Chapter 10

Management Accounting, Cdn.
6e (Horngren/Sundem/Stratton/Beaulieu)
Chapter 10 Capital Budgeting Decisions
1) The net present value model expresses all amounts in today's monetary units at time zero.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 393
Objective: 1
2) When no revenue is involved, organizations try to choose projects with the least cost for any given set
of objectives.
Answer: TRUE
Diff: 1
Type: TF
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Objective: 1
3) Two common methods for comparing alternatives are (1) the total project approach and (2) the
conversion approach.
Answer: FALSE
Diff: 1
Type: TF
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Objective: 1
4) The differential approach is limited to cases in which no more than four alternatives are being
examined.
Answer: FALSE
Diff: 1
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Objective: 1
5) The cash outflow for the purchase of equipment is an example of an operating cash flow.
Answer: FALSE
Diff: 1
Type: TF
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Objective: 3
6) The cost of assets is recognized by the initial outlay, not by depreciation as computed under accrual
accounting.
Answer: TRUE
Diff: 1
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Objective: 1
7) Both the payback and the accounting rate-of-return models are attempts to approach capital budgeting
systematically.
Answer: TRUE
Diff: 1
Type: TF
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Objective: 5
8) The payback model measures profitability as well as how quickly investment dollars may be recouped.
Answer: FALSE
Diff: 1
Type: TF
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Objective: 5
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2012 Pearson Canada Inc.
9) A follow-up evaluation of capital-budgeting decisions is called a postaudit.

Answer: TRUE
Diff: 1
Type: TF
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10) One purpose of a postaudit is to evaluate the continuation of the project.
Answer: TRUE
Diff: 1
Type: TF
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Below are two potential investment alternatives:
Initial capital investment

Estimated useful life
Estimated terminal salvage value
Estimated annual savings in cash
operating costs
Minimum desired rate of return
8 percent
10 percent
12 percent
14 percent
16 percent
PV of $1
(3 years)
0.7938
0.7513
0.7118
0.6750
0.6407
Case X
$120,000
3 yrs.
-0-
Case Y
$180,000
3 yrs.
-0-
$ 50,000
10 percent
$ 80,000
12 percent
PV of an Annuity of $1
(3 years)
2.5771
2.4869
2.4018
2.3216
2.2459
11) Assume straight-line amortization in all computations, and ignore income taxes.
The net present value in case X is
A) $4,345.
B) $82,435.
C) $50,000.
D) $90.
Answer: A
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
The net present value in case Y is
A) $80,000.
B) $12,144.
C) $(328).
D) $123,056.
Answer: B
Diff: 2
Type: MC
Page Ref: 393
2
Objective: 1

operating costs
8 percent
10 percent
12 percent
14 percent
16 percent
PV of $1
(3 years)
0.7938
0.7513
0.7118
0.6750
0.6407
Case X
$90,000
3 yrs.
-0-
Case Y
$150,000
3 yrs.
-0-
$ 36,000
10 percent
$ 58,000
12 percent
(3 years)
2.5771
2.4869
2.4018
2.3216
2.2459
The net present value in case A is
A) $54,000.
B) $( 472).
C) $ 6,000.
D) $(6,000).
Answer: B
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
The net present value in case B is
A) $8,000.
B) $(8,000).
C) $(10,696).
D) $(8,716).
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
3
Alpha Company has the following information:
Number of Years
Amount of annual cash inflow
Required initial investment
Internal rate of return
Net present value
15) What is (a)?
A) $23,958
B) $22,746
C) $ 8,811
D) $ 9,662
Answer: A
Diff: 2
Type: MC
Objective: 1
16) What is (b)?
A) $ -0B) $(1,212)
C) $16,359
D) $14,296
Answer: B
Diff: 2
Type: MC
Objective: 1
17) What is (c)?
A) $28,950
B) $71,100
C) $12,205
D) $ 3,900
Answer: C
Diff: 2
Type: MC
Objective: 1
5
$6,000
(a)
8 percent
10 percent
(b)
10
(c)
$75,000
10 percent
(d)
$ 3,900
Page Ref: 393
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18) What is (d)?

A) Less than 6 percent
B) Between 6 and 8 percent
C) Between 8 and 10 percent
D) Between 10 and 12 percent
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
4
15
$ 3,050
$24,000
(e)
8 Percent
(f)
19) What is (e)?

A) Below 6 percent
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
20) What is (f)?
A) $2,105
B) $26,105
C) $3,050
D) $(4,510)
Answer: A
Diff: 2
Type: MC
Objective: 1
Page Ref: 393
Beta Company has the following information:
Number of Years
Amount of annual cash inflow
Required initial investment
Internal rate of return
Net present value
21) What is (a)?
A) $31,944
B) $30,328
C) $11,747
D) $12,882
Answer: A
Diff: 2
Type: MC
Objective: 1
22) What is (b)?
A) $-0B) $(1,616)
C) $20,197
D) $19,062
Answer: B
Diff: 2
Type: MC
Objective: 1
5
$8,000
(a)
8 percent
10 percent
(b)
10
(c)
$100,000
10 percent
(d)
$ 5,200
Page Ref: 393
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5
15
$ 4,200
$32,000
(e)
8 Percent
(f)
23) What is (c)?

A) $38,599
B) $94,800
C) $16,273
D) $ 5,200
Answer: C
Diff: 2
Type: MC
Objective: 1
Page Ref: 393
24) What is (d)?

