Deck 11: Capital Budgeting

Question 1

The NPV method computes the present value of all expected future cash flows using a maximum desired rate of return.

Answer 1

False

Question 2

The lower the minimum desired rate of return, the lower the present value of each future cash inflow.

Answer 2

False

Question 3

The minimum rate under the NPV method is based on the cost of capital.

Answer 3

True

Question 4

DCF does not focus on net income.

Question 5

DCF methods are not based on the theory of compound interest.

Question 6

Under the NPV method, the higher the risk of a project, the lower the desired rate of return.

Question 7

When choosing among several investments, managers should pick the one with the lowest net present value.

Question 8

The IRR model determines the interest rate at which the NPV equals zero.

Question 9

When using the NPV model, a world of uncertainty is assumed.

Question 10

If the IRR is less than the minimum desired rate of return, a project is not desirable.

Question 11

The cost of capital is equal to the interest expense on the money borrowed for the project.

Question 12

A positive NPV means that accepting the project will increase the value of the firm.

Question 13

Depreciating an asset is a cash flow.

Question 14

The more sensitive to change a project is, the riskier it is.

Question 15

Two common methods for comparing alternatives are 1) the total project approach and
2) the conversion approach.

Question 16

When using the NPV model, it is assumed that capital markets are perfect.

Question 17

If IRR > minimum desired rate of return, then NPV > 0.

Question 18

Discounted-cash-flow models focus on a project's cash inflows and cash outflows without regard to the time value of money.

Question 19

When using the NPV method, time zero means the value today.

Question 20

The net-present-value model expresses all cash flows in monetary units measured at time zero.

Question 21

The marginal income tax rate is the tax rate paid on additional amounts of taxable income.

Question 22

Federal income taxes are based on the value of a company's assets.

Question 23

A good rule of thumb in tax planning is to recognize taxable income sooner rather than later.

Question 24

U.S.corporations are required to use the same method of calculating depreciation on both their income tax return and their annual published financial statements.

Question 25

The cash outflow for the purchase of equipment is an example of an operating cash flow.

Question 26

Primarily, working capital = receivables + inventories + payables.

Question 27

The only relevant cash flows are those that will differ among alternatives.

Question 28

A company will experience the same total tax savings over the life of an asset, regardless of the method of depreciation used.

Question 29

The differential approach can be used to compare any number of projects.

Question 30

When making capital budgeting decisions, the manager should consider the marginal tax rate, not the average tax rate that applies to the company.

Question 31

Depreciation and book values are relevant operating cash flows.

Question 32

Generally, the hardest part of making capital-budgeting decisions is predicting the relevant cash flows.

Question 33

The later a company takes the depreciation on its assets, the greater the present value of the income tax savings.

Question 34

Tax avoidance is illegally reducing taxes by recording fictitious deductions or failing to report income.

Question 35

The total project approach can be used to compare any number of projects.

Question 36

Most of the depreciation taken on an asset occurs at the end of its life when using accelerated depreciation.

Question 37

A depreciation deduction lowers a company's tax liability.

Question 38

Under United States tax laws, a company may estimate the useful life of an asset for depreciation purposes.

Question 39

Errors in forecasting terminal disposal values are usually not crucial because the present value of these flows is small.

Question 40

A reduction in a cash outflow is not treated the same way as a cash inflow.

Question 41

ARR = increase in expected average annual operating income x initial required investment.

Question 42

A recognized loss on a sale of an asset causes a company's tax liability to decrease.

Question 43

The cost of capital is sometimes referred to as _____.

A)the discount rate
B)the hurdle rate
C)the required rate of return
D)all of these answers are correct

Question 44

One purpose of a postaudit is to provide information for improving future predictions of cash flows.

Question 45

The accounting rate-of-return model shows the effects of an investment on an organization's financial statements.

Question 46

A follow-up evaluation of capital-budgeting decisions is called a postaudit.

Question 47

_____ is not another name for the required rate of return.

A)Hurdle rate
B)Discount rate
C)Compound rate
D)Cost of capital

Question 48

Long-term planning for making and financing investments that affect financial results for more than the current year is called _____.

A)operational budgeting
B)capital budgeting decisions
C)strategic analysis
D)sensitivity analysis

Question 49

Because a loss on the sale of an asset is tax deductible, companies often benefit more from losses than from gains.

Question 50

Nominal rate = real rate - inflation.

Question 51

The economic life of an asset may exceed the recovery period of the asset.

Question 52

The lower the minimum desired rate of return, the _____.

A)lower the present value of each future cash outflow
B)higher the net-present-value of the project
C)higher the present value of each future cash outflow
D)lower the present value of each future cash inflow

Question 53

Managers may use the payback period as a rough estimate of the riskiness of a project.

Question 54

Because future inflation has no effect on the current purchase price of an asset, inflation factors can be ignored when capital-budgeting decisions are made.

Question 55

Projects that recoup their investment quickly may be less risky than those that require a longer wait.

Question 56

ARR does not ignore the time value of money.

Question 57

The payback model measures profitability as well as how quickly investment dollars may be recouped.

Question 58

Below are two potential investment alternatives: $\begin{array}{lrr}&D&F\\\text { Initial capital investment } & \$ 180,000 & \$ 270,000 \\\text { Estimated useful life } & 3 \mathrm{yrs} & 3 \mathrm{yrs} \text {. } \\\text { Estimated terminal salvage value } & -0- & -0 \text { - } \\\text { Estimated annual savings in cash } & & \\\quad \text { operating costs } & \$ 80,000 & \$ 120,000 \\\text { Minimum desired rate of return } & 10 \% & 12 \%\end{array}$ Assume straight-line depreciation in all computations, and ignore income taxes.The net-present value in investment A is _____.

