Chapter 14
18. The interest rate used to find the present value of a future cash flow is the a. prime rate. b. discount rate. c. cutoff rate. d. internal rate of return.
B
37. If a project generates a net present value of zero, the profitability index for the project will a. equal zero. b. equal 1. c. equal -1. d. be undefined.
B
40. The profitability index is a. the ratio of net cash flows to the original investment. b. the ratio of the present value of cash flows to the original investment. c. a capital budgeting evaluation technique that doesn't use discounted values. d. a mandatory technique when capital rationing is used.
B
62. All other factors equal, which of the following would affect a project's internal rate of return, net present value, and payback period? a. an increase in the discount rate b. a decrease in the life of the project c. an increase in the initial cost of the project d. all of the above
C
90. If r is the discount rate, the formula [1/(1 + r)] refers to the a. future value interest factor associated with r for one period. b. present value of some future cash flow. c. present value interest factor associated with r for one period. d. future value interest factor for an annuity with a duration of r periods.
C
3. Most capital budgeting techniques focus on cash flows.
T
8. The payback method measures a. how quickly investment dollars may be recovered. b. the cash flow from an investment. c. the economic life of an investment. d. the profitability of an investment.
A
92. All other things being equal, as the time period for receiving an annuity lengthens, a. the related present value factors increase. b. the related present value factors decrease. c. the related present value factors remain constant. d. it is impossible to tell what happens to present value factors from the information given.
A
93. Which of the following indicates that the first cash flow is at the end of a period? Ordinary annuity Annuity due a. yes no b. yes yes c. no yes d. no no
A
94. Assume that X represents a sum of money that Bill has available to invest in a project that will yield a return of r. In the formula Y = X(1 + r), Y represents the a. future value of X in one period. b. future value interest factor associated with r. c. present value of X. d. present value interest factor associated with r.
A
96. In computing the accounting rate of return, the __________ level of investment should be used as the denominator. a. average b. initial c. residual d. cumulative
A
10. The payback period is the a. length of time over which the investment will provide cash inflows. b. length of time over which the initial investment is recovered. c. shortest length of time over which an investment may be depreciated. d. shortest length of time over which the net present value will be positive.
B
12. The time value of money is explicitly recognized through the process of a. interpolating. b. discounting. c. annuitizing. d. budgeting.
B
17. When a project has uneven projected cash inflows over its life, an analyst may be forced to use _______ to find the project's internal rate of return. a. a screening decision b. a trial-and-error approach c. a post investment audit d. a time line
B
21. The net present value method assumes that all cash inflows can be immediately reinvested at the a. cost of capital. b. discount rate. c. internal rate of return. d. rate on the corporation's short-term debt.
B
22. Which of the following changes would not decrease the present value of the future depreciation deductions on a specific depreciable asset? a. a decrease in the marginal tax rate b. a decrease in the discount rate c. a decrease in the rate of depreciation d. an increase in the life expectancy of the depreciable asset
B
29. The weighted average cost of capital that is used to evaluate a specific project should be based on the a. mix of capital components that was used to finance a project from last year. b. overall capital structure of the corporation. c. cost of capital for other corporations with similar investments. d. mix of capital components for all capital acquired in the most recent fiscal year.
B
31. The weighted average cost of capital approach to decision making is not directly affected by the a. value of the common stock. b. current budget for capital expansion. c. cost of debt outstanding. d. proposed mix of debt, equity, and existing funds used to implement the project.
B
42. If the total cash inflows associated with a project exceed the total cash outflows associated with the project, the project's a. net present value is greater than zero. b. internal rate of return is greater than zero. c. profitability index is greater than 1. d. payback period is acceptable.
B
43. The net present value and internal rate of return methods of decision making in capital budgeting are superior to the payback method in that they a. are easier to implement. b. consider the time value of money. c. require less input. d. reflect the effects of sensitivity analysis.
B
49. As the marginal tax rate goes up, the benefit from the depreciation tax shield a. decreases. b. increases. c. stays the same. d. can move up or down depending on whether the firm's cost of capital is high or low.
B
55. Multiplying the depreciation deduction by the tax rate yields a measure of the depreciation tax a. shield. b. benefit. c. payable. d. loss.
B
58. Which of the following best represents a screening decision? a. determining which project has the highest net present value b. determining if a project's internal rate of return exceeds the firm's cost of capital c. determining which projects are mutually exclusive d. determining which are the best projects
B
6. All other factors equal, a large number is preferred to a smaller number for all capital project evaluation measures except a. net present value. b. payback period. c. internal rate of return. d. profitability index.
