Deck 16: Capital Expenditure Decisions

Question 1

When preparing an NPV analysis on the disposal of an asset, like equipment, capital gains and losses are taxed at the same rate as ordinary income in the analysis.

Answer 1

False

Question 2

Two widely used methods of discounted-cash-flow analysis are the net-present-value method and the return on assets method.

Answer 2

False

Question 3

The incremental-cost approach looks at the difference in the NPVs of the cost of each relevant item under two alternatives in an analysis.

Answer 3

True

Question 4

An advantage of the NPV method is that the analyst can adjust for risk considerations.

Question 5

There is no adjustment in the payback method for the time value of money.

Question 6

All expenses represent cash outflows.

Question 7

When benefits are difficult to quantify in an NPV approach to a CIM investment decision, it is best to exclude them.

Question 8

Nominal dollars is another name for real dollars.

Question 9

If a proposal's profitability index is greater than one then the net present value is positive.

Question 10

Under MACRS, an asset's estimated salvage value is not subtracted in computing the asset's depreciation basis.

Question 11

MACRS depreciation is based on straight-line depreciation and is typically used for published financial statements.

Question 12

The last step in any investment analysis is to determine the cash flows that are relevant to the analysis.

Question 13

The internal rate of return equates the present value of a project's cash inflows with the present value of the cash outflows.

Question 14

Inflation is defined as a decline in the general purchasing power of a monetary unit, such as a dollar, across time.

Question 15

Activity-based-costing systems are costly, time-consuming to implement, and do not improve the ability of an analyst to estimate the cash flows associated with a proposed project.

Question 16

A company's hurdle rate is generally influenced by whether management uses the net-present-value method or the internal-rate-of-return method.

Question 17

Valid methods exist for ranking independent investment projects with positive net present values.

Question 18

When income taxes are considered in capital budgeting, the cash flows related to a company's advertising expense would be correctly figured by taking the cash paid for advertising and subtracting the result of multiplying [or advertising expense * (1 ‒ tax rate)].

Question 19

Some investment proposals require additional outlays for working capital.

Question 20

The payback period can only be used if net cash inflows are uniform throughout a project's life.

Question 21

Capital-budgeting decisions primarily involve:

A) emergency situations.
B) long-term decisions.
C) short-term planning situations.
D) cash inflows and outflows in the current year.
E) planning for the acquisition of capital.

Question 22

Which of the following would not involve a capital-budgeting analysis?

A) The acquisition of new equipment.
B) The addition of a new product line.
C) The adoption of a new cost driver for overhead application.
D) The construction of a new distribution facility.
E) The decision of a pro football team to trade for and sign a star quarterback to a long-term contract.

Question 23

A machine costs $25,000; it is expected to generate annual cash revenues of $8,000 and annual cash expenses of $2,000 for five years. The required rate of return is 12%.

The net present value of the machine is:

A) $(3,840).
B) $(3,370).
C) $0.
D) $21,630.
E) $28,840.

Question 24

Capital budgeting tends to focus primarily on:

A) revenues.
B) costs.
C) cost centers.
D) programs and projects.
E) allocation tools.

Question 25

The internal rate of return on an asset can be calculated:

A) if the return is greater than the hurdle rate.
B) if the asset's cash flows are identical to the future value of a series of cash flows.
C) if the future value of a series of cash flows can be arrived at by the annuity accumulation factor.
D) by finding a discount rate that yields a zero net present value.
E) by finding a discount rate that yields a positive net present value.

Question 26

Discounted-cash-flow analysis focuses primarily on:

A) the stability of cash flows.
B) the timing of cash flows.
C) the probability of cash flows.
D) the sensitivity of cash flows.
E) whether cash flows are increasing or decreasing.

Question 27

Consider the following factors related to an investment:
I) The net income from the investment.
II) The cash flows from the investment.
III) The timing of the cash flows from the investment.
Which of the preceding factors would be important considerations in a net-present-value analysis?

A) I only.
B) II only.
C) I and II.
D) II and III.
E) I, II, and III.

Question 28

A machine costs $25,000; it is expected to generate annual cash revenues of $8,000 and annual cash expenses of $2,000 for five years. The required rate of return is 12%. Using the tables that follow, which of the following statements about the machine's internal rate of return is true?

