Deck 11: Capital Budgeting

Question 1

The accounting rate of return is relatively straightforward to compute, but ignores the time value of money.

Answer 1

True

Question 2

The salvage of an asset is the residual value from disposing of the asset at the end of its useful life.

Answer 2

True

Question 3

Under the payback method to evaluate investments, we compute how long it takes to recoup the initial investment using discounted cash flows.

Answer 3

False

Question 4

Money is not a productive asset because it is not a long-lived resource.

Question 5

The greatest advantage of the payback method is that the payback period is easy to compute and to understand.

Question 6

The opportunity of cash is the time value of money.

Question 7

The greatest advantage of the modified payback method is that it considers all future cash flows from a project as does the NPV method.

Question 8

Unlike the Cost-Volume-Profit method, the NPV method does not allow users to perform "what-if" sensitivity analysis with respect to various estimates and assumptions, and to examine alternative scenarios.

Question 9

Regardless of the method used to evaluate long-lived resources, firms need to consider one very important factor: present value.

Question 10

Like the Net Present Value method, the Internal Rate of Return method assumes that the initial cash outflow takes place at the beginning of the period.

Question 11

The initial outlay for an asset does not include the cost of installation and training charges.

Question 12

As it relates to capital expenditure decisions, cost of capital is the opportunity cost of capital required for the proposed investment.

Question 13

Setting an estimated life expectancy of an asset too low understates the profitability of the investment and could result in the firm rejecting profitable opportunities.

Question 14

The present value factor is also known as the discount factor.

Question 15

The cost of capital is measured as the total of all costs incurred to ready an asset for its intended use, including purchase price, shipping and delivery, taxes, and any installation and training costs.

Question 16

Cost allocations ignore the "lumpy" nature of capacity resources, and estimate costs as if we can match supply and demand continuously and smoothly.

Question 17

The two main discounted cash flow techniques used in capital budgeting are net present value (NPR) and cost-volume-profit (CVP).

Question 18

Strategic plans specify how the company intends to achieve its long-term objectives, and dictate what resources the firm needs to execute its plans.

Question 19

The modified payback method accumulates the present value of future cash flows over time and compares the cumulative value with the initial cash outlay.

Question 20

When analyzing capital investments using the NPV method, the first step is to discount the initial investment.

Question 21

Real option analysis is a collection of mathematical techniques for valuing the flexibility associated with a project.

Question 22

Which of the following is not a typical operating cash outflow from a capital investment in equipment?

A)Hiring additional personnel.
B)Depreciation
C)Maintenance costs.
D)Repairs.
E)All of the above are typical operating cash outflows.

Question 23

U.S.tax laws only allow depreciation deductions using the Modified Accelerated Cost Recovery System (MACRS).

Question 24

Estimating future cash inflows and outflows, and identifying the appropriate discount rate for present value calculations is generally all companies need to evaluate a given capital expenditure.

Question 25

Which of the following is not one of the four elements of a capital expenditure decision about a single project?

A)Estimated life and salvage value.
B)Depreciation method.
C)Initial outlay.
D)Timing and amounts of operating cash flows.
E)Cost of capital.

Question 26

Which of the following is not a factor in increasing cash inflows from external sales resulting from a capital investment in new equipment?

A)Interest income.
B)Increased sales as a result of increased production.
C)Increased production as a result of fewer reworks.
D)Income from renting out the equipment's spare capacity.
E)All of the above are factors in increasing cash inflows.

Question 27

Which of the following methods for evaluating project profitability uses the time value of money?

A)Payback period.
B)Modified payback period.
C)Internal rate of return.
D)Accounting rate of return.
E)All of the above methods use the time value of money.

Question 28

Depreciation offers a tax shield that reduces the cash outflow associated with tax payments.

Question 29

Capital budgets allocate:

A)Cash flows to functioning activities.
B)Supply to demand.
C)Scarce capital among available investment opportunities.
D)Productive capacity among products.
E)None of the above.

Question 30

Taxes affect both the amount and timing of cash flows.

Question 31

A project is profitable if its internal rate of return:

A)Exceeds its discount rate.
B)Is zero.
C)Exceeds cash outflows of the project.
D)Exceeds its opportunity cost of capital.
E)None of the above.

Question 32

The hurdle rate reflects the minimum expected rate of return of the management from any project.

Question 33

Ignoring future benefits because they are hard to quantify can lead to lost opportunities.

Question 34

Money is a productive asset.Its opportunity cost is:

A)The time value of money.
B)Depreciation.
C)Inflation.
D)Replacement cost.
E)Valuation.

Question 35

Which of the following is not a part of the initial outlay for a capital expenditure?

A)Salvage value.
B)Shipping costs.
C)Taxes.
D)Installation costs.
E)Training charges.

Question 36

Gator Manufacturing is considering the purchase of equipment at a cost of $7,000.Gator expects the equipment to generate cash inflows of $2,000 each year for the next ten years.The payback period for the equipment is:

A)35%.
B)285%.
C)3.5 years.
D)2.85 years.
E)10 years.

Question 37

Net cash flows typically equal accounting income.

Question 38

Which of the following is not an assumption in performing NPV calculations found in Chapter 11?

A)The initial cash outflow takes place at the beginning of the period.
B)The internal rate of return is zero.
C)Subsequent cash inflows and outflows occur at the end of the relevant period.
D)The mathematics of new present value calculations assume that firms reinvest future cash inflows in projects that yield a return that equals the cost of capital.
E)All of the above are assumptions discussed in Chapter 11.

Question 39

Some firms accept low rates of return to compensate for the risk from taking on long-lived capital investments.

Question 40

Which of the following is not a tool for calculating net present value?

A)Present value tables.
B)Spreadsheet programs.
C)Real option analysis.
D)Financial calculators.
E)All of the above are tools for calculating net present value.

Question 41

Which of the following is not an advantage of the payback method?

A)It focuses on a project's downside risk.
B)It takes into account the time value of money.
C)It is easy to compute.
D)It is easy to understand.
E)All of the above are advantages of the payback method.

Question 42

The accounting rate of return is computed as:

A)Average annual income from the project divided by average annual investment.
B)Average annual income from the project divided by the length of time it takes to recoup the initial investment.
C)Average annual investment divided by the average annual income from the project.
D)Average annual investment divided by the length of time it takes to recoup the initial investment.
E)The initial cash outlay divided by the average annual income from the project.

Question 43

Redbird Corporation provides the following data: $$\begin{array} { l r } \text { Cash inflows } & \$ 50,000 \\\text { Cash outflows } & \$ 43,000 \\\text { Net income } & \$ 35,000 \\\text { Depreciation deduction } & \$ 5,000 \\\text { Accumulated depreciation } & \$ 10,000 \\\text { Tax rate } & 30 \%\end{array}$$ What is Redbird's tax shield?

A)$15,000.
B)$12,900.
C)$10,500.
D)$1,500.
E)$3,000.

Question 44

A firm pays taxes on:

A)Cash flows.
B)Accounting income.
C)Both A and B

Question 45

The depreciation tax shield is computed as:

A)Accumulated depreciation x tax rate.
B)Cash outflows from project x tax rate.
C)Depreciation deduction for the year x tax rate.
D)Discounted cash outflows from project x tax rate.
E)None of the above.

Question 46

Which of the following is a disadvantage of the payback method?

A)It overvalues the initial outlay.
B)It undervalues the initial outlay.
C)It overvalues future cash inflows.
D)It undervalues future cash inflows.
E)It is easy to compute but difficult to understand.

Question 47

The major reason net cash flows do not typically equal accounting income is:

A)Present value.
B)Depreciation.
C)Taxes.
D)Discounted cash flows.
E)None of the above.

Question 48

Belk’s Pizza has purchased a small auto in order to offer delivery to customers. The auto cost $18,000 and is expected to be used for six years. Having pizza delivery is expected to increase revenues by approximately $4,000 each year. The auto will be depreciated straight-line over three years.

Required:
a. Compute the payback period on the new auto.
b. List three non-financial considerations that Belk may have addressed in making the decision to purchase the new auto.

Question 49

The minimum expected rate of return of the management from any project is referred to as the:

A)The internal rate of return.
B)The hurdle rate.
C)A number greater than 1.
D)A number less than zero.
E)None of the above.

Question 50

The reduction of cash outflows associated with tax payments because of depreciation is referred to as:

A)Accrued taxes.
B)Deferred taxes.
C)Depreciation shield.
D)Tax shield.
E)None of the above.

Question 51

Which of the following statements describes the modified payback method?

A)We compute how long it takes to recoup the initial investment using undiscounted cash flows.
B)The method accumulates the present value of future cash flows over time and compares the cumulative value with the salvage value of the capital expenditure.
C)The method accumulates the absolute value of future cash flows over time and compares the cumulative value with the present value of the capital expenditure.
D)The year in which the accumulated present value of future cash flows exceeds the initial cash outflow determines the modified payback period.
E)None of the above describes the modified payback method.