All of the following are weaknesses of the accounting rate of return except

 All of the following are weaknesses of the accounting rate of return except:

multiple choice
it is easy to compute. Correct
it does not directly consider cash flows.
it ignores the time value of money.
it does not directly consider timing of cash flows.

Explanation
Knowledge Check 01
 
The accounting rate of return's strength is that it is easy to compute. All other answers are correct.

Chilly Company is considering investing $110,000 in a new refrigerator, designed to keep food extra crispy. The refrigerator will have a useful life of 10 years, a salvage value of $10,000, and is expected to generate an annual income of $15,000 in each year of its useful life. Chilly will use the straight-line method of depreciation. What is the accounting rate of return?

 Chilly Company is considering investing $110,000 in a new refrigerator, designed to keep food extra crispy. The refrigerator will have a useful life of 10 years, a salvage value of $10,000, and is expected to generate an annual income of $15,000 in each year of its useful life. Chilly will use the straight-line method of depreciation. What is the accounting rate of return?

multiple choice
30%
13.64%
16.67%
25% Correct

Explanation
Knowledge Check 01
 
Accounting rate of return = Annual income of $15,000 ÷ Average investment of $60,000 = 0.25 or 25%.
Average investment = ($110,000 cost plus $10,000 salvage value) / 2 = $60,000.

 

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All of the following are strengths of the payback period except

 All of the following are strengths of the payback period except:

multiple choice
it uses cash flows, not income.
it ignores the time value of money. Correct
it is easy to compute.

Explanation
Knowledge Check 01
 
The two strengths of the payback period are that it uses cash flows, not income and it is easy to compute. The fact that it ignores the time value of money is a weakness, not a strength.

Jelly Company is considering purchasing a machine with a cost of $20,000 and a useful life of 10 years. Jelly expects the machine to produce net annual cash flows of $2,000 in year 1, $10,000 in year 2, $5,000 in year 3, $12,000 in year 4, and $8,000 in year 5. What is the cash payback period of the machine?

 Jelly Company is considering purchasing a machine with a cost of $20,000 and a useful life of 10 years. Jelly expects the machine to produce net annual cash flows of $2,000 in year 1, $10,000 in year 2, $5,000 in year 3, $12,000 in year 4, and $8,000 in year 5. What is the cash payback period of the machine?

multiple choice
3 years
3.5 years
3.25 years Correct
4.25 years

Explanation
Knowledge Check 01
 
At the end of Year 0, the cumulative cash flows = Cost of $(20,000). At the end of Year 1, the cumulative present value of the cash flows = Year 0 amount of $(20,000) + Year 1 cash flow of $2,000 = $(18,000). At the end of Year 2, the cumulative cash flows = Year 1 amount of $(18,000) + Year 2 cash flow of $10,000 = $(8,000). At the end of Year 3, the cumulative cash flows = Year 2 amount of $(8,000) + Year 3 cash flow of $5,000 = $(3,000). At the end of Year 4, the cumulative cash flows = Year 3 amount of $(3,000) + Year 4 cash flow of $12,000 = $9,000. The cash flows changes from a negative to a positive number between years 3 and 4. If we assume that cash flows are received uniformly within each year, receipt of the $3,000 (to cover Year 3’s cumulative negative cash flow), occurs about 25% (or $3,000 ÷ Year 4’s cash flow of $12,000) the way through year 4. Thus, the payback period = 3.25 years (or 3 years + 0.25 years).

 

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Mint Company is considering purchasing a machine with a cost of $10,000 and a useful life of 20 years. Mint expects the machine to produce net annual cash flows of $2,000 each year. What is the cash payback period of the machine?

 Mint Company is considering purchasing a machine with a cost of $10,000 and a useful life of 20 years. Mint expects the machine to produce net annual cash flows of $2,000 each year. What is the cash payback period of the machine?

multiple choice
2 years
5 years Correct
10 years
0.20 years

Explanation
Knowledge Check 01
 
Payback period = Cost of investment of $10,000 ÷ Annual net cash flow of $2,000 = 5 years.

 

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Capital budgeting is risky because

Capital budgeting is risky because:

multiple choice
the outcome is certain
the decision is difficult to reverse Correct
small amounts of money are involved
the investment is short-term

Explanation
Knowledge Check 01

A capital budgeting decision is risky because: 1. The outcome is uncertain; 2. Large amounts of money are usually involved; 3. The investment involves a long-term commitment; and 4. The decision could be difficult or impossible to reverse.

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An investment has a cost $40,000 with net cash flows of $20,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, taken from a "present value of 1" table are 0.9259, 0.8573, 0.7938, 0.7350, what is the break-even time of the investment?

 An investment has a cost $40,000 with net cash flows of $20,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, taken from a "present value of 1" table are 0.9259, 0.8573, 0.7938, 0.7350, what is the break-even time of the investment?

multiple choice
Between years 1 and 2
2 years
Between years 2 and 3 Correct
Between years 3 and 4

Answer
Between years 2 and 3 

 
Explanation
Knowledge Check 01

At the end of Year 1, the cumulative present value of the cash flows = Cost of $(40,000). At the end of Year 2, the cumulative present value of the cash flows = Year 1 amount of $(40,000) + Present value of year 2 cash flow of (or Cash flow of $20,000 × PV factor of 0.9259) = $(21,482). At the end of Year 3, the cumulative present value of the cash flows = Year 2 amount of $(21,482) + Present value of year 3 cash flow of (or Cash flow of $20,000 × PV factor of 0.8573) = $17,416. The cumulative present value of cash flows changes from a negative to a positive number between years 2 and 3.