $100,000. The equipment
will reduce operating cash expenses by $25,000 each year. The new equipment has a salvage
value of $2,000 and will be depreciated over a 10-year useful life. The accounting rate of return
is closest to
a. 15.2%
b. 25%
c. 25.5%
d. 35%
Unit 9-4, LO5 – A
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Moderate, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $25,000 – [(100,000 - $2,000) ÷ 10] = $15,200
$15,200 ÷$100,000 = 15.2%

135. Johnson Whole Distributors has invested in equipment that cost $120,000. The equipment has
an 8-year life and no salvage value. Johnson uses straight-line depreciation. The equipment has
a payback period of 5 years. The accounting rate of return is closest to
a. 5%
b. 6.25%
c. 7.8%
d. 7.5%
Unit 9-4, LO5 – D
LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Difficult, Min: 3, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
Solution: $120,000 ÷ 5 = $24,000 revenue
Depreciation: $120,000 ÷ 8 = $15,000
($24,000 - $15,000) ÷ $120,000 = 7.5%

136. Keltner Enterprises is considering investing in a new packing machine. The new machine
will provide annual cash operating inflows of $12,300 for 5 years. The cost of the machine is
$42,300 and it can be sold at the end of its 5-year useful life for $6,800. Keltner’s required rate
of return is 10%. What is the packing machine’s payback period?
a. 3.44 years
b. 2.89 years
c. 3.99 years
d. 7.69 years
Unit 9-4, LO5 – A
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $42,300 ÷ $12,300 = 3.44 years
137. Andrea Kris is opening a small flower shop that will focus primarily on delivery, but will
provide a small showroom for walk-in customers. A local florist is retiring and selling her small
flower shop to Andrea for $162,500. The shop has a remaining life of 20 years. Andrea expects
to have revenues of $81,250 per year and pay approximately 60% of revenues in operating
costs. What is the payback period for Andrea’s flower shop?
a. 5 years
b. 2 years
c. 3.33 years
d. 6.66 years
Unit 9-4, LO5 – A
LO: 5, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: $162,500 ÷ [$81,250 x (1-0.60)] = 5 years

138. Andrea Kris is opening a small flower shop that will focus primarily on delivery, but will
provide a small showroom for walk-in customers. A local florist is retiring and selling her small
flower shop to Andrea for $162,500. The shop has a remaining life of 20 years. Andrea expects
to have revenues of $81,250 per year and pay approximately 60% of revenues in operating
costs. What is the accounting rate of return for Andrea’s flower shop?
a. 15%
b. 20%
c. 45%
d. 25%
Unit 9-4, LO6 – A
LO: 6, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: [[$81,250 x (1-0.6)] – ($162,500 ÷ 20)] ÷$162,500 = 15%

139. Judy Blue, CEO of the clothing store All Blue, is planning to open a new store in
Manhattan. She plans to purchase a small storefront for $5,250,000 which has a remaining
useful life of 15 years. She plans to hire 2 part-time sales clerks and will pay each of them
$34,000 per year in wages and other benefits. Judy expects that revenues will average $86,000
per month and other monthly operating costs will run $13,200. What is the accounting rate of
return for the Manhattan store?
a. 15.3%
b. 8.7%
c. 10%
d. 1.1%
Unit 9-4, LO6 – B
LO: 6, Bloom: C, Unit: 9-4, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Cost Management
Solution: [($86,000 - $13,200) x 12] – ($34,000 x 2) – ($5,250,000 ÷ 15) = $455,600
455,600 ÷$5,250,000 = 8.7%
Answers to Multiple-Choice Questions
Item Ans Item Ans Item Ans Item Ans Item Ans
31. B 53. A 75. A 97. B 119. C
32. A 54. B 76. A 98. A 120. C
33. C 55. C 77. B 99. B 121. C
34. C 56. D 78. C 100. D 122. A
35. D 57. B 79. B 101. D 123. A
36. A 58. A 80. B 102. A 124. B
37. B 59. D 81. A 103. C 125. D
38. C 60. C 82. C 104. B 126. B
39. C 61. C 83. C 105. B 127. C
40. A 62. C 84. A 106. A 128. C
41. B 63. B 85. B 107. B 129. B
42. C 64. A 86. C 108. C 130. C
43. C 65. C 87. B 109. C 131. A
44. A 66. A 88. C 110. B 132. B
45. B 67. D 89. C 111. C 133. B
46. C 68. C 90. D 112. A 134. A
47. A 69. C 91. A 113. D 135. D
48. B 70. A 92. D 114. B 136. A
49. D 71. A 93. B 115. A 137. A
50. D 72. B 94. C 116. B 138. A
51. D 73. C 95. A 117. C 139. B
52. C 74. C 96. A 118. C
 MATCHING
140. Match the following terms to the appropriate statement by placing the letter to the left of
each statement.

