Deck 9: Capital Budgeting Decisions

Question 1

If your required rate of return is 6%, the present value of $1,000 to be received three years from today is $839.60.

Answer 1

True

Question 2

The net present value method equates cash inflows to revenues, and cash outflows to expenses, as if occurring in the same accounting period.

Answer 2

True

Question 3

The only cash outflow that may exist in a net present value analysis is the initial investment.

Answer 3

False

Question 4

The internal rate of return is the rate of return that management desires to earn on its investments.

Question 5

The future value of all cash inflows minus the cash outflows equals the net present value of the investment.

Question 6

The process of determining present value removes the cost of interest from future cash flows to determine the value of the amount today.

Question 7

If the internal rate of return is greater than the required rate of return, the project should be accepted.

Question 8

The time value of money concept recognizes that a dollar received today is worth more than a dollar received in the future.

Question 9

If the required rate of return is greater than the internal rate of return of a potential investment, the company should deem the investment acceptable.

Question 10

The cost of capital is the weighted average of the costs of debt and equity financing used to generate capital for investments.

Question 11

Present value techniques are developed to equate future dollars to current dollars.

Question 12

In net present value analysis, the purchase of equipment today results in a cash outflow that is not discounted.

Question 13

Soft benefits are those that often have a significant nonfinancial impact on an investment decision and as such, should be included in the decision analysis.

Question 14

Riskier investments demand lower rates of return.

Question 15

In evaluating an investment opportunity, a company must know how much cash it receives from or pays for an investment and the timing of the cash flows because receipts and payments that occur in the future are worth more than those that occur earlier.

Question 16

If the net present value is equal to zero, the project should be accepted.

Question 17

The internal rate of return method ignores the time value of money.

Question 18

If the internal rate of return is used to calculate the net present value of a project, the net present value will be zero.

Question 19

Both the payback period and the net present value methods take into account the timing of future cash flows.

Question 20

One possible capital budgeting decision is the potential acquisition of a patent from a competitor.

Question 21

Present value techniques

A) determine the effects of time value of money on future net income that will be generated.
B) are a way of converting future dollars into their equivalent current dollars.
C) provide more conservative results than similar time value of money computations.
D) treat a dollar received today to be worth the value of a dollar to be received a year from today.

Question 22

When using the NPV function in Microsoft^© Excel, the initial cash flow at time zero is omitted from the range selected for the function.

Question 23

Cash flows used in calculating the net present value need not be adjusted for inflation because the interest rate used to discount the cash flows has already considered inflation.

Question 24

The more risky a potential investment is, the lower the company's required rate of return will be.

Question 25

The basic concept involved in time value of money calculations is that

A) it is better to receive a dollar today than to receive a dollar in the future.
B) incremental revenues must exceed incremental costs.
C) you get what you measure.
D) revenue must be earned in order for net income to be generated

Question 26

A project with positive cash flows will always generate an acceptable accounting rate of return.

Question 27

The internal rate of return method and the payback period method will always give the same decision as to whether to accept a project, if the same inputs are used.

Question 28

When using the internal rate of return function in Microsoft^© Excel to calculate the internal rate of return, the initial cash flow at time zero is omitted from the range selected for the function because it is not discounted.
Material from the appendix to the chapter is marked with an asterisk (*).

Question 29

Capital expenditure decisions

A) are useful for estimating inventory acquisition costs.
B) always involve the acquisition of long-lived assets.
C) consist of a final list of approved projects.
D) All of these answer choices are correct.

Question 30

The net present value method can be used to determine the effect of discontinuing one of a company's products.

Question 31

Depreciation itself is not a cash outflow, though it reduces the amount of income taxes that a company must pay.

Question 32

Which of the following pairs of techniques use the time value of money concept?

A) Payback period method and the internal rate of return method
B) Internal rate of return method and the accounting rate of return method
C) Accounting rate of return method and the payback period method
D) Internal rate of return method and the net present value method

Question 33

The depreciation tax shield is the amount of income taxes that the company avoids as a result of reporting depreciation expense.

Question 34

If an investment project generates tax-deductible expenses, cash inflows from the project will be reduced by the taxes resulting from the increase in income taxes payable.

Question 35

All else being equal, a company prefers projects with long payback periods, as these benefit the company for longer time periods.

Question 36

Which of the following is not considered a capital budgeting project?

A) Purchase of a new packaging machine
B) Purchase of land on which to build a new factory
C) Purchase of a new delivery truck to replace an old truck
D) Purchase of inventory to be sold in the future

Question 37

The payback period method ignores cash flows that occur after the end of the payback period.

Question 38

Which of the following is not a component of a time value of money calculation?

A) The amount of cash to be received
B) The time until the cash will be received
C) The opportunity costs of the alternative actions
D) The required rate of return

Question 39

Neither the accounting rate of return method nor the payback period method consider the timing of all future cash flows related to a potential investment.

Question 40

Managers may be discouraged from using present value techniques for evaluating investments because of the way in which their own performance is evaluated.

Question 41

Projects with a negative net present value will always have a(n)

A) payback period longer than the useful life of the investment.
B) internal rate of return that is less than the required rate of return.
C) accounting rate of return that is negative.
D) series of cash outflows that is greater than the initial cost of the project.

Question 42

To achieve exactly a 13% rate of return, how much would need to be invested today in an investment that returns $12,000 at the end of 3 years and $10,000 at the end of 5 years? Round to the nearest whole number.

A) $8,239
B) $13,745
C) $12,862
D) $60,920

Question 43

An annuity is

A) the time period in which the cash flows paid out for an investment will be recovered.
B) a series of equal payments.
C) necessary in order to calculate the net present value.
D) used to calculate depreciation in order to provide a tax shield.

Question 44

Assuming a 6% rate of return, how does the present value of an amount to be received two years from today compare to the present value of the same amount to be received three years from today?

A) The present value of the amount to be received in two years is greater than the present value of amount to be received three years from today.
B) The present value of the amount to be received in two years is lesser than the present value of amount to be received three years from today.
C) The present values of the two amounts are equal.
D) It is impossible to tell unless the actual amount to be received is known.

Question 45

Santo Automotive is considering producing a new automobile product, No Text, which disengages the ability to text while driving. Marketing data indicate that the company will be able to sell 39,000 units per year at $16 each. The product will be produced in a section of an existing factory that is currently not in use. To produce No Text, Santo must buy a machine that costs $820,000. The machine has an expected life of five years and will have an ending residual value of $50,000. Santo expects to generate net income of $56,000 per year. The income tax rate is 30% and the company's required rate of return is 10%. How much is the net present value?

A) ($23,932)
B) $7,113
C) $52,498
D) None of these answer choices are correct.

Question 46

An investment that costs $50,000 will return $15,000 operating cash flows per year for five years. Determine the net present value of the investment if the required rate of return is 14 percent. Should the investment be undertaken?

A) Yes, the profit is $25,000.
B) No, the accounting return is less than 14%.
C) No, the net present value is negative at $11,045.
D) Yes, the net present value is positive at $1,496.50.

Question 47

In which of the following situations will an annuity table be useful?
I) Calculating the net present value of an investment with equal cash flows for the first nine years, but a different flow in year 10
II) Calculating the internal rate of return of an investment with unequal cash flows each year
III) Calculating the net present value of an investment with an equal cash flow in years one through four, and a different equal cash flow in years 5 through 10

A) I, II, and III
B) II and III
C) I and III
D) I and II

Question 48

The required rate of return used to calculate an investment's net present value is related to the firm's

A) contribution margin.
B) cost of capital.
C) depreciation methods.
D) fixed costs.

Question 49

What is the present value factor for a $4,000 cash outflow that is made today?

A) 0.00
B) Some value greater than 1.00
C) 1.00
D) It depends on the rate of return that is required.

Question 50

Projects with a negative net present value will always have a(n)

A) payback period shorter than the life of the project.
B) accounting rate of return that is greater than zero.
C) an internal rate of return greater than the cost of capital.
D) None of these answer choices are correct.

Question 51

Projects A and B both have an initial outflow of $100,000. Project A will return a cash flow of $30,000 each year for the next 5 years. Project B will return $40,000 in year 1, $30,000 in year 2, $30,000 in year 3, $30,000 in year 4, and $20,000 in year 5. Which project will have the higher net present value?

A) Project A
B) Project B
C) The answer cannot be determined without knowing the required rate of return.
D) The answer cannot be determined without knowing the initial investment.

Question 52

What is the sum of the present values of all cash flows (inflows and outflows) called?

A) Cost of capital
B) Internal rate of return
C) Net present value
D) Required rate of return

Question 53

Which of the following is not one of the steps in the net present value method?

A) Identify the amount and timing of the cash flows.
B) Discount the cash flows.
C) Calculate the number of years required to recover the initial investment.
D) Compare the discounted net cash flows to zero.

Question 54

If a 14% rate of return can be achieved, how much will need to be invested today in order to receive $12,000 at the end of 3 years plus $10,000 at the end of 5 years? Round to the nearest whole number.

A) $33,053
B) $5,194
C) $11,426
D) $13,294

Question 55

Suppose you face the prospect of receiving $800 per year for the next five years and a $200 payment at the end of six years. How much is this prospect worth today if the required rate of return is 9%?

A) $4,200
B) $3,112
C) $3,242
D) $3,231

Question 56

Which of the following would most likely be the present value of a 4-year annuity of $2,000 per year, assuming a positive discount rate?

A) $8,000
B) $7,000
C) $9,500
D) $2,000

Question 57

Your required rate of return is greater than zero. How much is a payment of $3,000 to be received a year from today worth?

A) Less than $3,000 today
B) Exactly $3,000 today
C) More than $3,000 today
D) Not enough information is provided to determine the answer.

Question 58

Santo Automotive is considering producing a new automobile product, No Text, which disengages the ability to text while driving. Marketing data indicate that the company will be able to sell 40,000 units per year at $16 each. The product will be produced in a section of an existing factory that is currently not in use. To produce No Text, Santo must buy a machine that costs $820,000. The machine has an expected life of five years and will have an ending residual value of $50,000. Santo will depreciate the machine over five years using the straight-line method. In addition to the cost of the machine, the company will incur incremental annual manufacturing costs of $390,000. The income tax rate is 30% and the company's required rate of return is 10%. How much is net operating cash flow each year?

A) $67,200
B) $221,200
C) $175,000
D) $250,000

Question 59

If the time value of money techniques are used correctly, the present value of cash flows far in the future will be

A) lesser than the present value of the same amount of cash flows in the present.
B) greater than the present value of the same amount of cash flows in the present.
C) same as the future value of the same amount of cash flows in the present.
D) greater than the future value of the same amount of cash flows in the present.

Question 60

Maude Company's required rate of return on capital budgeting projects is 9%. The company is considering an investment that would yield a cash flow of $12,000 per year for five years. Ignoring taxes, what is the most that the company will be willing to invest in this project?

A) $46,676
B) $38,994
C) $60,000
D) $55,046

Question 61

Which one of the following is a soft benefit?

A) Decreased time to receive and process customers' payments
B) Enhanced reputation of the company
C) Depreciation tax shield
D) Reduction in the number of items spoiled during processing

Question 62

The following data pertain to an investment proposal: $$\begin{array} { l r } \text { Required investment } & \$ 75,000 \\\text { Annual cost savings } & \$ 18,000 \\\text { Projected life of investment } & 8 \text { years } \\\text { Projected salvage value } & \$ 4,000 \\\text { Required rate of return } & 16 \%\end{array}$$ Ignoring income taxes, how much is the net present value of the proposed investment?

A) $13,527
B) $3,185
C) $14,747
D) $4,405

Question 63

The return demanded by shareholders for the risk that they bear in supplying capital to the firm is

A) less for riskier firms.
B) only considered when a corporation has no debt.
C) measured by the internal rate of return.
D) called the cost of equity.

Question 64

What are soft benefits?

A) The reverse side of opportunity costs
B) Benefits those are hard to quantify
C) Projected cash flows that are expected to change
D) Considerations needed when a project has a negative internal rate of return

Question 65

The projected rate of return on a particular project is equal to the hurdle rate. Which statement is true?

A) The payback period will be longer than the period over which the return is expected to occur.
B) The project should be rejected.
C) A lower discount rate should be used.
D) The project should be accepted.

Question 66

Since present value analysis is concerned with cash flows, which of the following is not true?

A) Depreciation is always an incremental cash inflow.
B) Revenues are inflows in the period when the cash is received.
C) Expenses are outflows in the period when they are paid.
D) The salvage value of equipment is considered in the analysis.

Question 67

Which statement(s) is/are true concerning the internal rate of return?
I) It takes into account the time value of money.
II) It is the rate of return that equates the present value of future cash flows to the investment outlay.
A I only
B) II only
C) Neither I nor II
D) Both I and II

Question 68

Natchez, Inc. is considering the purchase of a new machine costing $200,000. The company will incur $5,000 per year in operating expenses but it will allow the company to earn an additional $100,000 per year in revenues. Natchez expects the machine to provide future benefits for 3 years and salvage value at the end of the 3-year period to be $10,000. The company uses straight-line depreciation method. The income tax rate is 30%. If the required rate of return is 10%, how much is the net present value of this project?

A) $20,143
B) $12,629
C) $43,769
D) None of these answer choices are correct.

