Summary of Questions by Objectives and Bloom's Taxonomy Part 1

PLANNING FOR CAPITAL INVESTMENTS SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY Ite SO BT Ite SO BT Ite SO BT Ite SO BT Item SO BT 21. 22. 23. 24. 25. 8 8 8 8 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 8 8 8 7 3 2 3 2 7 3 5 True-False Statements 1. 2. 3. 4. 5. 1 1 1 2 2 K K C C K 6. 7. 8. 9. 10. 2 3 3 3 4 C K C C K 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 1 1 1 1 1 1 2 2 2 2 2 2 2 3 K K K K K K AP C C K K C AP K 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 3 3 3 3 3 3 3 4 4 4 4 4 5 5 K C C AN K C K K K C C K K C 94. 95. 96. 2 3 3 AP E AP 97. 98. 99. 3,5 7 8 E E AP 100 101 102 * 2,3,8 2,3,8 E AP AP 103 104 105 2,3,8 2,3,7 3,5 112. 113. 1 2 K K 114. 115. 3 3 11. 12. 13. 14. 15. 4 4 5 5 5 C C K K C 16. 17. 18. 19. 20. 6 6 6 7 7 K C K K K 7 C C K K C Multiple Choice Questions 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 5 5 5 5 5 5 6 6 6 6 7 7 7 7 K K C K AP K K K K C K C AP K 68. 7 C 69. 3 AP 70. 5 AP 71. 7 AP 72. 3 AP 73. 2 AP 74. 3 AP 75. 8 AP 76. 7 AP 77. 8 AP 78. 8 AP 79. 8 K 80. 8 K 81. 8 C 8 AP C K C AP AP AP AP AP AP AP AP Brief Exercises Exercises E AN E 106. 3,5,7 E 107. 3,5,8 E 108. ** E 109. 3,6 E 110. 3,4 E 111. 3 E Completion Statements *1,2,3,5,7 **2,3,5,7,8 K 116. K 117. 3 4 K K 118. 5 119. 6 K K 120. 7 121. 8 K K SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Ite Typ Ite Typ Item Typ Item 1. 2. TF TF 3. 26. TF MC 27. 28. MC MC 4. 5. 6. TF TF TF 32. 33. 34. MC MC MC 35. 36. 37. MC MC MC 7. 8. 9. 39. 40. TF TF TF MC MC 41. 42. 43. 44. 45. MC MC MC MC MC 46. 69. 72. 74. 87. MC MC MC MC MC 10. 11. TF TF 12. 47. TF MC 48. 49. MC MC 13. 14. 15. TF TF TF 52. 53. 54. MC MC MC 55. 56. 57. MC MC MC 16. 17. TF TF 18. 60. TF MC 61. 62. MC MC 19. 20. 21. TF TF TF 64. 65. 66. MC MC MC 67. 68. 71. MC MC MC 22. 23. 24. TF TF TF 25. 75. 77. TF MC MC 78. MC 79. MC 80. MC Note: TF = True-False MC = Multiple Choice Typ Item Typ Study Objective 1 29. MC 31. 30. MC 100. Study Objective 2 Item Typ Item Typ MC Ex 112. C 38. MC 90. 73. MC 94. 88. MC 100. Study Objective 3 MC BE Ex 101. 102. 103. Ex Ex Ex 104. 108. 113. Ex Ex C 89. MC 100. 92. MC 101. 95. BE 102. 96. BE 103. 97. BE 104. Study Objective 4 50. MC 110. 51. MC 117. Study Objective 5 58. MC 93. 59. MC 97. 70. MC 100. Study Objective 6 63. MC 119. 109. Ex Study Objective 7 Ex Ex Ex Ex Ex 105. 106. 107. 108. 109. Ex Ex Ex Ex Ex 110. 111. 114. 115. 116. Ex Ex C C C 105. 106. 107. Ex Ex Ex 108. 118. Ex C BE Ex Ex 106. 108. 120. Ex Ex C MC MC BE 101. 102. 103. Ex Ex Ex 107. 108. 121. Ex Ex C 76. MC 98. 86. MC 100. 91. MC 104. Study Objective 8 81. 82. 83. MC MC MC C = Completion Ex = Exercise 84. 85. 99. Ex C MC BE Ex C BE = Brief Exercise The chapter also contains one set of eight Matching questions and three Short-Answer Essay questions. CHAPTER STUDY OBJECTIVES 1. Discuss the capital budgeting evaluation process, and explain what inputs are used in capital budgeting. Project proposals are gathered from each department and submitted to a capital budget committee, which screens the proposals and recommends worthy projects. Company officers decide which projects to fund, and the board of directors approves the capital budget. In capital budgeting, estimated cash inflows and outflows, rather than accrual-accounting numbers, are the preferred inputs. 2. Describe the cash payback technique. The cash payback technique identifies the time period to recover the cost of the investment. The formula is: Cost of capital expenditure divided by estimated annual cash inflow equals cash payback period. The shorter the payback period, the more attractive the investment. 3. Explain the net present value method. Under the net present value method, the present value of future cash inflows is compared with the capital investment to determine net present value. The decision rule is: Accept the project if net present value is zero or positive. Reject the project if net present value is negative. 4. Identify the challenges presented by intangible benefits in capital budgeting. Intangible benefits are difficult to quantify, and thus are often ignored in capital budgeting decisions. This can result in incorrectly rejecting some projects. One method for considering intangible benefits is to calculate the NPV, ignoring intangible benefits, and if the resulting NPV is below zero, evaluate whether the benefits are worth at least the amount of the negative net present value. Alternatively, intangible benefits can be incorporated into the NPV calculation, using conservative estimates of their value. 5. Describe the profitability index. The profitability index is a tool for comparing the relative merits of two alternative capital investment opportunities. It is computed by dividing the present value of future cash flows by the initial investment. The higher the index, the more desirable the project. 