A) The internal rate of return is greater than 12%.
B) The internal rate of return is between 10% and 12%.
C) The internal rate of return is less than 10%.
D) The internal rate of return must be greater than 15%.
E) There is insufficient information to make any judgment about the internal rate of return.

Question 29

The decision process that has managers select from among several acceptable investment proposals to make the best use of limited funds is known as:

A) capital rationing.
B) capital budgeting.
C) acceptance or rejection analysis (ARA).
D) cost analysis.
E) project planning.

Question 30

The hurdle rate that is used in a net-present-value analysis is the same as the firm's:

A) discount rate.
B) internal rate of return.
C) minimum desired rate of return.
D) objective rate of return.
E) discount rate and minimum desired rate of return.

Question 31

Which of the following is taken into account by the net-present-value method?

Question 32

A new asset is expected to provide service over the next four years. It will cost $500,000, generates annual cash inflows of $150,000, and requires cash operating expenses of $30,000 each year. In addition, a $10,000 overhaul will be needed in year 3.

If the company requires a 10% rate of return, the net present value of this machine would be:

A) $(127,110), and the machine meets the company's rate-of-return requirement.
B) $(127,110), and the machine does not meet the company's rate-of-return requirement.
C) $(129,600), and the machine does not meet the company's rate-of-return requirement.
D) $(151,700), and the machine meets the company's rate-of-return requirement.
E) None of the answers is correct.

Question 33

Grenada Company is contemplating the acquisition of a machine that costs $50,000 and promises to reduce annual cash operating costs by $11,000 over each of the next six years.

Which of the following is a proper way to evaluate this investment if the company desires a 12% return on all investments?

A) $50,000 versus - $11,000 * 6.
B) $50,000 versus - $66,000 * 0.507.
C) $50,000 versus - $66,000 * 4.111.
D) $50,000 versus - $11,000 * 4.111.
E) $50,000 *0.893 versus - $11,000 * 4.111.

Question 34

In a net-present-value analysis, the discount rate is often called the:

A) payback rate.
B) hurdle rate.
C) minimal value.
D) net unit rate.
E) objective rate of return.

Question 35

The true economic yield produced by an asset is summarized by the asset's:

A) non-discounted cash flows.
B) net present value.
C) future value.
D) annuity discount factor.
E) internal rate of return.

Question 36

A company that is using the internal rate of return (IRR) to evaluate projects should accept a project if the IRR:

A) is greater than the project's net present value.
B) equates the present value of the project's cash inflows with the present value of the project's cash outflows.
C) is greater than zero.
D) is greater than the hurdle rate.
E) is less than the firm's cost of investment capital.

Question 37

The internal rate of return:

A) ignores the time value of money.
B) equates a project's cash inflows with its cash outflows.
C) equates a project's cash outflows with its expenses.
D) equates the present value of a project's cash inflows with the present value of the cash outflows.
E) equates the present value of a project's cash flows with the future value of the project's cash flows.

Question 38

Barton Company can acquire a $900,000 machine now that will benefit the firm over the next 6 years.

Annual savings in cash operating costs are expected to total $190,000. If the hurdle rate is 8%, the investment's net present value is:

A) $(181,800).
B) $(21,630).
C) $44,970.
D) $184,920.
E) None of the answers is correct.

Question 39

Carlin Company, which uses net present value to analyze investments, requires a 10% minimum rate of return. A staff assistant recently calculated a $500,000 machine's net present value to be $86,400, excluding the impact of straight-line depreciation.

If Carlin ignores income taxes and the machine is expected to have a five-year service life, the correct net present value of the machine would be:

A) $(13,600).
B) $86,400.
C) $186,400.
D) $292,700.
E) $465,500.

Question 40

The mayor of Trenton is considering the purchase of a new computer system for the city's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased:

What can be said about the computer system's internal rate of return if the net present value at 12% is positive? Trenton uses a 10% discount rate for capital-budgeting decisions.

A) The internal rate of return is greater than 12%.
B) The internal rate of return is between 10% and 12%.
C) The internal rate of return is less than 10%.
D) The internal rate of return must be less than 5%.
E) There is insufficient information to make any judgment about the internal rate of return.

Question 41

Generally speaking, which of the following would not directly affect a company's income tax payments?

