ACCOUNTING 202 STRATEGIC BUSINESS ANALYSIS

CAPITAL BUDGETING
SEATWORK

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

a. It is used 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. None of these.
2. To make a capital investment decision, a manager must estimate the
a. impact of the investment on the firm’s profitability.
b. timing of cash flows.
c. risk of the investment.
d. All of these.
3. Managers use the accounting rate of return to evaluate potential investment projects because
a. debt contracts require that a firm maintain certain rations that are affected by income ad
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. All of these.
4. 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. payback period.
5. When the risk of obsolescence is high, managers will want
a. a shorter payback period.
b. a long payback period.
c. a payback period equal to the life of the investment.
d. None of these
6. 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.
7. 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
8. Cara Ho is considering an investment in a retail shopping mall. The initial investment is
P400,000. She expects to receive cash income of P80,000 a year. What is the payback period?
a. 4 year
b. 3.5 years
c. 5 years
d. 2.5 years
9. Ella Wong invested P150,000 in a project that pays her an even amount per year for 10 years.
The payback period is 6 years. What are Ella’s yearly cash inflows from the project?

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 a. P150,000
b. P15,000
c. P25,000
d. P90,000
10. Tere Won invested in a project with a payback period of 6 years. The project brings P18,000 per
year for a period of 9 years. What was the initial investment?
a. P108,000
b. P107,500
c. P162,000
d. P240,000
11. Nilo Morro has just invested P130,000 in a restaurant. He expects to receive income of P24,000
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%
12. An investment of P5,000 provides an average net cash flows of P320 with zero salvage value.
Depreciation is P35 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%
13. Bo Eto is considering investing P20,000 in a project with the following annual cash revenues and
expenses:
Cash Revenues Cash Expenses
Year 1 P8,000 P8,000
Year 2 P12,000 P8,000
Year 3 P15,000 P9,000
Year 4 P20,000 P10,000
Year 5 P20,000 P10,000
Depreciation will be P4,000 per year.
What is the accounting rate of return on the investment?
a. 15%
b. 35%
c. 70%
d. 10%
14. 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
15. Ong Company is considering an investment with the following data:

Initial cost P200,000

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 Annual net cash inflows P25,000
Expected life 10 years
Savage value None
Depreciation will be taken on a straight-line basis over the expected life of the investment.
Refer to the above data, what is the accounting rate of return for the investment?
a. 10%
b. 12.50%
c. 25%
d. 2.5%
16. Still on Ong Company. 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. P2,775
b. P202,775
c. P118,170
d. (P81,830)
17. 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
18. 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. All of these
19. 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 vale
d. Internal rate of return
20. Jack Co invests in a new piece of equipment costing P40,000. The equipment is expected to yield
the following amounts per year for the equipment’s four-year useful life:

Cash revenues P60,000

Cash expenses (32,000)
Depreciation expenses (straight-line) 10,000
Income provided from equipment P18,000

Cost of capital 14%

What is the net present value of this investment in equipment?
a. P81,592
b. P41,592
c. P(4,480)
d. P52,452
21. The following information pertains to an investment:
Investment P140,000
Annual revenues P96,000
Annual variable costs P32,000
Annual fixed out-of-pocket costs P20,000
Discount rate 12%
Expected life of project 8 years