6. Indicate the benefits of performing a post-audit. A post-audit is an evaluation of a capital investment’s actual performance. Post-audits create an incentive for managers to make accurate estimates. Post-audits also are useful for determining whether a project should be continued, expanded, or terminated. Finally, post-audits provide feedback that is useful for improving estimation techniques. 7. Explain the internal rate of return method. The objective of the internal rate of return method is to find the interest yield of the potential investment, which is expressed as a percentage rate. The decision rule is: Accept the project when the internal rate of return is equal to or greater than the internal required rate of return. Reject the project when the internal rate of return is less than the required rate. 8. Describe the annual rate of return method. The annual rate of return uses accounting data to indicate the profitability of a capital investment. It is obtained by dividing the expected annual net income by the amount of the average investment. The higher the rate of return, the more attractive the investment. TRUE-FALSE STATEMENTS 1. Capital budgeting decisions usually involve large investments and often have a significant impact on a company's future profitability. 2. The capital budgeting committee ultimately approves the capital expenditure budget for the year. 3. For purposes of capital budgeting, estimated cash inflows and outflows are preferred for inputs into the capital budgeting decision tools. 4. The cash payback technique is a quick way to calculate a project's net present value. 5. The cash payback period is computed by dividing the cost of the capital investment by the annual cash inflow. 6. The cash payback method is frequently used as a screening tool but it does not take into consideration the profitability of a project. 7. The cost of capital is a weighted average of the rates paid on borrowed funds, as well as on funds provided by investors in the company's stock. 8. Using the net present value method, a net present value of zero indicates that the project would not be acceptable. 9. The net present value method can only be used in capital budgeting if the expected cash flows from a project are an equal amount each year. 10. By ignoring intangible benefits, capital budgeting techniques might incorrectly eliminate projects that could be financially beneficial to the company. 11. To avoid accepting projects that actually should be rejected, a company should ignore intangible benefits in calculating net present value. 12. One way of incorporating intangible benefits into the capital budgeting decision is to project conservative estimates of the value of the intangible benefits and include them in the NPV calculation. 13. The profitability index is calculated by dividing the total cash flows by the initial investment. 14. The profitability index allows comparison of the relative desirability of projects that require differing initial investments. 15. Sensitivity analysis uses a number of outcome estimates to get a sense of the variability among potential returns. 16. A well-run organization should perform an evaluation, called a post-audit, of its investment projects before their completion. 17. Post-audits create an incentive for managers to make accurate estimates, since managers know that their results will be evaluated. 18. A post-audit is an evaluation of how well a project's actual performance matches the projections made when the project was proposed. 19. The internal rate of return method is, like the NPV method, a discounted cash flow technique. 20. The interest yield of a project is a rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected annual cash inflows. 21. Using the internal rate of return method, a project is rejected when the rate of return is greater than or equal to the required rate of return. 22. Using the annual rate of return method, a project is acceptable if its rate of return is greater than management's minimum rate of return. 23. The annual rate of return method requires dividing a project's annual cash inflows by the economic life of the project. 24. A major advantage of the annual rate of return method is that it considers the time value of money. 25. An advantage of the annual rate of return method is that it relies on accrual accounting numbers rather than actual cash flows. Answers to True-False Statements Item Ans. 1. 2. 3. 4. T F T F Item Ans. 5. 6. 7. 8. T T T F Item Ans. 9. 10. 11. 12. F T F T Item Ans. 13. 14. 15. 16. Item F T T F Ans. 17. 18. 19. 20. Item T T T T Ans. 21. 22. 23. 24. Item F T F F Ans. 25. F MULTIPLE CHOICE QUESTIONS 26. The capital budget for the year is approved by a company's a. board of directors. b. capital budgeting committee. c. officers. d. stockholders. 27. All of the following are involved in the capital budgeting evaluation process except a company's a. board of directors. b. capital budgeting committee. c. officers. d. stockholders. 28. Most of the capital budgeting methods use a. accrual accounting numbers. b. cash flow numbers. c. net income. d. accrual accounting revenues. 