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Capital Investment Decisions

1. Operational capital investment decisions affect all or a considerable part of a company's operations, have uncertain lives, and require large investments.
True
False

2. The cost of funds that can be used to finance a project is sometimes referred to as the cost of capital.
True
False

3. The payback period is the average accounting income a project generates per period divided by the amount of the investment in the project.
True
False

4. Both the internal rate of return (IRR) and the accounting rate of return (ARR) require the use of discounting cash flows.
True
False

5. The failure to use estimates of residual values in discounting models biases decisions, tending to favor making the strategic investment.
True
False

6. In which of the following situations would it NOT be useful to apply the concepts and techniques used in capital investment decisions?
a) A company is considering the purchase of a new machine that would reduce the cost of direct labor in the production process.
b) A company is comparing the profitability and capital investments of two district offices to determine which one has the best current return on investment.
c) A company is reviewing the past performance of two investment projects to determine which project had the best five-year return on the investment made in the respective projects.
d) A company is evaluating the potential investment in research and development expenses to develop a new product line.

7. In large firms where different divisions compete for limited investment capital, managers are tempted to make liberal cash flow assumptions that show positive Net Present Values (NPV) to obtain approval for their projects. What can senior management do to offset this tendency?
a) Senior management should stipulate a discount rate much higher than the company's cost of capital to reduce the present value of projects.
b) Senior management should stipulate a discount rate slightly higher than the company's cost of capital to reduce the present value of projects.
c) Senior management should stipulate a discount rate much lower than the company's cost of capital to reduce the present value of projects.
d) Senior management should stipulate a discount rate slightly lower than the company's cost of capital to reduce the present value of projects.

8. The new manufacturing environment has created profound changes in the way many companies make capital investment decisions. The factors and risks associated with these decisions have changed dramatically for all of the reasons below except
a) Because of a more competitive environment, cash flows required to justify capital investments are received over a much shorter period of time.
b) Because automation can be large in scope and have a pervasive impact on an entire company, investments are becoming more significant.
c) In the new manufacturing environment, investments have become much more strategic and risky.
d) Cash flows required to justify capital investments are received over a longer period of time.

9. Which of the following is NOT used to calculate Internal Rate of Return (IRR)?
a) The present value of the project cost
b) The weighted cost of capital
c) The number of periods (usually years) of the project's expected life
d) The cash flows each period

10. As the term is used in capital investment analysis, residual value refers to the
a) difference between money a company borrows for a project and money it actually uses.
b) difference between the amount of cash a company thinks it will need for a project and the amount it actually does need.
c) excess cash generated by a capital investment that is subsequently re-invested in the business.
d) investment's estimated market value at the end of its useful life.

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