Deck 4: Capital Budgeting and Business Valuation

Question 1

A problem associated with the payback method is:

A) it doesn't include cash flows after the payback period.
B) it uses the time value of money concept.
C) it assumes that all cash flows are invested at the cost of capital.
D) it usually requires less time than that required by the net present value method.

Answer 1

it doesn't include cash flows after the payback period.

Question 2

Calculate the payback period for the following investment: A machine costs $100,000 with installation costs of $15,000. Cash inflows are expected to be 26,000 per year for the next seven years.

A) 3.85 years
B) 4.42 years
C) 5 years
D) greater than 5

Answer 2

4.42 years

Question 3

Given the following information, calculate the net present value: Initial outlay is $50,000; required rate of return is 10%; current prime rate is 12%; and cash inflows for the next 4 years are $60,000, $30,000, $40,000, and $50,000.

A) less than 0
B) equal to 0
C) $93,542
D) $87,734

Answer 3

$93,542

Question 4

An acceptable net present value has a value:

A) equal to the IRR
B) = or > 0
C) = or <0
D) <0

Question 5

The internal rate of return is best described as that discount rate which:

A) equates the NPV and IRR.
B) equates all cash flows to the current market rate.
C) equals the required rate of return.
D) makes the NPV equal zero.

Question 6

Calculate the IRR for the following investment project: Initial investment is $75,000; inflows are $20,000 for the next five years;Required rate of return is 15%. (Round your answer to the nearest whole percentage)

A) 14%
B) >15%
C) 9%
D) 10%

Question 7

If the NPV of a project is $500 and the required rate of return is 8%, the IRR must be: 8

A) <8%
B) >$500
C) >8%
D) =8%

Question 8

Given the following information, calculate NPV: Initial investment is $50,000; inflows for the next four years are $12,000, $4,000, $12,000, $13,000; required rate of return is 8%.

A) $83,622
B) - $16,378
C) - $10,427
D) $0

Question 9

The project selection method most consistent with the goal of shareholder maximization is:

A) IRR.
B) NPV.
C) payback method.
D) both IRR and NPV.

Question 10

The relationship between NPV of a project and the required rate of return is:

A) determined by the relationship of NPV to IRR.
B) positive.
C) negative.
D) random.

Question 11

The NPV profile:

A) shows relationship between NPV and IRR.
B) shows how NPV changes for different cash flows.
C) is used to rank mutually exclusive projects.
D) shows a graph of a project's NPV given different discount rates.

Question 12

A project is accepted if its IRR is:

A) greater than the NPV.
B) less than or equal to the hurdle rate.
C) equal to or greater than the hurdle rate.
D) equal to the PV.

Question 13

The IRR is the point on the NPV profile where:

A) the NPV is equal or greater than 0.
B) the NPV equals 0.
C) the cost of capital is equal to the IRR.
D) the cost of capital equals the hurdle rate.

Question 14

Find the IRR for the following project: Outflow is $200,000; required rate of return is 18%; inflows are $50,000, $70,000, $80,000, and $100,000 respectively at the end of each year for the next four years.

A) 13.7%
B) 16.4%
C) 12%
D) 30%

Question 15

In cases of conflict among mutually exclusive projects, the one with highest:

A) IRR should be chosen.
B) with mutually exclusive projects, NPV = IRR so the highest of either is appropriate.
C) NPV should be chosen.
D) cost of capital should be chosen.

Question 16

For a high risk project, the analyst:

A) adjusts the discount rate upward for risk in the NPV form.
B) always rejects the project.
C) adjusts the discount rate upward for risk in the IRR form.
D) uses a risk- free rate of interest .

Question 17

Given the following information, calculate the NPV: Purchase price is $150,000, setup is $15,000; cash flows will be $15,000, $20,000, ($10,000), $30,000, and $50,000 respectively at the end of each year for the next five years. The required rate of return is 9%.

A) ($88,377)
B) $10,000
C) ($76,442)
D) ($72,934)

Question 18

Given the following information, calculate the IRR: Initial outflow is $20,000, cash inflows for the next six years are $8,000 per year. (Round your answer to the nearest whole percentage)

A) 30%
B) 16%
C) 25%
D) 33%

Question 19

Given the following information, calculate the payback period. Initial outflow is $20,000, cash inflows for the next six years are $8,000 per year.

