Question 1

Which of the following is not a characteristic of a capital expenditure, for the purposes of government budgeting?&#10;A) recurring nature&#10;B) large price tag&#10;C) long life&#10;D) none of the above&#10;Two government projects have the following benefit profiles:&#10;Project A Project B&#10;Initial Investment Cost 100,000 100,000&#10;Benefits, Year 1 0 40,000&#10;Benefits, Year 2 0 40,000&#10;Benefits, Year 3 80,000 40,000&#10;Benefits, Year 4 80,000 40,000

Accepted Answer

A recurring nature is not a characteristic of a capital expenditure. A capital expenditure is typically a one-time expense that has a large price tag, a long life, and is used to acquire or improve a long-term asset. Recurring expenditures, on the other hand, are ongoing expenses that are necessary to maintain operations or provide services, such as salaries or utility costs.

Question 2

Why are the capital costs of long-term projects discounted to present value?&#10;A) Because money that is received in the future has a greater value than money received now.&#10;B) To better account for the resource yield that will be foregone by a long-term investment.&#10;C) Because the amount of money that is spent in interest payments for the project should not be incorporated into the capital budget.&#10;D) To better account for the relative stability of tax-free government investments as compared to private sector projects.

Accepted Answer

Capital costs of long-term projects are discounted to present value to better account for the resource yield that will be foregone by a long-term investment. This means that the value of money is adjusted to reflect the time value of money, as money received now is generally considered more valuable than money received in the future.

Question 3

Which of the following statements is accurate?&#10;A) Because the combined benefits of the two projects over the four years each equals 160,000, the net present value of the projects will be equal.&#10;B) Because the sum of benefits 160,000) exceeds the investment cost 100,000) for both projects, the net present value of both projects will always be positive.&#10;C) The net present value of Project A becomes negative at a higher discount rate than does the net present value of Project B)&#10;D) The net present value of Project B becomes negative at a higher discount rate than does the net present value of Project A)

Accepted Answer

To determine which project's net present value becomes negative at a higher discount rate, we need to compare the present values of the benefits and costs of each project at different discount rates. Looking at the benefit profiles, we can see that Project B has higher benefits in the earlier years (year 1-2), while Project A has higher benefits in the later years (year 3-4). Because of this, Project B will have a higher present value of benefits at lower discount rates (due to the higher weighting of earlier years), while Project A will have a higher present value of benefits at higher discount rates (due to the higher weighting of later years). Therefore, we can conclude that the net present value of Project B becomes negative at a higher discount rate than the net present value of Project A.

Question 4

A lower discount rate applied to a given flow of returns in the future&#10;A) remain unchanged if the future dollars do not change.&#10;B) increase.&#10;C) decrease.&#10;D) change in a direction that cannot be determined in general.&#10;e.g., $5,000 at the end of 5 years, $10,000 at the end of 10 years, $15,000 at the end of 15 years, etc.) will cause the present value of that flow to:

Accepted Answer

A lower discount rate increases the present value of future cash flows because it reduces the rate at which those cash flows are discounted back to their present value.

Question 5

Advantages of a capital budget process include all the following EXCEPT:&#10;A) Extra review of infrastructure projects to prevent mistakes.&#10;B) Regularize purchase of infrastructure assets.&#10;C) Improve equity across generations.&#10;D) Facilitate borrowing to finance all infrastructure projects.

Accepted Answer

The capital budget process may not necessarily facilitate borrowing to finance all infrastructure projects. It may only prioritize and allocate funds for the most necessary projects based on available resources. The other options are advantages of a capital budget process.

Question 6

When evaluating the viability of a project, the test of economic efficiency requires that:&#10;A) NPV and BCR are greater than or equal to 0.&#10;B) NPV is greater than or equal to 0 and BCR is greater than or equal to 1.&#10;C) NPV is greater than or equal to 1 and BCR is greater than or equal to 0.&#10;D) NPV and BCR are greater than or equal to 1.&#10;Chapter Eight

Accepted Answer

The test of economic efficiency requires that NPV is greater than or equal to 0, which ensures that the project generates a positive cash flow, and BCR is greater than or equal to 1, which ensures that the benefits of the project outweigh the costs. Therefore, only choice B meets both criteria.

Question 7

Benefits received in the future are adjusted to their present value discounted) because:&#10;A) they are uncertain.&#10;B) the future may never come, or may come under unforeseen circumstances.&#10;C) markets indicate that people need to be compensated for postponing the enjoyment of benefits.&#10;D) None of the above is true.

Accepted Answer

The discounting of future benefits is a reflection of the fact that it is generally preferable to have something now rather than later. Economic theory suggests that markets determine the discount rate which reflects people's preference for present consumption rather than future consumption. Therefore, people need to be compensated for postponing the enjoyment of benefits.

Question 8

To what value would $20,000 compound in five years, assuming an annual discount rate of 5%?&#10;A) 25,526&#10;B) 21,000&#10;C) 20,000&#10;D) 19,048

Accepted Answer

To find the future value of an investment using compound interest, we can use the formula:

FV = PV x (1 + r)^n

where 
PV = present value (the initial investment amount)
r = annual interest rate (as a decimal)
n = number of years

In this case, the present value is $20,000, the annual interest rate is 5% (or 0.05 as a decimal), and the number of years is 5. So we can plug these values into the formula and solve for FV:

FV = $20,000 x (1 + 0.05)^5
FV = $20,000 x 1.27628
FV = $25,525.60

However, the answer options are rounded differently. The closest option to the calculated value is A, which is $25,526. Therefore, the best choice is A.

Question 9

Which of the following would be a reasonable component of a state capital budget?&#10;A) The salaries of the state planning agencies, because the impact of their efforts endures for many years.&#10;B) The cost of recurring purchases of motor vehicles.&#10;C) The cost of a new chair in the governor's office.&#10;D) None of the above.

Accepted Answer

State capital budgets typically fund long-term investments in infrastructure and facilities, not recurring expenses or minor purchases like those described in options A, B, and C.

Question 10

What is the Benefit Cost Ratio for a project costing $200,000 in the first year no discount) that produces a net benefit of $50,000/year for five years when the discount rate is 5%?&#10;A) $216,475&#10;B) $16,475&#10;C) 1.0824&#10;D) 4 years

Accepted Answer

To calculate the Benefit Cost Ratio (BCR), we need to divide the present value of benefits by the present value of costs.

Present value of costs = $200,000 (no discount rate in the first year)

Present value of benefits = $50,000 (1 - 1.05^-5)/0.05 = $223,525.06

BCR = $223,525.06 / $200,000 = 1.0824

A BCR greater than 1 means that the project is likely to be financially feasible and worthwhile. Therefore, the best choice would be C.

Question 11

What is the Net Present Value for a project costing $200,000 in the first year no discount) that produces a net benefit of $40,000/year for seven years when the discount rate is 7%?&#10;A) $215,572&#10;B) $15,572&#10;C) 1.0779&#10;D) 5 years

Accepted Answer

The answer of What is the Net Present Value for...

Deck 7: Capital Budgeting, Time Value of Money, and Cost-Benefit Analysis: Process, Structure, and Basic Tools