Chapter 14-Capital Investment Decisions: Multiple Choice

Chapter 14—Capital Investment Decisions
MULTIPLE CHOICE
1. Which of the following is true of capital investment decision making?

a. It is used only for independent projects.
b. It is used only for mutually exclusive projects.
c. It requires that funding for a project must come from sources with the same opportunity
cost of funds.
d. It is used to determine whether or not a firm should accept a special order.
e. None of these.
ANS: E PTS: 1 DIF: Difficulty: Easy
OBJ: LO: 14-1 NAT: BUSPROG: Analytic
STA: AICPA: FN-Decision Modeling | IMA: Investment Decisions | ACBSP: APC-27-Managerial
Accounting Features/Costs KEY: Bloom's: Comprehension
NOT: 2 min.
2. In general terms, a sound capital investment will earn

a. back its original capital outlay.
b. a return greater than existing capital investments.
c. back its original capital outlay and provide a reasonable return on the original investment.
d. back its original capital outlay by the midpoint of its useful life.
e. None of these.
ANS: C PTS: 1 DIF: Difficulty: Easy
NOT: 2 min.
3. To make a capital investment decision, a manager must estimate the

a. quantity of cash flows.
b. timing of cash flows.
c. risk of the investment.
d. impact of the investment on the firm's profitability.
e. All of these.
Accounting Features/Costs KEY: Bloom's: Knowledge
NOT: 2 min.
4. If the cash flows of a project are received evenly over the life of the project, the formula for the
calculating the payback period is
a. original investment/annual cash flow.
b. original investment  annual cash flow.
c. original investment + annual cash flow.
d. original investment  annual cash flow.
e. (original investment + annual cash flow)/annual cash flow.
ANS: A PTS: 1 DIF: Difficulty: Easy
STA: AICPA: FN-Decision Modeling | IMA: Investment Decisions | ACBSP: APC-37-Payback/ARR
Methods KEY: Bloom's: Knowledge NOT: 2 min.
5. The payback period provides information to managers that can be used to help
a. control the risks associated with the uncertainty of future cash flows.
b. minimize the impact of an investment on a firm's liquidity problems.
c. control the risk of obsolescence.
d. control the effect of the investment on performance measures.
e. All of these.
6. Which of the following is a drawback of the payback period?

a. It ignores a project's total profitability.
b. It uses a set discount rate.
c. It considers total profitability, requiring the forecasting of all future cash flows.
d. It uses before-tax cash flows rather than after-tax cash flows.
e. It uses operating income rather than cash flows.
ANS: A PTS: 1 DIF: Difficulty: Moderate
7. A formula for the accounting rate of return is

a. average income/initial investment.
b. initial investment/annual cash flow.
c. annual cash flow/initial investment.
d. initial investment/average income.
e. (average income + initial investment)/initial investment.
8. Managers may use the accounting rate of return to evaluate potential investment projects because
a. debt contracts require that a firm maintain certain ratios that are affected by income and
long-term asset levels.
b. it serves as a screening measure to insure that new investments do not affect key financial
ratios.
c. bonuses to managers may be based on accounting income and/or return on assets.
d. it can be tied to the manager's personal income.
e. All of these.
Methods KEY: Bloom's: Comprehension NOT: 2 min.
9. The time required for a firm to recover its original investment is the
a. internal rate of return.
b. net present value.
c. life of the project.
d. accounting rate of return.
e. payback period.
10. When the risk of obsolescence is high, managers will want

a. a shorter payback period.
b. a longer payback period.
c. a payback period equal to the life of the investment.
d. All of these.
e. None of these.
11. One disadvantage of the payback period is that

a. it is sometimes used as a crude measure of risk.
b. managers may choose investments with quick payback periods to maximize short term
criteria on which their own bonuses, etc. may be based.
c. it cannot be used for investments with unequal cash inflows.
d. it cannot be used if the entire cost of the investment does not occur immediately.
e. All of these.
ANS: B PTS: 1 DIF: Difficulty: Easy
12. A division manager was considering a project that required a significant initial investment. If accepted,
the project could have a negative impact on certain financial ratios that the firm was required to
maintain to satisfy debt contracts. To ensure that the ratios would not be adversely affected by the
investment, the manager would use which of the following capital investment models?
a. payback period
b. accounting rate of return
c. net present value
d. internal rate of return
e. None of these.
ANS: B PTS: 1 DIF: Difficulty: Moderate
13. Greg Moss has just invested $120,000 in a coffee shop. He expects to receive cash income of $15,000
a year. What is the payback period?
a. 5 years
b. 7.7 years
c. 4.5 years
d. 6.5 years
e. 8 years
ANS: E
Payback period = $120,000/$15,000 = 8 years
PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

