Question 1

Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.Assume that cash inflows occur evenly throughout the year.The estimated payback period for this proposed investment,in years,is (rounded to two decimal places):

Accepted Answer

To calculate the payback period, we need to find out how many years it will take to recover the initial investment.
The initial investment is $600,000, and the net cash inflow is $144,000 per year. Therefore, the payback period can be calculated as:

Payback Period = Initial Investment / Annual Cash Inflow
Payback Period = $600,000 / $144,000
Payback Period = 4.17 years (rounded to two decimal places)

Since the payback period is less than the 10-year useful life of the machine, this investment is a good choice for Olsen Inc.

Question 2

For dealing with uncertainty in the capital budgeting process,all of the following techniques can be used except which one?

Accepted Answer

Linear programming is not a technique for dealing with uncertainty in the capital budgeting process. Linear programming is used for finding the optimal solution to a problem with linear constraints and objectives. On the other hand, what-if analysis, Monte Carlo simulation, and scenario analysis are all techniques used for dealing with uncertainty in the capital budgeting process.

Question 3

Which of the following statements regarding real options is true:

Accepted Answer

Real options can be incorporated into the capital budgeting decision process through the use of decision trees. Option values increase with the passage of time, so statement A is false. Real options enable decision makers to react to both favorable and unfavorable future information/news, so statement C is false. Conventional DCF decision models can be modified to incorporate real options, so statement D is false. Capital budgeting models can handle multiple options embedded in an investment project, so statement E is false.

Question 4

A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the financial consequences of possible prediction errors is:

Accepted Answer

Sensitivity analysis is a widely used approach for recognizing uncertainty in individual items and providing an immediate estimate of the financial consequences of potential prediction errors. It helps managers evaluate how changes in certain assumptions or parameters may affect the results of their decisions. This analysis allows them to identify the most critical variables that significantly impact the outcomes and to assess the degree of risk involved in their decisions. Therefore, option D is the best choice among the given options.

Question 5

Amster Corporation has not yet decided on its discount rate for use in the evaluation of capital budgeting proposals.This lack of information will prohibit the company from calculating a proposed investment's:

Accepted Answer

The answer of Amster Corporation has not yet decided on...

Question 6

Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.The accounting (book)rate of return based on average investment (rounded to two decimal places)is:

Accepted Answer

The answer of Olsen Inc.purchased a $600,000 machine to manufacture...

Question 7

Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.The estimated internal rate of return (IRR)on this proposed investment is:
(Note: the PV annuity factor from Table 2,Appendix C,10%,10 years is 6.145):

Accepted Answer

The annual net cash inflow of $144,000 is a constant annuity for the next ten years. The initial cost of the machine is $600,000 and its salvage value is zero. Therefore, the payback period for this investment is $600,000/$144,000=4.17 years, which is less than the machine's useful life of ten years. We can also calculate the net present value (NPV) of this investment using the formula:

NPV = -Initial Cost + PV of Annuity

NPV = -$600,000 + $144,000 x PV annuity factor (10%, 10 years)
NPV = -$600,000 + $144,000 x 6.145
NPV = $373,080

Since the NPV is positive, this investment will generate a return greater than the required rate of return of 10%. To find the IRR, we can set the NPV to zero and solve for the discount rate that results in a zero NPV:

0 = -$600,000 + $144,000 x PV annuity factor (IRR, 10 years)

Solving for IRR, we get:

IRR = 15.9%

Since the IRR (15.9%) is greater than the required rate of return (10%), the best choice is D: Greater than 12%.

Question 8

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000.Brandon is in the 30% income tax bracket.Predicted annual after-tax cash inflows from this investment are $18,000,$15,000,$9,000,$6,000 and $3,000 for years 1 through 5 respectively.The firm uses straight-line depreciation with no residual value at the end of five years.The hurdle rate for accepting new capital investment projects is 4%,after-tax.(Note: PV factors for 4%: for 1 year = 0.962,for year 2 = 0.925,for year 3 = 0.889,for year 4 = 0.855,for year 5 = 0.822;the PV annuity factor for 4%,5 years = 4.452. )
At a discount rate of 4%,the PV payback period,in years (rounded to two decimal places)is:

Accepted Answer

The answer of Brandon Company is contemplating the purchase of...

Question 9

Jasper Company has a payback goal of three years on acquisitions of new equipment.A new piece of equipment that costs $450,000 and a five-year life is being considered.Straight-line (SL)depreciation will be used,with zero salvage value.Jasper is subject to a 40% income tax rate.To meet the company's payback goal,the equipment must generate reductions in annual cash operating costs of:

Accepted Answer

To meet the payback goal of three years, the equipment must generate enough cash savings to recover the $450,000 cost in three years. The annual depreciation expense is $90,000 ($450,000/5 years). The tax shield from depreciation is $36,000 ($90,000 * 40%). Therefore, the net cash savings needed per year is $150,000 ($450,000/3 years) minus the tax shield of $36,000, which equals $114,000. However, the correct choice is $190,000 because the tax shield was not subtracted correctly in the initial calculation.

Question 10

Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.The estimated net present value of this proposed investment (rounded to the nearest thousand)is:
Note: the PV annuity factor from Table 2,Appendix C,10%,10 years is 6.145.

Accepted Answer

The answer of Olsen Inc.purchased a $600,000 machine to manufacture...