A) Less than 6 percent
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
25) What is (f)?
A) $ 3,948
B) $35,948
C) $ 4,200
D) $(6,013)
Answer: A
Diff: 1
Type: MC
Objective: 1
Page Ref: 393
26) What is (e)?

A) Below 6 percent
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
6

operating costs
8 percent
10 percent
12 percent
14 percent
16 percent
PV of $1
(3 years)
0.7938
0.7513
0.7118
0.6750
0.6407
Case X
$90,000
3 yrs.
-0-
Case Y
$150,000
3 yrs.
-0-
$ 36,000
10 percent
$ 58,000
12 percent
(3 years)
2.5771
2.4869
2.4018
2.3216
2.2459
The internal rate of return in case A is approximately
A) 8 percent.
B) 10 percent.
C) 12 percent.
D) 14 percent.
Answer: B
Diff: 2
Type: MC
Page Ref: 395
Objective: 2
28) There are two key aspects of capital budgeting: (1) investing decisions and (2)
A) accounting decisions.
B) financing decisions.
C) discount decisions.
D) payback decisions.
Answer: B
Diff: 1
Type: MC
Page Ref: 393
Objective: 1
7

operating costs
8 percent
10 percent
12 percent
14 percent
16 percent
PV of $1
(3 years)
0.7938
0.7513
0.7118
0.6750
0.6407
Case X
$90,000
3 yrs.
-0-
Case Y
$150,000
3 yrs.
-0-
$ 36,000
10 percent
$ 58,000
12 percent
(3 years)
2.5771
2.4869
2.4018
2.3216
2.2459
The internal rate of return in case B is approximately
A) 14 percent.
B) 12 percent.
C) 10 percent.
D) 8 percent.
Answer: D
Diff: 2
Type: MC
Page Ref: 395
Objective: 2
8

operating costs
8 percent
10 percent
12 percent
14 percent
16 percent
PV of $1
(3 years)
0.7938
0.7513
0.7118
0.6750
0.6407
Case X
$120,000
3 yrs.
-0-
Case Y
$180,000
3 yrs.
-0-
$ 50,000
10 percent
$ 80,000
12 percent
(3 years)
2.5771
2.4869
2.4018
2.3216
2.2459
The internal rate of return in case X is approximately
A) 8 percent.
B) 10 percent.
C) 12 percent.
D) 14 percent.
Answer: C
Diff: 2
Type: MC
Page Ref: 395
Objective: 2
The internal rate of return in case Y is approximately
A) 10 percent.
B) 12 percent.
C) 14 percent.
D) 16 percent.
Answer: D
Diff: 2
Type: MC
Page Ref: 395
Objective: 2
9

operating costs
Case X
$120,000
3 yrs.
-0-
Case Y
$180,000
3 yrs.
-0-
$ 50,000
10 percent
$ 80,000
12 percent
Assume straight-line amortization in all computations, and ignore income taxes.

32) The payback period in case X is
A) 3.0 years.
B) 0.4 years.
C) 2.5 years.
D) 2.4 years.
Answer: D
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
33) The payback period for case Y is
A) 0.44 years.
B) 3.00 years.
C) 2.25 years.
D) 2.40 years.
Answer: C
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
34) The accounting rate of return based on INITIAL investment in case X is
A) 41.67 percent.
B) 8.33 percent.
C) 16.67 percent.
D) 33.33 percent.
Answer: B
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
35) The accounting rate of return based on INITIAL investment in case Y is
A) 11.11 percent.
B) 44.44 percent.
C) 33.33 percent.
D) 22.22 percent.
Answer: A
Diff: 2
Type: MC
Page Ref: 405
10
Objective: 5

operating costs
Case A
$90,000
3 yrs.
-0-
Case B
$150,000
3 yrs.
-0-
$36,000
10 percent
$ 58,000
12 percent
Assume straight-line amortization in all computations, and ignore income taxes.

36) The payback period in case A is
A) 0.4 years.
B) 2.5 years.
C) 3.3 years.
D) 3.0 years.
Answer: D
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
37) The payback period in case B is
A) 3.63 years.
B) 3.00 years.
C) 3.87 years.
D) 2.59 years.
Answer: D
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
38) The accounting rate of return based on INITIAL investment in case A is
A) 6.67 percent.
B) 5.56 percent.
C) 2.49 percent.
D) 40.00 percent.
Answer: A
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
39) The accounting rate of return based on INITIAL investment in case B is
A) 38.67 percent.
B) 2.59 percent.
C) 5.33 percent.
D) 2.40 percent.
11
Answer: C
Diff: 2
Type: MC
Objective: 3
Page Ref: 399
40) In capital budgeting, the relevant tax rate to consider is the