A) 4 years
B) 2.5 years
C) 5 years
D) 6 years

Question 20

The expected return of a current portfolios is 10%. A new project addition is being considered. The new project would comprise 40% of the entire new portfolio. The expected return of the new project is 11%. Calculate the expected return of the entire new portfolio.

A) 10.4%
B) 11%
C) 10.8%
D) 10%

Question 21

Incremental cash flow can best be described as:

A) cash flows that will occur only if an investment is undertaken.
B) relevant cash flows of new projects minus the initial investment.
C) new cash flows plus sunk costs.
D) initial investment of the project.

Question 22

Which of the following is not a major stage in the capital budgeting process?

A) finding projects
B) evaluating and selecting projects
C) estimating the cash flows associated with the project
D) establishing betas for the firm

Question 23

A problem with the NPV method of capital budgeting is:

A) it fails to take into account the time value of money.
B) it can be difficult to explain to non- financial people.
C) you may sometimes have two different values.
D) results are in percentages-not dollars which makes it difficult to understand.

Question 24

The hurdle rate is:

A) the NPV.
B) the number of years required to get the initial investment in the payback period.
C) the IRR.
D) the required rate of return.

Question 25

Use the following information to answer the question below.
A project has an initial cost of $50,000. The incremental inflows associated with the project are $20,000 in year one, $15,000 in years two and three, and $10,000 in year four. The appropriate discount rate for this project is 11%.

-What is the project's payback?

A) 4.0 years
B) 3.5 years
C) 2.5 years
D) 3.0 years

Question 26

Use the following information to answer the question below.
A project has an initial cost of $50,000. The incremental inflows associated with the project are $20,000 in year one, $15,000 in years two and three, and $10,000 in year four. The appropriate discount rate for this project is 11%.

-What is the project's NPV?

A) $10,000
B) $52,252
C) - $2252
D) $2252

Question 27

Use the following information to answer the question below.
A project has an initial cost of $50,000. The incremental inflows associated with the project are $20,000 in year one, $15,000 in years two and three, and $10,000 in year four. The appropriate discount rate for this project is 11%.

-What is the project's IRR?

A) 6.83%
B) 8.63%
C) 11.00%
D) 3.68%

Question 28

Use the following information to answer the question below.
A project has an initial cost of $50,000. The incremental inflows associated with the project are $20,000 in year one, $15,000 in years two and three, and $10,000 in year four. The appropriate discount rate for this project is 11%.

-What is the project's MIRR?

A) 14.43%
B) 8.63%
C) 9.73%
D) 11.00%

Question 29

Use the following information to answer the question below.
A project has an initial cost of $50,000. The incremental inflows associated with the project are $20,000 in year one, $15,000 in years two and three, and $10,000 in year four. The appropriate discount rate for this project is 11%.

-Should the company accept the project?

A) Yes
B) No
C) It depends on macroeconomic factors such as inflation
D) More information is needed

Question 30

Which of the following is a correct capital budgeting decision rule?

A) Accept a project if the hurdle rate is greater than the IRR.
B) Accept a project if the IRR is greater than the hurdle rate.
C) Accept a project if the hurdle rate is greater than the required rate of return.
D) Accept a project if the required rate of return is greater than the hurdle rate.

Question 31

Which of the following is correct?

A) IRR is preferred over NPV when the two methods conflict
B) Payback uses all relevant cash flows in its analysis.
C) Only incremental cash flows are relevant in the capital budgeting decision.
D) Only incremental revenues and costs are relevant in the capital budgeting decision.

Question 32

The following net cash flows are projected for two separate projects. Your required rate of return is 12%.
a. Calculate the payback period for each project.
b. Calculate the NPV of each project.
c. Calculate the IRR of each project.
d. Which project(s) would you accept and why?

Question 33

What is meant by risk adjusted discount rates?

Question 34

Explain why the NPV method of capital budgeting is preferable over the payback method.

Question 35

In cases of ranking conflict among mutually exclusive projects where the NPV and IRR methods give different results, which project should be chosen? Why?

Question 36

Explain what is meant by firm risk in capital budgeting decisions.

Question 37

Calculate the NPV and the IRR for the following project and state whether or not you would accept the new project.

Question 38

If there are multiple IRRs, how will you resolve the conflict?

Question 39

A firm is considering a project with a net present value of zero. Should the project be rejected? Would it be an automatic decision. Explain.