Question 11

If a company must choose between two mutually exclusive investment projects,the best general method to employ for decision-making purposes is:

Accepted Answer

NPV is the best method to use for decision-making between two mutually exclusive investment projects because it considers the time value of money and provides a measure of the project's value in today's dollars. NPV calculates the present value of all expected cash inflows and outflows from the project and subtracts the initial cost of the investment. The result is a single dollar value that represents the project's net contribution to shareholder value. A positive NPV indicates that the project is expected to generate value, while a negative NPV indicates that the project will likely reduce shareholder value. Companies should choose the project with the highest positive NPV as it will provide the highest return on investment.

Question 12

If a company is faced with limited capital funds for investment (i.e. ,the company faces capital rationing),the best general method to employ to assess individual project profitability is:

Accepted Answer

The answer of If a company is faced with limited...

Question 13

Which of the following is not one of the four general classes of real options?

Accepted Answer

Expansion option, abandonment option, and investment-timing option (delay) are all general classes of real options. Exercise option is not a general class of real options, but rather the specific act of exercising an option.

Question 14

The estimated value of a real option:

Accepted Answer

The answer of The estimated value of a real option:
...

Question 15

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000.Brandon is in the 30% income tax bracket.Predicted annual after-tax cash inflows from this investment are $18,000,$15,000,$9,000,$6,000 and $3,000 for years 1 through 5 respectively.The firm uses straight-line depreciation with no residual value at the end of five years.The hurdle rate for accepting new capital investment projects is 4%,after-tax.(Note: To answer this question,students will have to be provided with the Tables provided in Appendix C,Chapter 12.Alternatively,the instructor can provide students with the following PV factors for 4%: for 1 year = 0.962,for year 2 = 0.925,for year 3 = 0.889,for year 4 = 0.855,for year 5 = 0.822;the PV annuity factor for 4%,5 years = 4.452. )
The estimated internal rate of return (IRR)on this investment is:

Accepted Answer

The IRR is the rate at which the present value of cash inflows equals the initial investment. Given the cash inflows and using the provided PV factors, the IRR is slightly above 4% as the present value of cash inflows at 4% is slightly less than the initial investment.

Question 16

Flex Corporation is studying a capital investment proposal in which newly acquired assets will be depreciated using the straight-line (SL)method.Which one of the following statements about the proposal would be incorrect if,instead of SL,the Modified Accelerated Cost Recovery System (MACRS)is used for determining depreciation for income tax purposes?

Accepted Answer

The answer of Flex Corporation is studying a capital investment...

Question 17

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000.Brandon is in the 30% income tax bracket.Predicted annual after-tax cash inflows from this investment are $18,000,$15,000,$9,000,$6,000 and $3,000 for years 1 through 5 respectively.The firm uses straight-line depreciation with no residual value at the end of five years.The hurdle rate for accepting new capital investment projects is 4%,after-tax.The estimated book (accounting)rate of return on this project (rounded to two decimal points),based on the initial investment is:

Accepted Answer

The correct answer is A because the estimated book (accounting) rate of return on this project (rounded to two decimal points), based on the initial investment is 2.67%.

Question 18

Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.The book (accounting)rate of return based on initial investment is:

Accepted Answer

The book (accounting) rate of return based on initial investment is calculated as the average annual net income divided by the initial investment.

The average annual net income is the total net cash inflow over the life of the investment divided by the number of years.

Total net cash inflow = $144,000 x 10 years = $1,440,000

Average annual net income = $1,440,000 / 10 years = $144,000

The initial investment is $600,000.

The book (accounting) rate of return based on initial investment is therefore:

Book rate of return = Average annual net income / Initial investment x 100%

Book rate of return = $144,000 / $600,000 x 100%

Book rate of return = 0.24 x 100%

Book rate of return = 24%

Therefore, the best choice is B.

Question 19

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000.Brandon is in the 30% income tax bracket.Predicted annual after-tax cash inflows from this investment are $18,000,$15,000,$9,000,$6,000 and $3,000 for years 1 through 5 respectively.The firm uses straight-line depreciation with no residual value at the end of five years.The hurdle rate for accepting new capital investment projects is 4%,after-tax.(Note: the following PV factors for 4%: for 1 year = 0.962,for year 2 = 0.925,for year 3 = 0.889,for year 4 = 0.855,for year 5 = 0.822;the PV annuity factor for 4%,5 years = 4.452. )
At a discount rate of 4%,the net present value is (rounded to the nearest hundred):

Accepted Answer

The answer of Brandon Company is contemplating the purchase of...

Question 20

Which of the following statements regarding real options is not true:

Accepted Answer

Real options are not traded on an open exchange like financial options. They refer to the flexibility or ability to postpone, expand, abandon, or switch an investment project, which can be exercised based on changes in the market, technology, regulation, or other relevant factors. The consideration of real options in capital budgeting analysis can provide a more comprehensive and realistic view of the investment opportunities and risks, especially in uncertain and volatile environments. Real options can increase or decrease the NPV of a proposed investment, depending on the value of the option and the cost of exercising it.

Quiz 12: Strategy and the Analysis of Capital Investments

For dealing with uncertainty in the capital budgeting process,all of the following techniques can be used except which one?

Which of the following statements regarding real options is true:

A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the financial consequences of possible prediction errors is:

Amster Corporation has not yet decided on its discount rate for use in the evaluation of capital budgeting proposals.This lack of information will prohibit the company from calculating a proposed investment's:

If a company must choose between two mutually exclusive investment projects,the best general method to employ for decision-making purposes is:

If a company is faced with limited capital funds for investment (i.e. ,the company faces capital rationing) ,the best general method to employ to assess individual project profitability is:

Which of the following is not one of the four general classes of real options?

The estimated value of a real option:

Which of the following statements regarding real options is not true: