Deck 12: The Capital Budgeting Decision

Question 1

Depreciation is important in calculating projected cash flows because it generates a tax deduction.

Answer 1

True

Question 2

To find the exact internal rate of return for projects with uneven cash flows, we can interpolate between two present value annuity factors from Appendix
D.

Answer 2

False

Question 3

The net present value profile's primary advantage over the internal rate of return method is that it does not require the time consuming trial and error calculations of the IRR.

Answer 3

False

Question 4

A good capital budgeting program requires that a number of steps be taken in the decision making process. The first step is the explanation of data.

Question 5

The first administrative consideration in any capital budgeting process is collection of data.

Question 6

The payback method considers all cash inflows.

Question 7

Using the payback method can be appropriate when the time value of money is very low.

Question 8

A rapid payback may be important to firms having rapid technological development.

Question 9

With non-mutually exclusive events and no capital rationing, we will usually arrive at the same conclusions using either the net present value or internal rate of return methods.

Question 10

The payback method is Basic to understand and places a heavy emphasis on liquidity.

Question 11

It is not unusual for a corporate president, who deals with security analysts, to be as sensitive to after-tax income as to cash flow.

Question 12

In most capital budgeting decisions the emphasis should be on reported earnings rather than cash flows.

Question 13

Capital budgeting decisions involve a minimum time horizon of five years.

Question 14

Possibly the most overlooked part of the capital budgeting process is the search for new opportunities through innovation and creative thinking.

Question 15

Even though one project may have superior cash flows, top management may sometimes choose a project that inflates earnings instead of cash flow.

Question 16

Capital budgeting is only a concern of finance and accounting personnel.

Question 17

The internal rate of return is the interest rate that equates the cash outflows of an investment with the subsequent inflows.

Question 18

Non-mutually exclusive alternatives can be accepted at the same time.

Question 19

We add depreciation to net income to arrive at a true earnings picture.

Question 20

The payback method is not really a theoretically correct approach.

Question 21

The net present value profile examines the relationship of the discount rate to the net present value.

Question 22

The net present value profile allows a firm to examine the project's net present value over time.

Question 23

The base for depreciation expense calculations is equal to the cost of a new asset.

Question 24

Under the net present value method, cash flows are assumed to be reinvested at the firm's weighted average cost of capital.

Question 25

The net present value profile's weakness is that it does not provide a decision for mutually exclusive investments.

Question 26

Under MACRS depreciation, there are no tax credits for the purpose of calculating the base for depreciation expenses.

Question 27

Under MACRS depreciation, the tax life of an asset and its economically useful life are assumed to be the same.

Question 28

Under MACRS depreciation, taxes paid in the first year of an asset's life are subtracted from the base used to calculate depreciation expense.

Question 29

The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected.

Question 30

Although firms can elect to use straight-line depreciation, the MACRS depreciation schedules have superseded other depreciation methods for tax purposes.

Question 31

It is the difference in the reinvestment assumptions that can be significant in determining when to use the net present value or internal rate of return methods.

Question 32

Most real estate property is depreciated over a 10 year period.

Question 33

Under the modified accelerated-cost-recovery system of depreciation, cash flow tends to decline with the passage of time.

Question 34

Under capital rationing, a firm will maximize profitability.

Question 35

The profitability index is calculated by dividing the project's net present value by the present value of the projected cash outflows.

Question 36

The modified internal rate of return assumes that inflows are reinvested at 80 percent of the internal rate of return.

Question 37

In most cases, asset lives are shorter under MACRS depreciation than they would be with straight-line depreciation.

Question 38

For high-IRR investments, it is perfectly acceptable to assume that reinvestment will occur at an equally high, if not higher, rate.

Question 39

When using accelerated depreciation, the present value of future cash flows increases.

Question 40

For a small business, it is possible for the purchase price of an asset to be expensed rather than depreciated.

Question 41

The payback method has several disadvantages, among them:

A) payback fails to choose the optimum or most economic solution to a capital budgeting problem.
B) payback ignores cash inflows after the payback period.
C) a and b.
D) none of these.

Question 42

Cash flow can be said to equal

A) operating income less taxes plus depreciation.
B) operating income less taxes.
C) operating income before depreciation and taxes plus depreciation.
D) operating income after taxes minus depreciation.

Question 43

Which of the following statements about the "payback method" is true?

A) The payback method considers cash flows after the payback has been reached.
B) The payback method does not consider the time value of money.
C) The payback method uses discounted cash-flow techniques.
D) The payback method generally leads to the same decision as other investment selection methods.

Question 44

The reason cash flow is used in capital budgeting is because

A) cash rather than income is used to purchase new machines.
B) cash outlays need to be evaluated in terms of the present value of the resultant cash inflows.
C) to ignore the tax shield provided from depreciation ignores the cash flow provided by the machine which should be reinvested to replace old worn out machines.
D) all of these.

Question 45

In a replacement decision, a book loss on an old asset can be a valuable feature.

Question 46

Cash flow is used for a net present value analysis and earnings are used for an IRR and payback analysis.

Question 47

The first step in the capital budgeting process is

A) collection of data.
B) idea development.
C) assign probabilities.
D) determine cashflow.

Question 48

The dollar amount of losses incurred when an old asset is sold below book value is added to the purchase price of a new asset in calculating the base for depreciation.

Question 49

The reinvestment assumption is a downside of the IRR method of analysis because it assumes that cash flows are reinvested at the cost of capital.

Question 50

Investors discount the later years of a long-term project at a lower rate because they are generally less precise.

