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Exam 11: Capital Budgeting

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Question 51

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Foster Inc. is trying to decide whether to lease or purchase a piece of equipment needed for the next ten years. The equipment would cost $45,000 to purchase, and maintenance costs would be $5,000 per year. After ten years, Foster estimates it could sell the equipment for $20,000. If Foster leases the equipment, it would pay $12,000 each year, which would include all maintenance costs. If the hurdle rate for Foster is 10%, Foster should:

A) lease the equipment, as net present value of cost is about $5,700 less.
B) buy the equipment, as net present value of cost is about $5,700 less.
C) lease the equipment, as net present value of cost is about $2,000 less.
D) buy the equipment, as net present value of cost is about $45,000 less.

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

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Question 52

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The method that compares the present value of a project's future cash flows to the initial investment is:

A) accounting rate of return.
B) payback period.
C) net present value.
D) internal rate of return.

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

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Question 53

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The net present value method compares a project's future net income to the initial investment

Cortland Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net cash flows of $100,000. The equipment will have an initial cost of $400,000 and have a 5-year life. If the salvage value of the equipment is estimated to be $75,000, what is the annual net income? Ignore income taxes.

Fletcher Corp. is considering the purchase of a new piece of equipment. The equipment will have an initial cost of $400,000, a 5-year life, and a salvage value of $75,000. If the accounting rate of return for the project is 10%, what is the annual increase in net cash flow? Ignore income taxes.

Carmen, Inc. is considering three different independent investment opportunities. The present value of future cash flows, initial investment, net present value, and profitability index for each of the projects are as follows: In what order should Carmen prioritize investment in the projects?

Which of the following capital budgeting methods does not use discounted cash flows?

You invest $13,420 in an annuity contract that earns 8% interest, compounded annually. You are to receive annual payments for the next ten years. How much will each of the payments be?

The internal rate of return method uses cash flows rather than net income

Grace Corp., whose required rate of return is10%, is considering the purchase of a new piece of equipment. The internal rate of return of the project, which has a life of 8 years, is 12%. The project would have:

The profitability index is calculated as the present value of future cash flows divided by the initial investment

Randall Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $100,000 to purchase, and maintenance costs would be $10,000 per year. After five years, Randall estimates it could sell the equipment for $30,000. If Randall leases the equipment, it would pay $30,000 each year, which would include all maintenance costs. If the hurdle rate for Randall is 12%, Randall should:

Your grandmother has told you she can either give you $4,000 now or $5,000 when you graduate from college in three years. Your savings account earns 7% interest, compounded annually. Which option would be worth more to you now, and how much more?

Wilson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The salvage value of the equipment is estimated to be $100,000. If the hurdle rate is 10%, what is the approximate net present value?

Heidi Inc. is considering whether to lease or purchase a piece of equipment. The total cost to lease the equipment will be $120,000 over its estimated life, while the total cost to buy the equipment will be $75,000 over its estimated life. At Heidi's required rate of return, the net present value of the cost of leasing the equipment is $73,700 and the net present value of the cost of buying the equipment is $68,000. Based on financial factors, Heidi should:

Cloud Corp. is considering the purchase of a new piece of equipment. The equipment costs $30,000, and will have a salvage value of $4,000 after nine years. Using the new piece of equipment will increase Cloud's annual cash flows by $6,000. Cloud has a hurdle rate of 12%. a. What is the net present value? b. What would the net present value be with a 15% hurdle rate? c. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?

An example of a future value of a single amount problem would be finding how much the right to receive a certain amount in the future would be worth today

Carmen, Inc., which has a hurdle rate of 10%, is considering three different independent investment opportunities. Each project has a five-year life. The annual cash flows and initial investment for each of the projects are as follows: a. What is the present value of the annual cash flows for each of the three projects? b. What is the net present value of each of the projects? c. What is the profitability index of each of the projects? (Round to two decimal places.) d. In what order should Carmen prioritize investment in the projects?

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

The minimum required rate of return for a project is the: