Deck 11: Capital Budgeting

Question 1

An asset with a book value of $50,000 is sold at a loss (before taxes are considered) of $20,000. The applicable tax rate is 40%. is the tax effect of the loss.

A) $16,000 cash inflow
B) $8,000 cash inflow
C) $28,000 cash inflow
D) $8,000 cash outflow

Answer 1

C

Question 2

The cost of capital is sometimes referred to as:

A) the required rate of return
B) the hurdle rate
C) the discount rate
D) All of these answers are correct.

Answer 2

D

Question 3

Sam Butcher Company will purchase a van for $40,000. It will have a depreciable life of 5 years and no terminal salvage value. Assume a tax rate of 40% and a required after- tax rate of return of 12%. The present value of the total after- tax savings from depreciation, if the straight- line method is used, is:

A) $16,000
B) $24,000
C) $11,535
D) $17,303

Answer 3

C

Question 4

If the appropriate tax rate is 30%, the after- tax effect of a single depreciation deduction of $100,000 is a:

A) $30,000 net after- tax cash outflow
B) $70,000 net after- tax cash inflow
C) $30,000 net after- tax cash inflow
D) $70,000 net after- tax cash outflow

Question 5

In capital budgeting decisions, risk is a measure of:

A) the project's sensitivity to change
B) the project's desirability
C) the firm's credit worthiness
D) the likelihood that the project will succeed

Question 6

Assume that the desired rate of return is 10% and that interest is compounded annually. Identify how much must be invested today to have $10,000 in 5 years and 10 years, respectively.

A) $1,000; $5,000
B) $5,000; $1,000
C) $3,791; $6,145
D) $6,209; $3,855

Question 7

When using the net- present- value method, if the sum of the present values of the cash flows is positive, then:

A) the decision maker would be indifferent between accepting and rejecting the project
B) the present value of the cash outflows exceeds the present value of the cash inflows
C) the project should be rejected
D) the project is desirable

Question 8

Accelerated depreciation for tax purposes will generally produce a present value of tax savings that is:

A) less than that provided by straight- line depreciation
B) the same as that provided by straight- line depreciation
C) greater than that provided by straight- line depreciation
D) greater than that provided by any other depreciation method

Question 9

An asset with a book value of $200,000 is sold at a loss (before taxes are considered) of $40,000. If the applicable tax rate is 20%, is the tax effect of the loss.

A) $8,000 cash outflow
B) $48,000 cash inflow
C) $8,000 cash inflow
D) $208,000 cash inflow

Question 10

When choosing among several investments:

A) the cost of capital is irrelevant
B) risk should not be a factor
C) the one with the largest positive present value should be chosen
D) the one with the greatest net present value is the least desirable

Question 11

The lower the minimum desired rate of return, the:

A) lower the present value of each future cash outflow
B) lower the present value of each future cash inflow
C) higher the net present value of the project
D) higher the present value of each future cash outflow

Question 12

An initial investment of $42,000 is expected to generate annual cash flows of $10,000, $15,000, $15,000, and $12,000, respectively. Assume straight- line depreciation and ignore income taxes. The payback period is:

A) 3.83 years
B) 3 years
C) 3.17 years
D) indeterminable because the cash flows are uneven

Question 13

An annuity is:

A) a yearly payment of any amount
B) a cash amount received only once
C) a series of equal cash flows at equal intervals
D) None of these answers is correct.

Question 14

Accelerated depreciation:

A) charges a larger proportion of an asset's cost to the earlier years
B) charges a larger proportion of an asset's cost to the later years
C) increases an asset's recovery period
D) reduces an asset's estimated useful life

Question 15

An asset with a book value of $320,000 is sold at a $240,000 pre- tax gain in a year when the tax rate is 40%. is the net after- tax cash inflow resulting from this transaction.

A) $656,000
B) $464,000
C) $144,000
D) $560,000

Question 16

does not require an explicit adjustment for inflation.

A) The tax effect of depreciation
B) The nominal rate
C) The predicted operating cash flows
D) None of these answers is correct.

Question 17

An asset with a book value of $40,000 is sold at a loss (before taxes are considered) of $20,000. The applicable tax rate is 40%. The net after- tax cash effect of this transaction is a:

A) $28,000 cash inflow
B) $12,000 cash outflow
C) $48,000 cash inflow
D) $20,000 cash inflow

Question 18

An asset with a book value of $320,000 is sold at a $240,000 pre- tax gain in a year when the tax rate is 40%. is the tax effect of the gain.