Question 69

What does the cost of capital represent?

A) The weighted average of fixed and variable costs
B) The weighted average of the incremental cash inflows and outflows
C) The weighted average of debt and equity financing
D) The weighted average of the cost of borrowing on a long and short-term basis

Question 70

A project under consideration currently has a negative net present value of $11,600 using a 6% rate of return and an estimated 4-year life. What must be the minimum present value of the soft benefits of this project in order to make it acceptable? (Round the answer to nearest whole dollar.)

A) $12,296
B) $40,195
C) $9,188
D) $3,348

Question 71

Discount Dollar Store is considering the purchase of a new machine costing $220,000. This machine is estimated to generate an additional $88,000 per year in revenues. The machine will be depreciated using the straight-line method over its 4-year life. There is no expected salvage value at the end of its life. Expected annual net cash flows are $67,240 and expected annual net income from the new machine total $12,240. The required rate of return is 8% and the income tax rate is 28%. How much is the net present value of this project?

A) $2,706
B) ($179,460)
C) $71,465
D) $153,390

Question 72

Live Nutrition is considering the purchase of a new computer system for diagnosing health problems. The company estimates that the system will result in increased operating cash flows of $5,800 in year 1, $6,500 in year 2, and $11,400 in year 3. The company's required rate of return is 8%. What is the maximum cost the company will be willing to pay for the computer system?

A) $14,947
B) $23,700
C) $19,992
D) $43,692

Question 73

Under which one of the following situations should a project be accepted?

A) The internal rate of return is less than the cost of capital.
B) The hurdle rate is greater than the required rate of return.
C) The return on the project is equal to the required rate of return.
D) The internal rate of return is less than the cost of capital.

Question 74

Halloran, Inc. is planning a capital investment. The company has a 7.8% required rate of return and a 6.3% cost of capital. Results of its budgeting calculations for three possible investments, each with a 7-year expected useful life and no salvage value, follow:
$\begin{array}{|c|c|c|c|} \hline& \text { Payback Period Method } & \text { Net Present Value } & \text { Cost } \\\hline \text { Project 22 } & 5.2 & \$ 2,000 & \$ 125,000 \\\hline \text { Project 33 } & 6.9 & (\$ 2,000) & 62,000 \\\hline \text { Project } 77 & 7.5 & \$ 0 & 71,000\\\hline\end{array}$
Which of the reasons below is true concerning the acceptability of a particular project?

A) Project 33 incurs a net loss.
B) Project 33 generates a return that is less than the required rate of return.
C) The cash invested in Project 77 requires an additional half year to recover when compared to Project 22.
D) Project 77 will operate at breakeven.

Question 75

The cash inflows expected during a project's life are equal in amount. In determining the internal rate of return, how is the present value factor calculated?

A) By dividing the initial outlay by the annuity amount
B) By multiplying the annuity amount by the number of years it occurs
C) By looking in the present value of an annuity table for the number of years and the respective discount rate
D) By dividing the present value of the annuity by the initial outlay

Question 76

The following data pertain to an investment proposal: $$\begin{array} { l r } \text { Required equipment investment } & \$ 124,000 \\\text { Annual cost savings } & \$ 52,000 \\\text { Projected life of investment } & 4 \text { years } \\\text { Projected salvage value } & \$ 0 \\\text { Required rate of return } & 8 \%\end{array}$$ The income tax rate is 28%. To which amount is the internal rate of return on this investment closest?

A) 12.5%
B) Less than 6%
C) 25%
D) 2.38%

Question 77

Objective Products' required rate of return on capital budgeting projects is 9%. The company is considering an investment that would yield net annual operating cash flows of $30,000 for 3 years. What is the maximum amount that the company will be willing to invest in this project?

A) $75,939
B) $69,498
C) $90,000
D) $98,100

Question 78

Which of the following two methods are most likely give the same decision of accepting or rejecting a particular project?

A) Net present value and internal rate of return
B) Accounting rate of return and payback period
C) Accounting rate of return and internal rate of return
D) Net present value and accounting rate of return

Question 79

Mexicali Foods determined the net operating cash inflows during a project's life would not be equal in amount. How can the internal rate of return be found?

A) By averaging the cash flows and treating them as if they are equal
B) By determining the accounting rate of return
C) By determining the cost of equity
D) By trial and error using present value tables, a spreadsheet program, or a financial calculator

Question 80

Which of the following is the rate of return that equates the present value of future cash flows to the investment outlay?

A) Hurdle rate
B) Internal rate of return
C) Payback return
D) Accounting rate of return