Question 40

You have estimated the IRR for a new project with the following probabilities:
a. Calculate the mean of the project.
b. Calculate the standard deviation of the project.
c. Calculate the coefficient of variation.
d. Calculate the expected IRR of the new portfolio with the new project. The current portfolio has an expected IRR of 9% and a standard deviation of 3% and will represent 60% of the total portfolio.

Question 41

Explain the difference between the accept/reject decision and the ranking decision.

Question 42

Why does capital rationing occur if theory says any project that produces positive net present value should be undertaken?

Question 43

What are some of the problems associated with using the IRR method?

Question 44

Why may the IRR and NPV methods differ in their ranking of two mutually exclusive projects? Assume both projects are acceptable under either method.

Question 45

What is capital rationing? If imposed, what action should financial managers pursue?

Question 46

Your company uses its WACC as its required rate of return. As the financial manager, you are concerned that some of the components of the WACC may be about to increase. Why would you pay special attention to the IRR of a proposed project?

Question 47

What are the stages in the capital budgeting process?

Question 48

Distinguish between independent projects and mutually exclusive projects. Give examples of each.

Question 49

If a new machine requires an increase in current assets from $50,000 to $60,000 and current liabilities from $30,000 to $50,000, the dollar change in net working capital is:

A) zero.
B) negative.
C) undefined.
D) positive.

Question 50

What is the relevant cash flow in year three for the following projected cash flows of a new and an old machine?

A) $125,000
B) $ 55,000
C) $ 25,000
D) $ 50,000

Question 51

What is the relevant initial cash outflow of the following project for capital budgeting analysis purposes?

A) $138,000
B) $128,000
C) $123,000
D) $120,000

Question 52

Which of the following items would not represent an incremental cash flow?

A) shut- down cash flow
B) existing overhead expense
C) initial investment cash flow
D) operating cash flow

Question 53

With respect to changes in net working capital, which of the following could likely happen as sales increase?

A) increase in accounts receivables
B) increases in cash and gross fixed equipment
C) increase in long- term debt
D) decrease in payables

Question 54

What is the relevant initial cash outflow for the following project?

A) $62,000
B) $58,000
C) $60,000
D) $55,000

Question 55

Depreciation associated with a project will:

A) have no effect on incremental cash flows.
B) only affect the fixed asset account as depreciation is a sunk cost.
C) cause incremental operating cash flows to increase.
D) cause incremental operating cash flows to decrease.

Question 56

When an asset is eventually sold for less than its depreciated book value:

A) there are no tax effects.
B) the firm's tax liability is reduced by the amount of the loss times the ordinary income tax rate.
C) there is a capital gain tax.
D) then it is taxed as ordinary income gain.

Question 57

When an asset is sold for less than its acquisition cost but for more than its net book value:

A) the difference between the proceeds of disposition and the asset's net book value is reported on the financial statements as a gain on disposal.
B) the difference between the proceeds of disposition and the asset's net book value will generate a tax saving.
C) the difference between the proceeds of disposition and the asset's net book value will generate capital gains tax.
D) the difference between the proceeds of disposition and the asset's net book value will have no effect on the financial statement as all assets are shown as their historical cost less amortization.

Question 58

The relevant cash flows in capital budgeting can best be described as:

A) after- tax cash flows.
B) changes in fixed asset cash flows.
C) incremental cash flows.
D) externality cash flows.

Question 59

You have purchased a machine for $120,000 and for financial reporting purposes are amortizing it on a straight line basis over four years. At the end of year three you sell it for $10,000. The transaction will show on the financial statements as:

A) a gain on disposal of $10,000
B) a loss on disposal of $110,000
C) a loss on disposal of $20,000
D) a gain on disposal of $20,0000

Question 60

In capital budgeting financing costs associated with incremental cash flows:

A) are not included because they are not relevant cash flows.
B) are factored into the discount rate.
C) need to be included in the discounted cash flows because they will not occur if the project is rejected.
D) lead to distortions in the capital budgeting decision.

Question 61

Use the following information to answer the question below.


-Calculate the amortization related tax savings in year two:

A) $6,000
B) $5,400
C) $8,100
D) $7,200

Question 62

Use the following information to answer the question below.


-What will be the CCA tax savings in year one:

A) $7,500
B) $3,000
C) $1,800
D) $15,000

Question 63

The change in net working capital is measured by the change in:

A) total assets minus total liabilities.
B) (current assets plus fixed assets) minus current liabilities.
C) current assets minus current liabilities.
D) total assets minus (total liabilities plus total equity).