a. Annuity f. Present value

b. Discount rate g. Profitability index
c. Hurdle rate h. Return on investment
d. Internal rate of return i. Screening decision
e. Preference decision j. Simple rate of return

____ 1. Any return you receive over and above the original investment
____ 2. The discounted amount of an amount of money to be received in the future.
____ 3. The actual return earned on a project
____ 4. Compares the present value of a project’s cash flows to the net initial investment
____ 5. Managers determine which project will actually receive funds by rank-ordering them based
on selected criteria
____ 6. The minimum required rate of return
____ 7. A stream of equal cash flows received at set time intervals
____ 8. The goal is to narrow the list of capital proposals to include only those that are expected to
bring the desired level of return
____ 9. The return generated by an investment based on its operating income
____ 10. Interest rate used in the calculation of the present value of a future amount

Unit 9-1, 2, 3, 4, LO1, 2, 3, 4,

Solution:

1. h – Return on investment
2. f – Present value
3. d – Internal rate of return
4. g – Profitability index
5. e – Preference decision
6. c – Hurdle rate
7. a - Annuity
8. i – Screening decision
9. J – simple rate of return
10. b – Discount rate

LO: 1,2,3,4, Bloom: K, Unit: 9-1,9-2,9-3,9-4, Difficulty: Moderate, Min: 15, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA
PC: Problem Solving and Decision Making, IMA: Investment Decisions
 BRIEF EXERCISES
141. Identify which of the following items would be classified as capital assets.

a. Pollution prevention technology

b. Direct material
c. Computer generated manufacturing system
d. Office supplies
e. Delivery van

Unit 9-1, LO1

Solution:

a, c and e are capital assets.

LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

142. Identify which of the following items would be classified as capital assets.

a. Manufacturing equipment
b. Forklift
c. Janitorial supplies
d. Manufacturing overhead
e. Office furniture

Unit 9-1, LO1

Solution:

a, b and e are capital assets.

LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

143. Assume that on January 1, 2012 you purchased ten shares of XYZ Corporate stock for $22
each. On September 30, 2014, you sell one-half of your stock for $28 each. What is your return
on your investment?

Unit 9-1, LO1

Solution:

($28 -$22) x 5 = $30

LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 Brief Exercises 144 through 148 require the use of Present Value Tables.

144. The following data pertain to an investment proposal:

Cost of investment $45,000

Annual cost savings $10,000
Estimated salvage value $0
Expected life of investment 5 years
Discount rate 10%

What is the present value of the proposed investment?

Unit 9-2, LO2

Solution:

Present value of cost savings, 10%, 5 yrs ($10,000 x 3.7907) $37,907

Less initial investment, 0 periods $45,000
Net present value of proposed investment ($7,093)

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Moderate, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

145. If you wish to have $25,000 in five years, how much must you deposit today if you will earn
12% compounded annually on your investment?

Unit 9-2, LO2

Solution:

$25,000 x .5674 = $14,185

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

146. If you wish to have $25,000 at the end of five years, how much must your deposit each year if
you earn 12% compounded annually?

Unit 9-2, LO2

Solution:

$25,000/6.3529 = $3,935

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 147. Your company is considering a capital project that will require a net initial investment of
$249,972. The project is expected to have a 7-year life and will generate an annual cash inflow
of $43,200. What is the internal rate of return?

Unit 9-3, LO4

Solution:

$249,972/$43,200 =5.7864
Internal rate of return = 5%

LO: 4, Bloom: AP, Unit: 9-3, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

148. ABC Manufacturing is evaluating two capital projects. The company’s choice will be based on
the profitability index. Project #1 has a present value of cash flows of $200,000 and a net initial
investment of $180,000 while Project #2 has a present value of future cash flows of $820,000
and a net initial investment of $800,000. Which project will ABC choose? Why?

Unit 9-3, LO3

Solution:

Project #1 – $200,000/$180,000 = 1.111

Project #2 - $820,000/$800,000 = 1.025

ABC should choose Project #1 since its profitability index (1.11)is higher than the profitability
index of Project #2 (1.025).

LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 7, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 149. Complete the following table by answering “Yes” and “No” in the columns that apply to each
item. (First item is done for you.)

Considers Time Uses accounting Considers cash flows

value of money profitability over life of project
Net present value
Internal rate of return
Present value of an annuity
Payback period with uneven
cash flows
Return of investment
Simple rate of return

Unit 9-3, LO3

Solution:

Considers Time Uses accounting Considers cash flows

value of money profitability over life of project
Net present value Yes No Yes
Internal rate of return Yes No Yes
Present value of an annuity Yes No Yes
Payback period with uneven No No Yes*
cash flows
Return of investment No No No
Simple rate of return No Yes No

*Cash flows beyond payback period are ignored.