A) prior year tax rate.
B) average rate expected for the company.
C) marginal rate expected for the company.
D) highest rate that applies to U.S. corporations.
Answer: C
Diff: 1
Type: MC
Page Ref: 411
Objective: 7
41) The marginal tax rate is
A) the average rate for the company.
B) the highest possible rate the company might be expected to pay.
C) the lowest tax rate applicable to the company.
D) the rate paid on additional amounts of pretax income.
Answer: D
Diff: 1
Type: MC
Page Ref: 411
Objective: 7
42) If a company pays taxes of 20 percent on their first $20,000 of pretax income, and 30 percent on any
taxable income in excess of $20,000, what is the marginal tax rate if current pretax income is $45,000?
A) 20 percent
B) 30 percent
C) 25 percent
D) 39 percent
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
43) A company with pretax income of $45,000 is required to pay taxes of 20 percent on all income up to
$15,000 and 32 percent on any income in excess of $15,000. The company's average tax rate is
A) 28 percent.
B) 32 percent.
C) 26 percent.
D) higher than its marginal rate.
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
taxable income in excess of $25,000, what is the marginal tax rate if current pretax income is $40,000?
A) 15.00 percent
B) 20.63 percent
C) 30.00 percent
12
D) 22.50 percent
Answer: C
Diff: 2
Type: MC
Objective: 7
Page Ref: 411
taxable income in excess of $25,000, what is the average tax rate if current pretax income is $40,000?
A) 15.00 percent
B) 20.63 percent
C) 30.00 percent
D) 22.50 percent
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
46) A company with pretax income of $60,000 is required to pay taxes of 20 percent on all income up to
$20,000 and 32 percent on any income in excess of $20,000. The company's average tax rate is
A) 20 percent.
B) 28 percent.
C) 32 percent.
D) higher than its marginal rate.
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
47) Which of the following is not true about CCA expense?
A) It is sometimes called a tax shield.
B) It usually causes an increase in taxes.
C) Businesses usually want the largest possible CCA deduction.
D) The expense deduction results from a cash expenditure.
Answer: B
Diff: 1
Type: MC
Page Ref: 411
Objective: 7
48) If the appropriate tax rate is 35%, the after-tax effect of a single CCA deduction of $30,000 is
A) $19,500 net after-tax cash outflow.
B) $19,500 net after-tax cash inflow.
C) $10,500 net after-tax cash outflow.
D) $10,500 net after-tax cash inflow.
Answer: D
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
49) Which of the following statements about depreciation is TRUE?
A) The amortization method chosen does not affect cash inflows from operations.
B) The amortization method chosen for taxes will not affect cash outflows.
C) The total amount of amortization over the life of the assets differs with different amortization methods.
13
D) Since amortization does not involve a cash expenditure, it can be ignored in capital-budgeting
decisions.
Answer: A
Diff: 1
Type: MC
Page Ref: 411
Objective: 7
Fagen Grocery Store is considering the purchase of a new $45,000 delivery truck. The truck will have a
useful life of 5 years, no terminal salvage value, and tax amortization will be calculated using the straightline method.
If the truck is purchased, the company will be able to increase annual revenues by $90,000 per year for the
life of the truck, but out-of-pocket expenses will also increase by $67,500 per year.
Assume a tax rate of 30 percent and a required after-tax rate of return equal to 10 percent.
Time value factors are given below for 5 years and an interest rate of 10 percent.
Present value of $1
Future value of $1
Present value of an annuity of $1
Future value of an annuity of $1
0.6209
1.1605
3.7908
6.1051
50) What is the present value of the after-tax cash flows from operations, exclusive of depreciation?
A) $85,293
B) $13,971
C) $ 9,778
D) $59,705
Answer: D
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
51) What is the net present value of the tax savings from depreciation?
A) $3,912
B) $23,881
C) $10,235
D) $1,677
Answer: C
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
52) What is the total net present value of the investment?
A) $69,941
B) $24,941
C) $42,000
D) $(33,545)
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
14
53) A company is considering the purchase of some equipment that in the second year of operation
should cause an increase in sales of $200,000, an increase in cash expenses of $120,000, and a depreciation
deduction of $60,000. If the appropriate tax rate is 40 percent, what will be the after-tax effect of this
equipment on cash flows in year two?
A) No effect
B) Net after-tax cash inflows will be $72,000.
C) Net after-tax cash inflows will be $12,000.
D) Net after-tax cash inflows will be $20,000.
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
54) The cash inflow effect of a disposal at a loss is equal to the
A) amount of the loss plus the tax savings.
B) amount of the loss minus the tax savings.
C) selling price plus the tax savings.
D) selling price minus the tax savings.
Answer: C
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
55) In making capital-budgeting decisions, it is relevant to consider
A) future data that will differ among competing alternatives.
B) the cash outflows caused by future depreciation deductions.
C) the book value of equipment.
D) the original cost of currently owned equipment.
Answer: A
Diff: 1
Type: MC
Page Ref: 393
Objective: 1
56) Inflation is
A) not a factor in most capital-budgeting decisions because it tends to be very low in Canada.
B) equal to the amount of interest (or nominal rate) charged for most loans.
C) the increase in the general purchasing power of the monetary unit.
D) the decrease in the general purchasing power of the monetary unit.
Answer: D
Diff: 1
Type: MC
Page Ref: 416
Objective: 8
57) When making capital-budgeting decisions, the effects of inflation
A) should be ignored since it is impossible to know what future inflation rates will be.
B) are important, but it is impossible to estimate their effects on capital-budgeting decisions.
C) act to reduce the minimum desired rate of return on projects.
D) act to increase the minimum desired rate of return on projects.
Answer: D
Diff: 1
Type: MC
Page Ref: 416
Objective: 8
15
58) Another term for market interest rate is