NAT: BUSPROG: Analytic
Methods KEY: Bloom's: Application NOT: 2 min.
14. Carol Harrison is considering an investment in a retail shopping mall. The initial investment is
$400,000. She expects to receive cash income of $80,000 a year. What is the payback period?
a. 4 year
b. 3.5 years
c. 5 years
d. 2.5 years
e. 6 years
ANS: C

15. Elena Wallace invested $150,000 in a project that pays her an even amount per year for 10 years. The
payback period is 6 years. What are Elena's yearly cash inflows from the project?
a. $150,000
b. $15,000
c. $25,000
d. $90,000
e. Cannot be determined from this information.
ANS: C
Cash inflows = $150,000/6 years = $25,000/year
PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

16. Tessa Wilson invested in a project with a payback period of 6 years. The project brings $18,000 per
year for a period of 9 years. What was the initial investment?
a. $108,000
b. $107,500
c. $162,000
d. $240,000
e. Cannot be determined from this information.
ANS: A
6 years x $18,000 = $108,000

17. Neil Morrison has just invested $130,000 in a restaurant. He expects to receive income of $24,000 a
year, and to have the investment for 8 years. What is the accounting rate of return?
a. 5.60%
b. 18.46%
c. 14.52%
d. 12.41%
e. 4.50%
ANS: B
ARR = $24,000/$130,000 = 18.46%

18. An investment of $5,000 provides an average net cash flows of $320 with zero salvage value.
Depreciation is $35 per year. The accounting rate of return using the original investment is
a. 4.0%
b. 5.1%
c. 5.7%
d. 3.2%
e. 2.4%
ANS: C
ARR = ($320 - $35)/$5,000 = .057 or 5.7%

19. Buster Evans is considering investing $20,000 in a project with the following annual cash revenues
and expenses:
Cash Cash
Revenues Expenses
Year 1 $ 8,000 $ 8,000
Year 2 $12,000 $ 8,000
Year 3 $15,000 $ 9,000
Year 4 $20,000 $10,000
Year 5 $20,000 $10,000
Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?

a. 15%
b. 35%
c. 70%
d. 75%
e. None of these.
ANS: E
Cash Less: Cash Less: Operating
Revenues Expenses Depreciation Income
Year 1 $ 8,000 $ 8,000 $4,000 $ (4,000)
Year 2 $12,000 $ 8,000 $4,000 $ 0
Year 3 $15,000 $ 9,000 $4,000 $ 2,000
Year 4 $20,000 $10,000 $4,000 $ 6,000
Year 5 $20,000 $10,000 $4,000 $ 6,000
Total Income $10,000
Average annual income = $10,000/5 = $2,000

ARR = $2,000/$20,000 = 0.1 or 10%

20. Coriander Company is considering a project with an initial investment of $426,800 in new equipment
that will yield annual net cash flows of $80,000, and will be depreciated at $53,350 per year over its
eight year life. What is the accounting rate of return?
a. 320%
b. 18.74%
c. 6.24%
d. 31.27%
e. 50.0%
ANS: C
ARR = ($80,000  $53,350)/$426,800 = 0.0624 or 6.24%

21. When comparing the payback method and the accounting rate of return methods, which of the
following is true?
Profitability Time Value of Money

i Ignored by both methods Ignored by both methods
ii Ignored by both methods Used in accounting rate of return; ignored
by payback method
iii Considered by accounting method, not by Ignored by both methods
payback
iv Considered by accounting method, not by Considered by both methods
payback
a. i
b. ii
c. iii
d. iv
ANS: C PTS: 1 DIF: Difficulty: Moderate
22. Oakland Shop is considering the purchase of a used printing press costing $9,600. The printing press
would generate a net cash inflow of $4,000 per year for three years. At the end of three years, the press
would have no salvage value. The company's cost of capital is 10%. The company uses straight-line
depreciation with no mid-year convention.
What is the accounting rate of return on the original investment in the press to the nearest percent,
assuming no taxes are paid?
a. 41.67%
b. 8.33%
c. 75.00%
d. 10.00%
ANS: B
SUPPORTING CALCULATIONS:
[$4,000  ($9,600/3)]/$9,600 = 8.33%

Figure 14-1.
A company is considering two projects.
Project I Project II
Initial investment $120,000 $120,000
Cash inflow Year 1 $40,000 $20,000
23. Refer to Figure 14-1. What is the payback period for Project I?
a. 1 year
b. 3 years
c. 2.5 years
d. 3.5 years
e. 5 years
ANS: B

24. Refer to Figure 14-1. What is the payback period for Project II?
a. 1 year
b. 2 years
c. 3.5 years
d. 4 years
e. 5 years
ANS: D
$20,000 + $20,000 + $32,000 + $48,000 = $120,000
4 years