LO: 3, Bloom: K, Unit: 9-3, Difficulty: Moderate, Min: 12, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

150. Marple Industries is evaluating a capital project with a net initial investment of $120,000. The
project is expected to generate net cash inflows of $15,000 each year. Calculate the payback
period for the project.

Unit 9-3, LO3

Solution:

$120,000/$15,000 = 8 years

LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions
 EXERCISES
151. Identify which of the following items would be classified as capital assets.

a. New Ultrasound equipment for pediatric department of General Hospital

b. Depreciation on hospital equipment
c. Fitness equipment at local gym
d. Land held for future development
e. Cost of painting factory building
f. Manufacturing overhead
g. Recycle machine purchased by local waste management center
h. Steel used to produce automobiles
i. Laser machine used in factory to cut marble
j. Salary of computer technician

Unit 9-1, LO1

Solution:

a, c, d, g, and i are capital assets.

LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 15, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions

152. Identify which of the following items would be classified as capital assets.

a. New equipment to replace less efficient old equipment

b. Car wash business
c. Depreciation on building
d. 150 acres of land to be used to build a new factory building
e. Computed Axial Tomography Machine (CAT Scan machine)
f. Manufacturing overhead
g. Pollution prevention technology
h. Direct material
i. Computer generated manufacturing system
j. Office supplies

Unit 9-1, LO1

Solution:

a, b, d, e, g, and i are capital assets.

LO: 1, Bloom: C, Unit: 9-1, Difficulty: Difficult, Min: 15, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication, IMA:
Investment Decisions
 153. Felder’s manufacturing is considering the purchase of new equipment that costs $750,000 to
replace equipment that is old and inefficient. Felder has found a buyer for the old equipment
who will pay $8,000 for it. The new equipment is expected to produce $12,000 of additional
revenue each year, but will result in additional maintenance cost of $2,000. The new equipment
will have a salvage of $10,000 and will be depreciated over 10 years.

Required:

Identify the amount and timing of the cash flows relevant to Felder’s decision to purchase the
new equipment.

Unit 9-1, LO1

Solution:

Cash flow Time period

Purchase price of new equipment $750,000 0
Additional revenue $12,000 1-10
Additional maintenance cost ($2,000) 1-10
Selling price of old equipment $8,000 0
Salvage value of equipment $10,000 10

LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Moderate, Min: 10, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 154. Friendly Freddie’s Furniture Store uses an 8-year old van to deliver furniture to customers
within a 50-mile radius of the store. The van has an original cost of $22,000. It costs $1,000 each
month to operate the van. Unfortunately, the van was in an accident last week and it will cost
$5,000 for repairs. Freddie has found a new van that will cost $35,000. Freddie expects to get 10
years use from the new van and estimates that the operating costs will be $800 each month.
Freddie can sell his old van as is for $2,500.

Required:

Identify the amount and timing of the cash flows relevant to Friendly Freddie’s decision to
replace the van.

Unit 9-1, LO1

Solution:

Cash flow Time period

Purchase price of new van $35,000 0
Operating cost savings $2,400 1-10
Repair of old van if kept ($5,000) 0
Salvage of old van $2,500 0

LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Moderate, Min: 10, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

155. Patricia is 66 years old and is planning to retire this year. She is covered under her company’s
retirement policy which gives her two payment options. The first option is to receive annuity
payments of $20,000 each year for the next 20 years. The second option is to receive $250,000
immediately upon retirement. The interest rate is 4%.

Required:

a. What is the present value of Patricia’s first option?

b. What is the present value of Patricia’s second option?

c. Which option should Patricia choose?

Unit 9-2, LO2

Solution:

a. $20,000 x 13.5903 = $271,806

b. $250,000

c. Patricia should take the annuity option as the present value of the annuity is greater than
the $250,000 immediate payment.
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 12, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

156. Marilyn’s parents have agreed to help her purchase a new car upon graduation in four years.
They have given her two choices. The first choice is that they will give her $4,000 each year for
the next four years for her to invest herself. The second choice is that they will wait four years
and give her $18,000. Marilyn can invest the money at a 4% rate.

Required:

a. Which option should Marilyn choose? Why?

b. If Marilyn can invest the money at 8%, which options should she choose? Why?

Unit 9-2, LO2

Solution:

a. Option 1 – $4,000 x 3.6299 = $14,520; Option 2 – $18,000 x .8548 = $15,386

Marilyn should take option 2 since the present value is greater than in option 1.

b. Option 1 - $4,000 x 3.3121 = $13,248; Option 2 - $18,000 x .7350 = $13,230

Marilyn should take option 1 since the present value is slightly greater than option 2.