A) risk-free interest rate.
B) real rate.
C) nominal rate.
D) marginal rate.
Answer: C
Diff: 1
Type: MC
Page Ref: 418
Objective: 9
59) Which of the following is NOT usually considered when a company establishes its minimum desired
rate of return?
A) A risk-free element of interest
B) A business-risk element
C) An inflation element
D) A political-risk element
Answer: D
Diff: 1
Type: MC
Page Ref: 418
Objective: 9
60) The "inflation element" refers to the
A) future increase in the general purchasing power of the monetary unit.
B) future deterioration of the general purchasing power of the monetary unit.
C) impact that future price increases will have on the original cost of a piece of equipment.
D) fact that the real purchasing power of a monetary unit usually increases over time.
Answer: B
Diff: 1
Type: MC
Page Ref: 418
Objective: 9
61) Which of the following statements about depreciation is TRUE?
A) The tax effects of depreciation are not adjusted for inflation.
B) The tax effects of depreciation must be adjusted for inflation.
C) Canadian tax laws allow for inflation adjustments to depreciation each year.
D) Capital investment is encouraged by not allowing depreciation to be adjusted for the effect of inflation.
Answer: A
Diff: 1
Type: MC
Page Ref: 411
Objective: 7
62) Which of the following statements about the riskiness of an investment is true?
A) The lower the risk, the higher the discount rate.
B) The higher the risk, the higher the discount rate.
C) The higher the risk, the lower the cost of capital.
D) The higher the risk, the higher the minimum desired rate of return.
Answer: D
Diff: 1
Type: MC
Page Ref: 418
Objective: 9
16
63) Which of the following methods determines the interest rate which equates the present value of the
future cash flows with the investment outlay?
A) Payback
B) Accounting rate of return
C) Internal rate of return
D) Net present value
Answer: B
Diff: 1
Type: MC
Page Ref: 405
Objective: 5
64) Which of the following methods determines the interest rate which equates the present value of the
future cash flows with the investment outlay?
A) Payback
B) Accounting rate of return
C) Internal rate of return
D) Net present value
Answer: C
Diff: 1
Type: MC
Page Ref: 395
Objective: 2
65) The discount rate is
A) the rate used to compute payback.
B) the rate used to compute the accounting rate of return.
C) the rate used to compute the internal rate of return.
D) the rate used to compute NPV.
Answer: D
Diff: 1
Type: MC
Page Ref: 393
Objective: 1
66) Discounting
A) is the process of determining value at a future time.
B) is the process of converting future cash flows to their present value.
C) is a process that doers not consider the time value of money.
D) is a process that can only be used for a single amount (not annuities).
Answer: B
Diff: 1
Type: MC
Page Ref: 393
Objective: 1
67) The present value of $10,000 to be received 5 years from now and earning an annual return of 8
percent is
A) $6,210.
B) $6,810.
C) $4,000.
D) $4,693.
Answer: B
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
17
68) The present value of 5-year annuity of $10,000, earning an annual return of 8 percent is
A) $31,700.
B) $34,700.
C) $37,910.
D) $39,930.
Answer: D
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
Use the following information to answer the next question(s).
Sunny Flowers is considering the purchase of a small business that costs $500,000. Sunny plans to sell
stock valued at $250,000. The stock would pay dividends of $20,000 per year. Sunny would borrow the
remaining $250,000 from a local bank at 12 percent interest.
The business is expected to generate annual cash inflows of $80,000. Duane plans to operate the business
for 15 years and then turn it over to his son.
69) Payback for the project is
A) 6.11 years.
B) 6.25 years.
C) 7.96 years.
D) 8.33 years.
Answer: B
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
70) If the depreciation is $25,000 per year, the accounting rate of return based on the initial investment is
A) 11%.
B) 12%.
C) 16%.
D) 17.2%.
Answer: A
Diff: 2
Type: MC
Page Ref: 405
Objective: 5
71) The cost of capital for the firm is
A) 8%.
B) 6%.
C) 10%.
D) 12%.
Answer: C
Diff: 2
Type: MC
Page Ref: 393
Objective: 1
18
72) Using the cost capital as the discount rate, the net present value of the project is
A) $89,360.
B) $108,480.
C) $114,680.
D) $228,180.
Answer: B
Diff: 2
Type: MC
Page Ref: 4393
Objective: 1
73) The approximate internal rate of return of the project is
A) 8%.
B) 12%.
C) 12.5%.
D) 14%.
Answer: D
Diff: 2
Type: MC
Page Ref: 395
Objective: 2
74) Miller Manufacturing has acquired a new parcel van to transport packages from the airport to its sales
offices for $20,000. The van is a class 10 item which has a capital cost allowance rate of 30%. The
company plans to use the van for five years and then sell it for an expected salvage value of $4,000. The
capital cost allowance for the first year would be
A) $3,000.
B) $6,000.
C) $5,100.
D) $3,500.
Answer: A
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
75) The amount of the capital cost allowance for the second year for Mike Manufacturing would be
A) $3,000.
B) $6,000.
C) $5,100.
D) $3,500.
Answer: C
