Question 1

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
\(\begin{array}{llll}&&\text { Proposal }\
\text { Type of Capital } & 1 & 2 & 3 \
\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\hline
&& \text { Mut Excl } & \text { Mut Excl } \
\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\hline
\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \
\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \
\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\
\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \
\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \
\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \
\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\
\text { Annual net profits before }\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\
\text { Annual net profits before }\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\
\end{array}\)
$\text { "Not applicable }$
-For Proposal 3, the book value (UCC) of the existing asset is__________

Accepted Answer

The book value (UCC) of the existing asset for Proposal 3 is calculated by considering the original cost, the CCA rate, and the number of years the asset has been depreciated. The original cost is $100,000, and it has been depreciated at 20% per year since 2000. By 2004, it has been depreciated for 4 years. The UCC is calculated as $100,000 * (1 - 0.2)^4 = $46,080.

Question 2

The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.

Accepted Answer

The statement is true because the payback period only focuses on the length of time it takes to recover the initial investment without taking into account the time value of money.

Question 3

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.
-The incremental after-tax cash inflow for year 1 is___________

Accepted Answer

The answer of Cuda Marine Engines, Inc. must develop the...

Question 4

In general, projects with similar-sized investments and lower cash inflows in the early years tend to be preferred at higher discount rates.

Accepted Answer

At higher discount rates, projects with larger cash inflows in the early years are generally preferred because the value of money received sooner is not as heavily reduced by the discounting process.

Question 5

The net present value is found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.

Accepted Answer

The net present value (NPV) is found by subtracting a project's initial investment from the present value of its cash inflows discounted at the project's cost of capital or discount rate, not necessarily the internal rate of return (IRR).

Question 6

One basic technique used to evaluate after-tax operating cash flows is to

Accepted Answer

Noncash charges such as depreciation and amortization are added to net income in order to adjust for the fact that they are not actual cash expenses. This yields a more accurate representation of the actual cash generated by the business operations.

Question 7

A firm is evaluating two independent projects utilizing the internal rate of return technique. ProjectX has an initial investment of $80,000 and cash inflows at the end of each of the next five years of$25,000. Project Z has an initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should

Accepted Answer

To evaluate the projects using the internal rate of return technique, we need to find the rate at which the projects' net present value is equal to zero. If the IRR of a project is greater than the cost of capital, the project is acceptable.

For Project X:
Initial investment = $80,000
Cash inflow each year = $25,000
Since the cash inflows occur at equal intervals, this can be treated as an annuity.
Using the formula for the annuity cash inflow, we find that the internal rate of return for Project X is 22.47%.

For Project Z:
Initial investment = $120,000
Cash inflow each year = $40,000
Again, this can be treated as an annuity.
Using the formula for the annuity cash inflow, we find that the internal rate of return for Project Z is 23.80%.

Since both projects have internal rates of return greater than the cost of capital, we should accept both if possible. However, the question limits the acceptance to the maximum cost of capital of 15%.

At a cost of capital of 15%, only Project Z has an IRR greater than the cost of capital. Therefore, we should accept only Project Z.

Question 8

A conventional cash flow pattern associated with capital investment projects consists of an initial

Accepted Answer

A conventional cash flow pattern associated with capital investment projects starts with the initial outflow of the investment and is typically followed by a series of inflows as the project generates revenue or cost savings.

Question 9

The tax treatment regarding the sale of existing assets which are sold for their book value results in

Accepted Answer

When assets are sold for their book value, there is no gain or loss to be recognized, so there is no tax benefit or liability.

Question 10

In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

Accepted Answer

This is the formula for calculating payback period for an annuity.

Question 11

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
\(\begin{array}{llll}&&\text { Proposal }\
\text { Type of Capital } & 1 & 2 & 3 \
\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\hline
&& \text { Mut Excl } & \text { Mut Excl } \
\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\hline
\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \
\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \
\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\
\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \
\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \
\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \
\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\
\text { Annual net profits before }\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\
\text { Annual net profits before }\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\
\end{array}\)
$\text { "Not applicable }$
-For Proposal 3, the initial outlay equals___________

Accepted Answer

The initial outlay for Proposal 3 is calculated as the cost of the new asset ($300,000) plus installation costs ($15,000) minus the sale proceeds of the old asset ($120,000), resulting in $195,000.

Question 12

All benefits expected from a proposed project must be measured on a cash flow basis which may be found by adding any noncash charges deducted as expense on the firm's income statement back to net income.

Accepted Answer

All benefits from a project should be measured on a cash flow basis which involves adding any noncash charges (such as depreciation) back to net income.

Question 13

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
\(\begin{array}{llll}&&\text { Proposal }\
\text { Type of Capital } & 1 & 2 & 3 \
\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\hline
&& \text { Mut Excl } & \text { Mut Excl } \
\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\hline
\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \
\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \
\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\
\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \
\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \
\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \
\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\
\text { Annual net profits before }\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\
\text { Annual net profits before }\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\
\end{array}\)
$\text { "Not applicable }$
-For Proposal 2, the book value (UCC) of the existing asset is____________

Accepted Answer

The answer of Computer Disk Duplicators, Inc. has been considering...

Question 14

Investment tax credits provided by the Canadian government to stimulate economic development in selected regions of the country are relevant cash flows in capital budgeting.

Accepted Answer

Investment tax credits provided by the government can reduce the initial cost of a capital project and therefore impact the cash flows associated with the project. As such, they are relevant cash flows that should be considered in capital budgeting.

Question 15

purchasing a new computer system

Accepted Answer

The statement is incomplete and does not provide enough information to determine its truth value.

Question 16

The tax treatment regarding the sale of existing assets which are depreciable and used in business and are sold for less than the book value results in

Accepted Answer

When depreciable assets used in business are sold for less than their book value, it results in a terminal loss, which can be used to offset other income.

Question 17

Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could actually reinvest intermediate cash inflows, the use of NPV is, in theory, preferable to IRR.

Accepted Answer

NPV takes into account the cost of capital which is a more accurate estimate of the rate at which the firm could reinvest intermediate cash inflows. On the other hand, IRR assumes that the intermediate cash inflows are reinvested at the same rate as the project's overall rate of return, which may not always be realistic. Therefore, in theory, NPV is preferred over IRR.

Question 18

Relevant cash flows for a project are best described as

Accepted Answer

Relevant cash flows refer to the incremental cash flows that are directly related to a particular project and are relevant for making decisions about that project. Sunk cash flows, incidental cash flows, and accounting cash flows are not considered relevant cash flows for a project.

Question 19

___________projects do not compete with each other; the acceptance of one the others fromconsideration.

Accepted Answer

The answer of ___________projects do not compete with each other;...

Question 20

When the net present value is negative, the internal rate of return is___________the cost of capital.

Accepted Answer

If the net present value is negative, it means that the initial investment is greater than the present value of the expected future cash flows. Therefore, the internal rate of return must be less than the cost of capital.

Quiz 12: Capital Budgeting: Principles and Techniques