29. The first step in the capital budgeting evaluation process is to a. request proposals for projects. b. screen proposals by a capital budgeting committee. c. determine which projects are worthy of funding. d. approve the capital budget. 30. The capital budgeting decision depends in part on the a. availability of funds. b. relationships among proposed projects. c. risk associated with a particular project. d. all of these. 31. Capital budgeting is the process a. used in sell or process further decisions. b. of determining how much capital stock to issue. c. of making capital expenditure decisions. d. of eliminating unprofitable product lines. 32. If an asset costs $70,000 and is expected to have a $10,000 salvage value at the end of its ten-year life, and generates annual net cash inflows of $10,000 each year, the cash payback period is a. 8 years. b. 7 years. c. 6 years. d. 5 years. 33. If a payback period for a project is greater than its expected useful life, the a. project will always be profitable. b. entire initial investment will not be recovered. c. project would only be acceptable if the company's cost of capital was low. d. project's return will always exceed the company's cost of capital. The cash payback technique 34. a. b. c. d. should be used as a final screening tool. can be the only basis for the capital budgeting decision. is relatively easy to compute and understand. considers the expected profitability of a project. 35. The cash payback period is computed by dividing the cost of the capital investment by the a. annual net income. b. net annual cash inflow. c. present value of the cash inflow. d. present value of the net income. 36. When using the cash payback technique, the payback period is expressed in terms of a. a percent. b. dollars. c. years. d. months. 37. A disadvantage of the cash payback technique is that it a. ignores obsolescence factors. b. ignores the cost of an investment. c. is complicated to use. d. ignores the time value of money. 38. Bark Company is considering buying a machine for $120,000 with an estimated life of ten years and no salvage value. The straight-line method of depreciation will be used. The machine is expected to generate net income of $8,000 each year. The cash payback period on this investment is a. 15 years. b. 10 years. c. 6 years. d. 3 years. 39. The discount rate is referred to by all of the following alternative names except the a. cost of capital. b. cutoff rate. c. hurdle rate. d. required rate of return. 40. The rate that a company must pay to obtain funds from creditors and stockholders is known as the a. hurdle rate. b. cost of capital. c. cutoff rate. d. all of these. 41. The higher the risk element in a project, the a. more attractive the investment. b. higher the net present value. c. higher the cost of capital. d. higher the discount rate. If a company's required rate of return is 10% and, in using the net present value method, a project's net present value is zero, this indicates that the 42. a. b. c. d. project's rate of return exceeds 10%. project's rate of return is less than the minimum rate required. project earns a rate of return of 10%. project earns a rate of return of 0%. 43. Using the profitability index method, the present value of cash inflows for Project Flower is $88,000 and the present value of cash inflows of Project Plant is $48,000. If Project Flower and Project Plant require initial investments of $90,000 and $40,000, respectively, and have the same useful life, the project that should be accepted is a. Project Flower. b. Project Plant. c. Either project may be accepted. d. Neither project should be accepted. 44. The primary capital budgeting method that uses discounted cash flow techniques is the a. net present value method. b. cash payback technique. c. annual rate of return method. d. profitability index method. 45. When the annual cash flows from an investment are unequal, the appropriate table to use is the a. future value of 1 table. b. future value of annuity table. c. present value of 1 table. d. present value of annuity table. 46. A company's cost of capital refers to the a. rate the company must pay to obtain funds from creditors and stockholders. b. total cost of a capital project. c. cost of printing and registering common stock shares. d. rate of return earned on common stock. 47. Intangible benefits in capital budgeting would include all of the following except increased a. product quality. b. employee loyalty. c. salvage value. d. product safety. 48. Intangible benefits in capital budgeting a. should be ignored because they are difficult to determine. b. include increased quality or employee loyalty. c. are not considered because they are usually not relevant to the decision. d. have a rate of return in excess of the company’s cost of capital. 49. To avoid rejecting projects that actually should be accepted, 1. 2. 3. a. b. c. d. intangible benefits should be ignored. conservative estimates of the intangible benefits' value should be incorporated into the NPV calculation. calculate net present value ignoring intangible benefits and then, if the NPV is negative, estimate whether the intangible benefits are worth at least the amount of the negative NPV. 1 2 3 both 2 and 3 are correct. 