A)$18,952
B)$123,652)
C)$75,000
D)$186,518

Question 59

Real rate = risk-free rate + business-risk rate.

Question 60

_____ is not a phase of capital budgeting.

A)A postaudit of the investment
B)The selection of the investment to undertake
C)The identification of potential investments
D)The identification of possible sources of funds for the investment

Question 61

_____ are decisions on whether to acquire an asset, a project, a company, or a product line.

A)Financing decisions
B)Accounting decisions
C)Investment decisions
D)Payback decisions

Question 62

An accountant's main function in capital budgeting is to _____.

A)identify potential investments
B)choose which investments to make
C)gather and interpret information
D)all of these answers are correct.

Question 63

In capital budgeting decisions, risk is a measure of the _____.

A)likelihood that the project will succeed
B)firm's credit worthiness
C)project's desirability
D)project's sensitivity to change

Question 64

_____ is a cash inflow.

A)Purchase price of an asset
B)Interest expense
C)Revenue generated by a project
D)Depreciation expense

Question 65

When using the net?present?value method, if the sum of the present values of the cash flows is positive, then the _____.

A)project should be rejected
B)project is desirable
C)present value of the cash outflows exceeds the present value of the cash inflows
D)decision maker would be indifferent between accepting and rejecting the project

Question 66

George has offered to give you $10,000 today or $3,000 per year for the next five years.If the cost of capital is 10%, Harvey should _____.

A)choose $10,000 today
B)choose $3,000 for five years
C)choose either because the results will be the same
D)do nothing.Harvey cannot make a decision with the above information.

Question 67

_____ shows the financial consequences that would occur if actual cash flows differ from expected cash flows.

A)Discount analysis
B)Interest analysis
C)Sensitivity analysis
D)Forecasting

Question 68

When comparing projects using the differential approach, a manager should choose the _____.

A)project with the largest positive net present value
B)project with the largest negative net present value
C)first project considered if the present value is positive
D)second project considered if the present value positive

Question 69

When choosing among several investments _____.

A)the one with the greatest net present value is the least desirable
B)the one with the largest positive present value should be chosen
C)risk should not be a factor
D)the cost of capital is irrelevant

Question 70

When considering a capital?budgeting project, a manager should first determine the _____.

A)risk of the investment
B)payback period
C)internal rate of return
D)accounting rate of return

Question 71

The "break-even" cash flow is the point at which _____.

A)the present value of variable cost equals the present value of fixed costs
B)the present value of the cash inflows equals the present value of the cash outflows
C)the hurdle rate equals the market rate
D)total cash revenues equal the total cash expenses

Question 72

Assume that the desired rate of return is 10% and that interest is compounded annually. Identify how much must be invested today to have $10,000 in 5 years and 10 years, respectively.

A)$5,000; $1,000
B)$3,791; $6,145
C)$6,209; $3,855
D)$1,000; $5,000

Question 73

When evaluated using a nominal rate of 8%, the net present value of a project is zero.Identify which one of the following statements is true.

A)At 6% the project is desirable and at 8%, it is undesirable.
B)At 8% the project is desirable and at 6%, it is undesirable.
C)The project is desirable at 6% or 8%.
D)The project is undesirable at 6% or 8%.

Question 74

At the current discount rate, the net present value of an 8-year project is zero.Assuming that the current discount rate and the annual cash flows are unchanged, identify which one of the following statements is true.

A)The project will be desirable if the project's life is increased to 10 years.
B)The project will be desirable if the project's life is reduced to 5 years.
C)The project is equally desirable at 5 and 10 years.
D)The project is equally undesirable at 5 and 10 years.

Question 75

An annuity is _____.

A)a series of equal cash flows at equal intervals
B)a cash amount received only once
C)a yearly payment of any amount
D)None of these answers is correct.

Question 76

_____ is not a common way to recognize risk.

A)Increasing the minimum desired rate of return for riskier projects
B)Reducing individual expected cash inflows by an amount that depends on their risk
C)Increasing expected cash outflows by an amount that depends on their risk
D)Increasing the expected life of riskier projects

Question 77

Below are two potential investment alternatives: $\begin{array}{lrr}&S&T\\\text { Initial capital investment } & \$ 180,000 & \$ 270,000 \\\text { Estimated useful life } & 3 \mathrm{yrs} & 3 \mathrm{yrs} \text {. } \\\text { Estimated terminal salvage value } & -0- & -0 \text { - } \\\text { Estimated annual savings in cash } & & \\\quad \text { operating costs } & \$ 75,000 & \$ 150,000 \\\text { Minimum desired rate of return } & 10 \% & 12 \%\end{array}$ Assume straight-line depreciation in all computations, and ignore income taxes. The net-present value in investment Y is _____.

A)$120,000
B)$90,270
C)$492)
D)$184,584

Question 78

_____ and financing decisions are two key aspects of capital budgeting.

A)Accounting decisions
B)Investing decisions
C)Discount decisions
D)Payback decisions

Question 79

Identify which one of the following statements regarding the risk of an investment is true.

A)The lower the risk, the higher the discount rate.
B)The higher the risk, the lower the hurdle rate.
C)The higher the risk, the lower the cost of capital.
D)The higher the risk, the higher the minimum desired rate of return.

Question 80

In the net-present-value model, the perfect capital markets assumption means that _____.

A)a company can borrow exactly the amount of money it needs
B)each lender charges the same interest rate
C)all amounts can be borrowed at the minimum desired rate of return
D)net cash inflows equal net cash outflows