Question 64

An increase in current liabilities that come with the addition of a new project:

A) are not included in capital budgeting analysis because it is not a relevant cash flow.
B) should equal the increase in current assets.
C) should be added to the initial cash outflow.
D) reduce the amount of the initial investment.

Question 65

Which of the following situations would not be considered as an incremental cash flow for a proposed new machine?

A) tax changes
B) prepaid rent expense
C) spare parts inventory
D) opportunity costs

Question 66

Calculate the incremental operating cash flow for year two for a new proposed project given the following information:

A) $50,800
B) $6,300
C) $60,300
D) $104,800

Question 67

An externality can best be described as:

A) something that always represents a negative impact.
B) an example of opportunity costs.
C) an impact, positive or negative, that a new project would have on existing projects.
D) something that should not be considered in the capital budgeting process because it cannot be measured quantifiably.

Question 68

If the last asset in the UCC pool is sold for less than its purchase price but more than its undepreciated capital cost:

A) the asset sale will generate no tax consequences.
B) the difference is taxed as an ordinary loss.
C) the difference is taxed as a capital gain.
D) the difference is taxed at the ordinary income rate.

Question 69

Calculate the incremental operating cash flow for year one for the following information:

A) $1,400,000
B) ($30,000)
C) ($70,000)
D) $1,030,000

Question 70

The present value of the salvage value is:

A) a sunk cost.
B) an opportunity cost.
C) part of the shut- down cash flows.
D) equal to the sale price of a machine at the end of its life.

Question 71

Which of the following is not an example of a sunk cost?

A) a soil sample to determine if the land will support the proposed production facility.
B) a marketing demand study to see if demand exists for the proposed product.
C) an environmental impact study to determine if plant emissions will affect the environment.
D) rent forgone on a vacant building that will be used by the project.

Question 72

Use the following information to answer the question below.
You have been asked by the CEO of Gastric Anxiety Supplier (GAS) to evaluate the proposed acquisition of a new Standardized Test Templater (PowerPoint based) for the firm's accounting area. A recently completed $100,000 marketing survey demonstrates a high demand for the product. The equipment's basic price is $740,000 and it would cost another $220,000 to modify it for high altitude (Wasatch Mountain) use. The templater will be assigned to an asset class with a CCA rate of 60% declining balance. It will be sold after 3 years for $200,000. Use of the equipment would require a one-time increase in net working capital (spare parts inventory) of $75,000. The templater would have no effect on revenues, but it is expected to save the firm $440,000 per year in pre-tax operating costs, mainly labor. The firm's tax rate is 40 percent. Gastric uses a discount rate of 20%.

-What will be the additional (non operating) non operating cash flow in year 3?

A) $200,000
B) $264,000
C) $390,720
D) $275,000

Question 73

Use the following information to answer the question below.
You have been asked by the CEO of Gastric Anxiety Supplier (GAS) to evaluate the proposed acquisition of a new Standardized Test Templater (PowerPoint based) for the firm's accounting area. A recently completed $100,000 marketing survey demonstrates a high demand for the product. The equipment's basic price is $740,000 and it would cost another $220,000 to modify it for high altitude (Wasatch Mountain) use. The templater will be assigned to an asset class with a CCA rate of 60% declining balance. It will be sold after 3 years for $200,000. Use of the equipment would require a one-time increase in net working capital (spare parts inventory) of $75,000. The templater would have no effect on revenues, but it is expected to save the firm $440,000 per year in pre-tax operating costs, mainly labor. The firm's tax rate is 40 percent. Gastric uses a discount rate of 20%.

-What will be the present value of the of the operating cost savings over the life of the project?

A) $556,111
B) $566,200
C) $370,741
D) $926,851

Question 74

Use the following information to answer the question below.
You have been asked by the CEO of Gastric Anxiety Supplier (GAS) to evaluate the proposed acquisition of a new Standardized Test Templater (PowerPoint based) for the firm's accounting area. A recently completed $100,000 marketing survey demonstrates a high demand for the product. The equipment's basic price is $740,000 and it would cost another $220,000 to modify it for high altitude (Wasatch Mountain) use. The templater will be assigned to an asset class with a CCA rate of 60% declining balance. It will be sold after 3 years for $200,000. Use of the equipment would require a one-time increase in net working capital (spare parts inventory) of $75,000. The templater would have no effect on revenues, but it is expected to save the firm $440,000 per year in pre-tax operating costs, mainly labor. The firm's tax rate is 40 percent. Gastric uses a discount rate of 20%.

