Deck 12: The Capital Budgeting Decision

Question 1

Cash flow can be said to equal:

A) income before amortization and taxes minus taxes.
B) income before amortization and taxes plus taxes.
C) income before amortization and taxes plus amortization.
D) income after taxes minus amortization.

Answer 1

A

Question 2

The longer the life of an investment:

A) the more significant the discount rate.
B) the less significant the discount rate.
C) Makes no difference.
D) the easier it is to determine the discount rate.

Answer 2

A

Question 3

Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000.The current market value of the old machine is $25,000 but the book value is $32,000.What is the net cash outflow for the new machine with consideration for the sale of the old machine?

A) $70,000
B) $45,000
C) $38,000
D) $32,000

Answer 3

B

Question 4

The reason cash flow is used in capital budgeting is because:

A) income is used to purchase new machines.
B) cash outlays need to be evaluated in terms of the present value of the resultant cash inflows.
C) to include the tax shield provided from amortization ignores the cash flow provided by the machine which should be reinvested to replace old worn out machines.
D) cash includes all accounting accruals.

Question 5

Under the capital cost allowance system:

A) the life span over which an asset may be amortized is fixed at five years.
B) all assets are amortized down to their salvage value.
C) recovery periods for different types of assets are broken down into categories.
D) the tax effect of accounting depreciation is included.

Question 6

Which of the following is not a step in creating the net present value profile?

A) Determining the net present value at a zero discount rate.
B) Determining the net present value at a normal discount rate.
C) Determining the project's internal rate of return.
D) Determining the payback period for the project.

Question 7

The net present value profile:

A) doesn't work if projects have a negative net present value.
B) is a substitute for the IRR.
C) graphically portrays the relationship between the discount rate and the net present value.
D) is determined by the cost of debt.

Question 8

A firm is selling an old asset below book value in a replacement decision.As the firm's tax rate is raised,the net cash outflow (purchase price less proceeds from the sale of the old asset plus CCA effects)would:

A) go up.
B) go down.
C) remain the same.
D) More information required.

Question 9

The net present value method is a better method of evaluation than the internal rate of return method because:

A) the NPV method discounts cash flows at the internal rate of return.
B) the NPV method is a more liberal method of analysis.
C) the NPV method discounts cash flows at the firm's more conservative cost of capital.
D) the NPV method includes accruals and other accounting discounts.

Question 10

Which of the following is not a time-adjusted method for ranking investment proposals?

A) Net present value method
B) Payback period
C) Internal rate of return method
D) Profitability index

Question 11

Using higher discount rates,:

A) accelerated amortization is more valuable than straight line amortization.
B) straight-line amortization is more valuable than accelerated amortization.
C) amortization policy makes no difference.
D) later year amortization has a higher net present value.

Question 12

In using the internal rate of return method,it is assumed that cash flows can be reinvested at:

A) the cost of equity.
B) the cost of capital.
C) the internal rate of return.
D) the prevailing interest rate.

Question 13

If projects are mutually exclusive:

A) they can only be accepted under capital rationing.
B) the selection of one alternative precludes the selection of other alternatives.
C) the payback method should be used.
D) the net present-value should be used.

Question 14

Which statement is true about amortization?

A) Amortization is a cash expense that provides tax shield benefits.
B) The greater the amortization expenses in earlier years,the lower the present value of the project
C) The CCA amortization schedules supersede other methods for tax purposes
D) The cash inflow from amortization increases profit.

Question 15

The _________ assumes returns are reinvested at the cost of capital.

A) payback period
B) internal rate of return
C) net present value
D) capital rationing

Question 16

For acceptable investments,the discount rate assumption under the internal rate of return is generally:

A) higher than under the net present-value method.
B) lower than under the net present-value method.
C) at the cost of capital.
D) below the cost of capital.

Question 17

Capital rationing:

A) is a way of preserving the assets of the firm over the long term.
B) is a less than optimal way to arrive at capital budgeting decisions.
C) assures shareholder wealth maximization.
D) assures maximum potential profitability.

Question 18

As the cost of capital increases:

A) fewer projects are accepted.
B) more projects are accepted.
C) project selection remains unchanged.
D) projects become more profitable.

Question 19

An investment project has a positive net present value.The internal rate of return is:

A) less than the cost of capital.
B) greater than the cost of capital.
C) equal to the cost of capital.
D) indeterminate; it depends on the length of the project.

Question 20

Which of the following statements about the "payback period" is true?

A) The payback period considers cash flows after the payback has been reached.
B) The payback period does not consider the time value of money.
C) The payback period uses discounted cash-flow techniques.
D) The payback period generally leads to the same decision as other investment selection methods.

Question 21

The payback period has several disadvantages,which include:

A) payback optimizes the most economic solution to a capital budgeting problem.
B) payback includes cash inflows after the payback period.
C) payback fails to choose the optimum or most economic solution to a capital budgeting problem.
D) payback ignores liquidity concerns.

Question 22

For CCA amortization,automobiles and light trucks fit into the:

A) 30% category.
B) 20% category.
C) 10% category.
D) 5% category.

Question 23

An asset just purchased,qualifies for a 20% CCA rate and qualifies for a 5% ITC.If the asset cost $60,000 what is the amortization base (UCC)in the second year before CCA is taken?

A) $54,000
B) $51,000
C) $56,000
D) $48,000

Question 24

The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method:

A) discounts cash flows at the project's internal rate of return.
B) concentrates on the liquidity aspects of investment projects.
C) discounts cash flows at the firm's weighted average cost of capital.
D) ignores cash flows after the payback period.

Question 25

With non-mutually exclusive projects:

A) the payback period will select the best project.
B) the net present value method will always select the best project.
C) the internal rate of return method will always select the best project.
D) the net present value and the internal rate of return methods will always accept or reject the same project.

Question 26

An equipment replacement decision,under resultant cash flow analysis,requires:

A) calculating the present value of all cash flows associated with the new equipment minus the salvage value of the old asset.
B) calculating the present value of all changes in cash flows from the old equipment to the new equipment.
C) subtracting the purchase price of the old equipment from the purchase price of the new equipment.
D) recalculating the amortization schedule of the old equipment.

Question 27

Project A has a $5,000 net present value at a zero discount rate and an internal rate of return of 12%.Project B has an $8,000 net present value at a 0% discount rate and an IRR of return of 10%.If the projects are mutually exclusive,which one should be chosen?

A) Project A because it has a higher internal rate of return.
B) Project B if the cost of capital is less than the crossover point.
C) Both projects if the net present value is positive.
D) Neither project meets the investment criteria.

Question 28

Suppose that interest rates (and,therefore,the firm's Weighted Average Cost of Capital)increase.This would not change the capital budgeting choices a firm would make if it:

A) uses payback period analysis.
B) uses net present value analysis.
C) uses internal rate of return analysis.
D) uses profitability indexes.

Question 29

The Wet Corp.has an investment project that will reduce expenses by $15,000 per year for 3 years.The project's cost is $20,000,with a 20% CCA rate.Using a 40% tax rate,calculate the net operating cash flow at the end of year 1?

A) $-15,000
B) $+11,000
C) $+9,000
D) $+9,800

Question 30

If a firm is experiencing no capital rationing,it should accept all investment proposals:

A) as long as it has available funds.
B) that return an amount equal to or greater than the cost of capital.
C) that return an amount greater than the cost of equity.
D) that are available,regardless of return.

Question 31

There are several disadvantages to the payback period,one of which is that:

A) payback ignores the time value of money.
B) payback emphasizes receiving money back as fast as possible for reinvestment.
C) payback is easy to use and to understand.
D) payback can be used in conjunction with time adjusted methods of evaluation.

Question 32

A characteristic of capital budgeting is:

A) a large amount of money is always involved.
B) the internal rate of return must be less than the cost of capital.
C) the internal rate of return must be greater than the cost of capital.
D) the time horizon is at least five years.

