ACCT 3203 Chapter 12

The internal rate of return for a project with an original investment outlay followed by a series of uneven after-tax cash inflows can be estimated by using:

1) A trial-and-error approach 2) The built-in IRR function in Excel

Common cash flows associated with the disposal stage of a capital investment project include:

1) Asset-removal costs 2) Asset-restoration costs (to bring the asset back to an original state)

A proper capital budgeting analysis includes an analysis of after-tax cash flows and the timing of these flows because:

1) Companies are valued on the basis of their dividend-paying ability 2) The timing of cash flows matter due to the time value of money 3) Companies are valued based on their ability to generate "free cash flow"

The NPV decision model is recommended for capital budgeting decision making purposes, relative to the internal rate of return (IRR) model, when the:

1) Decision involves a choice between two mutually exclusive projects 2) Project has multiple IRRs

The net present value (NPV) decision model is recommended for capital budgeting decision making purposes, relative to the internal rate of return (IRR) model, when the:

1) Decisions involves a choice between two mutually exclusive projects 2) Project has multiple IRRs

The cost of common stock (and retained earnings) as estimated by the capital asset pricing model (CAPM) includes the:

1) Estimated market return on a market portfolio of securities 2) Risk-free rate of interest 3) Particular firm's "beta coefficient"

The capital asset pricing model (CAPM):

1) Estimates required rate of return on equity for a company 2) Can be used to estimate the rate of return on equity for a company 3) Includes a risk premium

To properly analyze an asset-replacement decision we need to:

1) Focus on the incremental (i.e., differential) costs and revenues associated with the two decision alternatives 2) Determine, at the end of the life of the project, differential recovery of net working capital (old versus new asset) 3) Calculate, at the termination of the project, differential after-tax cash proceeds from the sale or disposal of each asset (old versus new)

Relevant financial data for the analysis of proposed capital investment projects includes:

1) Future after-tax revenues associated with the proposed investment 2) Incremental administrative costs due to the acceptance of a proposed project

Regarding the use of the modified internal rate of return (MIRR) for capital budgeting purposes:

1) Given the controversy surrounding MIRR, the safest bet (except under capital rationing) is to use NPV as the decision criterion 2) It suffers from the same drawback of IRR when evaluating mutually exclusive projects

In the capital budgeting analysis of a proposed investment, opportunity cost should be:

1) Included in the analysis because they meet the test of information relevancy 2) Expressed on an after-tax basis

Net working capital:

1) Increases cash inflows at project disposal 2) Is invested during project initiation

Discounted cash flow (DCF) decision models for making capital investment decisions include the:

1) Internal rate of return (IRR) method 2) Net present value (NPV) method 3) Profitability index (PI) model

Breakeven after-tax cash flow:

1) Is a measure of risk or uncertainty, within a capital budgeting context 2) Can be estimated for a project by using the GOAL SEEK function in Excel

The analytic hierarchy process (AHP):

1) Is a structured way to ensure that proposed capital investment projects are formally linked to organizational strategy 2) Can be used in conjunction with the analysis of capital expenditure proposals 3) Is an example of a multi-criteria decision model

A capital budget is a:

1) Listing of approved investment projects 2) Schedule of anticipated cash outflows associated with the approved set of investment projects

The modified internal rate of return (MIRR) for a proposed investment project:

1) Provides a more conservative estimate of a project's rate of return than the project's IRR 2) Assumes that interim cash inflows earn a return equal to the company's WACC

When a company is faced with capital rationing, capital budget amounts should be allocated to projects of the basis of:

1) Relative profitability 2) NPV per dollar invested

The net present value (NPV) of a project with a set of uneven after-tax cash inflows, following an original investment outlay, can be estimated by:

1) Subtracting the original investment from the PV of future after-tax cash inflows, estimated using PV factors for each after-tax cash flow 2) Using the built-in NPV function in Excel, based on the weighted-average cost of capital for the company

The cost of preferred stock, as a component in the weighted-average cost of capital (WACC), is:

1) The current dividend yield on the company's preferred stock 2) Calculated as the ratio of the current dividend per share on the stock to the current market price of the stock

The internal rate of return (IRR) on a proposed investment project is:

1) The interest rate that results in a NPV of zero 2) An estimate of the true rate of return on the project

Important attributes of the AHP (analytical hierarchy process) include:

1) The use of pairwise-comparisons that decision makers must make to establish the relative importance of specific decision criteria 2) The ability to combine both quantitative (e.g., financial) and non-quantitative (e.g., strategic) factors in an overall decision model

Real options should included in a formal capital budgeting analysis because:

1) Their existence affects the overall risk associated with investing in a given project 2) They may change a project's expected cash flows

The NPV of a project that has an investment outlay in year 0 followed in uniform stream of after-tax cash inflows can be determined by:

1) Using the NPV built-in function in Excel 2) Converting the cash flows to PV by using an annuity factor and then subtracting the original investment outlay

If a project has uniform after-tax inflows, the internal rate of return (IRR) for the project can be estimated by:

1) Using the built-in IRR function in Excel 2) Using the annuity table and interpolating if desired

If the PV of the estimated cash inflows for a proposed project is greater than the PV of the cash outflows for the project, then the project:

1) Will have a positive NPV 2) Is an acceptable investment 3) Adds shareholder value

A company has a $200,000 bank loan outstanding at 9% interest and $100,000 of $20 par value preferred stock outstanding (5,000 shares) that pays a 15% dividend. The current market value of the stock is $110,000 or $22 per share. Given a tax rate of 30%, calculate the company's cost of preferred stock

13.64%

The weighted-average cost of capital (WACC) for a company represents:

An estimate of the average after-tax cost of obtaining capital (funds) for a company

The yield-to-maturity of a debt instrument represents:

An estimate of the effective rate of interest on the instrument

The WACC is appropriate to use in DCF model to evaluate _____-_____ projects

Average-risk

The process of identifying, evaluating, selecting, and controlling long-term project investments is called

Capital budgeting

A project that involves a large expenditure of funds and expected future benefits that last for several years is a(n)

Capital investment

The final stage of the capital budgeting process is to:

Conduct a post-audit of the investment project

The IRR and NPV capital budgeting models will lead to the same decision recommendation if (or when) the:

Decision is limited to accepting or rejecting a given investment project

Non-cash expenses:

Decrease the firm's income tax liability

A non cash revenue ___ the cash available to a for-profit from that pays taxes in the United States

Decreases

Depreciation and other non cash expenses ____ taxable income and ____ after-tax cash flow

Decreases; increases

In a proper analysis of a proposed capital investment project, the ____ ____ is used to convert future after-tax cash flows to a present-value basis

Discount rate

The term "yield-to-maturity" for a debt instrument (such as a bond) refers to the ____ interest rate of a debt

Effective

For purposes of calculating the weighted-average cost of capital (WACC), the after-tax cost of debt, given a tax rate = t, is defined as the:

Effective interest rate on the debt * (1-t)

Under the IRR decision model, a project should be accepted if the:

Estimated IRR of the project is greater than the company's discount rate

Because net working capital is invested at the beginning of a project and returned at the end, it can be ignored when determining the after-tax cash flows for capital investment analysis

False

Noncash revenues and expenses are not considered when calculating after-tax cash flows associated with a proposed capital investment project

False

An alternative to the use of the NPV or IRR decision model for capital budgeting purposes is dictated when the:

Firms faces a capital constraint

The minimum acceptable rate of return on a proposed investment is referred to as the ____ _____ for the investment

Hurdle rate

The rate of return that produces an NPV of zero is the:

Internal rate of return (IRR)

Under the NPV model, a project should be accepted if:

Its estimated NPV is greater than zero

Within the context of the capital asset pricing model (CAPM), market risk premium is defined as:

The excess of the expected market rate of return over the estimated risk-free of return

The reinvestment assumption in conventional IRR calculations may:

Make bad projects look acceptable

In determining weights to be used in estimating a company's weighted-average cost of capital (WACC):

Market values of the capital components (debt and equity) should be used

A company's beta coefficient (as used in conjunction with the CAPM):

Measures the sensitivity of a given stock's return to overall market fluctuations

The analysis hierarchy process (AHP) is popular ____ ____ model

Multicriteria decision

A company is considering two projects - F & G. If F is accepted, then G cannot be accepted. If G is accepted, then F cannot be accepted. This implies that F & G are ____ _____ projects

Mutually exclusive

An in-depth review of a completed capital investment project, for purposes of comparing projected results (benefits and costs) to realized results (both financial and non-financial) is referred to as a(n):

Post audit

The current equivalent dollar value of a future cash flow, using an appropriate discount rate, is known as its

Present value

The formula to calculate the after-tax amount of a cash operating expense, given a tax rate of t, is:

Pretax cash operating expense * (1-t)

The estimated NPV of a proposed capital investment project is:

The difference between the present value of estimated after-tax cash inflows and after-tax cash outflows

Capital budgeting refers to:

Procedures used by an organization to plan and control its portfolio of capital expenditures

A criticism of the conventional IRR method is that it assumes that interim after-tax cash inflows from a project are:

Reinvested at the IRR rate

The term capital structure refers to the:

Relative mix of debt vs. equity in a company's capital structure

The name for a variety of methods (What-if analysis, scenario analysis, and Monte Carlo simulation) that examine how an amount changes if factors involved in predicting that amount changes is

Sensitivity analysis

The processes an organization uses to monitor the progress of achieving strategic goals is called a(n) ____ _____ system

Strategic control

The formula to calculate the after-tax effect of a taxable cash receipt, given a tax rate of t, is:

Taxable cash receipt * (1-t)

When outflows are expressed as negative numbers, the estimated net present value (NPV) of a proposed capital investment project is:

The sum of the present value of cash inflows and present value of cash outflows

In a capital budgeting context, current assets (other than cash) less current liabilities equals net

Working capital