Figure 14-2.
A company is considering two projects.
Project A Project B
25. Refer to Figure 14-2. What is the payback period for Project A?
a. 4.5 year
b. 2.5 years
c. 5 years
d. 3.5 years
e. 4 years
ANS: E

26. Refer to Figure 14-2. What is the payback period for Project B?
a. 2 years
b. 4.5 years
c. 3.5 years
d. 2.5 years
e. 3 years
ANS: D
$90,000 + $90,000 + 0.5($40,000) = $200,000 = 2.5 years

Figure 14-3.
Davis Company is considering the purchase of a new piece of equipment that will cost $1,600,000 and
have a life of five years with no expected salvage value. The expected cash flows associated with the
project are as follows:
Cash Cash Expenses &

Year Revenues Depreciation
1 $1,500,000 $900,000
2 $1,500,000 $900,000
3 $1,500,000 $900,000
4 $1,500,000 $900,000
5 $1,500,000 $900,000
27. Refer to Figure 14-3. What is the average annual income for this project?
a. $900,000
b. $1,500,000
c. $600,000
d. $700,000
e. $300,000
ANS: C
Income per year = $1,500,000 - $900,000 = $600,000

28. Refer to Figure 14-3. What is the accounting rate of return for the project?
a. 83.33%
b. 31.25%
c. 47.00%
d. 37.50%
e. 43.75%
ANS: D
ARR = $600,000/$1,600,000 = 0.375 = 37.5%

Figure 14-4.
Sony Lavery is considering investing $45,000 in a project with the following cash revenues and
expenses:
Cash Expenses &

Year 1 $18,000 $8,000
Year 2 $22,000 $10,000
Year 3 $22,000 $9,000
Year 4 $24,000 $9,000
Year 5 $26,000 $9,000
Year 6 $28,000 $12,000
Year 7 $28,000 $11,000
Year 8 $28,000 $12,000
29. Refer to Figure 14-4. What is the average income for the project?
a. $19,250
b. $30,000
c. $20,000
d. $14,500
e. $18,000
ANS: D
Average income = (sum of revenues - sum of expenses)/years
Average income = ($196,000 - $80,000)/8
Average income = $116,000/8 = $14,500

STA: AICPA: FN-Measurement | IMA: Investment Decisions | ACBSP: APC-33-Incremental
analysis KEY: Bloom's: Application NOT: 4 min.
a. 32%
b. 41%
c. 20%
d. 26%
e. 35%
ANS: A
Average income = (sum of revenues - sum of expenses)/years
Average income = ($196,000 - $80,000)/8
Average income = $116,000/8 = $14,500
ARR = Average income/Investment
ARR = $14,500/$45,000 = 0.32 or 32%

31. Refer to Figure 14-4. Assuming straight-line depreciation over 8 years, what is the payback period for
the project?
a. between 4 and 5 years
b. between 2 and 3 years
c. between 5 and 6 years
d. between 7 and 8 years
e. between 6 and 7 years
ANS: B
Year Revenues Cash Expenses & Depreciation Revenues - Cash Net cash flow
Depreciation expenses & depreciation (add back
depreciation)
Year 1 $18,000 $8,000 5,625 $10,000 $15,625
Year 2 $22,000 $10,000 5,625 $12,000 $17,625
Year 3 $22,000 $9,000 5,625 $13,000 $18,625
Year 4 $24,000 $9,000 5,625 $15,000 $20,625
Year 5 $26,000 $9,000 5,625 $17,000 $22,625
Year 6 $28,000 $12,000 5,625 $16,000 $21,625
Year 7 $28,000 $11,000 5,625 $17,000 $22,625
Year 8 $28,000 $12,000 5,625 $16,000 $21,625
$196,000 $80,000

Figure 14-5.
Sara Turner is considering investing $60,000 in a project with the following cash revenues and
expenses:
Cash Expenses &

Year 1 $16,000 $16,000
Year 2 $18,000 $16,000
Year 3 $17,000 $17,000
Year 4 $26,000 $14,000
Year 5 $26,000 $14,000
32. Refer to Figure 14-5. Assuming straight-line depreciation over five years, what is the payback period
for this investment?
a. between 3 and 4 years
b. between 2 and 3 years
c. between 3 and 4 years
d. between 4 and 5 years
e. between 1 and 2 years
ANS: A
Year Revenues Cash Expenses & Depreciation Actual cash outflow Net cash flow
Depreciation (add back
depreciation)
Year 1 $16,000 $16,000 12,000 $4,000 $12,000
Year 2 $18,000 $16,000 12,000 $4,000 $14,000
Year 3 $17,000 $17,000 12,000 $5,000 $12,000
Year 4 $26,000 $14,000 12,000 $12,000 $24,000
Year 5 $26,000 $14,000 12,000 $12,000 $24,000
Net cash inflows for 4 years period

is between 3 and 4 years.
Net cash
inflows
$12,000
$14,000
$12,000
$22,000
$60,000

a. 8.67%
b. 15.60%
c. 7.50%
d. 3.10%
e. Cannot be calculated with this information.
ANS: A
What is the accounting rate of return for the project?
Average income = $26,000/5 years = $5,200
ARR = Average income/Investment
ARR = $5,200/$60,000 = 0.0866 or 8.67%