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Easy, Min: 8, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

157. The following data pertain to an investment proposal:

Cost of investment $45,000

Annual cost savings $10,000
Expected life of investment 5 years
Discount rate 10%

What is the present value of the proposed investment?

Unit 9-2, LO2

Solution:

Present value of cost savings, 10%, 5 yrs ($10,000 x 3.7907) $37,907

Less initial investment, 0 periods $45,000
Net present value of proposed investment ($7,093)

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 158. Jonathan, a student at Local University, has decided to major in accounting because his goal is
to become an FBI agent. Jonathan knows that accounting is one of the entry programs that
qualify an applicant for a special agent career. As most students do, Jonathan wants to purchase
a nice car when he graduates in five years with his master’s degree. Because his expected salary
will be good, he wants a high-performance sports car. He has found the car of his dreams for
$58,000. Jonathan’s parents have promised him a graduation present of $25,000 when he
finishes his master’s degree.

Required:

a. Calculate how much money Jonathan needs to deposit in his savings account today to
be able to pay cash for the car upon graduation, assuming that his parents contribute
what Jonathan expects. Jonathan can earn 8% on his deposit, compounded annually.

b. Calculate how much money Jonathan needs to deposit in his savings accountant today
to be able to pay cash for the car upon graduation, assuming that his parents contribute
what Jonathan expects. Jonathan can earn 8% on his deposit, compounded semi-
annually.

Unit 9-2, LO2

Solution:

a. $33,000 x .6806 = $22,460

b. $33,000 x .6756 = $22,295

LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions
 159. Rayburn Industries is evaluating the investment of $140,000 in a new packing machine that
should provide annual cash operating inflows of $30,000 for 6 years. At the end of 6 years, the
packing machine will be sold for $5,000. Rayburn’s required rate of return is 8%.

Required:

a. What is the machine’s net present value?

b. Based on net present value, should Rayburn purchase the new packing machine? Why
or Why not?

c. List two qualitative items that Rayburn should consider in the decision to purchase the
new machine.

Unit 9-3, LO3

Solution:

a.
Present value of an annuity - $30,000 x 4.6229 $138,687
Present value of $1 $5,000 x .6302 3,151
Present value of initial investment (140,000)
Net present value $ 1,838

b. Rayburn should purchase the new packing machine because the net present value is
positive.

c. (Answers will vary) One qualitative consideration might be the impact on the employees. If
the new packing machine will result in the layoff of employees, morale of the other
employees may be negatively affected. Other considerations might be the impact on the
environment and safety features of the new machine.

LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 15, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 160. Betty’s Bakery needs to purchase a new oven costing $8,000 to replace her old oven that
cannot be repaired. The new oven has several features that the old oven did not have and is
expected to have a useful life of 12 years. Betty does not expect the oven will have any salvage
value at the end of its life.

Required:

a. If Betty’s required rate of return is 8%, what level of annual cash savings must the oven
generate to be considered an acceptable investment under the net present value
method?

b. If Betty decides the cash savings will not be sufficient to justify the cost of the new oven,
list two alternatives she might consider.

Unit 9-3, LO3

Solution:

a. $8,000/7.5361 = $1,062

b. (Answers may vary)

• Purchase an oven with fewer features
• Alter her offerings to include items that would be more profitable because of the
new oven (If she does not offer early morning pastries and the new oven offers a
timer that will automatically turn on, she might prepare pastries in the evening, set
the timer, and increase her morning sales of freshly-baked pastries)
• Purchase a used oven with the same features
• Rent an oven until such time that the profitability justifies the price of the new oven

LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 10, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 161. General Hospital is planning to add a new diagnostic machine which should improve its quality
of certain blood tests. The machine under consideration has a cost of $79,189 and is expected to
save the hospital $8,000 each year. The machine has an expected useful life of 14 years.

Required:

a. Calculate the internal rate of return on the diagnostic machine.

b. If the hospital uses a hurdle rate of 6%, should the diagnostic machine be purchased?
Why or why not?

Unit 9-3, LO4

Solution:

a. $79,189/$8,000 = 9.8986; internal rate of return = 5%

b. No; the factor for 6%, 14 years is 9.2950 which would produce a negative net present value
for the machine.

LO: 4, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

162. ABC Company is considering the purchase of a new piece of equipment costing $138,875. The
equipment has a 7-year useful life and is expected to generate $24,000 in annual cost savings.
ABC has a 4% required rate of return.

Required:

a. What is the internal rate of return for the equipment (round to nearest factor)

b. Should ABC purchase the new equipment? Why or Why not?