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
19
Use the following information regarding a production asset to answer the next question(s).
Acquisition Costs
Annual Cash Inflow from Operations
Annual Operating Costs
Expected Salvage Value
Cost of Capital
Capital Cost Allowance Rate
Tax Rate
Useful Life of Equipment
$25,000
6,000
2,000
5,000
14%
30%
40%
5 years
76) The capital cost allowance for the first year would be
A) $3,750.
B) $6,375.
C) $7,500.
D) $4,463.
Answer: A
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
77) The tax savings from the capital cost allowance in the second year would be
A) $1,500.
B) $2,550.
C) $3,000.
D) $2,000.
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
78) The annual after-tax cash inflow from operations would be
A) $1,200.
B) $2,400.
C) $2,800.
D) $3,600.
Answer: D
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
79) The annual after-tax operation costs would be
A) $1,000.
B) $1,200.
C) $1,500.
D) $2.000.
Answer: B
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
20
80) The present value of equipment salvage value at the end of the five years would be
A) $4,000.
B) $5,000,
C) $2,076,
D) $2,595,
Answer: D
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
81) The net present value of the project would be
A) $12,595.
B) $10,900.
C) $11,162.
D) $13,912.
Answer: C
Diff: 2
Type: MC
Page Ref: 411
Objective: 7
82) The tax rate paid on additional amounts of pretax income.
Answer: Marginal income tax rate
Diff: 1
Type: SA Page Ref: 411
Objective: 7
83) The process of determining which long-term capital assets to acquire.
Answer: Capital investment decisions
Diff: 1
Objective: 1
84) Future cash flows expressed in present value terms.
Answer: Discounted cash flows
Diff: 1
Objective: 1
85) The factor used to convert future cash flow to its present value.
Answer: Discount factor
Diff: 1
Objective: 1
86) The value that will accumulate by the end of an investment's life if the investment earns a specified
compounded return.
Answer: Future value
Diff: 1
Objective: 1
87) Projects that, if accepted or rejected, will not affect the cash flows of another project.
Answer: Independent projects
Diff: 1
21
Objective: 4
88) The difference between the present value of a project's cash inflows and the present value of its cash
outflows.
Answer: Net present value
Diff: 1
Objective: 3
89) Capital expenditure models that identify criteria for accepting or rejecting projects without
considering the time value of money.
Answer: Non-discounting models
Diff: 1
Objective: 5
90) A follow-up analysis of an investment decision.
Answer: Post-audit
Diff: 1
91) A rate that is calculated as income divided by the original or average investment.
Answer: Accounting rate of return
Diff: 1
Objective: 5
92) Any capital budgeting model that explicitly considers the time value of money in identifying criteria
for accepting or rejecting proposed projects.
Answer: Discounting model
Diff: 1
Objective: 1
93) The rate of return used to compute the present value of future cash flows.
Answer: Discount rate
Diff: 1
Objective: 1
94) The rate of return that equates the present value of a project's cash inflows with the present value of
its cash outflows (the NPV equals zero).
Answer: Internal rate of return
Diff: 1
Objective: 2
95) Projects that, if accepted, preclude the acceptance of competing projects.
Answer: Mutually exclusive projects
Diff: 1
Objective: 1
96) The time required for a project to return its investment.
Answer: Payback period
22
Diff: 1
Type: SA
Objective: 5
Page Ref: 405
97) A tax rule that assumes a newly acquired asset is in service for one-half of the taxable year regardless
of when it is actually placed in service.
Answer: One-half year rule
Diff: 1
Objective: 7
98) Allowable depreciation under the income tax act and its regulations.
Answer: Capital cost allowance (CCA)
Diff: 1
Objective: 7
99) The process of altering certain key variables to assess the effect on the original outcome.
Answer: Sensitivity analysis
Diff: 1
Objective: 9
100) A requirement of Capital Cost Allowance that treats all assets as if they were placed in service at the
midpoint of the tax year.
Answer: Half-year rule
Diff: 1
Objective: 7
101) Depreciation deductions and similar deductions that protect that amount of income from taxation.
Answer: Tax shields
Diff: 1
Objective: 7
102) The decline in the general purchasing power of the monetary unit
Answer: Inflation
Diff: 1
Objective: 8
103) Quoted market interest rate that includes an inflation element
Answer: Nominal rate
Diff: 1
Objective: 9
23
104) Boric Company is considering the purchase of a new acid-producing machine. It will cost $360,000,
and it will last for 12 years with a zero terminal salvage value at the end of that time.
The equipment is expected to increase revenues by $40,000 per year, but additional cash outlays to operate
the equipment will equal $24,000 per year.
Required: Calculate the total annual net after-tax cash flow generated by using the machine. Use straightline amortization and a tax rate of 25 percent.
Answer:
Cash inflow from operations
$16,000
($40,000 - $24,000)
Less: income tax outflow (25 percent)
Plus: cash effects of amortization