Question 33

The Dammon Corp.has the following investment opportunities: $\begin{array}{rrrr}&\text { Machine A } & \text { Machine B } & \text { Machine C } \\&(\$ 15,000) & (\$ 22,500) & (\$ 37,500)\\& \text { Inflows } & \text { Inflows } & \text { Inflows } \\\text { year 1 } & \$ 6,000 & \$ 12,000 & \$-0- \\\text { year 2 } & 9,000 & 12,000 & 30,000 \\\text { year 3 } & 3,000 & 10,500 & 30,000 \\\text { year 4 } & -0- & 10,500 & 15,000 \\\text { year 5 } & -0- & -0- & 15,000\end{array}$ Under the payback period and assuming these machines are mutually exclusive,which machine(s)would Dammon Corp.choose?

A) Machine A
B) Machine B
C) Machine C
D) None of the machines will be accepted.

Question 34

Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not mutually exclusive,the firm should accept all investment proposals:

A) for which it can obtain financing.
B) that have a positive net present value.
C) that have positive cash flows.
D) that provide returns greater than the after tax cost of debt.

Question 35

The investment tax credit:

A) increases the tax bill for the year in which the asset is purchased.
B) has a provision for a cash refund.
C) increases the base upon which CCA is calculated.
D) increases the amount of CCA write-off available each year.

Question 36

If the capital budgeting decision includes a replacement analysis,then:

A) a gain from the sale of the old asset will represent a tax savings inflow.
B) only incremental cash flows should be looked at.
C) the sale price and tax savings will increase the cash inflows throughout the asset's life.
D) only initial cash in-flow should be considered.

Question 37

An investment tax credit (ITC):

A) increases the amortization base for tax purposes.
B) decreases the amortization base for tax purposes.
C) does not affect the amortization base for tax purposes.
D) may increase or decrease the amortization base for tax purposes.

Question 38

If an old asset sells below book value (UCC)and the asset pool ends,from a tax standpoint:

A) there is a decrease in cash flow.
B) there is an increase in cash flow.
C) there is no effect on cash flow.
D) there is a decrease in net present value.

Question 39

Capital budgeting is primarily concerned with:

A) capital formation in the economy.
B) planning future financing needs.
C) evaluating investment alternatives.
D) minimizing the cost of capital.

Question 40

An investment tax credit (ITC)of $100 in comparison to CCA expense of $100 provides:

A) the same tax shield benefits.
B) less tax shield benefits.
C) greater tax shield benefits.
D) Cannot determine with the information given.

Question 41

Capital budgeting is primarily concerned with:

A) capital formation in the economy.
B) planning future financing needs.
C) evaluating investment alternatives.
D) minimizing the cost of capital.

Question 42

The internal rate of return (IRR)assumes that funds are reinvested at the:

A) cost of capital.
B) yield on the investment.
C) minimal acceptable rate to the firm.
D) yield to maturity.

Question 43

The internal rate of return is:

A) less than the weighted average cost of capital.
B) the discount rate that produces a project net present value of zero.
C) the discount rate that produces a positive project net present value.
D) unrelated to the weighted average cost of capital.

Question 44

NPV is superior to average accounting return as a capital budgeting technique because:

A) it employs the accounting definition of income.
B) it values each cash flow equally based on dollar value.
C) it employs the actual cost of an investment.
D) it employs cash flows.

Question 45

$\begin{array}{lrrr} &\text { Machine A } & \text { Machine B } & \text { Machine-C } \\&(\$ 20,000) & (\$ 30,000) & (\$ 40,000) \\& \text { Inflows } & \text { Inflows } & \text { Inflows } \\\text { year 1 } & \$ 10,000 & \$ 12,000 & \$-0- \\\text { year 2 } & 10,000 & 12,000 & 10,000 \\\text { year 3 } & 5,000 & 10,500 & 30,000 \\\text { year 4 } & 2,000 & 10,500 & 15,000 \\\text { year 5 } & -0- & -0- & 15,000\end{array}$

-Under the payback period and assuming these machines are mutually exclusive,which machine(s)would Horne Robinson Inc.choose?

