SU 11

For the next 2 years, a lease is estimated to have an operating net cash inflow of $7,500 per annum, before adjusting for $5,000 per annum tax-basis lease amortization, and a 40% tax rate. The present value of an ordinary annuity of $1 per year at 10% for 2 years is 1.74. What is the lease's after-tax present value using a 10% discount factor?

$11,310

Beginning January 1, Year 1, Justin deposits 12 monthly payments of $1,000 in a savings account, with the last payment made on December 1, Year 1. If the monthly interest rate is 1%, what is the present value of the deposits?

$11,370

Whatney Co. is considering the acquisition of a new, more efficient press. The cost of the press is $360,000, and the press has an estimated 6-year life with zero salvage value. Whatney uses straight-line depreciation for both financial reporting and income tax reporting purposes and has a 40% corporate income tax rate. In evaluating equipment acquisitions of this type, Whatney uses a goal of a 4-year payback period. To meet Whatney's desired payback period, the press must produce a minimum annual before-tax operating cash savings of

$110,000

Para Co. is reviewing the following data relating to an energy-saving investment proposal: Ignoring the tax effect, what would be the annual savings needed to make the investment realize a 12% yield?

$12,306

Henry is saving for a new-model car to be delivered in 1 year. He signed an agreement with a car dealer to pay $1,500 monthly for 12 months at a monthly interest rate of 2%. The first payment is due in 1 month. What is the price of the car?

$20,115

A corporation is considering purchasing a machine that costs $100,000 and has a $20,000 salvage value. The machine will provide net annual cash inflows of $25,000 per year and has a 6-year life. The corporation uses a discount rate of 10%. The discount factor for the present value of a single sum 6 years in the future is 0.564. The discount factor for the present value of an annuity for 6 years is 4.355. What is the net present value of the machine?

$20,155

Aaron Co. needs a machine for a 5-year project. It can either (1) buy a machine without borrowing for a cash outlay of $515,000 or (2) enter into a 5-year operating lease for an annual payment of $105,000. The machine has an estimated useful life of 5 years, after which it can be sold for $15,000. The average tax rate is 30%, the discount rate for the project is 6%, and the straight-line depreciation method is used. What is the present value of the relevant net cash outflows of the direct purchase option?

$377,435

The CFO of a publicly traded chemical manufacturer is in the process of evaluating the company's dividend policy in relation to shareholder value. The company's dividend per share has been held constant at $2.30 for the last 10 years. The CFO would like to implement a 5% yearly dividend growth policy at the company starting next year. The CFO has determined that the required return in the market for the company's stock is 13%. What is the forecasted value of the company stock in 5 years if the CFO's dividend growth policy is implemented?

$38.53

Oak Co. bought a machine that will depreciate on the straight-line basis over an estimated useful life of 7 years. The machine has no salvage value. Oak expects the machine to generate after-tax net cash inflows from operations of $110,000 in each of the 7 years. Oak's minimum rate of return is 12%. Information on present value factors is as follows:

$490,040

Salem Co. is considering a project that yields annual net cash inflows of $420,000 for Years 1 through 5 and a net cash inflow of $100,000 in Year 6. The project will require an initial investment of $1,800,000. Salem's cost of capital is 10%. Present value information is presented below: What was Salem's expected net present value for this project?

-152,200

Fresh Co. is purchasing new equipment at a price of $160,000. The new equipment is expected to save $30,000 in cash payments annually. The equipment's estimated useful life is 8 years, with no residual value, and it is depreciated using the straight-line method. Fresh's predetermined minimum desired rate of return is 11%. The present value of an annuity of $1 at 11% for 8 periods is 5.146. Present value of $1 due in 8 periods at 11% is .434. Assuming an effective tax rate of 40%, what is the net present value based on the information above?

-26,204

The College Honor Society sells hot pretzels at the home football games. The pretzels are sold for $1.00 each, and the cost per pretzel is $.30. Any unsold pretzels are discarded because they will be stale before the next home game. The estimated demand for pretzels at the next home football game using an expected value approach is

4,400 pretzels.

Clifford Co. calculates the net present value (NPV) of a potential project for different discount rates. Based on the following results, what is the approximate internal rate of return (IRR) of the project?

6.1

Amster Corporation has not yet decided on its hurdle rate for use in the evaluation of capital budgeting projects. This lack of information will prohibit Amster from calculating a project's

No Yes No

A company invested in a new machine that will generate revenues of $35,000 annually for 7 years. The company will have annual operating expenses of $7,000 on the new machine. Depreciation expense, included in the operating expenses, is $4,000 per year. The expected payback period for the new machine is 5.2 years. What amount did the company pay for the new machine?

