OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
Multiple Choice
1. LO 11.1 Capital investment decisions often involve all of the following except ________.
A. qualitative factors or considerations
B. short periods of time
C. large amounts of money
D. risk
Solution
B
2. LO 11.1 Preference decisions compare potential projects that meet screening decision criteria
and will be ranked in their preference order to differentiate between alternatives with respect to
all of the following characteristics except ________.
A. political prominence
B. feasibility
C. desirability
D. importance
Solution
A
3. LO 11.1 The third step for making a capital investment decision is to establish baseline
criteria for alternatives. Which of the following would not be an acceptable baseline criterion?
A. payback method
B. accounting rate of return
C. internal rate of return
D. inventory turnover
Solution
D
4. LO 11.3 You are explaining time value of money factors to your friend. Which factor would
you explain as being larger?
A. The future value of $1 for 12 periods at 6% is larger.
B. The present value of $1 for 12 periods at 6% is larger.
C. Neither one is larger because they are equal.
D. There is not enough information given to answer this question.
Solution
A
5. LO 11.3 If you are saving the same amount each month in order to buy a new sports car when
the new models are released, which of the following will help you determine the savings needed?
A. future value of one dollar
B. present value of one dollar
C. future value of an ordinary annuity
D. present value of an ordinary annuity
Solution
C
Page 1 of 33
,OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
6. LO 11.3 You want to invest $8,000 at an annual interest rate of 8% that compounds annually
for 12 years. Which table will help you determine the value of your account at the end of 12
years?
A. future value of one dollar
B. present value of one dollar
C. future value of an ordinary annuity
D. present value of an ordinary annuity
Solution
A
7. LO 11.3 Using the information provided, what transaction represents the best application of
the present value of an annuity due of $1?
A. Falcon Products leases an office building for 8 years with annual lease payments of
$100,000 to be made at the beginning of each year.
B. Compass, Inc., signs a note of $32,000, which requires the company to pay back the
principal plus interest in four years.
C. Bahwat Company plans to deposit a lump sum of $100,000 for the construction of a solar
farm in 4 years.
D. NYC Industries leases a car for 4 yearly annual lease payments of $12,000, where
payments are made at the end of each year.
Solution
A
8. LO 11.3 Grummet Company is acquiring a new wood lathe with a cash purchase price of
$80,000. The Wood Master Industries (the manufacturer) has agreed to accept $23,500 at the end
of each of the next 4 years. Based on this deal, how much interest will Grummet pay over the life
of the loan?
A. $94,000
B. $80,000
C. $23,500
D. $14,000
Solution
D. ($23,500 × 4) $80,000 = $14,000
9. LO 11.3 The process that determines the present value of a single payment or stream of
payments to be received is ________.
A. compounding
B. discounting
C. annuity
D. lump-sum
Solution
B
10. LO 11.3 The process of reinvesting interest earned to generate additional earnings over time
is ________.
A. compounding
B. discounting
C. annuity
D. lump-sum
Solution
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,OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
A
11. LO 11.4 The NPV method assumes that cash inflows associated with a particular investment
occur when?
A. only at the time of the initial investment
B. only at the end of the year
C. only at the beginning of the year
D. at any of these times
Solution
D
12. LO 11.4 Which of the following does not assign a value to a business opportunity using
time-value measurement tools?
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. payback period method
Solution
D
13. LO 11.4 Which of the following discounts future cash flows to their present value at the
expected rate of return, and compares that to the initial investment?
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. future value method
Solution
B
14. LO 11.4 This calculation determines profitability or growth potential of an investment,
expressed as a percentage, at the point where NPV equals zero.
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. future value method
Solution
A
15. LO 11.5 The IRR method assumes that cash flows are reinvested at ________.
A. the internal rate of return
B. the company’s discount rate
C. the lower of the company’s discount rate or internal rate of return
D. an average of the internal rate of return and the discount rate
Solution
A
16. LO 11.5 When using the NPV method for a particular investsment decision, if the present
value of all cash inflows is greater than the present value of all cash outflows, then ________.
A. the discount rate used was too high
B. the investment provides an actual rate of return greater than the discount rate
C. the investment provides an actual rate of return equal to the discount rate
D. the discount rate is too low
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, OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
Solution
B
Questions
1. LO 11.1 What are the steps involved in the process for capital decision-making?
Solution
The process for capital decision-making involves five steps: 1. Determine capital needs. 2.
Explore resource limitations. 3. Establish baseline criteria for alternatives. 4. Evaluate
alternatives using screening and preference decisions. 5. Make the decision.