Figure 14-7.
Osler Company is considering an investment with the following data:
Initial cost $200,000

Annual net cash inflows $ 25,000
Expected life 10 years
Salvage value none
Depreciation will be taken on a straight-line basis over the expected life of the investment.
34. Refer to Figure 14-7. What is the accounting rate of return for the investment?
a. 10%
b. 12.5%
c. 25%
d. 2.5%
e. 20%
ANS: D
Depreciation = $200,000/10 years = $20,000/year
Average annual income = $25,000  $20,000 = $5,000
ARR = $5,000/$200,000 = 0.025 or 2.5%

35. Refer to Figure 14-7. The company requires a minimum rate of return of 4%. What is the net present
value of the investment?
Period 1 2 3 4 5 6 7 8 9 10
4% 0.962 1.886 2.775 3.630 4.452 5.242 6.002 6.773 7.435 8.111
a. $2,775
b. $202,775
c. $118,170
d. ($81,830)
ANS: A
NPV = (8.111  $25,000)  $200,000 = $2,775

STA: AICPA: FN-Decision Modeling | IMA: Investment Decisions | ACBSP: APC-38-NPV/IRR
36. Which of the following provides an absolute dollar measure?

a. internal rate of return
b. net present value
c. payback period
d. accounting rate of return
e. None of these.
ANS: B PTS: 1 DIF: Difficulty: Easy
OBJ: LO: 14-2 | LO: 14-3 | LO: 14-4 NAT: BUSPROG: Analytic
37. The required rate of return used in the net present value model can also be called the
a. hurdle rate.
b. minimum acceptable rate of return.
c. cost of capital.
d. discount rate.
e. All of these.
38. If net present value is negative, it means that the return on the investment is
a. less than the discount rate.
b. more than the discount rate.
c. equal to the discount rate.
d. acceptable.
e. meaningless since the return on the investment bears no relationship to the discount rate.
39. A division manager is considering a project that requires a significant initial investment. The
company's top management will not approve any project that does not return at least 12%. The
manager will most likely use which of the following capital investment models?
a. payback period
b. accounting rate of return
c. net present value
d. internal rate of return
e. None of these.
ANS: C PTS: 1 DIF: Difficulty: Moderate
40. A firm is evaluating a project that has a net present value of $0 when a discount rate of 8% is used. A
discount rate of 6% will result in a
a. negative net present value.
b. positive net present value.
c. net present value of $0.
d. The question cannot be answered based upon the information provided.
41. Jackson Company invests in a new piece of equipment costing $40,000. The equipment is expected to
yield the following amounts per year for the equipment's four-year useful life:
Cash revenues $ 60,000

Cash expenses (32,000)
Depreciation expenses (straight-line) (10,000)
Income provided from equipment $ 18,000
Cost of capital 14%
What is the net present value of this investment in equipment?

a. $81,592
b. $41,592
c. $(4,480)
d. $52,452
ANS: B
NPV = ($60,000  $32,000)  2.914  $40,000 = $41,592 (PVAF n = 4, 14%)

42. The following information pertains to an investment:
Investment $140,000
Annual revenues $ 96,000
Annual variable costs $ 32,000
Annual fixed out-of-pocket costs $ 20,000
Discount rate 12%
Expected life of project 8 years
The present value of the annual cash flow (rounded) is

a. $136,822.
b. $152,538.
c. $204,884.
d. $218,592.
ANS: D
Revenues $ 96,000
Less: Variable costs (32,000)
Fixed out-of-pocket costs (20,000)
Annual cash flow $ 44,000
PVAF, n = 8, 12% 4.968
Present value $218,592

43. A firm is considering a project with an annual cash flow of $200,000. The project would have a seven
year life, and the company uses a discount rate of 10%. What is the maximum amount the company
could invest in the project and have the project still be acceptable?
a. $718,200
b. $1,400,000
c. $973,600
d. $200,000
ANS: C
$200,000  4.868 (PVAF, n = 7, 10%) = $973,600

44. A firm is considering a project with an annual cash flow of $80,000. The project would have a 10-year
life, and the company uses a discount rate of 8%. What is the maximum amount the company could
invest in the project and have the project still be acceptable (rounded)?
a. $800,000
b. $536,800
c. $406,420
d. $727,208
ANS: B
$80,000  6.710 (PVAF, n = 10, 8%) = $536,800