A) Machine A
B) Machine B
C) Machine C
D) Machine A and B

Question 46

The reason cash flow is used in capital budgeting is because:

A) income rather than cash is used to purchase new machines.
B) cash outlays need not be evaluated in terms of the present value of the resultant cash inflows.
C) the tax shield provided from amortization ignores the cash flow provided by the machine which should be reinvested to replace old worn out machines.
D) cash flow includes accounting accruals.

Question 47

Which statement is true about amortization?

A) Amortization is a cash expense that provides tax shield benefits.
B) The lesser the amortization expenses in earlier years,the higher the present value of the project.
C) The CCA amortization schedules supersede other methods for tax purposes.
D) Amortization is a cash flow that represents the annual cost of an asset.

Question 48

Capital rationing assumes that:

A) a limited amount of capital is available.
B) a limited number of investments are available.
C) maximum value creation will be obtained.
D) all projects are acceptable.

Question 49

The internal rate of return (IRR)and net present value (NPV)methods:

A) always give the same investment decision.
B) never give the same investment decision.
C) usually give the same investment decision.
D) always give a decision different from the payback period method.

Question 50

The first step in the capital budgeting process is:

A) collection of data.
B) idea development.
C) assigning probabilities.
D) determining cash flow.

Question 51

The modified internal rate of return (MIRR)assumes:

A) inflows are invested at the traditional interest rate of return.
B) inflows are reinvested at the cost of capital.
C) outflows are funded with debt.
D) outflows are funded with equity.

Question 52

Using a required rate of return of 12%.
$\begin{array} { | c | r | } \hline { \text { Perpetual Power Machine Co. - Purchase of a New High Machining Tool } } \\\hline \text { Year } & \text { Cash Flow } \\\hline \text { Year 1 } & \$ 500 \\\hline \text { Year 2 } & \$ 500 \\\hline \text { Year 3 } & \$ 3,000 \\\hline \text { Year 4 } & \$ 3,000 \\\hline \text { Year 5 } & \$ 10,000 \\\hline\end{array}$

-What is this project's NPV if the initial capital investment is $7,162?

A) $3,399
B) $12,000
C) $8,500
D) $3,000

Question 53

The profitability index will give the same investment decision as:

A) the payback period.
B) the average accounting return.
C) the net present value.
D) It can be different from each of these techniques.

Question 54

Assume a corporation has earnings before depreciation and taxes of $82,000,depreciation of $45,000,and that it has a 30 percent tax bracket.What are the after-tax cash flows for the company?

A) $70,900
B) $82,000
C) $42,000
D) $37,000

Question 55

Which of the following statements about the "payback period" is true?

A) The payback period considers cash flows after the payback has been reached.
B) The payback period considers the time value of money.
C) The payback period uses discounted cash-flow techniques.
D) The payback period fails to produce an objective decision to accept or reject an individual project.

Question 56

A firm may adapt capital rationing because:

A) it is hesitant to use external sources of financing.
B) it wishes to maximize value.
C) it is fearful of too much growth.
D) it has a constraint on the amount of funds

Question 57

The net present value method is a better method of evaluation than the internal rate of return method because:

A) the NPV method discounts cash flows at the internal rate of return.
B) the NPV method is a more liberal method of analysis.
C) the NPV method discounts cash flows at higher than the firm's cost of capital.
D) the NPV method allows the financial manager to select between mutually exclusive projects.

Question 58

$\begin{array}{lrrr} &\text { Machine A } & \text { Machine B } & \text { Machine-C } \\&(\$ 20,000) & (\$ 30,000) & (\$ 40,000) \\& \text { Inflows } & \text { Inflows } & \text { Inflows } \\\text { year 1 } & \$ 10,000 & \$ 12,000 & \$-0- \\\text { year 2 } & 10,000 & 12,000 & 10,000 \\\text { year 3 } & 5,000 & 10,500 & 30,000 \\\text { year 4 } & 2,000 & 10,500 & 15,000 \\\text { year 5 } & -0- & -0- & 15,000\end{array}$

-Under NPV evaluation and assuming these machines are mutually exclusive,which machine(s)would Horne Robinson Inc.choose?