A) A $656,000 cash outflow
B) A $144,000 cash outflow
C) A $96,000 cash outflow
D) A $224,000 cash outflow

Question 19

Chaparral Company pays taxes of 25% on their first $30,000 of pre- tax income, and 35% on any taxable income in excess of $30,000. The marginal tax rate, if current pre- tax income is $45,000, is:

A) 30%
B) 60%
C) 25%
D) 35%

Question 20

A five year MACRS asset which cost $50,000 with zero terminal value was sold at the end of its useful life for $20,000. The tax rate is 40%. is the net after- tax cash inflow resulting from the transaction.

A) $62,000
B) $12,000
C) $58,000
D) $8,000

Question 21

is a cash inflow.

A) Revenue generated by a project
B) Purchase price of an asset
C) Interest expense
D) Depreciation expense

Question 22

Bond Corporation is considering the purchase of an asset for $400,000. It is expected that the product manufactured by the equipment can be sold for $150,000 and there will be annual production costs, exclusive of depreciation, equal to $80,000. The asset will have a 10- year life, no terminal salvage value, and straight- line depreciation will be used for tax purposes. The tax rate applicable to the company is 30%. The total net annual after- tax effect on cash resulting from the investment is a:

A) $12,000 inflow
B) $49,000 inflow
C) $61,000 inflow
D) $21,000 inflow

Question 23

is (are) not a relevant cash inflow or cash outflow.

A) Operating cash flows
B) Depreciation
C) Initial cash inflow and outflow at time zero
D) Future disposal value

Question 24

An asset with a book value of $160,000 is sold at a loss (before taxes are considered) of $40,000. If the applicable tax rate is 20%, the net after- tax cash effect of this transaction is a(n):

A) $8,000 cash inflow
B) $128,000 cash inflow
C) $48,000 cash inflow
D) $8,000 cash outflow

Question 25

The "break- even" cash flow is the point at which:

A) total cash revenues equal the total cash expenses
B) the hurdle rate equals the market rate
C) the present value of the cash inflows equals the present value of the cash outflows
D) the present value of variable cost equals the present value of fixed costs

Question 26

At the current discount rate, the net present value of an 8- year project is zero. Assuming that the current discount rate and the annual cash flows are unchanged, identify which one of the following statements is true.

A) The project is equally undesirable at 5 and 10 years.
B) The project will be desirable if the project's life is reduced to 5 years.
C) The project will be desirable if the project's life is increased to 10 years.
D) The project is equally desirable at 5 and 10 years.

Question 27

An initial investment of $270,000 is expected to generate $120,000 in annual cost savings over the asset's expected 3- year life. Assume straight- line depreciation and ignore income taxes. The accounting rate of return based on initial investment is:

A) 33.33%
B) 11.11%
C) 44.44%
D) None of these answers is correct.

Question 28

The disposal value at the date of termination of a project is:

A) a decrease in the cash outflow in the year acquired
B) an increase in the cash inflow in the year of disposal
C) an increase in the cash outflow in the year of disposal
D) a decrease in the cash inflow in the year acquired

Question 29

Identify which one of the following statements is true.

A) Predictions of cash flows and discount rates should be computed without regard to inflation.
B) When two projects are mutually exclusive, the project that has the smallest net present value should be undertaken.
C) If alternate projects have unequal lives, comparisons may be made over the useful life of either the longer- lived project or the shorter- lived one.
D) Comparisons between alternatives are best made without considering tax effects.

Question 30

An initial investment of $180,000 is expected to generate $75,000 in annual cost savings over the asset's expected 3- year life. Assume straight- line depreciation and ignore income taxes. The accounting rate of return based on initial investment is:

A) 16.67%
B) 41.67%
C) 8.33%
D) None of these answers is correct.

Question 31

Alice Maid Company will purchase a van for $40,000. It will have a depreciable life of 5 years and no terminal salvage value. Assume a tax rate of 40% and a required after- tax rate of return of 12%. The present value of the after- tax saving from depreciation in year 2, if an accelerated method is used (of twice the straight- line rate), is:

A) $3,827
B) $6,378
C) $2,551
D) None of these answers is correct.

Question 32

A 5- year depreciation period usually means that:

A) the company will depreciate the asset over 5 years for tax purposes
B) the company expects to use the asset for 5 years
C) the original cost of the asset will be recouped in 5 years
D) All of these answers are correct.