A) Advertising expense.
B) Gain on sale of machinery.
C) Sales revenue.
D) Land owned by the firm.
E) Loss on sale of building.

Question 42

The rule for project acceptance under the internal rate of return method is that:

A) IRR should be greater than zero.
B) IRR should be less than zero.
C) IRR should be greater than the hurdle rate.
D) IRR should be less than the hurdle rate.
E) IRR should equal the hurdle rate.

Question 43

Consider the following statements about the total-cost and the incremental-cost approaches of investment evaluation:
I) Both approaches will yield the same conclusions.
II) Choosing between these approaches is a matter of personal preference.
III) The incremental approach focuses on cost differences between alternatives.
Which of the above statements is (are) true?

A) I only.
B) II only.
C) III only.
D) II and III.
E) I, II, and III.

Question 44

Of the five expenses that follow, which one is most likely treated differently than the others when income taxes are considered in a discounted-cash-flow analysis?

A) Salaries expense.
B) Advertising expense.
C) Depreciation expense.
D) Utilities expense.
E) Office expense.

Question 45

The net-present-value method assumes that project funds are reinvested at the:

A) hurdle rate.
B) rate of return earned on the project.
C) cost of debt capital.
D) cost of equity capital.
E) internal rate of return.

Question 46

When a company is analyzing a capital project by a discounted-cash-flow approach and income taxes are being considered, depreciation:

A) should be ignored.
B) should be considered because it results in a tax savings.
C) should be considered because it is a fixed cost.
D) should be considered because it is a cash inflow.
E) should be considered because, like other expenses, it is a cash outlay related to operations.

Question 47

When income taxes are considered in capital budgeting, the cash flows related to a company's advertising expense would be correctly figured by taking the cash paid for advertising and:

A) adding the result of multiplying (advertising expense * tax rate).
B) adding the tax rate.
C) adding the result of multiplying [advertising expense *(1 ‒ tax rate)].
D) subtracting the result of multiplying (advertising expense * tax rate).
E) subtracting the result of multiplying [advertising expense * (1 ‒ tax rate)].

Question 48

The systematic follow-up on a capital project to see how the project actually turns out is commonly known as:

A) capital budgeting assessment (CBA).
B) a postaudit.
C) control of capital expenditures (CCE).
D) overall cost performance.
E) the cost evaluation phase.

Question 49

Coulter Company is studying a capital project that will produce $600,000 of added sales revenue, $400,000 of additional cash operating expenses, and $50,000 of depreciation. Assuming a 30% income tax rate, the company's after-tax cash inflow (outflow) is:

A) $105,000.
B) $125,000.
C) $155,000.
D) $175,000.
E) None of the answers is correct.

Question 50

When income taxes are considered in capital budgeting, the cash flows related to a company's depreciation expense would be correctly figured by taking the cash paid for depreciation and:

A) adding the result of multiplying (depreciation expense * tax rate).
B) adding the result of multiplying [depreciation expense * (1 ‒ tax rate)].
C) subtracting the result of multiplying (depreciation expense * tax rate).
D) subtracting the result of multiplying [depreciation expense * (1 ‒ tax rate)].
E) None of the answers, because there is no cash paid for depreciation.

Question 51

A company's cash flows for income taxes are normally affected by:

A) revenues.
B) operating expenses.
C) gains on the sale of assets.
D) losses on the sale of assets.
E) All of the answers are correct.

Question 52

Consider the following statements about capital budgeting postaudits:
I) Postaudits can be used to detect desirable projects that were rejected.
II) Postaudits can be used to detect undesirable projects that were accepted.
III) Postaudits may reveal shortcomings in cash-flow projections, providing insights that allow a company to improve future predictions.
Which of the above statements is (are) correct?

A) I only.
B) II only.
C) III only.
D) II and III.
E) I, II, and III.

Question 53

Jenkins plans to generate $650,000 of sales revenue if a capital project is implemented. Assuming a 30% tax rate, the sales revenue should be reflected in the analysis by a:

A) $195,000 inflow.
B) $195,000 outflow.
C) $455,000 inflow.
D) $455,000 outflow.
E) $650,000 inflow.

Question 54

Higgins Company plans to incur $350,000 of salaries expense if a capital project is implemented. Assuming a 30% tax rate, the salaries should be reflected in the analysis by a:

A) $105,000 inflow.
B) $105,000 outflow.
C) $245,000 inflow.
D) $245,000 outflow.
E) $350,000 outflow.