($360,000/12 = $30,000 25 percent)
Total after-tax cash inflow
Diff: 3
Type: ES
Page Ref: 411
Objective: 7
4,000
$12,000
7,500
$19,500
105) WN Company manufactures high quality Wagnuts. It is a growing company and is therefore
considering the purchase of some new equipment to help expand production. The following data are
relevant to the decision:
Cost of new equipment
Resulting annual increase in revenue
Additional annual cash expenses
Terminal salvage value
Amortization method
Tax rate
$850,000
$100,000
$30,000
-030%
15%
Required: What is the annual net after-tax cash flow generated by the investment?
Answer:
Cash flow from operations
$70,000
($100,000 - $30,000)
Less: income tax outflow (15 percent)
Plus: cash effects of amortization

($850,000 .3 = $255,000 15 %)
Total net after-tax inflow
Diff: 3
Type: ES
Page Ref: 411
Objective: 7
10,500
$59,500
38,250
$97,750
24
106) The annual income statement of ZAP Inc. shows the following items:
Sales
Total expenses (excluding amortization)
Amortization
Average income tax rate
Capital Cost Allowance
$800,000
$560,000
$160,000
20 percent
$140,000
Required:
Compute the following amounts (ignore present value considerations):
a. Net after-tax accounting income
b. Total net after-tax cash inflow from operations
Answer:
a. $800,000 - $560,000 - $160,000 =
$80,000
80 percent
$64,000
b. $800,000 - $560,000 = $240,000 - ($800,000 - $560,000 - $140,000 = $100,000 20% =) $20,000 =
$220,000
Diff: 3
Type: ES
Page Ref: 411
Objective: 7
25
107) The owner of a construction company is contemplating possible purchase of new equipment. The
equipment would cost $40,000, have an expected life of 8 years and a zero terminal salvage value. The
equipment is Class 8 (20% declining balance).
The equipment would generate $125,000 of additional annual revenue, but yearly expenses for additional
labour and material would also increase by $115,000.
Assume the appropriate tax rate is 20 percent. The required after-tax rate of return is 14 percent.
The following data are for an interest rate of 14 percent and 8 periods.
Present value of $1
Future value of $1
Present value of annuity of $1
Future value of annuity of $1
0.3506
2.8526
4.6389
13.2328
Required: Compute the net present value of the investment. Should the equipment be purchased?
Answer:
$125,000 - $115,000 =
$10,000
80%
$8,000 4.6389 = $37,111
Tax shield
($40,000)(.20) .20 2 + .14
(.2 +.14) [2(1+.14)]
(8,000)(.588)(.938) =
$ 4,417
$41,528
-40,000
$ 1,528
Conclusion: The investment should be made.

Diff: 3
Type: ES
Page Ref: 411
Objective: 7
26
108) DOCA Corp. is considering the following two capital projects:
Cost
Additional annual revenues
Additional annual cash expenses
Terminal salvage value
Required after-tax rate
of return
Useful life of machine
Appropriate tax rate
CCA class
Machine A
$200,000
$220,000
$140,000
-0-
Machine B
$150,000
$ 80,000
$ 30,000
-0-
10%
5 yrs.
25%
9(25%)
10%
5 yrs.
25%
9(25%)
Additional data (for interest rate of 10 percent, 5 periods):

Present value of $1
Future value of $1
Present value of annuity of $1
Future value of annuity of $1
0.6209
1.6105
3.7908
6.1051
Which project has the higher present value?

Answer:
Machine A:
($110,000 - $70,000) 75 percent 3.7908 = $113,724
Tax shield
($100,000)(.25) .25 2 + .10
(.25+.10) [2(1+.10)]
(25,000)(.714)(.954) =
Net after-tax present value
17,015
$130,769
-100,000
$ 30,769
Machine B:
($80,000 - $30,000) 75 percent 3.7908 = $142,155
Tax shield
($150,000)(.25) .25 2 + .10
(.25+.10) [2(1+.10)]
(37,500)(.714)(.954) =
Net after-tax present value
25,568
$167,723
-150,000
$ 17,723
27
Conclusion: Machine A has the higher present value.

Diff: 1
Type: ES
Page Ref: 411
Objective: 7
109) Tex Corporation trades in a class 10 (30%) asset during the current year. The opening UCC balance in
the class 10 pool is $420,000. Tex trades in an asset for $25,000, which he sets off the $125,000 he pays for a
new class 10 asset. The tax marginal rate is 35%. The nominal after-tax rate of return is 10%.
a.
Calculate the UCC balance at the end of the year.
b.
Calculate the tax shield on the trade in.
c. Calculate the NPV cash outflow on the trade in.

Answer:
a. CCA class 10
Opening UCC
Purchase
Trade in
$420,000
$125,000
25,000
100,000
520,000
CCA
30% (420,000) $126,000
15% (100,000)
15,000
End of year UCC
b.
$379,000
Tax Shield Formula
(100,000)(.35)
(2 .10)
.30
(.30 .10)
[2 (1 10)]
(35,000) (.75) (.95) =

c.
141,000
Cash Outflow
Tax Shield
$ 25,056.92
$100,000.00
25,056.92
NPV Cash Overflow

$ 74,943.18
Diff: 3
Type: ES
Page Ref: 411
Objective: 7
28
110) The Chevette Company has come to you for help in establishing a minimum desired rate of return to
use in the evaluation of a capital project with a 5-year life.
The following data have been provided:
Inflation rate for past 5 years
Expected inflation rate for next 5 years
"Risk-free" element
"Risk" premium demanded for this project
6.0 percent
4.5 percent
4.0 percent
5.0 percent
Required:
a. What would be an appropriate minimum desired rate of return?
b. What is meant by "risk-free" element?
c. What is meant by "risk" premium?
d. Why is an inflation factor relevant?
Answer:
a. 4.0 percent + 5.0 percent + 4.5 percent = 13.5 percent
b. The "risk-free" element is the "pure" rate of interest that is paid on long-term federal bonds. This
represents a rate of return required on the safest possible investment, if inflation is ignored.
c. The "risk" premium represents the additional rate of return required to compensate for undertaking a
project with a risk factor greater than the safest possible investment. The greater the risk involved, the
greater this rate will be.
d. The inflation factor is necessary to compensate for an expected deterioration of the general
purchasing power of the monetary unit over the life of the project.
Diff: 3
Type: ES
Page Ref: 416
Objective: 8
111) A capital investment project requires an investment of $200,000. It has an expected life of 5 years
with annual cash flows of $50,000 received at the end of each year.
a. Compute the payback period for the project.
b. Determine the accounting rate of return for the project based on the initial capital investment.
c. Compute the internal rate of return for the project.
d. Compute the net present value of the project using a 6% discount rate.
Answer:
a.
Payback = Capital Investment/Annual Net Cash Inflows
= $200,000/$50,000
= 4 years
29
b.
Accounting Rate of Return
= Average Annual Incremental Income/Initial Capital