$166,400

Pole Co. is investing in a machine with a 3-year life. The machine is expected to reduce annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3. Present values of an annuity of $1 at 14% are Using a 14% cost of capital, what is the present value of these future savings?

$62,900

If a firm borrows $500,000 at 10% and is required to maintain $50,000 as a minimum compensating balance at the bank, what is the effective interest rate on the loan?

11.1%

A company has the following financial information: Net operating profit after taxes $18,000 Capital expenditures 10,000 Depreciation expense 8,000 Change in working capital 4,000 What amount is the company's free cash flow?

12,000

Aaron plans to save for the tuition cost of his son by investing a lump sum on January 1, Year 1. If he can invest at an interest rate of 2% per annum and the tuition of $33,000 is to be paid on January 1, Year 11, what investment is required?

27,070

The profitability index approach to investment analysis

Always yields the same accept/reject decisions for independent projects as the net present value method.

Capital budgeting is concerned with

Analysis of long-range decisions.

Which of the following statements is correct regarding financial decision making?

Capital budgeting is based on predictions of an uncertain future.

Which of the following events would decrease the internal rate of return of a proposed asset purchase?

Decrease tax credits on the asset.

Which one of the following statements about the payback method of investment analysis is correct? The payback method

Does not consider the time value of money.

The net present value of an investment project represents the

Excess of the discounted cash inflows over the discounted cash outflows.

A(n) <List A> lease transfers ownership of the leased asset to the lessee. A(n) <List B> lease does not.

Finance Operating

The Booster Club at Blair College sells hot dogs at home basketball games. The group has a frequency distribution of the demand for hot dogs per game and plans to apply the expected value decision rule to determine the number of hot dogs to stock. The Booster Club should select the demand level that

Has the greatest expected monetary value.

Fraud management programs

Have tangible and intangible components.

A company uses its company-wide cost of capital to evaluate new capital investments. What is the implication of this policy when the company has multiple operating divisions, each having unique risk attributes and capital costs?

High-risk divisions will over-invest in new projects and low risk divisions will under-invest in new projects.

Which of the following is irrelevant in projecting the cash flows of the final year of a capital project?

Historical cost of equipment disposed of in the project's first year.

Which of the following characteristics represent an advantage of the internal rate of return technique over the accounting rate of return technique in evaluating a project? Recognition of the project's salvage value Emphasis on cash flows Recognition of the time value of money

II and III.

Which of the following is not a shortcoming of the internal rate of return (IRR) method?

IRR is easier to visualize and interpret than net present value (NPV).

A multiperiod project has a positive net present value. Which of the following statements is correct regarding its required rate of return?

Less than the project's internal rate of return.

A characteristic of the payback method (before taxes) is that it

Neglects total project profitability.

Which of the following is not a form of non-price competition typical under monopolistic competition?

Special discounts.

In a capitalistic society, it is not considered possible to have 100% employment of the labor force. Therefore, full employment is defined as something less than 100% employment because of the existence of

Structural and frictional unemployment.

When ranking two mutually exclusive investments with different initial amounts, management should give first priority to the project

That has the greater profitability index.

Which of the following phrases defines the internal rate of return on a project?

The discount rate at which the net present value of the project equals zero.

When estimating cash flow for use in capital budgeting, depreciation is

Utilized in determining the tax costs or benefits.

The capital budgeting technique known as internal rate of return uses

Yes Yes

Buff Co. is considering replacing an old machine with a new machine. Which of the following items is economically relevant to Buff's decision? (Ignore income tax considerations.)

no yes

Dough Distributors has decided to increase its daily muffin purchases by 100 boxes. A box of muffins costs $2 and sells for $3 through regular stores. Any boxes not sold through regular stores are sold through Dough's thrift store for $1. Dough assigns the following probabilities to selling additional boxes through regular stores: What is the expected value of Dough's decision to buy 100 additional boxes of muffins?

$52

Morton Company needs to pay a supplier's invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance. The amount Morton Company must borrow to pay the supplier within the discount period and cover the compensating balance is

$54,444

If a firm purchases raw materials from its supplier on a 3/10, net 30, cash discount basis, the equivalent annual interest rate (using a 360-day year) of forgoing the cash discount and making payment on the 30th day is

55.67%

Which of the following is an advantage of net present value modeling?

It accounts for compounding of returns.