2. LO 11.1 Why does a company evaluate both the money allocated to a project and the time
allocated to the project?
Solution
When exploring resource limitations, a company must evaluate its ability to invest in capital
expenditures given the availability of funds and time. Sometimes a company may have enough
funds to cover capital investments in both machinery and buildings. Often, however, they only
have enough funds to invest in one of the opportunities. If this is the situation, the company must
evaluate the time allocation to each project, as well as the money needed to obtain the asset.
Time allocation considerations can include employee commitments and project set-up
requirements. Time allocations of employee commitments and set-up needs also require money
resource limitations.
3. LO 11.1 What is the next thing a company needs to do after it establishes investment criteria?
Solution
The company then needs to establish alternatives, which are options available for investment,
and evaluate the options using common measurement methods, including the payback method,
accounting rate of return, net present value, and internal rate of return.
4. LO 11.1 What is the screening decision?
Solution
Alternatives will first be challenged by the predetermined criteria for that investment
opportunity, called a screening decision. The screening decision allows companies to remove
alternatives that would be less desirable for pursuit given their inability to meet basic standards.
5. LO 11.1 Your supervisor is on the company’s capital investment decision team that is to
decide on alternatives for the acquisition of a new computer system for the company. The
supervisor says, “The book value of the existing computer system for the firm that we are
considering replacing is nothing but an accounting amount and as such is irrelevant in the capital
expenditure analysis.” Does this reasoning make sense? Why or why not?
Solution
From the standpoint of the decision to replace the asset, the book value of an existing asset is
irrelevant. Book value is just the historical cost (or value) of the asset less the total depreciation
calculated to date. A gain or loss situation often happens when the asset is sold for more or less
than its book value, respectively. It is only at that point that the company truly realizes whether
they have extra value or not enough value in the assets. This difference can provide either a gain
or a loss to the company that will impact the taxes at year-end. Therefore, gains or losses
affecting tax payments, plus cash flows, are important, since cash-flow effects are relevant in
capital investment decisions.
6. LO 11.1 Ekon owns a small tow-truck business that responds to state patrol requests to tow
Page 4 of 33
Chapter 11: Capital Budgeting Decisions
Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
Multiple Choice
1. LO 11.1 Capital investment decisions often involve all of the following except ________.
A. qualitative factors or considerations
B. short periods of time
C. large amounts of money
D. risk
Solution
B
2. LO 11.1 Preference decisions compare potential projects that meet screening decision criteria
and will be ranked in their preference order to differentiate between alternatives with respect to
all of the following characteristics except ________.
A. political prominence
B. feasibility
C. desirability
D. importance
Solution
A
3. LO 11.1 The third step for making a capital investment decision is to establish baseline
criteria for alternatives. Which of the following would not be an acceptable baseline criterion?
A. payback method
B. accounting rate of return
C. internal rate of return
D. inventory turnover
Solution
D
4. LO 11.3 You are explaining time value of money factors to your friend. Which factor would
you explain as being larger?
A. The future value of $1 for 12 periods at 6% is larger.
B. The present value of $1 for 12 periods at 6% is larger.
C. Neither one is larger because they are equal.
D. There is not enough information given to answer this question.
Solution
A
5. LO 11.3 If you are saving the same amount each month in order to buy a new sports car when
the new models are released, which of the following will help you determine the savings needed?
A. future value of one dollar
B. present value of one dollar
C. future value of an ordinary annuity
D. present value of an ordinary annuity
Solution
C
Page 1 of 33
,OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
6. LO 11.3 You want to invest $8,000 at an annual interest rate of 8% that compounds annually
for 12 years. Which table will help you determine the value of your account at the end of 12
years?
A. future value of one dollar
B. present value of one dollar
C. future value of an ordinary annuity
D. present value of an ordinary annuity
Solution
A
7. LO 11.3 Using the information provided, what transaction represents the best application of
the present value of an annuity due of $1?
A. Falcon Products leases an office building for 8 years with annual lease payments of
$100,000 to be made at the beginning of each year.
B. Compass, Inc., signs a note of $32,000, which requires the company to pay back the
principal plus interest in four years.
C. Bahwat Company plans to deposit a lump sum of $100,000 for the construction of a solar
farm in 4 years.
D. NYC Industries leases a car for 4 yearly annual lease payments of $12,000, where
payments are made at the end of each year.
Solution
A
8. LO 11.3 Grummet Company is acquiring a new wood lathe with a cash purchase price of
$80,000. The Wood Master Industries (the manufacturer) has agreed to accept $23,500 at the end
of each of the next 4 years. Based on this deal, how much interest will Grummet pay over the life
of the loan?