50. All of the following statements about intangible benefits in capital budgeting are correct except that they a. include increased quality and employee loyalty. b. are difficult to quantify. c. are often ignored in capital budgeting decisions. d. cannot be incorporated into the NPV calculation. 51. In evaluating high-tech projects, a. only tangible benefits should be considered. b. only intangible benefits should be considered. c. both tangible and intangible benefits should be considered. d. neither tangible nor intangible benefits should be considered. 52. Using a number of outcome estimates to get a sense of the variability among potential returns is a. financial analysis. b. post-audit analysis. c. sensitivity analysis. d. outcome analysis. 53. If a company's required rate of return is 9%, and in using the profitability index method, a project's index is greater than 1, this indicates that the project's rate of return is a. equal to 9%. b. greater than 9%. c. less than 9%. d. unacceptable for investment purposes. 54. The profitability index is computed by dividing the a. total cash flows by the initial investment. b. present value of cash flows by the initial investment. c. initial investment by the total cash flows. d. initial investment by the present value of cash flows. 55. The capital budgeting method that takes into account both the size of the original investment and the discounted cash flows is the a. cash payback method. b. internal rate of return method. c. net present value method. d. profitability index. 56. The profitability index a. does not take into account the discounted cash flows. b. is calculated by dividing total cash flows by the initial investment. c. allows comparison of the relative desirability of projects that require differing initial investments. d. will never be greater than 1. 57. The capital budgeting method that allows comparison of the relative desirability of projects that require differing initial investments is the a. cash payback method. b. internal rate of return method. c. net present value method. d. profitability index. 58. The following information is available for a potential investment for Panda Company: Initial investment Net annual cash inflow Net present value Salvage value Useful life $40,000 10,000 18,112 5,000 10 yrs. The potential investment’s profitability index is a. 4.00 b. 2.85 c. 2.50 d. 1.45 59. An approach that uses a number of outcome estimates to get a sense of the variability among potential returns is a. the discounted cash flow technique. b. the net present value method. c. risk analysis. d. sensitivity analysis. 60. Post-audits of capital projects a. are usually foolproof. b. are done using different evaluation techniques than were used in making the original capital budgeting decision. c. provide a formal mechanism by which the company can determine whether existing projects should be supported or terminated. d. all of these. 61. A post-audit should be performed using a. a different evaluation technique than that used in making the original decision. b. the same evaluation technique used in making the original decision. c. estimated amounts instead of actual figures. d. an independent CPA. 62. A thorough evaluation of how well a project's actual performance matches the projections made when the project was proposed is called a a. pre-audit. b. post-audit. c. risk analysis. d. sensitivity analysis. 63. Performing a post-audit is important because a. managers will be more likely to submit reasonable data when they make investment proposals if they know their estimates will be compared to actual results. b. it provides a formal mechanism by which the company can determine whether existing projects should be terminated. c. it improves the development of future investment proposals because managers improve their estimation techniques by evaluating their past successes and failures. d. all of these. 64. A capital budgeting method that takes into consideration the time value of money is the a. annual rate of return method. b. return on stockholders' equity method. c. cash payback technique. d. internal rate of return method. 65. The internal rate of return is the interest rate that results in a a. positive NPV. b. negative NPV. c. zero NPV. d. positive or negative NPV. 66. In using the internal rate of return method, the internal rate of return factor was 4.0 and the equal annual cash inflows were $12,000. The initial investment in the project must have been a. $12,000. b. $3,000. c. $48,000. d. $24,000. 67. The capital budgeting technique that finds the interest yield of the potential investment is the a. annual rate of return method. b. internal rate of return method. c. net present value method. d. profitability index method. 68. All of the following statements about the internal rate of return method are correct except that it a. recognizes the time value of money. b. is widely used in practice. c. is easy to interpret. d. can be used only when the cash inflows are equal.