Question 1

The cost of capital is the average cost an organization pays to obtain the resources (i.e., borrowed funds, as well as on funds provided by investors in the company's stock) necessary to make investments.

Accepted Answer

The average rate considers such items as the effective interest rate on debt (notes or bonds), the effective dividend rate on preferred stock, and the discount rate that equates the present value of all dividends expected on common stock over the life of the organization to the current market value of the organization's common stock.

Question 2

The payback period method is frequently used as a screening tool, but it does not take into consideration the profitability of a project.

Accepted Answer

The payback period method tells how many periods it will take to recover the initial investment. It does not consider additional cash inflows or the time value of the cash inflows.

Question 3

The payback period and the accounting rate of return methods are inferior to the net present value method because neither considers cash flows.

Accepted Answer

The payback period method uses cash flows. However, neither payback nor accounting rate of return considers the time value of money.

Question 4

The net present value method and internal rate of return method are both deficient to the extent that neither method considers investment size.

Accepted Answer

The net present value method gives explicit consideration to investment size. Internal rate of return does not.

Question 5

To avoid accepting projects that actually should be rejected, a company should ignore all nonquantitative benefits in evaluating net present value.

Accepted Answer

Nonquantitative factors such as market position, operational performance, and strategy implementation often play a decisive role in management's final decision to accept or reject a project.

Question 6

The objective of capital budgeting models is to eliminate risk.

Accepted Answer

All capital budgeting models involve risk, including risk related to cost of the initial investment, time required to complete the initial investment and begin operations, whether the new facilities will operate as planned, life of the facilities, customers' demand for the product or service, final selling price, operating costs, and disposal values.

Question 7

The depreciation tax shield is calculated as depreciation divided by tax rate.

Accepted Answer

The depreciation tax shield is calculated as depreciation times tax rate.

Question 8

Taxes have the effect of reducing both cash inflows from taxable revenues and cash outflows for tax deductible expenses.

Accepted Answer

Taxes are paid on revenues, resulting in a reduction of after-tax revenues. Taxes are saved on tax deductible expenses such as depreciation.

Question 9

When given a choice between $500 today or $500 tomorrow, a rationale decision maker will choose $500 today only because of risk.

Accepted Answer

Two reasons for the decision involve the time value of money and risk.

Question 10

An annuity is a series of payments of any size received over equal intervals of time.

Accepted Answer

An annuity is a series of equal size payments paid or received over equal intervals of time.
Multiple Choice

Question 11

_______________ involve(s) investment of significant financial resources in projects to develop or introduce new products or services, to expand current production or service capacity, or to change current production or service facilities.

Accepted Answer

Capital expenditures refer to the funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. This involves significant financial investments in projects to develop new products or services, expand current production or service capacity, or modify current production or service facilities.

Question 12

Which of the following activities falls under the range of responsibility assumed by the capital budgeting committee?

Accepted Answer

The capital budgeting committee reviews, analyzes, and approves or rejects capital expenditure proposals. In addition, the committee provides guidance to managers in the formulation of capital expenditure proposals.

Question 13

Which of the following processes involve the development of capital budgeting project performance reports that compare planned to actual results?

Accepted Answer

A post-audit involves the development of project performance reports comparing planned and actual results.

Question 14

A precondition for effective capital budgeting requires having:

Accepted Answer

Effective capital budgeting requires a defined mission, long range goals, and a business strategy.

Question 15

Which of the following expenditures would be classified as part of the initial investment phase for equipment?

Accepted Answer

The initial phase includes expenditures to acquire plant, property, equipment, and working capital to purchase inventory and recruit and train employees.

Question 16

The third phase of a project's cash flows is:

Accepted Answer

The third phase is disinvestment at which time assets are disposed of and the initial investment is recovered.

Question 17

Firefox Company is considering the following investment proposal:
$$\begin{array}{lr}
\text{Initial investment:} \
\text{~~~~Depreciable assets (straight-line)} & \$36,000 \
\text{~~~~Working capital} & 4,000 \
\text{Operations (per year for 4 years):} \
\text{~~~~Cash receipts} & \$25,000 \
\text{~~~~Cash expenditures} & 11,000 \
\text{Disirvestment:} \
\text{~~~~Salvage value of equipment} & \$3,000 \
\text{~~~~Recovery of working capital} & 4,000 \
\text{Discount rate:} & 10 \text{ percent} \
\end{array}$$ Additional information for interest rate of 10 percent and four time periods:
$$\begin{array} { l l } 
\text { Present value of } \$ 1 & 0.68301 \
\text { Present value of an annuity of } \$ 1 & 3.16987
\end{array}$$ What is the net present value for the investment?

Accepted Answer

The answer of Firefox Company is considering the following investment...

Question 18

Firefox Company is considering the following investment proposal:
$$\begin{array}{lr}
\text{Initial investment:} \
\text{~~~~Depreciable assets (straight-line)} & \$36,000 \
\text{~~~~Working capital} & 4,000 \
\text{Operations (per year for 4 years):} \
\text{~~~~Cash receipts} & \$25,000 \
\text{~~~~Cash expenditures} & 11,000 \
\text{Disirvestment:} \
\text{~~~~Salvage value of equipment} & \$3,000 \
\text{~~~~Recovery of working capital} & 4,000 \
\text{Discount rate:} & 10 \text{ percent} \
\end{array}$$ Using a spreadsheet or financial calculator, determine the net present value for the investment.
The investment's net present value is:

Accepted Answer

The answer of Firefox Company is considering the following investment...

Question 19

Which of the following is part of a project's operations phase?

Accepted Answer

Capital budgeting recognizes cash flows in the three phases of a project. Collections of accounts receivable is an operations cash flow. However, depreciation is not a cash flow and the cost of financing capital expenditures is considered separately from capital budgeting, often under the topic of financial management.

Question 20

Which of the following amounts would be classified as part of the disinvestment phase for a project?

Accepted Answer

Disinvestment includes expenditures to dismantle facilities and dispose of waste.

Quiz 12: Capital Budgeting Decisions

The cost of capital is the average cost an organization pays to obtain the resources (i.e., borrowed funds, as well as on funds provided by investors in the company's stock) necessary to make investments.

The payback period method is frequently used as a screening tool, but it does not take into consideration the profitability of a project.

The payback period and the accounting rate of return methods are inferior to the net present value method because neither considers cash flows.

The net present value method and internal rate of return method are both deficient to the extent that neither method considers investment size.

To avoid accepting projects that actually should be rejected, a company should ignore all nonquantitative benefits in evaluating net present value.

The objective of capital budgeting models is to eliminate risk.

The depreciation tax shield is calculated as depreciation divided by tax rate.

Taxes have the effect of reducing both cash inflows from taxable revenues and cash outflows for tax deductible expenses.

When given a choice between $500 today or $500 tomorrow, a rationale decision maker will choose $500 today only because of risk.

An annuity is a series of payments of any size received over equal intervals of time.

_______________ involve(s) investment of significant financial resources in projects to develop or introduce new products or services, to expand current production or service capacity, or to change current production or service facilities.

Which of the following activities falls under the range of responsibility assumed by the capital budgeting committee?

Which of the following processes involve the development of capital budgeting project performance reports that compare planned to actual results?

A precondition for effective capital budgeting requires having:

Which of the following expenditures would be classified as part of the initial investment phase for equipment?

The third phase of a project's cash flows is:

Which of the following is part of a project's operations phase?

Which of the following amounts would be classified as part of the disinvestment phase for a project?