B
6. The decision concerning which assets to acquire to achieve an organization's objectives is an investing decision.
T
7. The payback period ignores the time value of money.
T
9. An organization's discount rate should be equal to or exceed the organization's cost of capital.
T
33. For an annuity due, the first cash flow occurs at the end of the period.
F
35. The accounting rate of return considers the time value of money.
F
36. Accounting rate of return is based on cash flows.
F
8. An organization's discount rate should be less than the organization's cost of capital.
F
17. Depreciation expense provides a tax shield against the payment of taxes.
T
18. The tax benefit from depreciation expense is the depreciation amount multiplied by the tax rate.
T
2. Capital budgeting uses both financial and non-financial criteria when evaluating projects.
T
20. Using MACRS depreciation for tax purposes and straight-line depreciation for book purposes will affect after-tax cash flows during the life of a project.
T
22. A decision in which projects are ranked according to their impact on achieving company objectives is a preference decision.
T
23. In a mutually inclusive project situation, if one project is chosen, all related projects are also chosen.
T
25. Managers must often use multiple measures to effectively rank capital projects.
T
26. Reinvestment assumptions are different under each method of ranking capital projects.
T
27. When considering risk, a manager will often use a judgmental method of risk adjustment.
T
28. When using the risk-adjusted discount rate method, a manager increases the rate used for discounting future cash inflows.
T
30. Postinvestment audits can provide feedback of the accuracy of original cash flow estimates.
T
31. Present value and future value computations assume the use of compound interest.
T
32. For an ordinary annuity, the first cash flow occurs at the end of the period.
T
34. The accounting rate of return considers the salvage value of an asset.
T
4. Project funding is a financing decision.
T
5. Project funding is an investing decision.
F
1. Which of the following capital budgeting techniques ignores the time value of money? a. payback period b. net present value c. internal rate of return d. profitability index
A
11. Which of the following capital budgeting techniques has been criticized because it fails to consider investment profitability? a. payback method b. accounting rate of return c. net present value method d. internal rate of return
A
14. When using one of the discounted cash flow methods to evaluate the desirability of a capital budgeting project, which of the following factors is generally not important? a. method of financing the project under consideration b. timing of cash flows relating to the project c. impact of the project on income taxes to be paid d. amounts of cash flows relating to the project
A
23. To reflect greater uncertainty (greater risk) about a future cash inflow, an analyst could a. increase the discount rate for the cash flow. b. decrease the discounting period for the cash flow. c. increase the expected value of the future cash flow before it is discounted. d. extend the acceptable length for the payback period.
A
25. For a project such as plant investment, the return that should leave the market price of the firm's stock unchanged is known as the a. cost of capital. b. net present value. c. payback rate. d. internal rate of return.
A
26. The pre-tax cost of capital is higher than the after-tax cost of capital because a. interest expense is deductible for tax purposes. b. principal payments on debt are deductible for tax purposes. c. the cost of capital is a deductible expense for tax purposes. d. dividend payments to stockholders are deductible for tax purposes.
A
28. The combined weighted average interest rate that a firm incurs on its long-term debt, preferred stock, and common stock is the a. cost of capital. b. discount rate. c. cutoff rate. d. internal rate of return.
A
3. In comparing two projects, the ___________ is often used to evaluate the relative riskiness of the projects. a. payback period b. net present value c. internal rate of return d. discount rate
A
34. The salvage value of an old lathe is zero. If instead, the salvage value of the old lathe was $20,000, what would be the impact on the net present value of the proposal to purchase a new lathe? a. It would increase the net present value of the proposal. b. It would decrease the net present value of the proposal. c. It would not affect the net present value of the proposal. d. Potentially it could increase or decrease the net present value of the new lathe.
A
38. If the profitability index for a project exceeds 1, then the project's a. net present value is positive. b. internal rate of return is less than the project's discount rate. c. payback period is less than 5 years. d. accounting rate of return is greater than the project's internal rate of return.
A
44. If an investment has a positive net present value, the a. internal rate of return is higher than the discount rate. b. discount rate is higher than the hurdle rate of return. c. internal rate of return is lower than the discount rate of return. d. hurdle rate of return is higher than the discount rate.
A
5. Assume that a project consists of an initial cash outlay of $100,000 followed by equal annual cash inflows of $40,000 for 4 years. In the formula X = $100,000/$40,000, X represents the a. payback period for the project. b. profitability index of the project. c. internal rate of return for the project. d. project's discount rate.
A
50. When a profitable corporation sells an asset at a loss, the after-tax cash flow on the sale will a. exceed the pre-tax cash flow on the sale. b. be less than the pre-tax cash flow on the sale. c. be the same as the pre-tax cash flow on the sale. d. increase the corporation's overall tax liability.
A
54. A project's after-tax net present value is increased by all of the following except a. revenue accruals. b. cash inflows. c. depreciation deductions. d. expense accruals.
A
56. Annual after-tax corporate net income can be converted to annual after-tax cash flow by a. adding back the depreciation amount. b. deducting the depreciation amount. c. adding back the quantity (t depreciation deduction), where t is the corporate tax rate. d. deducting the quantity [(1- t) depreciation deduction], where t is the corporate tax rate.
A
59. Which of the following are tax deductible under U.S. tax law? a. interest payments to bondholders b. preferred stock dividends c. common stock dividends d. all of the above
A
60. Sensitivity analysis is a. an appropriate response to uncertainty in cash flow projections. b. useful in measuring the variance of the Fisher rate. c. typically conducted in the post investment audit. d. useful to compare projects requiring vastly different levels of initial investment.
A
16. An organization's hurdle rate should be at least equal to the organization's cost of capital.
T
104. The weighted average cost of capital represents the a. cost of bonds, preferred stock, and common stock divided by the three sources. b. equivalent units of capital used by the organization. c. overall cost of capital from all organization financing sources. d. overall cost of dividends plus interest paid by the organization.
C
13. The time value of money is considered in long-range investment decisions by a. assuming equal annual cash flow patterns. b. investing only in short-term projects. c. assigning greater value to more immediate cash flows. d. ignoring depreciation and tax implications of the investment.
C
15. With regard to a capital investment, net cash inflow is equal to the a. cost savings resulting from the investment. b. sum of all future revenues from the investment. c. net increase in cash receipts over cash payments. d. net increase in cash payments over cash receipts.
C
16. In a discounted cash flow analysis, which of the following would not be consistent with adjusting a project's cash flows to account for higher-than-normal risk? a. increasing the expected amount for cash outflows b. increasing the discounting period for expected cash inflows c. increasing the discount rate for cash outflows d. decreasing the amount for expected cash inflows
C
19. A firm's discount rate is typically based on a. the interest rates related to the firm's bonds. b. a project's internal rate of return. c. its cost of capital. d. the corporate Aa bond yield.
C
2. Which of the following capital budgeting techniques may potentially ignore part of a project's relevant cash flows? a. net present value b. internal rate of return c. payback period d. profitability index
C
20. In capital budgeting, a firm's cost of capital is frequently used as the a. internal rate of return. b. accounting rate of return. c. discount rate. d. profitability index.
C
24. A change in the discount rate used to evaluate a specific project will affect the project's a. life. b. payback period. c. net present value. d. total cash flows.
C
33. If an analyst desires a conservative net present value estimate, he/she will assume that all cash inflows occur at a. mid year. b. the beginning of the year. c. year end. d. irregular intervals.
C
41. Which method of evaluating capital projects assumes that cash inflows can be reinvested at the discount rate? a. internal rate of return b. payback period c. profitability index d. accounting rate of return
C
51. In a typical (conservative assumptions) after-tax discounted cash flow analysis, depreciation expense is assumed to accrue at a. the beginning of the period. b. the middle of the period. c. the end of the period. d. irregular intervals over the life of the investment.
C
61. If management judges one project in a mutually inclusive set to be acceptable for investment, a. all the other projects in the set are rejected. b. only one other project in the set can be accepted. c. all other projects in the set are also accepted. d. only one project in the set will be rejected.
C
21. A decision in which projects are ranked according to their impact on achieving company objectives is a screening decision.
F
103. A capital budget is used by management to determine in what to invest how much to invest a. no no b. no yes c. yes no d. yes yes
D
27. The basis for measuring the cost of capital derived from bonds and preferred stock, respectively, is the a. pre-tax rate of interest for bonds and stated annual dividend rate less the expected earnings per share for preferred stock. b. pre-tax rate of interest for bonds and stated annual dividend rate for preferred stock. c. after-tax rate of interest for bonds and stated annual dividend rate less the expected earnings per share for preferred stock. d. after-tax rate of interest for bonds and stated annual dividend rate for preferred stock.
D
30. Debt in the capital structure could be treated as if it were common equity in computing the weighted average cost of capital if the debt were a. callable. b. participating. c. cumulative. d. convertible.
D
32. The ___________________ is the highest rate of return that can be earned from the most attractive, alternative capital project available to the firm. a. accounting rate of return b. internal rate of return c. hurdle rate d. opportunity cost of capital
D
35. The net present value method of evaluating proposed investments a. measures a project's internal rate of return. b. ignores cash flows beyond the payback period. c. applies only to mutually exclusive investment proposals. d. discounts cash flows at a minimum desired rate of return.
D
36. Which of the following statements is true regarding capital budgeting methods? a. The Fisher rate can never exceed a company's cost of capital. b. The internal rate of return measure used for capital project evaluation has more conservative assumptions than the net present value method, especially for projects that generate a positive net present value. c. The net present value method of project evaluation will always provide the same ranking of projects as the profitability index method. d. The net present value method assumes that all cash inflows can be reinvested at the project's cost of capital.
D
39. If a project's profitability index is less than 1, the project's a. discount rate is above its cost of capital. b. internal rate of return is less than zero. c. payback period is infinite. d. net present value is negative.
D
4. Which of the following capital budgeting techniques does not routinely rely on the assumption that all cash flows occur at the end of the period? a. internal rate of return b. net present value c. profitability index d. payback period
D
45. The rate of interest that produces a zero net present value when a project's discounted cash operating advantage is netted against its discounted net investment is the a. cost of capital. b. discount rate. c. cutoff rate. d. internal rate of return.
D
46. For a profitable company, an increase in the rate of depreciation on a specific project could a. increase the project's profitability index. b. increase the project's payback period. c. decrease the project's net present value. d. increase the project's internal rate of return.
D
47. Which of the following capital expenditure planning and control techniques has been criticized because it might mistakenly imply that earnings are reinvested at the rate of return earned by the investment? a. payback method b. accounting rate of return c. net present value method d. internal rate of return
D
48. If the discount rate that is used to evaluate a project is equal to the project's internal rate of return, the project's _____________ is zero. a. profitability index b. internal rate of return c. present value of the investment d. net present value
D
52. The pre-tax and after-tax cash flows would be the same for all of the following items except a. the liquidation of working capital at the end of a project's life. b. the initial (outlay) cost of an investment. c. the sale of an asset at its book value. d. a cash payment for salaries and wages.
D
53. The after-tax net present value of a project is affected by a. tax-deductible cash flows. b. non-tax-deductible cash flows. c. accounting accruals. d. all of the above.
D
57. Income taxes are levied on a. net cash flow. b. income as measured by accounting rules. c. net cash flow plus depreciation. d. income as measured by tax rules.
D
7. The payback method assumes that all cash inflows are reinvested to yield a return equal to a. the discount rate. b. the hurdle rate. c. the internal rate of return. d. zero.
D
9. If investment A has a payback period of three years and investment B has a payback period of four years, then a. A is more profitable than B. b. A is less profitable than B. c. A and B are equally profitable. d. the relative profitability of A and B cannot be determined from the information given.
D
91. Future value is the a. sum of dollars-in discounted to time zero. b. sum of dollars-out discounted to time zero. c. difference of dollars-in and dollars-out. d. value of dollars-in minus dollars-out for future periods adjusted for any interest-compounding factor.
D
95. The capital budgeting technique known as accounting rate of return uses salvage value time value of money a. no no b. no yes c. yes yes d. yes no
D
24. In a mutually inclusive project situation, if one project is chosen, all related projects are eliminated from further consideration.
F
29. When using the risk-adjusted discount rate method, a manager increases the rate used for discounting future cash outflows.
F
1. Capital budgeting uses financial criteria exclusively when evaluating projects.
F
11. The net present value method provides the actual rate of return for a project.
F
14. If a project's internal rate of return is greater than or equal to an organization's hurdle rate, the project is considered to be an unacceptable investment.
F
19. The tax benefit from depreciation expense is the depreciation amount divided by the tax rate.
F
10. If the net present value is positive, the actual return on a project exceeds the required rate of return.
T
12. The profitability index gauges the efficiency of a firm's use of capital.
T
13. If a project's internal rate of return is greater than or equal to an organization's hurdle rate, the project is considered to be an acceptable investment.
T
15. The internal rate of return is the rate at which a project's net present value is zero.
T