Kern Co. is planning to invest in a 2-year project that is expected to yield cash flows from operations, net of income taxes, of $50,000 in the first year and $80,000 in the second year. Kern requires an internal rate of return of 15%. The present value of $1 for one period at 15% is 0.870 and for two periods at 15% is 0.756. The future value of $1 for one period at 15% is 1.150 and for two periods at 15% is 1.323. The maximum that Kern should invest immediately is

$103,980

On January 1, Year 1, Linda decides to retire in 10 years. She wants to receive $30,000 annually for 5 years, with the first payment made on January 1, Year 10. For this purpose, she invests in a financial security that requires contributions of equal amounts annually, with the first payment due January 1, Year 1, and the last payment due January 1, Year 9. Assuming an interest rate of 2% per annum, what is the annual contribution to the security?

$14,503

Crenshaw Manufacturing has decided to acquire new equipment for its manufacturing facilities and is currently deciding how to finance the acquisition. Crenshaw can either (1) buy the equipment without borrowing or (2) enter into an operating lease agreement. The price of the equipment is $750,000, with an estimated useful life of 10 years and no salvage value. The equipment is expected to increase sales by $2,000,000 per year by incurring $1,600,000 of cost of goods sold. Assuming an average tax rate of 20%, what is the relevant cash inflow each year of buying the equipment in comparison with the lease option?

$15,000

Clark Co., which has a 14% cost of capital, invests in a project with an internal rate of return (IRR) of 16%. Over the 3-year life of the project, it is expected to generate net cash inflows of $20,000 at the end of the first year and $35,000 at the end of the second year. To recover the initial investment of $55,000, what is the minimum net cash inflow at the end of the last year of the project?

$18,339

Yarrow Co. is considering the purchase of a new machine that costs $450,000. The new machine will generate net cash flow of $150,000 per year and net income of $100,000 per year for 5 years. Yarrow's desired rate of return is 6%. The present value factor for a 5-year annuity of $1, discounted at 6%, is 4.212. The present value factor of $1, at compound interest of 6% due in 5 years, is 0.7473. What is the new machine's net present value?

$181,800

The following information pertains to Krel Co.'s computation of net present value relating to a contemplated project:

$300,000

Jane purchases a financial security on January 1, Year 1. The security will pay $3,000 monthly for 5 months, with the first payment due on February 1, Year 1. The security was originally priced at a monthly rate of 1%, but Jane agreed with the seller to price the security at a monthly rate of 2%. How much does Jane save?

$420

A company borrows to buy a machine for $400,000 at a borrowing rate of 5% on January 1, Year 1. The average tax rate of the company is 30%. The loan is repaid with equal payments within 2 years, with the first payment made on December 31, Year 1. What is the present value of the cash inflow relating to the interest from the machine?

$8,498

A company invests $100,000 in property. The company has a contract to sell it for $120,000 in one year. The bank has a guaranteed interest rate of 10%. What is the net present value of the company's investment in the property?

$9,091

A company is conducting a risk analysis on a project. One task has a risk probability estimated to be 0.15. The task has a budget of $35,000. If the risk occurs, it will cost $6,000 to correct the problem caused by the risk event. What is the expected monetary value of the risk event?

$900

Charlton Co. has the following financing options for the purchase of equipment on January 1, Year 1: Option 1: Sell the old equipment for $50,000 and use the proceeds with a loan of $450,000 to buy new equipment. The interest rate of the loan is 5%, and it will be repaid by equal payments in 10 years. The first payment will be due on December 31, Year 1. The cost of the old equipment is $300,000, with accumulated straight-line depreciation of $240,000, a remaining useful life of 2 years, and no salvage value. The new equipment has an estimated useful life of 10 years and no salvage value. It will be depreciated for tax purposes using the straight-line method. Option 2: Enter into an operating lease of 10 years for an annual lease payment of $57,000. What is the present value of the total relevant cash inflows relating to depreciation?

$99,091

An investment in a new product will require an initial outlay of $20,000. The cash inflow from the project will be $4,000 a year for the next 6 years. The payment will be received at the end of each year. What is the net present value of the investment at 8% using the correct factor from below?

-1,508.48

At the end of its fiscal year, Krist, Inc., had the following account balances: What is Krist's quick (acid-test) ratio?

0.750

Tam Co. is negotiating to purchase equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an annuity of $1 at 12% for 10 periods is 5.65. Present value of $1 due in 10 periods at 12% is .322. Accrual accounting rate of return based on initial investment to Tam Co. is

10

Bond Company needs to determine its effective interest rate on its current bank loan outstanding. Bond makes interest payments of $90,000 on a loan with a balance of $1,000,000. The bank requires that $100,000 be retained as a compensating balance. What is the effective interest rate?