Question 55

Hampton Company plans to incur $230,000 of additional cash operating expenses and produce $410,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

A) a $57,000 inflow.
B) a $57,000 outflow.
C) a $126,000 outflow.
D) a $126,000 inflow.
E) a $161,000 outflow.

Question 56

Consider the following statements about taxes and after-tax cash flows:
I) Capital budgeting analyses should incorporate after-tax cash flows rather than before-tax cash flows.
II) Added company revenues will result in lower taxes for a firm.
III) Operating expenses may actually provide a tax benefit for an organization.
Which of the above statements is (are) correct?

A) I only.
B) II only.
C) III only.
D) I and II.
E) I and III.

Question 57

The rule for project acceptance under the net-present-value method is that:

A) NPV should be greater than zero.
B) NPV should be less than zero.
C) NPV should equal zero.
D) NPV should be less than the hurdle rate.
E) NPV should equal the hurdle rate.

Question 58

Bowers Company plans to incur $190,000 of salaries expense and produce $320,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

A) a $39,000 inflow.
B) a $39,000 outflow.
C) a $91,000 inflow.
D) a $91,000 outflow.
E) None of the answers is correct.

Question 59

Pizza Company has $70,000 of depreciation expense and is subject to a 30% income tax rate. On an after-tax basis, depreciation results in a:

A) $21,000 inflow.
B) $21,000 outflow.
C) $49,000 inflow.
D) $49,000 outflow.
E) neither an inflow nor an outflow because depreciation is a noncash expense.

Question 60

The internal-rate-of-return method assumes that project funds are reinvested at the:

A) hurdle rate.
B) rate of return earned on the project.
C) cost of debt capital.
D) cost of equity capital.
E) rate of earnings growth (REG).

Question 61

Consider the following statements about depreciation tax shields:
I) A depreciation tax shield provides distinct benefits to a business.
II) A depreciation tax shield should be ignored when doing a net-present-value analysis.
III) A depreciation tax shield can occur in more than one year.
Which of the above statements is (are) correct?

A) I only.
B) II only.
C) III only.
D) I and II.
E) I and III.

Question 62

Consider the following statements about the investment in working capital in a capital budgeting analysis:
I) Working capital often increases as the result of higher balances in accounts receivable or inventory necessary to support a project.
II) Working capital increases are sources of cash and should be included in a discounted-cash-flow analysis.
III) The time 0 cash investment in working capital is included in a discounted-cash-flow analysis as a cash outflow.
Which of the above statements is (are) correct?

A) I only.
B) II only.
C) III only.
D) I and II.
E) I and III.

Question 63

Workman Company is considering a five-year project that requires a typical investment in working capital, in this case, $100,000. Consider the following statements about this situation:
I) Workman should include a $100,000 outflow that occurs at time 0 in a discounted-cash-flow analysis.
II) Workman should include separate $100,000 outflows in each year of the project's five-year life.
III) Workman should include a $100,000 recovery of its working-capital investment in year 5 of a discounted-cash-flow analysis.
Which of the above statements is (are) correct?

A) I only.
B) II only.
C) III only.
D) I and II.
E) I and III.

Question 64

A depreciation tax shield is a(n):

A) after-tax cash outflow.
B) increase in income tax.
C) factor that has no effect on cash flows.
D) reduction in income tax.
E) sporadic fluctuation in income tax.

Question 65

The Modified Accelerated Cost Recovery System (MACRS) assumes that, on average, assets will be placed in service:

A) at the beginning of the tax year.
B) three months into the tax year.
C) halfway through the tax year.
D) at the end of the tax year.
E) in the next tax year.

Question 66

In 10 years, Hopkins Company plans to receive $9,000 cash from the sale of a machine that has a $5,000 book value.

If the firm is subject to a 30% income tax rate and has an 8% after-tax hurdle rate, the correct discounted net cash flow would be:

A) $2,916.90.
B) $3,611.40.
C) $4,167.00.
D) $4,722.60.
E) None of the other answers is correct.

Question 67

Which of the following is the proper calculation of a company's depreciation tax shield?