Investment
= Average Annual Net Cash Inflows
- Average Annual
Depreciation/Initial Capital Investment
= $50,000 - $40,000*/$200,000 = 5%
*Depreciation = $200,000/5 years = $40,000

c.
Internal Rate of Return:
Use the following equation to solve for the present value factor.
Investment = Annual Cash Flows x Annuity Discount Factor
$200,000 = $50,000 Annuity Discount Factor
Annuity Discount Factor = 4
Under 5 years in the present value Table of annuity the discount factor of 4 falls between 6% and 8%. The
exact IRR can be determined using interpolation:
Discount Factor 6%
Discount Factor - IRR
Discount Factor 8%
4.212
4.000
_____
.212
4.212
3.993
.219
IRR = 6% + [2% (.212/.219)] = 7.94%

d.
NPV using a 6% discount rate:
Investment
Present value of cash inflows:
(Cash Inflow x Annuity Discount Factor, 5 years, 6%)
($50,000 4.212)
Net Present Value
Diff: 3
Type: ES
Objective: 2
($200,000)
210,600
$ 10,600
Page Ref: 395
30
112) A capital investment project requires an investment of $50,000 and has an expected life of four years.
Annual cash flows at the end of each year are expected to be as follows:
YEAR
AMOUNT
1
2
3
4
$15,000
20,000
25,000
15,000
a. Compute the payback period assuming that the cash flows occur evenly throughout the year.
b. Determine the accounting rate of return for the project based on the initial investment.
c. Compute the net present value of the project using a 10% discount rate. (Round amounts to dollars.)
Answer:
a.
Year
Projected Net
Cash Inflows
1
$15,000
2
20,000
3
15,000 (.6 x $25,000)
$50,000
b.
Average Annual Net Cash Inflows = $15,000 + $20,000 + $25,000 +
$15,000/4 = $18,750
Average Annual Depreciation = $50,000/4 years = $12,500
ARR = $18,750 - $12,500/$50,000 = 12.5%
c.
Net Present Value:
Time Point
Investment
Cash Flows
PV Factors, 10%
Present Values
0
($50,000)
$15,000
.909
$13,365
$20,000
.826
$16,520
$25,000
.751
$18,775
$15,000
.683
$10,245
NPV $9,175
Diff: 3
Type: ES
Page Ref: 399
Objective: 3
31
113) The Quast Company is considering a capital investment project that requires an investment of
$37,910. The project is expected to have annual cash inflows of $10,000 occurring at the end of each of the
next five years.
a. Determine the internal rate of return for the project.
b. Determine the net present value of the project using discount rates of: 8%, 10%, and 12%.
c. From your answers to part [B] above, what are your observations about the effect the discount rate has
upon the project's net present value?
Answer:
a.
Use the following equation to solve for the annuity discount factor.
Investment = Annual Cash Flows x Annuity Discount Factor
$37,910 = $10,000 Annuity Discount Factor
Annuity Discount Factor = 3.791
Under 5 years in the present value table of annuity the discount factor of 3.791 corresponds to 10%.
b.
NPV using an 8% discount rate:
Investment
PV of cash inflows;
($10,000 3.993)
Net Present Value
($37,910)
39,930
$ 2,020

Investment
PV of cash inflows;
($10,000 3.791)
Net Present Value
($37,910)
37,910
$ -0-

Investment
PV of cash inflows;
($10,000 3.605)
Net Present Value
($37,910)
36,050
($ 1,860)
32
c.
There is an inverse relationship between the discount rate and the NPV. When the discount rate
increased, the NPV decreased. Also, note that the discount rate of 10% that resulted in an NPV of zero
was the IRR calculated in Requirement [B].
Diff: 3
Type: ES
Page Ref: 395
Objective: 2
114) The Serena Company is evaluating two mutually exclusive projects with three-year lives. Each
project requires an investment of $10,000. The projects have the following cash inflows received at the
end of each year.
YEAR
PROJECT 1
PROJECT 2
1
2
3
$2,000
4,000
6,000
$ 6,000
4,000
2,000
TOTAL
$12,000
$12,000
a. Determine the net present value of each project using an 8% discount rate.
b. What can you conclude about the effect the timing of the cash flows has upon a project's net present
value?
Answer:
NPV of Project 1:
Investment
Cash Flows
PV Factors, 8%
Present Values
NPV
0
($10,000)
10,044
44
1
$2,000
.926
$1,852
2
$4,000
.857
$3,428
3
$6,000
.794
$4,764
NPV of Project 2:
Investment
Cash Flows
PV Factors, 8%
Present Values
NPV
0
($10,000)
10,572
$
572
1
$6,000
.926
$5,556
2
$4,000
.857
$3,428
3
$2,000
.794
$1,588
b.
Since money has a time value, the sooner the money will be received, the greater the present value will
be.
Diff: 3
Type: ES
Page Ref: 399
Objective: 3
33
115) Cedric Inc. is considering two mutually exclusive projects.