Question 33

An initial investment of $270,000 is expected to generate $120,000 in annual cost savings over the asset's expected 3- year life. Assume straight- line depreciation and ignore income taxes. The payback period is:

A) 2.40 years
B) 3.00 years
C) 0.75 years
D) 2.25 years

Question 34

An accountant's main function in capital budgeting is to:

A) identify potential investments
B) gather and interpret information
C) choose which investments to make
D) All of these answers are correct.

Question 35

Identify which one of the following statements regarding the risk of an investment is true.

A) The higher the risk, the higher the minimum desired rate of return.
B) The higher the risk, the lower the hurdle rate.
C) The higher the risk, the lower the cost of capital.
D) The lower the risk, the higher the discount rate.

Question 36

The annual cash operating inflows, after taxes, of a newly purchased asset are expected to be $60,000. The expected useful life is 5 years; the nominal rate includes an inflation factor of 5%. The annual cash operating inflow for 1 year is:

A) $57,000
B) $63,000
C) $66,150
D) $60,000

Question 37

When evaluated using a nominal rate of 8%, the net present value of a project is zero. Identify which one of the following statements is true.

A) At 6% the project is desirable and at 8% it is undesirable.
B) The project is undesirable at 6% or 8%.
C) At 8% the project is desirable and at 6% it is undesirable.
D) The project is desirable at 6% or 8%.

Question 38

Ajax Company pays 15% on the first $50,000 of pre- tax income and 30% on any additional pre- tax income. Ajax Company currently earns $52,000. An investment under consideration is expected to add $20,000 in pre- tax income. is the rate on the additional income.

A) 22.5%
B) 30%
C) 15%
D) None of these answers is correct.

Question 39

is not a phase of capital budgeting.

A) A post- audit of the investment
B) The identification of possible sources of funds for the investment
C) The identification of potential investments
D) The selection of the investment to undertake

Question 40

is not considered an outflow at time zero.

A) The initial investment of inventories and receivables
B) The installation cost of new equipment
C) The disposal cost of old equipment
D) The disposal value of new equipment

Question 41

Buffy Company pays taxes of 15% on their first $20,000 of pre- tax income, and 30% on any taxable income in excess of $20,000. The average tax rate, if current pre- tax income is $50,000, is:

A) 24%
B) 21%
C) 15%
D) 30%

Question 42

is not another name for the required rate of return.

A) Cost of capital
B) Discount rate
C) Hurdle rate
D) Compound rate

Question 43

When comparing projects using the differential approach, a manager should:

A) choose the first project considered if the present value is positive
B) choose the second project considered if the present value positive
C) choose the project with the largest positive net present value
D) choose the project with the largest negative net present value

Question 44

In relevant- cost analysis, the only pertinent overhead costs are those that:

A) will differ among alternatives
B) vary with production levels
C) remain the same among alternatives
D) are fixed within a relevant range

Question 45

Below are two potential investment alternatives: $\begin{array}{lll}&A&B\\\text { Initial capital investment } & & \\\$ 180,000 & \$ 270,000 & \\\text { Estimated useful life } & 3 \text { yrs. } & 3 \text { yrs. } \\\text { Estimated terminal salvage value } & -0- & -0- \\\text { Estimated annual savings in cash } & & \\\text { op erating costs } & \$ 75,000 & \$ 120,00 \\\text { Minimum desired rate of return } & 10 \% & 12 \%\end{array}$
Assume straight- line depreciation in all computations, and ignore income taxes. The net present value in investment A is:

A) $75,000
B) $6,518
C) $(123,652)
D) $186,518

Question 46

and financing decisions are two key aspects of capital budgeting.

A) Investing decisions
B) Discount decisions
C) Accounting decisions
D) Payback decisions

Question 47

are decisions on whether to acquire an asset, a project, a company, or a product line.

A) Financing decisions
B) Accounting decisions
C) Payback decisions
D) Investment decisions

Question 48

Harvey has offered to give you $10,000 today or $3,000 per year for the next five years. If the cost of capital is 10%, Harvey should:

A) choose $3,000 for five years
B) choose $10,000 today
C) choose either because the results will be the same
D) Do nothing. Harvey cannot make a decision with the above information.