A) Depreciation / tax rate.
B) Depreciation / (1 - tax rate).
C) Depreciation * tax rate.
D) Depreciation * (1 - tax rate).
E) Depreciation deduction + income taxes.

Question 68

A machine was sold in December 20x3 for $9,000. It was purchased in January 20x1 for $15,000, and depreciation of $12,000 was recorded from the date of purchase through the date of disposal. Assuming a 40% income tax rate, the after-tax cash inflow at the time of sale is:

A) $3,600.
B) $6,600.
C) $8,400.
D) $9,000.
E) $11,400.

Question 69

A new machine is expected to produce a MACRS deduction in three years of $50,000.

If the company has a 12% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow to include in an acquisition analysis would be:

A) $0.
B) $10,680.
C) $24,920.
D) $46,280.
E) None of the other answers is correct.

Question 70

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation and changes to the Modified Accelerated Cost Recovery System (MACRS), the investment's net present value will:

A) increase.
B) remain the same.
C) decrease.
D) change, but the direction cannot be determined based on the data presented.
E) fluctuate in an erratic manner.

Question 71

If a company desires to be in compliance with current income tax law and write off the cost of its assets rapidly, the firm would use:

A) straight-line depreciation.
B) sum-of-the-years'-digits depreciation.
C) accelerated depreciation.
D) the Modified Accelerated Cost Recovery System (MACRS).
E) annuity depreciation.

Question 72

Use the following information to answer the following Questions
Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate.

-The net after-tax cash flow of the disposal is:

A) $2,100.
B) $2,350.
C) $2,500.
D) $2,650.
E) None of the answers is correct.

Question 73

In eight years, Shu Company plans to receive $11,000 cash from the sale of a machine that has a $16,000 book value.

If the firm is subject to a 30% income tax rate and has a 12% after-tax hurdle rate, the correct discounted net cash flow would be:

A) $606.
B) $1,414.
C) $3,838.
D) $5,050.
E) None of the answers is correct.

Question 74

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used Modified Accelerated Cost Recovery System (MACRS) and changes to the straight-line depreciation, the investment's net present value will:

A) increase.
B) remain the same.
C) decrease.
D) change, but the direction cannot be determined based on the data presented.
E) fluctuate in an erratic manner.

Question 75

Young Company received $18,000 cash from the sale of a machine that had a $13,000 book value. If the company is subject to a 30% income tax rate, the net cash flow to use in a discounted-cash-flow analysis would be:

A) $3,500.
B) $6,500.
C) $12,600.
D) $16,500.
E) $19,500.

Question 76

Donata Company purchased equipment for $30,000 in December 20x1. The equipment is expected to generate $10,000 per year of additional revenue and incur $2,000 per year of additional cash expenses, beginning in 20x2. Under MACRS, depreciation in 20x2 will be $3,000. If the firm's income tax rate is 40%, the after-tax cash flow in 20x2 would be:

A) $3,200.
B) $3,600.
C) $4,800.
D) $6,000.
E) None of the answers is correct.

Question 77

Julio Company purchased a $200,000 machine that has a four-year life and no salvage value. The company uses straight-line depreciation on all asset acquisitions and is subject to a 30% tax rate. The proper cash flow to show in a discounted-cash-flow analysis as occurring at time 0 would be:

A) $(200,000).
B) $(140,000).
C) $(35,000).
D) $15,000.
E) $50,000.

Question 78

A machine is expected to produce annual savings in cash operating costs of $400,000 for the next six years.

If the company has a 10% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow would be:

A) $522,600.
B) $947,520.
C) $1,219,400.
D) $1,742,000.
E) None of the answers is correct.

Question 79

A company that uses accelerated depreciation:

A) would write off a larger portion of an asset's cost sooner than under the straight-line method.
B) would find that depreciation speeds up, with a small portion taken in early years and larger amounts taken in later years.
C) would find that more tax benefits occur earlier than under the straight-line method.
D) would find itself out of compliance with generally accepted accounting principles (GAAP).
E) would both write off a larger portion of an asset's cost sooner than under the straight-line method and find that more tax benefits occur earlier than under the straight-line method.

Question 80

Use the following information to answer the following Questions
Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate.

-The loss on disposal would be:

A) $350.
B) $500.
C) $650.
D) $2,500.
E) None, because the transaction produced a gain.