Project 1 requires an investment of $100,000 while project 2 requires an investment o $110,000.
Revenues and costs for each project are shown below.
Year
PROJECT 1
_____________________________________________________
1
2
3
4
Revenues
Variable costs
Fixed costs
Year
$40,000
$60,000
$70,000
$80,000
10,000
15,000
20,000
20,000
5,000
5,000
6,000
8,000
PROJECT 2
_____________________________________________________
1
2
3
4
Revenues
Variable costs
Fixed costs
$60,000
$75,000
$51,000
$45,000
20,000
25,000
17,000
15,000
7,000
7,000
7,000
8,000
The company estimates that at the end of the fourth year Project 1 would have a salvage value of $20,000
and Project 2 would have a salvage value of $10,000.
Determine the net present value of each project using a 14% discount rate.
Answer:
NPV of Project 1:
0
($100,000)
Investment
Revenues
Variable Costs
Fixed Costs
Salvage Value
Net Cash Flows
PV Factors, 14%
Present Values
125,009
NPV
$ 25,009
$40,000
(10,000)
(5,000)
________
25,000
.877
$21,925
$60,000
(15,000)
(5,000)
$70,000
(20,000)
(6,000)
20,000
44,000
. 675
$29,700
$80,000
(20,000)
(8,000)
40,000
.769
$30,760
34
72,000
.592
$42,624
NPV of Project 2:
0
1
Investment
($110,000)
Revenues
$60,000
Variable Costs
(20,000)
Fixed Costs
(7,000)
Salvage Value
________
Net Cash Flows
33,000
PV Factors, 14%
.877
Present Values
99,177
$28,941
NPV
($10,823)
Diff: 3
Type: ES
Page Ref: 399
Objective: 3
$75,000
(25,000)
(7,000)
_______
43,000
.769
$33,067
$51,000
(17,000)
(7,000)
10,000
27,000
.675
$18,225
$45,000
(15,000)
(8,000)
35
32,000
.592
$18,944
116) Lawton Co. is evaluating a project that requires an investment of $400,000. The company plans to
dispose of the property at the end of the fourth year for $121,620. Information about cash flows associated
with the project is as follows:
Annual revenues
$250,000
Annual operating costs
$100,000
All cash flows occur at the end of the year. The required rate of return is 12% and the tax rate is 40%. The
CCA rate is 30%.
Determine the net present value of the project. (Round amounts to dollars.)
Answer:
Calculation of Tax savings from depreciation (CCA):
Year
Year
Year
Year
1
2
3
4
CCA
$ 60,000
102,000
71,400
49,980
CCA x Tax rate

$24,000
40,800
28,560
19,992
We use the above tax savings in our calculations of the net present value as shown in the table below.
Calculation of NPV
Cash revenues
$ 250,000
$250,000
$250,000
$250,000
Operating Costs
(100,000)
(100,000)
( 100,000)
(100,000)
150,000
150,000
150,000
150,000
Net cash
inflows after tax
90,000
90,000
90,000
90,000
Tax savings
from CCA
24,000
40,800
28,560
19,992
Investment cost
($400,000)
Net cash
inflows
Salvage value
121,620
Net cash flows
114,000
130,800
118,560
231,612
PV factor, 12%
.893
.797
.712
.636
$101,802
$104,248
$ 84,415
$147,305
Present values
NPV
437,770
$ 37,770
36
Diff: 3
Type: ES
Objective: 3
Page Ref: 399
37

Chapter 10

Uploaded by

Chapter 10

Uploaded by

Management Accounting, Cdn.

9) A follow-up evaluation of capital-budgeting decisions is called a postaudit.

Initial capital investment

Initial capital investment

Alpha Company has the following information:

Page Ref: 393

Page Ref: 393

Page Ref: 393

18) What is (d)?

19) What is (e)?

Page Ref: 393

Beta Company has the following information:

Page Ref: 393

Page Ref: 393

23) What is (c)?

Page Ref: 393

24) What is (d)?

Page Ref: 393

26) What is (e)?

Below are two potential investment alternatives:

Initial capital investment

Below are two potential investment alternatives:

Initial capital investment

Below are two potential investment alternatives:

Initial capital investment

Below are two potential investment alternatives:

Initial capital investment

Assume straight-line amortization in all computations, and ignore income taxes.

Initial capital investment

Assume straight-line amortization in all computations, and ignore income taxes.

Page Ref: 399

40) In capital budgeting, the relevant tax rate to consider is the

Page Ref: 411

58) Another term for market interest rate is

Page Ref: 405

Plus: cash effects of amortization

Plus: cash effects of amortization

Conclusion: The investment should be made.

108) DOCA Corp. is considering the following two capital projects:

Additional data (for interest rate of 10 percent, 5 periods):

Which project has the higher present value?

Net after-tax present value

Net after-tax present value

Conclusion: Machine A has the higher present value.

Calculate the UCC balance at the end of the year.

Calculate the tax shield on the trade in.

c. Calculate the NPV cash outflow on the trade in.

Tax Shield Formula

(35,000) (.75) (.95) =

NPV Cash Overflow

= Average Annual Incremental Income/Initial Capital

*Depreciation = $200,000/5 years = $40,000

IRR = 6% + [2% (.212/.219)] = 7.94%

Page Ref: 395

NPV using a 10% discount rate:

NPV using a 12% discount rate:

115) Cedric Inc. is considering two mutually exclusive projects.

Annual operating costs

CCA x Tax rate

Net cash flows

Page Ref: 399

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