-What is the net cost of the templater (the year 0 cash flow)?

A) $740,000
B) $1,035,000
C) $960,000
D) $1,135,000

Question 75

Use the following information to answer the question below.
You have been asked by the CEO of Gastric Anxiety Supplier (GAS) to evaluate the proposed acquisition of a new Standardized Test Templater (PowerPoint based) for the firm's accounting area. A recently completed $100,000 marketing survey demonstrates a high demand for the product. The equipment's basic price is $740,000 and it would cost another $220,000 to modify it for high altitude (Wasatch Mountain) use. The templater will be assigned to an asset class with a CCA rate of 60% declining balance. It will be sold after 3 years for $200,000. Use of the equipment would require a one-time increase in net working capital (spare parts inventory) of $75,000. The templater would have no effect on revenues, but it is expected to save the firm $440,000 per year in pre-tax operating costs, mainly labor. The firm's tax rate is 40 percent. Gastric uses a discount rate of 20%.

-What is the net operating cash flows in year 3?

A) $390,720
B) $321,600
C) $566,200
D) $436,800

Question 76

Use the following information to answer the question below.
You have been asked by the CEO of Gastric Anxiety Supplier (GAS) to evaluate the proposed acquisition of a new Standardized Test Templater (PowerPoint based) for the firm's accounting area. A recently completed $100,000 marketing survey demonstrates a high demand for the product. The equipment's basic price is $740,000 and it would cost another $220,000 to modify it for high altitude (Wasatch Mountain) use. The templater will be assigned to an asset class with a CCA rate of 60% declining balance. It will be sold after 3 years for $200,000. Use of the equipment would require a one-time increase in net working capital (spare parts inventory) of $75,000. The templater would have no effect on revenues, but it is expected to save the firm $440,000 per year in pre-tax operating costs, mainly labor. The firm's tax rate is 40 percent. Gastric uses a discount rate of 20%.

-What is the additional (nonoperating) cash flow in year 3?

A) $146,880
B) $275,000
C) $221,880
D) $125,000

Question 77

Explain why sunk costs should not be included in a capital budgeting analysis, but opportunity costs should be included. How do we include these opportunity costs into our analysis?

Question 78

Use the following information to answer the question below.
You have been asked to render an opinion to your boss as to whether your employer should enter into the short-term capital project described below.
The project requires the purchase of a new piece of equipment for a price of $25,000. The firm has paid a consultant $1,000 to estimate the revenues expected from the project. The firm that ships the equipment and installs it in our plant will charge $500.
The project's incremental operating cashflows before taxes will be $15,000 per year for three years. At the end of three years the equipment will be sold for $7344. The equipment will go into an asset class with a CCA rate of 40%. The tax rate is 34% and the firm's required rate of return is 17%. (Note:this is not the only asset in the pool.)
-a. What is the tax basis for the equipment?
b. What are the depreciation deductions for years 1, 2, and 3?
c. Calculate the total operating cash flow for each of the three years.

Question 79

Use the following information to answer the question below.
You have been asked to render an opinion to your boss as to whether your employer should enter into the short-term capital project described below.
The project requires the purchase of a new piece of equipment for a price of $25,000. The firm has paid a consultant $1,000 to estimate the revenues expected from the project. The firm that ships the equipment and installs it in our plant will charge $500.
The project's incremental operating cashflows before taxes will be $15,000 per year for three years. At the end of three years the equipment will be sold for $7344. The equipment will go into an asset class with a CCA rate of 40%. The tax rate is 34% and the firm's required rate of return is 17%. (Note:this is not the only asset in the pool.)
-Based on your net cash flows that you have calculated in the question above, what is the:
a. payback period
b. net present value
c. internal rate of return

Question 80

The Dawn Co. is considering the purchase of new machines in order to expand their business. The machines have a useful life of five years. The required rate of return for the expansion is 17%. The company's tax rate is 40%.

-a. What is the cash outflow at t = 0?
b. What are the deprecation deductions for financial reporting purposes if machines are to be depreciated over 8 years using straight line depreciation?
c. What is the book value of the machines at the end of year five?
d. What is the taxable gain/loss from the sale of the machines at the end of the useful life if they are sold for the estimated salvage value?
e. What is the tax on the sale of the machines at the end of year five ?