Question 51

There are several disadvantages to the payback method, among them:

A) payback ignores the time value of money.
B) payback emphasizes receiving money back as fast as possible for reinvestment.
C) payback is Basic to use and to understand.
D) payback can be used in conjunction with time adjusted methods of evaluation.

Question 52

It is more likely for financial managers to focus on cash flow and corporate executives to focus on earnings of the company.

Question 53

Assume a corporation has earnings before depreciation and taxes of $82,000, depreciation of $45,000, and that it has a 30 percent tax bracket. What are the after-tax cash flows for the company?

A) $70,900
B) $82,000
C) $42,000
D) None of these

Question 54

A tax loss on the sale of a depreciable asset used in business or trade may be written off against income.

Question 55

If an asset is sold for a price above its book value, the difference is considered taxable income to the firm.

Question 56

Capital rationing is generally a positive action for a firm because it prevents rapid growth which can drive up the cost of capital.

Question 57

Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and that the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project?

A) $18,000
B) $19,000
C) A loss of $21,000
D) None of these

Question 58

Which of the following is not a time-adjusted method for ranking investment proposals?

A) Net present value method
B) Payback method
C) Internal rate of return method
D) All of these are time-adjusted methods

Question 59

When NPV and IRR analysis provide inconsistent rankings of projects, the financial manager should generally select the project with the highest IRR.

Question 60

Capital budgeting is primarily concerned with

A) capital formation in the economy.
B) planning future financing needs.
C) evaluating investment alternatives.
D) minimizing the cost of capital.

Question 61

The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method

A) assumes that cash flows are reinvested at the project's internal rate of return.
B) concentrates on the liquidity aspects of investment projects.
C) assumes that cash flows are reinvested at the firm's weighted average cost of capital.
D) none of these.

Question 62

As the cost of capital increases

A) fewer projects are accepted.
B) more projects are accepted.
C) project selection remains unchanged.
D) None of these.

Question 63

You require an IRR of 14% to accept a project. If the project will yield $10,000 per year for 10 years, what is the maximum amount that you would be willing to invest in the project?

A) Less than $50,000
B) More than $50,000 and less than $60,000
C) More than $60,000 and less than $70,000
D) More than $70,000

Question 64

The internal rate of return and net present value methods:

A) always give the same investment decision answer.
B) never give the same investment decision answer.
C) usually give the same investment decision answer.
D) always give answers different from the payback method.

Question 65

If an investment project has a positive net present value, then the internal rate of return is

A) less than the cost of capital.
B) greater than the cost of capital.
C) equal to the cost of capital.
D) indeterminate; it depends on the length of the project.

Question 66

Assume a $6,500 investment and the following cash flows for two alternatives. Under the payback method, which of the following would be concluded?

A) Investment X should be selected
B) Investment Y should be selected
C) Investment X and Y provide the same payback period
D) Neither investment is acceptable under the payback method

Question 67

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

A) cost of capital.
B) yield on the investment.
C) minimal acceptable rate to the corporation.
D) yield to maturity.

Question 68

Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not mutually exclusive, the firm should accept all investment proposals

A) for which it can obtain financing.
B) that have a positive net present value.
C) that have positive cash flows.
D) that provide returns greater than the after-tax cost of debt.

Question 69

Stone Inc. is evaluating a project with an initial cost of $9,500. Cash inflows are expected to be $1,500, $1,500 and $10,000 in the three years over which the project will produce cash flows. If the discount rate is 9%, what is the net present value of the project?

A) Less than $0
B) Between $0 and $400
C) Between $400 and $800
D) More than $800

Question 70

If projects are mutually exclusive

A) they can only be accepted under capital rationing.
B) the selection of one alternative precludes the selection of other alternatives.
C) the payback method should be used.
D) the net present-value should be used.

Question 71

The longer the life of an investment

A) the more significant the discount rate.
B) the less significant the discount rate.
C) Makes no difference.
D) None of these.

Question 72

In using the internal rate of return method, it is assumed that cash flows can be reinvested at

A) the cost of equity.
B) the cost of capital.
C) the internal rate of return.
D) the prevailing interest rate.

Question 73

A characteristic of capital budgeting is

A) a large amount of money is always involved.
B) the internal rate of return must be less than the cost of capital.
C) the internal rate of return must be greater than the cost of capital.
D) the time horizon is at least five years.

Question 74

The _________ assumes returns are reinvested at the cost of capital.

A) payback method
B) internal rate of return
C) net present value
D) capital rationing

Question 75

A project requires an investment of $2,500 and has a net present value of $430. If the IRR is 10%, what is the profitability index for the project?

A) 0.25
B) 2.33
C) 0.70
D) 1.17

Question 76

For acceptable investments, the reinvestment assumption under the internal rate of return is generally

A) higher than under the net present-value method.
B) lower than under the net present-value method.
C) at the cost of capital.
D) below the cost of capital.

Question 77

The Dammon Corp. has the following investment opportunities: Under the payback method and assuming these machines are mutually exclusive, which machine(s) would Dammon Corp. choose?

A) Machine A
B) Machine B
C) Machine C
D) Machine A and B

Question 78

Suppose that interest rates (and, therefore, the firm's Weighted Average Cost of Capital) increase. This WOULD NOT CHANGE the capital budgeting choices a firm would make if it

A) uses payback period analysis.
B) uses net present value analysis.
C) uses internal rate of return analysis.
D) uses profitability indexes.

Question 79

With non-mutually exclusive projects.

A) the payback method will select the best project.
B) the net present value is not acceptable.
C) the internal rate of return method will always select the best project.
D) the net present value and the internal rate of return methods will accept or reject the same project.

Question 80

You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000 per year for 10 years. What is the internal rate of return?

A) 5%
B) 6%
C) 7%
D) More than 7%