Question 49

An initial investment of $180,000 is expected to generate $85,000 in annual cost savings over the asset's expected 3- year life. Assume straight- line depreciation and ignore income taxes. The payback period is:

A) 3.0 years
B) 2.12 years
C) 0.88 years
D) None of these answers is correct.

Question 50

is an approach that compares two or more alternatives by computing the total impact on cash flows of each alternative and then converting these total cash flows to their present values.

A) The sensitivity approach
B) The payback approach
C) The total project approach
D) The differential approach

Question 51

The cash inflow effect of a disposal at a gain is equal to the:

A) selling price minus the tax paid
B) selling price plus the tax paid
C) amount of the loss plus the tax paid
D) amount of the loss minus the tax paid

Question 52

Robin Company is considering the purchase of a new $80,000 delivery van. The van will have a useful life of 5 years, no terminal salvage value, and tax depreciation will be calculated using the straight- line method. If the van is purchased, the company will be able to increase annual revenues by $90,000 per year for the life of the van, but out- of- pocket expenses will also increase by $60,000 per year. Assume a tax rate of 40% and a required after- tax rate of return equal to 10%. The annual net after- tax cash effect of operations, exclusive of depreciation, is a(n):

A) $30,000 inflow
B) $2,000 inflow
C) $12,000 inflow
D) $18,000 inflow

Question 53

The automatic rejection of one investment upon the acceptance of another investment is the definition of:

A) inflation
B) mutually exclusive investments
C) unequal time periods
D) differential analysis

Question 54

A company pays taxes of 25% on their first $25,000 of pre- tax income, and 35% on any taxable income in excess of $25,000. The marginal tax rate, if current pre- tax income is $30,000, is:

A) 30%
B) 25%
C) 35%
D) None of these answers is correct

Question 55

Caribbean Corporation is considering the purchase of equipment for $360,000. The asset will have a 10- year life, no terminal salvage value, and straight- line depreciation will be used for tax purposes. It is expected that annual sales of the product manufactured by the equipment will be $180,000, and that there will be annual production costs, exclusive of depreciation, equal to
$120,000. The tax rate applicable to the company is 30%. The annual net after- tax cash effect of operations, exclusive of depreciation, is a(n):

A) $18,000 inflow
B) $42,000 inflow
C) $18,000 outflow
D) $42,000 outflow

Question 56

is the decline in the general purchasing power of the monetary unit.

A) Inflation
B) The accounting rate of return
C) The nominal rate
D) The payback period

Question 57

The marginal tax rate is:

A) the rate paid on additional amounts of pre- tax income
B) the highest possible rate the company might be expected to pay
C) the lowest tax rate applicable to the company
D) the average rate for the company

Question 58

Acme Company, with pre- tax income of $80,000, is required to pay taxes of 25% on all income up to $20,000 and 35% on any income in excess of $20,000. Acme Company's average tax rate is:

A) 25.0%
B) 32.5%
C) 26.5%
D) 30.0%

Question 59

If the appropriate tax rate is 30%, the after- tax effect of an $100,000 savings in labor cost is:

A) $70,000 net after- tax cash inflow
B) $30,000 net after- tax cash outflow
C) $30,000 net after- tax cash inflow
D) $70,000 net after- tax cash outflow

Question 60

Matt Helm Corporation is considering the purchase of an asset for $400,000. It is expected that the product manufactured by the equipment can be sold for $150,000 and that there will be annual production costs, exclusive of depreciation, equal to $80,000. The asset will have a 10- year life, no terminal salvage value, and straight- line depreciation will be used for tax purposes. The tax rate applicable to Matt Helm Corporation is 30%. If the equipment is purchased, the total net after- tax effect on cash flows over the entire life of the investment is:

A) $210,000 outflow
B) $90,000 inflow
C) $610,000 inflow
D) $210,000 inflow

Question 61

Identify which one of the following is a reason to study a simpler model such as the payback method.

A) Simpler models are more accurate because they require less estimation.
B) Simpler models might provide some useful information to supplement the discounted- cash- flows analysis.
C) Simpler models are conceptually superior to discounted- cash- flows analysis.
D) The payback method is the most popular method of capital budgeting.

Question 62

Arranging the relevant cash flows by project is a step in the:

A) total project approach
B) internal rate of return approach
C) accounting rate of return approach
D) payback method

Question 63

The method companies use to depreciate most assets under United States income tax laws

Question 64

is a nondiscounted- cash- flows model that has profitability as an objective.