A. $94,000
B. $80,000
C. $23,500
D. $14,000
Solution
D. ($23,500 × 4) $80,000 = $14,000
9. LO 11.3 The process that determines the present value of a single payment or stream of
payments to be received is ________.
A. compounding
B. discounting
C. annuity
D. lump-sum
Solution
B
10. LO 11.3 The process of reinvesting interest earned to generate additional earnings over time
is ________.
A. compounding
B. discounting
C. annuity
D. lump-sum
Solution
Page 2 of 33
,OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
A
11. LO 11.4 The NPV method assumes that cash inflows associated with a particular investment
occur when?
A. only at the time of the initial investment
B. only at the end of the year
C. only at the beginning of the year
D. at any of these times
Solution
D
12. LO 11.4 Which of the following does not assign a value to a business opportunity using
time-value measurement tools?
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. payback period method
Solution
D
13. LO 11.4 Which of the following discounts future cash flows to their present value at the
expected rate of return, and compares that to the initial investment?
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. future value method
Solution
B
14. LO 11.4 This calculation determines profitability or growth potential of an investment,
expressed as a percentage, at the point where NPV equals zero.
A. internal rate of return (IRR) method
B. net present value (NPV)
C. discounted cash flow model
D. future value method
Solution
A
15. LO 11.5 The IRR method assumes that cash flows are reinvested at ________.
A. the internal rate of return
B. the company’s discount rate
C. the lower of the company’s discount rate or internal rate of return
D. an average of the internal rate of return and the discount rate
Solution
A
16. LO 11.5 When using the NPV method for a particular investsment decision, if the present
value of all cash inflows is greater than the present value of all cash outflows, then ________.
A. the discount rate used was too high
B. the investment provides an actual rate of return greater than the discount rate
C. the investment provides an actual rate of return equal to the discount rate
D. the discount rate is too low
Page 3 of 33
, OpenStax Principles of Accounting, Volume 2: Managerial Accounting
Chapter 11: Capital Budgeting Decisions
Solution
B
Questions
1. LO 11.1 What are the steps involved in the process for capital decision-making?
Solution
The process for capital decision-making involves five steps: 1. Determine capital needs. 2.
Explore resource limitations. 3. Establish baseline criteria for alternatives. 4. Evaluate
alternatives using screening and preference decisions. 5. Make the decision.
2. LO 11.1 Why does a company evaluate both the money allocated to a project and the time
allocated to the project?
Solution
When exploring resource limitations, a company must evaluate its ability to invest in capital
expenditures given the availability of funds and time. Sometimes a company may have enough
funds to cover capital investments in both machinery and buildings. Often, however, they only
have enough funds to invest in one of the opportunities. If this is the situation, the company must
evaluate the time allocation to each project, as well as the money needed to obtain the asset.
Time allocation considerations can include employee commitments and project set-up
requirements. Time allocations of employee commitments and set-up needs also require money
resource limitations.
3. LO 11.1 What is the next thing a company needs to do after it establishes investment criteria?
Solution
The company then needs to establish alternatives, which are options available for investment,
and evaluate the options using common measurement methods, including the payback method,
accounting rate of return, net present value, and internal rate of return.
4. LO 11.1 What is the screening decision?
Solution
Alternatives will first be challenged by the predetermined criteria for that investment
opportunity, called a screening decision. The screening decision allows companies to remove
alternatives that would be less desirable for pursuit given their inability to meet basic standards.
5. LO 11.1 Your supervisor is on the company’s capital investment decision team that is to
decide on alternatives for the acquisition of a new computer system for the company. The
supervisor says, “The book value of the existing computer system for the firm that we are
considering replacing is nothing but an accounting amount and as such is irrelevant in the capital
expenditure analysis.” Does this reasoning make sense? Why or why not?
Solution
From the standpoint of the decision to replace the asset, the book value of an existing asset is
irrelevant. Book value is just the historical cost (or value) of the asset less the total depreciation
calculated to date. A gain or loss situation often happens when the asset is sold for more or less
than its book value, respectively. It is only at that point that the company truly realizes whether
they have extra value or not enough value in the assets. This difference can provide either a gain
or a loss to the company that will impact the taxes at year-end. Therefore, gains or losses
affecting tax payments, plus cash flows, are important, since cash-flow effects are relevant in
capital investment decisions.
6. LO 11.1 Ekon owns a small tow-truck business that responds to state patrol requests to tow
Page 4 of 33
