Question 1

An internal rate of return greater than the cost of capital, guarantees that the firm earns at least its required return. Such an outcome should enhance the market value of the firm and therefore the wealth of its owners.

Accepted Answer

This statement is true because if the internal rate of return is greater than the cost of capital, it means that the firm's investments are generating more returns than the cost of capital, which is the minimum required return. This would increase the firm's profitability and market value, leading to an increase in the wealth of its owners.

Question 2

Opportunity costs should be included as cash outflows when determining a project's incremental cash flows.

Accepted Answer

Opportunity costs are the potential benefits that are lost when choosing one alternative over another. Since these benefits represent a cash outflow, they should be included in the calculation of incremental cash flows when evaluating a project's financial viability. Failure to factor in opportunity costs could result in underestimating the true cost of a project and lead to incorrect investment decisions.

Question 3

If a firm moves into a higher tax bracket, the firm's CCA tax shields become less valuable than previously, all else equal.

Accepted Answer

When a firm moves into a higher tax bracket, the value of its CCA (Capital Cost Allowance) tax shields actually increases because the tax savings from the deductions are greater at higher tax rates.

Question 4

If net present value of a project is greater than zero, the firm will earn a return greater than its costof capital. Such a project should enhance the wealth of the firm's owners.

Accepted Answer

A positive net present value indicates that the project's expected cash inflows exceed its expected cash outflows, which means that the project generates more cash than it costs. This implies that the project will earn a return greater than the cost of capital, and will enhance the wealth of the firm's owners.

Question 5

Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

Accepted Answer

Mutually exclusive projects are those where the acceptance of one project eliminates the others from consideration because they serve the same purpose and only one can be chosen.

Question 6

The basic cash flows that must be considered when determining the initial investment associated with a capital expenditure are the installed cost of the new asset, the after-tax proceeds (if any) from the sale of an old asset, and the change (if any) in net working capital.

Accepted Answer

These are the three main cash flows that should be considered when calculating the initial investment of a capital expenditure.

Question 7

The discount rate, required return, cost of capital, or opportunity cost is the minimum return that must be earned on a project to leave the firm's market value unchanged.

Accepted Answer

The discount rate is the minimum return required to leave the firm's market value unchanged.

Question 8

Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

Accepted Answer

This statement is true. NPV assumes that intermediate cash flows are reinvested at the cost of capital, while IRR assumes that they can be reinvested at the same IRR as the project.

Question 9

The depreciable value of an asset is equal to its purchase price minus installation costs, if any.

Accepted Answer

The depreciable value of an asset is typically calculated as the purchase price plus installation costs, minus any salvage value.

Question 10

Capital budgeting technique is used to evaluate the firm's fixed asset investments which provide the basis for the firm's earning power and value.

Accepted Answer

This statement is true. Capital budgeting techniques are used to evaluate proposed projects and determine if they are viable investments for a company. Fixed assets are long-term assets that contribute to a company's earning power and value, so it is important for companies to carefully evaluate potential investments in these assets using capital budgeting techniques.

Question 11

A $60,000 outlay for a new machine with a usable life of 15 years is an operating expenditure thatwould appear as a fixed asset on the firm's balance sheet.

Accepted Answer

A $60,000 outlay for a new machine is a capital expenditure, not an operating expenditure, and it would appear as a fixed asset on the firm's balance sheet.

Question 12

For conventional projects, both NPV and IRR techniques will always generate the sameaccept-reject decision, but differences in their underlying assumptions can cause them to rank projects differently.

Accepted Answer

The NPV and IRR methods can lead to the same accept-reject decision for conventional projects, but differences in cash flow timing and reinvestment rate assumptions can cause them to rank projects differently.

Question 13

A non-conventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows.

Accepted Answer

The answer of A non-conventional cash flow pattern associated with...

Question 14

If a firm has unlimited funds to invest, all the independent projects that meet its minimum investment criteria can be implemented.

Accepted Answer

If a firm has unlimited funds to invest, it can invest in all the independent projects that meet its minimum investment criteria as there is no constraint on the availability of funds.

Question 15

In capital budgeting, the preferred approaches in assessing whether a project is acceptable, or to rank projects, are those that integrate time-value procedure, risk, return, valuation concept, and the cost of capital.

Accepted Answer

The integration of time-value procedure, risk, return, valuation concept, and cost of capital is important to properly evaluate and rank capital projects. Ignoring any of these factors can result in incorrect decisions and outcomes. Therefore, it is true that these are the preferred approaches in assessing capital projects.

Question 16

The CCA rate for automobiles is higher than the CCA rate for brick buildings.

Accepted Answer

This is because automobiles have a shorter useful life than brick buildings, and therefore require a higher CCA rate for depreciation.

Question 17

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a decision criterion or as a supplement to sophisticated decision techniques.

Accepted Answer

This statement is true. The payback period is often used as a measure of risk because it indicates how quickly the initial investment in a project will be recovered. Many firms use it as a decision criterion or as a supplement to other more sophisticated decision techniques.

Question 18

Conflicting rankings using NPV and IRR result from differences in the magnitude and timing of cash flows.

Accepted Answer

Conflicting rankings using NPV and IRR can occur when there are differences in the timing and magnitude of cash flows, leading to different results. NPV discounts cash flows back to the present using a predetermined interest rate, while IRR determines the interest rate at which the NPV equals zero. Therefore, different cash flow patterns can lead to different rankings in terms of project profitability.

Question 19

If an asset is depreciable and used in business, any loss on sale of the asset is deductible onlyagainst capital gains.

Accepted Answer

A loss on the sale of a depreciable business asset is generally deductible as an ordinary loss, not just against capital gains.

Question 20

In evaluating a proposed project, since our concern is only with how much more or less operating cash will flow into the firm as a result of the proposed project, incremental operating cash inflows are the relevant cash flows.

Accepted Answer

Incremental operating cash inflows are the relevant cash flows because they reflect the additional cash flows generated by the proposed project, and are therefore the most important factor in evaluating the project's potential profitability. Other types of cash flows, such as sunk costs or overhead expenses, are less relevant to this analysis.

Quiz 12: Capital Budgeting: Principles and Techniques