A) Payback
B) Internal rate of return
C) Net present value
D) Accounting rate of return

Question 65

is not a common way to recognize risk.

A) Increasing expected cash outflows by an amount that depends on their risk
B) Reducing individual expected cash inflows by an amount that depends on their risk
C) Increasing the minimum desired rate of return for riskier projects
D) Increasing the expected life of riskier projects

Question 66

The time it will take to recoup, in the form of cash inflows from operations, the initial dollars invested in a project is known as the:

A) internal return period
B) accounting return period
C) accelerated recovery period
D) payback period

Question 67

Sally Sweet Tooth Company will purchase a van for $50,000. The van's depreciable life is 5 years with no terminal salvage value. Assume a tax rate of 40% and a required after- tax rate of return of 12%. The annual after- tax effect of depreciation, if the straight- line method is used for taxes, is a:

A) $6,000 inflow
B) $4,000 outflow
C) $6,000 outflow
D) $4,000 inflow

Question 68

is (are) a factor which complicates the analysis in capital budgeting.

A) Inflation
B) Income taxes
C) Mutually exclusive projects
D) All of these answers are correct.

Question 69

Identify which of the following statements regarding the payback model is false.

A) The payback model measures how quickly investment dollars may be recouped.
B) A project with a shorter payback time is not necessarily preferable to one with a longer payback time.
C) The payback model measures profitability.
D) The payback model provides a rough estimate of risk.

Question 70

A reduction in a cash outflow:

A) reduces the future disposal value of an asset
B) increases the future disposal value of an asset
C) is not relevant for capital budgeting
D) is treated as a cash inflow

Question 71

A company is considering the purchase of some equipment that in the second year of operation should cause an increase in sales of $150,000, an increase in cash expenses of $90,000, and a depreciation deduction of $45,000. If the appropriate tax rate is 40%, the after- tax effect of this equipment on cash flows in year two is:

A) net after- tax cash inflows of $9,000
B) net after- tax cash inflows of $15,000
C) net after- tax cash inflows of $54,000
D) no effect

Question 72

Used in capital budgeting, it shows the financial consequences that would occur if actual cash inflows, outflows, and project lives differed from those expected

Question 73

Long- term planning for making and financing investments that affect financial results for more than the current year is called:

A) capital budgeting decisions
B) strategic analysis
C) sensitivity analysis
D) operational budgeting

Question 74

shows the financial consequences that would occur if actual cash flows differ from expected cash flows.

A) Discount analysis
B) Forecasting
C) Sensitivity analysis
D) Interest analysis

Question 75

The purposes of post- audits include all of the following except:

A) providing information for improving future predictions of cash flows
B) seeing that investment expenditures are proceeding on time and within budget
C) evaluating the continuation of the project
D) comparing actual project results with similar projects to evaluate manager performance

Question 76

When comparing projects using the total project approach, a manager should:

A) choose the project with the largest positive net present value
B) choose the first project considered if the present value is positive
C) choose the second project considered if the present value positive
D) choose the project with the largest negative net present value

Question 77

When considering the net cash inflows resulting from a capital- budgeting decision, taxes will:

A) increase the amount of the cash savings by (1 - tax rate)
B) increase the amount of the cash savings by the tax rate
C) reduce the amount of the cash savings by (1 - tax rate)
D) reduce the amount of the cash savings by the tax rate

Question 78

Below are two potential investment alternatives: $\begin{array}{lll}&X&Y\\\text { Initial capital investment } & \$ 180,000 & \$ 270,000 \\\text { Estimated useful life } & 3 \text { yrs. } & 3 \text { yrs. } \\\text { Estimated teminal salvage value } & -0- & -0- \\\text { Estimated annual savings in cash } & & \\\text { oper atingcosts } & \$ 75,000 & \$ 120,000 \\\text { Minimum desired rate of return } & 10 \% & 12 \%\end{array}$ Assume straight- line depreciation in all computations, and ignore income taxes. The net present value in investment Y is:

A) $120,000
B) $184,584
C) $18,216
D) $(492)

Question 79

When considering a capital- budgeting project, a manager should first determine the:

A) accounting rate of return
B) payback period
C) risk of the investment
D) internal rate of return

Question 80

In the net- present- value model, the perfect capital markets assumption means that:

A) net cash inflows equal net cash outflows
B) a company can borrow exactly the amount of money it needs
C) all amounts can be borrowed at the minimum desired rate of return
D) each lender charges the same interest rate