A) Machine A
B) Machine B
C) Machine C
D) Machine A and B

Question 59

Using a required rate of return of 12%.
$\begin{array} { | c | r | } \hline { \text { Perpetual Power Machine Co. - Purchase of a New High Machining Tool } } \\\hline \text { Year } & \text { Cash Flow } \\\hline \text { Year 1 } & \$ 500 \\\hline \text { Year 2 } & \$ 500 \\\hline \text { Year 3 } & \$ 3,000 \\\hline \text { Year 4 } & \$ 3,000 \\\hline \text { Year 5 } & \$ 10,000 \\\hline\end{array}$

-What is this project's payback period if initial capital investment is $7,500?

A) 3 years 3 months
B) 5 years
C) 9 years
D) 4 years 2 months

Question 60

At higher tax rates,CCA amortization is:

A) more beneficial.
B) less beneficial.
C) decreased.
D) unaffected.

Question 61

The "payback method" has the following advantages:

A) easy to understand,emphasis on liquidity,considers all cash flows.
B) easy to understand,emphasis on liquidity,quick view of investment risk.
C) easy to understand,uses the time value of money concept,quick view of investment risk.
D) accepts all projects that may add value to the firm,emphasis on liquidity,quick view of investment risk.

Question 62

Under the payback method and assuming these machines are mutually exclusive,which machine(s)would Dammon Corp.choose?

A) Machine A
B) Machine B
C) Machine C
D) Machine A and B

Question 63

The payback period is easy to understand and places a heavy emphasis on liquidity.

Question 64

It is not unusual for a corporate president,who deals with security analysts,to be as sensitive to after tax income as cash flow.

Question 65

Under capital rationing,a firm will maximize profitability.

Question 66

You require an IRR of 14% to accept a project.If the project will yield $10,000 per year for 10 years,what is the maximum amount that you would be willing to invest in the project?

A) Less than $50,000
B) More than $50,000 and less than $60,000
C) More than $60,000 and less than $70,000
D) More than $70,000

Question 67

There are several disadvantages to the payback method,among them:

A) payback ignores the time value of money.
B) payback emphasizes receiving money back as fast as possible for reinvestment.
C) payback is basic to use and to understand.
D) payback can be used in conjunction with time adjusted methods of evaluation.

Question 68

A long term investment:

A) may use various discount rates.
B) may ignore the discount rate.
C) is easier to determine the discount rate than a short term investment.
D) should use lower discount rates than a short term investment.

Question 69

Assume a project has earnings before depreciation and taxes of $15,000,depreciation of $25,000,and that the firm has a 30 percent tax bracket.What are the after-tax cash flows for the project?

A) $18,000
B) $19,000
C) A loss of $21,000
D) $25,000

Question 70

The first administrative consideration in any capital budgeting process is collection of data.

Question 71

The payback method has several advantages,among them:

A) payback indicates the optimum or most economic solution to a capital budgeting problem.
B) payback ignores cash inflows after the payback period.
C) payback is easy to calculate.
D) payback utilizes the time value of money.

Question 72

The payback period is not really a theoretically correct approach.

Question 73

We add amortization to net income to arrive at a true profit picture.

Question 74

The internal rate of return is the average annual rate of return from the investment.

Question 75

Suppose that interest rates (and,therefore,the firm's Weighted Average Cost of Capital)increase.This would not change the capital budgeting choices a firm would make if it:

A) uses payback period analysis.
B) uses net present value analysis.
C) uses internal rate of return analysis.
D) uses profitability indexes.

Question 76

Non-mutually exclusive alternatives can be accepted at the same time.

Question 77

With a higher CCA rate,the present value of tax savings increases.

Question 78

With non-mutually exclusive events and no capital rationing,we will usually arrive at the same conclusions using either the net present value or internal rate of return methods.

Question 79

Which of the following is not a time-adjusted method for ranking investment proposals?

A) Net present value method
B) Payback method
C) Internal rate of return method
D) Modified internal rate of return

Question 80

You buy a new piece of equipment for $7,360,and you receive a cash inflow of $1,000 per year for 10 years.What is the internal rate of return?

A) 5%
B) 6%
C) 7%
D) More than 7%