Unit 9-3, LO3

Solution:

a. $138,875/$24,000 = 5.7864; Internal rate of return = 5%

b. Yes, the factor for 4%, 7 years is 6.0021 producing a present value of the cash savings of
$144,050 which is greater than the cost of the equipment.

LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 163. Sycamore Industries has provided the following information on a proposed project:

Initial net investment cost of project $140,000

Annual cash inflows $20,000
Salvage value $0
Useful life of project 10 years
Required rate of return 10%
Straight-line depreciation per year $14,000

Required:

a. What is the payback period for the investment?

b. What is the simple rate of return on the investment?

c. What is the internal rate of return on the investment?

Unit 9-3, 4, LO4, 5, 6

Solution:

a. $145,000/$20,000 = 7 years

b. ($20,000-$14,000)/$140,000 = 4.29%

c. $140,000/$20,000 = 7; Factor from Present Value of an Annuity Table nearest 7 for 10 years
= 7%

LO: 4,5,6, Bloom: AP, Unit: 9-3,9-4, Difficulty: Easy, Min: 12, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 164. Birch manufacturing is considering the addition of another product line to its offerings.
Equipment needed to produce the new line will cost $200,000. Birch estimates that the net cash
inflows from the new product line will be as follows:

Years 1-10 $18,000 (each year)

Years 11-15 $5,000 (each year)
Year 16-20 $2,000

Required:

a. What is the payback period for the new product line?

b. If the company can establish a steady customer base before production starts and the
cash inflows will be $15,000 per year for years 1 – 15, what will be the payback period?

Unit 9-4, LO5

Solution:

a. $18,000 x 10 = $180,000; $200,000 - $180,000 = $20,000; $20,000/$5,000 = 4

10 years + 4 years = 14 years

b. $200,000/$15,000 = 13 1/3 years

LO: 5, Bloom: AP, Unit: 9-4, Difficulty: Moderate, Min: 8, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

165. Murphy’s Manufacturing has provided the following information on a proposed project:

Initial net investment cost of project $80,000

Annual cash inflows $10,000
Salvage value $0
Useful life of project 10 years
Required rate of return 10%
Straight-line depreciation per year $8,000

Required:

a. What is the payback period for the investment?

b. What is the simple rate of return on the investment?

Unit 9-4, LO 5, 6
Solution:

a. $80,000/$10,000 = 8 years

b. ($10,000-$8,000)/$80,000 = 2.5%
LO: 5,6, Bloom: AP, Unit: 9-4, Difficulty: Easy, Min: 8, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

PROBLEMS
166. Carla’s Citrus packs and ships high-quality oranges, grapefruit, and other fruit to
retailers in the U.S. Carla has been experiencing an increase in demand for its products and is
considering the purchase of a new packaging machine to replace the machine currently in use.
The new machine will cost $202,500, and installation will require an additional $4,050. The
machine has a useful life of 10 years and is expected to have a salvage value of $5,400 at the
end of its useful life. The variable cost to operate the new machine is $13.50 per carton
compared to the current machine’s variable cost of $13.65 per carton. Carla expects to pack
250,000 cartons each year. If the new machine is purchased, Carla will avoid a required $13,500
overhaul of the current machine in three years. The current machine has a market value of
$16,200.

Required
a. Calculate the net present value of the new packaging machine. Assume that Carla uses a 10%
discount rate.
b. Do you recommend that Carla purchase the new machine? Why or why not?
c. Assume that Carla has adopted a new 15% discount rate. Do you recommend that Carla
purchase the new machine? Why or why not?

Solution:
a.
10% PV Present Value
Cash Flow Timing Amount Factor
Purchase price Year 0 ($202,500) 1.0000 ($202,500)
Installation Year 0 (4,050) 1.0000 (4,050)
Salvage of old equipment Year 0 16,200 1.0000 16,200
Salvage of new equipment Year 10 5,400 .3855 2,082
Variable cost savings Years 1-10 37,500 6.1446 230,423
Avoided overhaul 3 13,500 .7513 10,143
Net present value $ 52,298

b. Yes, the NPV is greater than $0, indicating that the return on the machine exceeds the 10%
discount rate.

c.
15% PV Present Value
Cash Flow Timing Amount Factor
Purchase price Year 0 ($202,500) 1.0000 ($202,500.00)
Installation Year 0 (4,050) 1.0000 (4,050.00)
Salvage of old equipment Year 0 16,200 1.0000 16,200.00
Salvage of new equipment Year 10 5,400 .2472 1334.88
Variable cost savings Years 1-10 37,500 5.0188 188,205.00
Avoided overhaul 3 13,500 .6575 8,876.25
 Net present value $ 8,066.13

The machine should be purchased. The NPV is greater than $0, meaning the return in the
machine is greater than the 15% discount rate.
LO: 3, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 15-18, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

167. Jodi Jarvis won a $10 million lottery and elected to receive her winnings in 20 equal
annual installments. After receiving the first 10 installments, Jodi and her husband divorced, and
the remaining 10 payments became part of the property settlement. The judge who presided
over the divorce proceedings awarded one-half interest in the future lottery payments to Jodi
and the other half to her ex-husband. Following the divorce, Jodi decided to sell her interest in
the 10 remaining lottery payments to raise the cash needed to open a bakery. An investor has
offered Jodi $1,677,520.