Figure 14-6.
Present value of $1
Periods 4% 6% 8% 10% 12% 14%
1 0.962 0.943 0.926 0.909 0.893 0.877
2 0.925 0.890 0.857 0.826 0.797 0.769
3 0.889 0.840 0.794 0.751 0.712 0.675
4 0.855 0.792 0.735 0.683 0.636 0.592
5 0.822 0.747 0.681 0.621 0.567 0.519
6 0.790 0.705 0.630 0.564 0.507 0.456
7 0.760 0.665 0.583 0.513 0.452 0.400
8 0.731 0.627 0.540 0.467 0.404 0.351
9 0.703 0.592 0.500 0.424 0.361 0.308
10 0.676 0.558 0.463 0.386 0.322 0.270
Present value of an Annuity of $1

Periods 4% 6% 8% 10% 12% 14%
1 0.962 0.943 0.926 0.909 0.893 0.877
2 1.886 1.833 1.783 1.736 1.690 1.647
3 2.775 2.673 2.577 2.487 2.402 2.322
4 3.630 3.465 3.312 3.170 3.037 2.914
5 4.452 4.212 3.993 3.791 3.605 3.433
6 5.242 4.917 4.623 4.355 4.111 3.889
7 6.002 5.582 5.206 4.868 4.564 4.288
8 6.733 6.210 5.747 5.335 4.968 4.639
9 7.435 6.802 6.247 5.759 5.328 4.946
10 8.111 7.360 6.710 6.145 5.650 5.216
45. Refer to Figure 14-6. Morgan Clinical Practice is considering an investment in new imaging
equipment that will cost $400,000. The equipment is expected to yield cash inflows of $80,000 per
year for a six year period. Morgan set a required rate of return at 10%. What is the net present value of
the investment? (Note: there may be a rounding error depending on the table you use to compute your
answer. Choose the answer closest to the one you calculate.)
a. $51,600
b. ($51,600)
c. $348,400
d. ($348,600)
e. $451,600
ANS: B
Year Cash Flow Discount factor Present Value
0 $(400,000) 1.000 $(400,000)
16 80,000 4.355 348,400
NPV $ (51,600)

46. Refer to Figure 14-6. Morgan Clinical Practice is considering an investment in new imaging
equipment that will cost $400,000. The equipment is expected to yield cash inflows of $80,000 per
year for a six year period. At the end of the sixth year, the firm expects to recover $150,000 from the
sale of the equipment. Morgan set a required rate of return at 10%. What is the net present value of the
investment? (Note: there may be a rounding error depending on the table you use to compute your
answer. Choose the answer closest to the one you calculate.)
a. ($33,000)
b. $45,200
c. $433,000
d. $33,000
e. ($177,280)
ANS: D
0 $(400,000) 1.000 $(400,000)
16 80,000 4.355 348,400
6 150,000 0.564 84,600
NPV $ 33,000

47. Refer to Figure 14-6. Roman Knoze is considering two investments. Each will cost $20,000 initially.
Project 1 will return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000
in year 1, $10,000 in year 2, and $15,000 in year 3. Roman requires a minimum rate of return of 10%.
What is the net present value of Project 1? (Note: there may be a rounding error depending on the
table you use to compute your answer. Choose the answer closest to the one you calculate.)
a. $20,000
b. $25,670
c. $4,860
d. $22,530
e. $2,530
ANS: C
0 $(20,000) 1.000 $(20,000)
1 10,000 0.909 9,090
2 10,000 0.826 8,260
3 10,000 0.751 7,510
NPV $ 4,860

48. Refer to Figure 14-6. Roman Knoze is considering two investments. Each will cost $20,000 initially.
Project 1 will return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000
in year 1, $10,000 in year 2, and $15,000 in year 3. Roman requires a minimum rate of return of 10%.
What is the net present value of Project 2?
a. $5,670
b. $20,000
c. $2,530
d. $24,070
e. $4,070
ANS: E
0 $(20,000) 1.000 $(20,000)
1 5,000 0.909 4,545
2 10,000 0.826 8,260
3 15,000 0.751 11,265
NPV $ 4,070

49. Refer to Figure 14-6. Jan Rigby is considering an investment that will cost $20,000 initially, and return
annual cash flows of $10,000 in each of three years. Jan requires a minimum rate of return of 8%.
What is the present value of the cash inflows? (Note: there may be a rounding error depending on the
table you use to compute your answer. Choose the answer closest to the one you calculate.)
a. $25,770
b. $20,000
c. $5,770
d. $45,770
e. $10,000
ANS: A
0 $(20,000) 1.000 $(20,000)
1 10,000 0.926 9,260
2 10,000 0.857 8,570
3 10,000 0.794 7,940
NPV $ 5,770

