Capital Budgeting Paper 33

Correct answer: (D)
The $4,000 deposited at the end of each of the next 3 years is a 3-year annuity. The future value of an ordinary annuity factor for 3 years at 8% is 3.25. We multiply the $4,000 that will be deposited each year by 3.25 to calculate the future value of the $4,000 deposits, which equals $13,000. This $13,000 needs to be added to the future value of the $75,000 that is already in the bank account. The $75,000 already in the bank account will also be there for 3 years. The future value of $1 factor for 3 years at 8% is 1.26. $75,000 × 1.26 = $94,500. $13,000 + $94,500 = $107,500, the future value at the end of 3 years of all the funds in the account.

Correct answer: (B)
This is a future value of $1 question. The factor in the Future Value of $1 table used to calculate the future value of earnings per share ($4.41) after 5 years, beginning with an earnings per share of $3.00, will be found at the intersection of 5 years and the interest rate (rate of growth) in the Future Value of $1 table. To find the factor, divide the ending value of $4.41 after five years by the beginning value, $3.00. The result is 1.47. Next, turn to the Future Value of $1 table in this book following the Time Value of Money discussion. Look across the 5-year line until you see a factor that is close to 1.47. The factor 1.469 appears under the rate of 8%. Therefore, 8% is the forecasted compound annual growth rate in earnings per share. To prove that, multiply $3.00 by 1.469, the factor for a compound annual growth rate of 8% after 5 years. The result is the $4.41 earnings per share forecasted after 5 years.

Correct answer: (A)
This question is intended to test a candidate’s understanding of the conceptual relationships between present values of single amounts and present values of annuities, and the impact of length of time on present value amounts. Getting the correct answer does not require (or expect) the actual calculation of present values for each of the four choices. Here is the logic:
1. Recognize that all of the choices are for the same amount, $100. Therefore, the amount of the principal will not create a difference in present values for the choices.
2. Next, notice that choices A, B, and D are for annuities; choice C is for a single amount to be received in four years, longer than choices B and D, and as long as choice A. Since the present value of a single amount has to be less than the present value of a series of equal amounts due within the same or less time, choice C cannot result in the highest present value.
3. Next, since choices A, B, and D are all for annuities of the same amount, the longer the annuity, the higher the present value. Choices B and D are for three years; choice A is for four years.
4. Therefore, choice A will result in the highest present value.

Correct answer: (B)
A present value of 1 factor is used because only one payment is to be made. Present value (which also is cost) = (present value of 1 factor) x (future payment). The future payment is being discounted to its present value.

Correct answer: (C)
ROI is calculated as income / invested capital. The income of the company was $11,000 ($311,000 - $250,000 - $50,000) and the invested capital was $40,000. Therefore, the ROI was 27.5% ($11,000 / $40,000)

Choice "c" is correct. The weighted-average cost of capital is frequently used as the hurdle rate within capital budgeting techniques. Investments that provide a return that exceeds the weighted-average cost of capital should continuously add to the value of the firm.

Choice "b" is correct. Capital budgeting decisions do not include the financing of short-term working capital needs, which are more operational in nature.

Choice "A" is correct. The payback period is the time period required for cash inflows to recover the initial investment. The emphasis of the technique is on liquidity (i.e., cash flow) .

Correct answer: (C)
Average accumulated expenditures

Correct answer: (D)
Restoration costs