Required
a. What discount rate did the investor use in calculating the purchase price?
b. If Jodi can invest the money she gets at 6%, which is the better option, keeping the
annuity or accepting the investor’s offer? Why?
c. What needs might Jodi have that would make the investor’s offer the preferable option,
no matter what the interest rate (within reason)?

Solution:
a. The original lottery payments were $500,000 per year ($10,000,000/30), so Jodi’s share is
$250,000 per year.

$250,000 × PVA20, i% = $1,677,520

PVA20, i% =
PVA20, i% = 6.71008

Looking in the 10 periods row of the present value of an annuity table finds 6.71008 as the
factor for 8%.

b.
Present value = $250,000 × PVA10, 6%
= $250,000 × 7.36009
= $1,840,023

At an 6% discount rate, the annuity is worth $1,840,023, so the investor’s offer is too low. Jodi
should keep the annuity.

c. After the divorce, Jodi may need cash immediately to make living arrangements. Additionally,
she will incur up-front costs to open the bakery that will require cash payments in the near
future.
LO: 2, Bloom: AP, Unit: 9-2, Difficulty: Moderate, Min: 12, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

168. Major Emig owns a pet store. Major wants to convert a storeroom into a space that can
be leased to a pet groomer. Major believes that pet owners coming to the store to have their
pets groomed will shop while they wait and generate additional revenues for the store. The
conversion would cost $180,000 and will have a useful life of 20 years. The space will be leased
to a local pet groomer for $36,000 per year. Electricity, water and other utilities are expected to
be $7,200 per year.

Required
a. Calculate the annual operating income generated by the conversion project.
b. Calculate the accounting rate of return for the conversion project.
c. If the conversion project is successful in generating new business for the pet store, how will the
accounting rate of return be affected?

a. OI = $36,000 - $7,200 – ($180,000/20) = $19,800

b. $19,800/180,000 = 11%

c. If the conversion project is successful, additional revenues and profits will be generated,
increasing the accounting rate of return.

LO: 6, Bloom: AP, Unit: 9-4, Difficulty: Moderate, Min: 10-12, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

169. Press Smart’s pressing machine sells for $185,556. At this price, the annual cost savings
that the pressing machine will generate for Rob’s Dry Cleaner over its 8-year life will yield an
internal rate of return of 12%. Rob’s Dry Cleaner requires that all projects achieve a return of
15%.

Required
What price does Rob’s Dry Cleaner need to negotiate with Press Smart so that the system will achieve
that return?

At the list price of $185,556, the annual cost savings required to generate a 12% internal rate of return is
$37,253.25.

$185,556/Annual Cost Savings = PVA8, 12%

$185,556/Annual Cost Savings = 4.9676

$185,556/4.9676 = Annual Cost Savings

37,353.25 = Annual Cost Savings

With annual cost savings of $37,253.25, Rob’s Dry Cleaners must negotiate a price of $167,167 to
generate an internal rate of return of 15%.

Purchase Price/$37,253.25 = PVA8, 15%

Purchase Price/$37,253.25 = 4.4873

Purchase Price = 4.4873 x 37,253.25

Purchase Price = $167,167

LO: 4, Bloom: AP, Unit: 9-3, Difficulty: Moderate, Min: 8-10, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

SHORT ANSWER
170. List three specific capital assets each of the following companies would acquire?

1. Toyota
2. Dole Pineapple Company
3. McDonalds
4. Delta Airlines
5. St. Jude’s Hospital

Unit 9-1, LO1

Solution:

1. Waste Chemical Treatment Equipment , Building, Robotic welding equipment, computer

aided manufacturing equipment
2. Factory building, Land, Equipment for processing fruit
3. Store fixtures, kitchen equipment, building
4. Airplanes, luggage handling equipment, maintenance equipment
5. Building, diagnostic equipment, surgical room equipment, emergency vehicles

LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Difficult, Min: 10-15, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication,
IMA: Investment Decisions
 171. What are three specific capital assets each of the following companies might acquire?