50. The interest rate that sets the present value of a project's cash inflows equal to the present value of the
project's cost is called the ____.
a. present value
b. discount rate
c. company cost of capital
d. payback period
e. internal rate of return
51. Which of the following is true regarding the internal rate of return for a project?
a. If the internal rate of return is less than the required rate of return, the project will be
rejected.
b. If the internal rate of return is equal to the required rate of return, the net present value of
the project is zero.
c. If the internal rate of return is more than the required rate of return, the project will be
accepted.
d. Managers may believe (in most cases, incorrectly) that the internal rate of return is the
compounded rate of return earned by the initial investment.
e. All of these.
ANS: E PTS: 1 DIF: Difficulty: Moderate
52. Elizabeth Myers invested in a project that required an initial amount of $1,560, and returned one cash
inflow of $12,000 at the end of the 18th year. A partial table of the present value of an annuity of $1 in
arrears is as follows:
Year 2% 4% 6% 8% 10% 12% 14% 16%

18 0.700 0.494 0.350 0.250 0.180 0.130 0.095 0.069
What is the internal rate of return for this investment?

a. 8%
b. 10%
c. 12%
d. 14%
e. 16%
ANS: C
To find the interest rate implied, set the present value of the initial investment equal to the present
value of the cash inflow.
$1,560 (1.00) = $12,000  (discount rate)

discount rate = 0.130
This discount rate matches the one for an internal rate of return of 12%.

53. Jerry Hall invested in a project that required an initial amount of $52,160, and returned cash inflows of
$10,000 per year for 10 years. A partial table of the present value of an annuity of $1 in arrears is as
follows:
Year 2% 4% 6% 8% 10% 12% 14% 16%

10 7.983 8.111 7.360 6.710 6.145 5.650 5.216 4.833
What is the internal rate of return for this investment?

a. 8%
b. 10%
c. 12%
d. 14%
e. 16%
ANS: D
Discount factor = $52,160/$10,000 = 5.216
This discount factor matches the one for an internal rate of return of 14%.

54. Amatra Inc., has the opportunity to invest in new equipment that will cost $113,000. The net cash
inflows for ten years equal $20,000 per year. What is the internal rate of return for the investment? A
partial table of the present value of an annuity of $1 in arrears is as follows:
Year 2% 4% 6% 8% 10% 12% 14% 16%

10 7.983 8.111 7.360 6.710 6.145 5.650 5.216 4.833
a. 8%
b. 10%
c. 12%
d. 14%
e. 16%
ANS: C
Discount factor = $113,000/$20,000 = 5.650
This discount factor matches the one for an internal rate of return of 12%.

55. Shoring Company is considering a project with an internal rate of return of 14.5%. Shoring requires a
minimum rate of return of 12%. The net present value of the project is
a. negative.
b. infinite.
c. equal to zero.
d. positive.
e. None of these.
ANS: D PTS: 1 DIF: Difficulty: Easy
56. The internal rate of return is defined as

a. a blend of the costs of capital from all sources.
b. the minimal acceptable interest rate on investments.
c. the difference between the present value of the cash inflows and outflows associated with
a project.
d. the interest rate that sets the present value of a project's cash inflows equal to the present
value of a project's cost.
ANS: D PTS: 1 DIF: Difficulty: Moderate
57. Jones Company is considering the purchase of a new machine for $57,000. The machine would
generate an annual cash flow of $17,411 for 5 years. At the end of five years, the machine would have
no salvage value. The company's cost of capital is 12%. The company uses straight-line depreciation.
What is the internal rate of return for the machine rounded to the nearest percent?
a. 12%
b. 18%
c. 14%
d. 16%
ANS: D
$57,000/$17,411 = 3.274, which is the pv factor for n = 5, i = 16%

58. A firm is considering a project requiring an investment of $27,000. The project would generate an
annual cash flow of $6,296 for the next seven years. The company uses the straight-line method of
depreciation. The approximate internal rate of return for the project is
a. 6%.
b. 8%.
c. 12%.
d. 14%.
ANS: D
$27,000/$6,296 = 4.288
PVAF of 4.288, n = 7, corresponds to 14%

59. Cooper Industries is considering a project that would require an initial investment of $101,000. The
project would result in cost savings of $62,000 in year 1 and $70,000 in year two. The internal rate of
return is
a. between 16% and 17%.
b. between 18% and 20%.
c. under 15%.
d. none of these.
ANS: B
Support:
At 18%, the two discount factors would be .847 and .718
($62,000  .847) + ($70,000  .718) = $102,774
At 20% the two discount factors would be .833 and .694

