Accounting & Finance Unit 3 1 Practice Test 1

Test TWO

Topic: CAPITAL INVESTMENT TECHNIQUES

Student Name:__________________________________________________________________

Time Allowed: 60 Minutes Total Marks: 60 Marks Weighting: 6%

SECTION ONE: Multiple Choice Questions (8 Marks)

Choose the most appropriate answer for each of the following questions:

1. Capital investment decisions should be based on both quantitative and qualitative factors. Which of
the following is not a qualitative factor?

(a) Changing social customs

(b) Environmental impact
(c) Taxation considerations
(d) Occupational health

2. It is a characteristic of capital investment decisions that they:

(a) usually involve large sums of money relative to the size of the business
(b) are taken by shareholders at a general meeting
(c) can be easily reversed as circumstances change
(d) carry a relatively low risk

3. Capital investment decisions

(a) Usually involve relatively large sums of money

(b) Are generally fairly low risk
(c) Can easily be reversed
(d) Must be referred to the shareholders for decision

4. Which is not a relevant factor in calculating the payback period?

(a) the purchase price of the asset

(b) the discounted value of future cash flows
(c) the cost of transporting the asset to the business
(d) the cash flows generated up to the payback period

Rossmoyne Senior High School Business Department

Accounting & Finance Unit 3 2 Practice Test 1

5. Capital expenditures have a large impact on a business and it is expected that they will:

(a) have a long payback period

(b) improve cash outflows
(c) improve product or service quality
(d) All of the above

6. Examples of capital investment decisions include:

(a) establishing a new store

(b) purchasing new machinery
(c) taking over an existing business
(d) all of the above

7. Cash outflows for a business may include

(a) the likely residual cash value of an investment when completed

(b) increased depreciation costs
(c) increased payments for operational costs
(d) all of the above

8. In determining the present value of a cash inflow or outflow we must first determine
whether the amounts are a lump sum or an annuity:

(a) Lump sum means the amount is one figure overall

(b) Lump sum means the amounts are the same each year
(c) Annuity means the amount is a sequence of equal cash flows each period
(d) Annuity means an annual amount is received each year

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Rossmoyne Senior High School Business Department

Accounting & Finance Unit 3 3 Practice Test 1

SECTION TWO: Practical and Related Theory Questions (47 Marks)

Question 9

Phillips Ltd manufactures television sets. The business is evaluating the purchase of new robotic
plant and equipment costing $780 000 cash. It is estimated that the new plant and equipment will
have a useful life of 10 years and an estimated residual value of $78 000. If purchased, it should
generate cost savings in wages of $153 000 per annum. The maintenance cost of the new plant and
equipment is expected to increase by $30 000 each year.

Required:

(a) Calculate the payback period for the plant and equipment in years and months.

ANSWER: _____________________________________________________ (4 Marks)

(b) Based on quantitative factors alone, is the plant and equipment an acceptable investment, if
the predetermined acceptable period set by management is 6 years? Explain your answer
briefly.

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(1 Mark)

(c) Based on a Cost of Capital of 12%, calculate the net present value of the plant and
equipment. Round all figures to two decimal places.

ANSWER: _____________________________________________________ (7 Marks)

(d) Describe the net present value decision rule. Based on this rule, indicate whether this
project will be accepted or rejected. (3 Marks)
Rossmoyne Senior High School Business Department
Accounting & Finance Unit 3 4 Practice Test 1

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Question 10

Alexis and his wife Serena are the owners of ‘OneStop Shop, a thriving business selling all sports
accessories and equipment, currently situated in Bullcreek. The business wants to expand and is
looking at the following Options.

Option 1 Option 2
Details
For each Option Extension/Renovation New Building
(Bullcreek) (Myaree)
$460 000 initially, and a further
Cost of investment $800 000
$300 000 after the first year
Residual value $76 000 $80 000

Useful life 5 5
$500 000 for year 1,
Incremental net cash inflows $550 000 for year 2 and 3 $460 000 per year
$600 000 for years 4 and 5
$366 000 for year 1,
Incremental operating expenses* $396 000 for year 2 and 3 $320 000 per year
$516 000 for year 4 -5
Discount rate 10% 10%

Additional Information:

* The business depreciates its assets using the straight line method.

* The expenses above are all cash expenses except for depreciation (which has been included in
the above figures)

Required

Rossmoyne Senior High School Business Department

Accounting & Finance Unit 3 5 Practice Test 1

(a) Calculate the depreciation amount for both the Bullcreek and Myaree options.
(2 Marks)

(b) Determine the net cash outflows each year for both the Bullcreek and Myaree options.
(4 Marks)

(c) Prepare a table to calculate the net cash flows for the Bullcreek option. (Show Workings)
(6 Marks)

(d) Calculate the net cash flows for the Myaree option. (Show Workings) (1 Mark)

(e) ‘OneStop Shop’ reviews proposed capital investment options using the payback method.
Management has decided that projects with a payback period of less than three years should
be subject to further review.
Rossmoyne Senior High School Business Department
Accounting & Finance Unit 3 6 Practice Test 1

Calculate the payback period for the Bullcreek option. (Show Workings)
(5 Marks)

The payback period for Bullcreek is: _________________________________________

(f) The owners request that you use the discounted cash flow analysis to investigate the options
further.

Calculate the net present value of the Bullcreek option. Round final calculation to the
nearest dollar. (Show Workings) (10 Marks)

Bullcreek option Net Present Value is: _________________________________________

(g) If the Myaree option has a payback period of 2 Years and 10 Months, and a net present
value of $276 587.20 positive, would you choose Myaree or Bullcreek? Why?
Rossmoyne Senior High School Business Department
Accounting & Finance Unit 3 7 Practice Test 1

Would your answer be different if Myaree’s payback period was 2 Years 1 Month? Why?
(4 Marks)

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SECTION THEORY: Theory Question (5 Marks)

“When making an expensive capital investment decision, the management will want to make sure
the business:

 meets customer expectations;

 remains competitive;
 meets all legal and political requirements.”

Discuss this statement.

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END OF TEST

Rossmoyne Senior High School Business Department