1. Friendly Freddie’s Furniture Store

2. Fishing boat manufacturer
3. Cancer research institute
4. Manufacturer of women’s dresses
5. City Taxi Service

Unit 9-1, LO1

Solution:
1. Store fixtures, warehouse, delivery trucks, forklift
2. Manufacturing equipment, warehouse, retail store building, engineering equipment
3. Research and development lab, research equipment, treatment equipment, furniture
for treatment area
4. Manufacturing equipment, warehouse, factory building, computers and software for
accounting department
5. Taxis, maintenance equipment, shop building, computers

LO: 1, Bloom: AP, Unit: 9-1, Difficulty: Difficult, Min: 10-15, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: Communication,
IMA: Investment Decisions

172. One of your managers has requested the purchase of a new capital asset and as part of your
analysis you are calculating the present value of the project’s cash flow. Your manager has
argued that your analysis is flawed. You believe the manager is trying to manipulate the analysis.
You have determined the amount and timing of the project’s cash flow.

Required:

a. Discuss how a manager can increase the project’s present value without substantially
altering it.

b. How can a company prevent managers from using such a method to their benefit?

Unit 9-2, LO2

Solution:

a. If the manager lowers the discount rate, the present value will increase and thus, the
manager’s project will look better than it actually is

b. Companies can prevent managers from lowering the discount rate to make his or her
project look more attractive than it is, thus making it acceptable, by having a company-wide
minimum discount rate that all projects must meet or exceed.

LO: 2, Bloom: K,AN, Unit: 9-2, Difficulty: Difficult, Min: 10, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 173. What are the three factors needed to determine the present value of any future amount?

Unit 9-2, LO2

Solution:

To determine the present value of any future amount, you need to know three pieces of
information:
1. The future amount to be received
2. The interest rate
3. When the future amount will be received

LO: 2, Bloom: K, Unit: 9-2, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

174. The net present value approach to capital budgeting involves four steps. List the steps.

Unit 9-3, LO3

Solution:

1. Identify the amount and timing of each cash flow

2. Determine the appropriate discount rate
3. Calculate the present value of each cash flow
4. Calculate the net present value of the project

LO: 3, Bloom: K, Unit: 9-3, Difficulty: Easy, Min: 5, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and
Decision Making, IMA: Investment Decisions

175. Using the payback method to evaluate capital projects is a simpler method than either net
present value or internal rate of return. Answer the following questions relating to the payback
method.

a. What does the payback period measure?

b. How is the payback period calculated when the annual cash flows are equal?

c. How is the payback period calculated when the annual cash flows are not equal?

Unit 9-4, LO4

Solution:
 a. The payback period measures the time it takes, in years, for an investment to return the
original amount of invested capital.

b. The payback period of a project that produces even cash flows each year is calculated by
dividing the net initial investment by the projected annual cash flow.

c. The payback period of a project that does not produce even cash flows each year is
calculated by adding up the annual cash flows until the cumulative total cash flow equals the
net initial investment.

LO: 4, Bloom: K, Unit: 9-4, Difficulty: Moderate, Min: 12, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving
and Decision Making, IMA: Investment Decisions

ESSAY

176. Investing in a capital project may involve making screening decisions, preference decisions
and funding decisions. Discuss how each of the decisions is made, the goal of each, and give an
example of each.

Unit 9-1, LO1

Solution:

In a screening decision, a proposed project is compared to a performance benchmark to

determine whether the project should be considered further. Organizations may set a minimum
required return on investment, a minimum number of years in which the project must return
the original investment, or both. As projects are proposed, they are compared to the
benchmark. If a project’s expected outcome is greater than or equal to the benchmark, it
becomes a candidate for funding, otherwise, it is dismissed from consideration. The goal of the
screening decision is to narrow the list of capital proposals to include only those that are
expected to bring the desired level of return. An example of a screening decision is a manager
wishing to purchase a new piece of equipment for the factory. If the minimum rate of return set
by the company is 8% and the calculated rate of return is 6%, the project will not be considered
for funding.

In a preference decision, the projects that have been subjected to a screening decision compete
against one another for the available capital funds. In a preference decision, managers
determine which project will actually receive funds by rank-ordering them based on selected
criteria, both financial and non-financial. The goal of a preference decision is to order the
projects from most desirable moving down until funds are not available. An example is when a
project meets the minimum rate of return, but because of environmental issues, the managers
determine that the benefits of the project does not outweigh the risks of an environmental
disaster, penalties, loss of reputation, etc.

Even though managers believe projects deserve funding and, in the preference decision phase,
funds that were expected may not actually be available. In that case, only those projects for
which funds are available will be undertaken. An example might be that a new product line has
 been accepted for funding. However, because an expected loan for the project was not
approved by the bank, the project cannot go forward.

LO: 1, Bloom: K,C, Unit: 9-1, Difficulty: Moderate, Min: 20-25, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions

177. When making the decision to replace an old factory machine with a new one, financial and
non-financial factors are considered. As with any investment, a company investing in factory
machinery expects that the new machinery will generate a future return.