($62,000  .833) + ($70,000  .694) = $100,226

Figure 14-8.
Present value of an Annuity of $1 in Arrears

Periods 4% 6% 8% 10% 12% 14%
1 0.962 0.943 0.926 0.909 0.893 0.877
2 1.886 1.833 1.783 1.736 1.690 1.647
3 2.775 2.673 2.577 2.487 2.402 2.322
4 3.630 3.465 3.312 3.170 3.037 2.914
5 4.452 4.212 3.993 3.791 3.605 4.433
6 5.242 4.917 4.623 4.355 4.111 3.889
7 6.002 5.582 5.206 4.868 4.564 4.288
8 6.733 6.210 5.747 5.335 4.968 4.639
9 7.435 6.802 6.247 5.759 5.328 4.946
10 8.111 7.360 6.710 6.145 5.650 5.216
60. Refer to Figure 14-8. Lucas Company is considering a project with an initial investment of $530,250
in new equipment that will yield annual net cash flows of $95,000, and will be depreciated at $75,750
per year over its seven year life. What is the internal rate of return?
a. 8%
b. 6%
c. 12%
d. 10%
e. 14%
ANS: B
Discount rate = $530,250/$95,000 = 5.582 corresponding to a 6% IRR
Salvage value is zero after depreciation.

61. Refer to Figure 14-8. Sawyer Company is considering a project with an initial investment of $226,000
that will yield annual net cash flows of $40,000, and will be depreciated at $22,600 per year over its
ten year life. What is the internal rate of return?
a. 6%
b. 8%
c. 10%
d. 12%
e. 14%
ANS: D
Discount factor = $226,000,/$40,000 = 5.650 corresponding to an IRR of 12%
Salvage value is zero after depreciation.

Figure 14-9.
Kenner Company is considering two projects.
Project A Project B
Annual cash flows $20,676 $6,011
Life of the project 6 years 5 years
Depreciation per year $14,167 $4,800
Present value of an Annuity of $1 in Arrears

Periods 8% 10% 12% 14%
1 0.926 0.909 0.893 0.877
2 1.783 1.736 1.690 1.647
3 2.577 2.487 2.402 2.322
4 3.312 3.170 3.037 2.914
5 3.993 3.791 3.605 4.433
6 4.623 4.355 4.111 3.889
7 5.206 4.868 4.564 4.288
8 5.747 5.335 4.968 4.639
9 6.247 5.759 5.328 4.946
10 6.710 6.145 5.650 5.216
62. Refer to Figure 14-9. Which of the two projects, A or B, is better in terms of internal rate of return?
a. project A with an IRR of 12%
b. project B with an IRR of 14%
c. project A with an IRR of 10%
d. project B with an IRR of 10%
e. both projects have the same IRR
ANS: A
Project A: Discount factor = $85,000/$20,676 = 4.111, corresponding to an IRR of 12%
Project B: Discount factor = $24,000/$6,011 = 3.993, corresponding to an IRR of 8%
PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-4 | LO: 14-6

63. Refer to Figure 14-9. Suppose that Kenner Company requires a minimum rate of return of 8%. Which
project is better in terms of net present value?
a. project A with NPV of $10,585
b. project B with NPV of $7,756
c. project A with NPV of $4,210
d. project B with NPV of $1,212
e. both projects have the same NPV
ANS: A
Project A NPV = ($20,676 x 4.623) - $85,000 = $10,585
Project B NPV = ($6,011 x 3.993) - $24,000 = -$1.92
PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3 | LO: 14-6

64. Which of the following compares the actual benefits from an investment with the estimated benefits,
and the actual operating costs of the investment with estimated operating costs?
a. internal rate of return
b. discounted returns
c. postaudit
d. opportunity cost
e. capital investment decision making
ANS: C
A post-audit compares the actual benefits with the estimated benefits and actual operating costs with
estimated operating costs; it evaluates the overall outcome of the investment and proposes corrective
action if needed.

NOT: 2 min.
65. Which of the following is a disadvantage of postaudits?

a. They evaluate profitability rather than cash flows.
b. They may point to the need for additional funding for the project.
c. They tend to hold managers accountable for capital investment decision making.
d. The assumptions driving the original analysis may be invalidated by changes in the actual
operating environment.
e. All of these.
ANS: D PTS: 1 DIF: Difficulty: Moderate
NOT: 2 min.
66. Which of the following is not a benefit of postaudits of capital investments?

a. Considers changes in the actual operating environment.
b. Guides managers to make capital investment in the best interests of the firm.
c. Ensures that resources are used wisely by evaluating profitability.
d. Supplies feedback to managers that should help improve decision making.
e. All of these are benefits.
ANS: A
Post-audits, however, are costly. Moreover, even though they may provide significant benefits, they
have other limitations. Most obvious is the fact that the assumptions driving the original analysis may
often be invalidated by changes in the actual operating environment.

NOT: 3 min.
67. A follow-up analysis of a capital investment after it is implemented is called a

a. capital investment review.
b. profitability analysis.
c. postaudit.
d. peer review.
ANS: C
A key element in the capital investment process is a follow-up analysis of a capital project once it is
implemented. This analysis is called a post-audit.