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 The present value of the annual cash flow (rounded) is
a. P136,822.
b. P152,538.
c. P204,884.
d. P218,592.
22. A firm is considering a project with an annual cash flow of P200,000. The project would have a
seven year life, and the company uses a discount rate of 10 percent. What is the maximum
amount the company could invest in the project and have the project still be acceptable?
a. P718,200
b. P1,400,000
c. P973,600
d. P200,000
23. Mo Clinical Practice is considering an investment in new imaging equipment that will cost
P400,000. The equipment is expected to yield cash inflows of P80,000 per year for a six year
period. Required rate of return at 10 percent. What is the net present value of the investment?
a. P51,600
b. (P51,600)
c. P348,400
d. (P348,600)
24. Mo Clinical Practice is considering an investment in new imaging equipment that will cost
P400,000. The equipment is expected to yield cash inflows of P80,000 per year for a six year
period. At the end of the sixth year, the firm expects to recover P150,000 from the sale of the
equipment. Mo set a required rate of return at 10 percent. What is the net present value of the
investment?
a. (P33,000)
b. P45,200
c. P433,000
d. P33,000
25. 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. internal rate of return
26. Eli Mo invested in a project that required an initial amount of P1,560, and returned one cash
inflow of P12,000 at the end of the 18 th year. A partial table of the present value of an annuity of
P1 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%
27. Jero Ho invested in a project that required an initial amount of P52,160, and returned cash
inflows of P10,000 per year for 10 years.
What is the internal rate of return for this investment?
a. 8%
b. 10%
c. 12%
d. 14%
28. Kho industries is considering a project that would require a initial investment of P101,000. The
project would result in cost savings of P62,000 in year 1 and P70,000 in year two. The internal
rate of return is

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 a. between 16% and 17%.
b. between 18% and 20%.
c. under 15%.
d. None of these
29. Ken Company is considering two projects.
Project A Project B
Initial investment P85,000 P24,000
Annual cash flows P20,676 P6,011
Life of the project 6 years 5 years
Depreciation per year P14,167 P4,800
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
30. Still based on no. 29 above, Ken Company requires a minimum rate of return of 8 percent.
Which project is better in terms of net present value?
a. Project A with NPV of P10,585
b. Project B with NPV of P7,756
c. Project A with NPV of P4,210
d. Project B with NPV of P1,212
31. 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. Post audit
d. Opportunity cost
32. The best model for choosing the best of several competing projects is
a. net present value.
b. internal rate of return.
c. payback period.
d. accounting rate of return.
33. 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.
34. Five mutually exclusive projects had the following information:
V W X Y Z
NPV P(6,000) P40,000 P30,000 P10,000 P20,000
IRR 8% 11% 13% 10% 12%
Which project is preferred?
a. Project V
b. Project W
c. Project X
d. Project Y
35. 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

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36. A project requires an initial investment of P70,000 and has a profitability index of 1.141. The
present value of the future cash inflows from this investment is
a. P61,350
b. P68,920
c. P75,210
d. P79,870
37. A capital budgeting decision model has provided the following information:
Proposal A Proposal B
Investment P1,000,000 P1,800,000
Profitability index 1.2 2.1
Net present value P600,000 P300,000
The best project is
a. Proposal A because it has the highest net present value.
b. Proposal B because it has the highest profitability index.
c. Proposal B because its profitability index is over 2.0.
d. Proposal A because it has the highest net present value even though its Investment base
is smaller.
38. Dee Publishers, Inc. is considering replacing an old press that cost P800,000 six years ago with a
new one that would cost P2,250,000. Shipping and installation would cost an additional
P200,000. The old press has a book value of P150,000 and could be sold currently for P50,000.
The increased production of the new press would increase inventories by P40,000, accounts
receivable by P160,000 and accounts payable by P140,000. Dee’s net initial investment for
analyzing the acquisition of the new press assuming a 35% income tax rate would be
a. P2,450,000
b. P2,425,000
c. P2,600,000
d. P2,250,000
39. An investment of P75,000 is expected to produce annual cash earnings of P25,000. Its estimated
salvage value is P35,000 at the end of the first year, and this is expected to decline at the rate of
P10,000 annually thereafter. Project life is 5 years. What is the bailout payback period?
a. 5 years
b. 2 years
c. 3 years
d. 4 years
40. How is a weighted average cost of capital computed?
a. Compute a weight for each type of capital corresponding to its relative importance in the
firm’s capital structure.
b. Compute the cost of each source of capital.
c. Multiply the cost of each type of capital by their respective weight and add up the
products to arrive at the weighted average cost of capital
d. All of these