Required:

a. Define the two types of returns that can be expected from investments in a long-term
asset such as factory machinery.

b. List three financial factors that a company might consider before making an investment
in factory machinery.

c. List three non-financial factors that a company might consider before making an
investment in factory machinery.

d. List one cost that is not included in a decision to replace an old factory machine with a
new one.

Unit 9-1, LO1

Solution:

a. Two types of return can be expected from investment in a long-term asset: return of
investment and return on investment. Return of investment means recouping the original
investment. Return on investment is any return you receive over and above the original
investment.

b. Answers will vary. Several examples are cash inflows generated, cost savings, whether or
not the project meets the company’s minimum required rate of return, how much cash is
required for the project, or the payback period.

c. Answers will vary. Several examples are the impact of the investment on employee morale,
environmental considerations, impact on customer satisfaction, expertise needed for the
project, alternative use of assets if project fails.

d. Sunk cost, or the cost of the old machine.

LO: 1, Bloom: C, Unit: 9-1, Difficulty: Moderate, Min: 16, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 178. Long-term investment decisions, including capital budgeting decisions, involve outflows of
cash at one time or more and inflows of cash at other times. Managers must decide whether
the inflows justify the outflows.

Required:

a. List three examples of cash inflows and three examples of cash outflows that might be
involved in making a capital budgeting decision.

b. Many capital budgeting decisions are made using present value calculations. What three
factors does present value depend on?

Unit 9-2, LO2

Solution:

a. Answers will vary.

Outflows – cash paid for asset, taxes and shipping charges, cost of removing old
asset, cost of installation of new asset

Inflows – additional revenue generated, reduced labor costs, reduced material cost,
estimated salvage value of new equipment, sale of old equipment

b. To determine the present value of any future amount, you need to know three
pieces of information: (1) the future amount to be received, (2) the interest rate,
and (3) when the future amount will be received.

LO: 2, Bloom: C, Unit: 9-2, Difficulty: Moderate, Min: 10, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions
 179. You are a member of a team responsible for screening capital budgeting projects. Another
team member has come to you in private and explained that she has become confused with
so many “returns” that the team has been discussing. She has made a list of the terms she is
having trouble understanding. Her list includes the following:

1. Return on investment
2. Return of investment
3. Internal rate of return
4. Simple rate of return
5. Accounting rate of return
6. Unadjusted rate of return

Required:

Prepare a brief summary of each of the above terms.

Unit 9-1,3, 4, LO1, 4, 6

Solution:

1. Return on investment – any return you receive over and above the original investment
2. Return of investment – getting your money back, or recouping your original investment
3. Internal rate of return – the actual return earned by the project. Compare the internal
rate of return to the company’s minimum required rate of return. If the internal rate is
greater or equal to the minimum, the project is acceptable.
4. Simple rate of return – another name for the accounting rate of return. It is the return
generated by an investment based on its operating income. It does not focus on cash
flows.
5. Accounting rate of return – also referred to as the simple rate of return and the
unadjusted rate of return. It is the return generated by an investment based on its
operating income. It does not focus on cash flows.
6. Unadjusted rate of return – another name for the accounting rate of return. It is the
return generated by an investment based on its operating income. It does not focus on
cash flows.

LO: 1,4,5, Bloom: K, Unit: 9-1,9-3,9-4, Difficulty: Easy, Min: 10, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving and Decision Making, IMA: Investment Decisions
 180. The payback period and the accounting rate of return ignore are two methods of evaluating
capital budgeting decisions. Like other approaches, these two methods have advantages and
disadvantages.

Required:

a. What is an advantage of these two methods?

b. List two disadvantages of the payback period and explain how to calculate the payback
period.

c. List two advantages and two disadvantages of the accounting rate of return and explain
how to calculate the return.

Unit 9-4, LO5

Solution:

a. An advantage of the payback period and the accounting rate of return is that they are
simpler to calculate than other methods that use the time value of money.

b. Disadvantages of the payback period is that it ignores the time value of money and it
ignores cash flows that occur after the payback period. The payback period is calculated
by dividing the net initial investment by the projected annual cash flow.

c. Two major weaknesses of accounting rate of return are that it doesn’t consider cash
flows or the time value of money. The accounting rate of return is determined by
calculating the additional revenues generated by the investment and then subtracting all
additional operating expenses to determine the incremental net operating income. The
net operating income is then divided by the amount of the initial investment. If any
existing equipment is sold as part of the project, the initial investment is reduced by its
salvage value.

LO: 5, Bloom: K, Unit: 9-4, Difficulty: Moderate, Min: 12, AACSB: Analytic, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving and Decision Making, IMA: Investment Decisions