NOT: 2 min.
68. The best person/group in a firm to perform a postaudit of a capital investment is usually
a. the manager of that investment.
b. the CEO.
c. the board of directors.
d. the internal audit staff.
e. an external auditor.
ANS: D
Generally, more objective results are obtainable if the postaudit is done by an independent party. Since
considerable effort is expended to ensure as much independence as possible for the internal audit staff,
that group is usually the best choice for this task.

NOT: 2 min.
69. The capital investment decision making model that assumes that each cash inflow is reinvested at the
required rate of return is
a. net present value.
b. internal rate of return.
c. payback period.
e. None of these.
70. The capital investment decision making model that assumes that each cash inflow is reinvested at the
project's own rate of return is
b. accounting rate of return.
c. payback period.
d. internal rate of return.
e. None of these.
71. The best model for choosing the best of several competing projects is
b. internal rate of return.
c. payback period.
e. None of these.
72. When investing in automated systems, which of the following intangible or indirect benefits may be
important?
a. improved customer satisfaction
b. improved market share
c. reduced support labor cost
d. reduced lead time
e. All of these.
STA: AICPA: BB-Leveraging Technology | IMA: Investment Decisions | ACBSP: APC-27-
Managerial Accounting Features/Costs KEY: Bloom's: Knowledge
NOT: 2 min.
73. Which of the following is true regarding the measurement and use of indirect and intangible benefits in
capital investment decision making?
a. ABC has made identifying indirect benefits easier.
b. Intangible benefits cannot be measured.
c. Indirect and intangible benefits should not be considered, only direct costs and benefits are
considered.
d. Actions by competitors are not considered.
e. None of these.
NOT: 2 min.
74. A division manager is choosing between two mutually exclusive projects.
Project A Project B
Net present value $235,000 $210,000
Internal rate of return 13% 15%
The company requires any project to earn at least 12%. The manager believes that cash inflows from
the project can be reinvested at the rate of 12%. Which project will the manager likely choose?
a. Project B
b. Project A
c. both Projects A and B
d. neither Project A nor B
NOT: 3 min.
75. How do NPV and IRR differ?

a. NPV measures profitability in absolute terms, whereas the IRR method measures
profitability in relative terms.
b. IRR should be used for choosing among competing, mutually exclusive projects.
c. NPV considers the time value of money and IRR does not.
d. Both NPV and IRR will generate the same decisions.
76. Five mutually exclusive projects had the following information:
V W X Y Z
NPV $(6,000) $40,000 $30,000 $10,000 $20,000
IRR 8% 11% 13% 10% 12%
Which project is preferred?

a. Project V
b. Project W
c. Project X
d. Project Y
ANS: B
Project W, because it has the highest NPV.

77. The earning of interest on interest is

a. present value.
b. future value.
c. discount rate.
d. compounding of interest.
e. interest earned.
78. A series of equal future cash flows is a(n)

a. future amount.
b. future earnings.
c. annuity.
d. earnings to be discounted.
e. insurance.
ANS: C PTS: 1 DIF: Difficulty: Easy
79. The reason that a discount factor in Year 3 is less than a discount factor in Year 2 is that
a. cash flows are uneven.
b. compounding does not occur.
c. cash flows are even.
d. present value is positive.
e. a dollar received in 3 years is worth less than a dollar received in 2 years.

Chapter 14-Capital Investment Decisions: Multiple Choice

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Chapter 14—Capital Investment Decisions

1. Which of the following is true of capital investment decision making?

2. In general terms, a sound capital investment will earn

3. To make a capital investment decision, a manager must estimate the

6. Which of the following is a drawback of the payback period?

7. A formula for the accounting rate of return is

10. When the risk of obsolescence is high, managers will want

11. One disadvantage of the payback period is that

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

Depreciation will be $4,000 per year.

What is the accounting rate of return on the investment?

Average annual income = $10,000/5 = $2,000

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

Profitability Time Value of Money

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

Cash Cash Expenses &

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

Cash Expenses &

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

Cash Expenses &

Net cash inflows for 4 years period

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-2

Initial cost $200,000

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-2

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

36. Which of the following provides an absolute dollar measure?

Cash revenues $ 60,000

Cost of capital 14%

What is the net present value of this investment in equipment?

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

42. The following information pertains to an investment:

The present value of the annual cash flow (rounded) is

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

Present value of an Annuity of $1

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-3

PTS: 1 DIF: Difficulty: Easy OBJ: LO: 14-3

Year 2% 4% 6% 8% 10% 12% 14% 16%

What is the internal rate of return for this investment?

$1,560 (1.00) = $12,000  (discount rate)

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-4

Year 2% 4% 6% 8% 10% 12% 14% 16%

What is the internal rate of return for this investment?

PTS: 1 DIF: Difficulty: Moderate OBJ: LO: 14-4