10%

On July 1, Dichter Company obtained a $2,000,000, 180-day bank loan at an annual rate of 12%. The loan agreement requires Dichter to maintain a $400,000 compensating balance in its checking account at the lending bank. Dichter would otherwise maintain a balance of only $200,000 in this account. The checking account earns interest at an annual rate of 6%. Based on a 360-day year, the effective interest rate on the borrowing is

12.67

Tam Co. is negotiating to purchase equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an annuity of $1 at 12% for 10 periods is 5.65. Present value of $1 due in 10 periods at 12% is .322. Net present value to Tam Co. is

13,000

Oliver Co. is considering investing in a project with a profitability index of 1.0 based on the present value of future net cash flows. The cost of capital of the project is 15%, the risk-free interest rate is 3%, and the market rate of return is 6%. What is the internal rate of return (IRR) of the project?

15%

Clifford's pension fund will pay $40,000 per year for the next 5 years at the end of each year, after which the pension fund balance will be zero. The annual interest rate for the first 3 years is 3%, and the rate for the remaining 2 years is 4%. What is the current pension fund balance?

182,374

The Hopkins Company has estimated that a proposed project's 10-year annual net cash benefit, received each year end, will be $2,500 with an additional terminal benefit of $5,000 at the end of the 10th year. Assuming that these cash inflows satisfy exactly Hopkins' required rate of return of 8%, what is the initial cash outlay?

19,090

Jasper Company has a payback goal of 3 years on new equipment acquisitions. A new sorter is being evaluated that costs $450,000 and has a 5-year life. Straight-line depreciation will be used; no salvage is anticipated. Jasper is subject to a 40% income tax rate. To meet the company's payback goal, the sorter must generate reductions in annual cash operating costs of

190,000

Jorelle Company's financial staff has been requested to review a proposed investment in new capital equipment. Applicable financial data is presented below. There will be no salvage value at the end of the investment's life and, due to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at the end of each year. All cash flows are assumed to take place at the end of each year. For investment proposals, Jorelle uses a 12% after-tax target rate of return. The traditional payback period for the investment proposal is

2.23 years.

Harvey Co. is evaluating a capital investment proposal for a new machine. The investment proposal shows the following information: If acquired, the machine will be depreciated using the straight-line method. The payback period for this investment is

2.5 years.

Johnson Software has developed a new software package. Johnson's sales manager has prepared the following probability distribution describing the relative likelihood of monthly sales levels and relative income (loss) for the company's new software package. If Johnson decides to market its new software package, the expected value of additional monthly income will be

23,200

If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid within 15 days (using a 360-day year), the approximate cost or benefit of the trade credit terms is

24%

The following information pertains to three shipping terminals operated by Krag Corp.: Krag's internal auditor randomly selects one set of shipping documents, ascertaining that the set selected contains an error. The probability that the error occurred in the land terminal is

25%

The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified the four sources of funds given below. The cost of Alternative 4 to Frame Supply Company is

25.0%

Jackson Corporation uses net present value techniques in evaluating its capital investment projects. The company is considering a new equipment acquisition that will cost $100,000, fully installed, and have a zero salvage value at the end of its 5-year productive life. Jackson will depreciate the equipment on a straight-line basis for both financial and tax purposes. Jackson estimates $70,000 in annual recurring operating cash income and $20,000 in annual recurring operating cash expenses. Jackson's desired rate of return is 12% and its effective income tax rate is 40%. What is the net present value of this investment on an after-tax basis?

36,990

Tam Co. is negotiating to purchase equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an annuity of $1 at 12% for 10 periods is 5.65. Present value of $1 due in 10 periods at 12% is .322. Payback period to Tam Co. is

5.0 years.

Neu Co. is considering the purchase of an investment that has a positive net present value based on Neu's 12% hurdle rate. The internal rate of return would be

> 12%

Which of the following changes would result in the highest present value?

A $100 decrease in taxes each year for 4 years.

A depreciation tax shield is

A reduction in income taxes.

Which one of the following would cause the demand curve for a normal good to shift to the left?

A rise in the price of a complementary commodity.

What is an internal rate of return?

A time-adjusted rate of return from an investment.

Of the following decisions, capital budgeting techniques would least likely be used in evaluating the

Adoption of a new method of allocating nontraceable costs to product lines.

Capital budgeting is used for the decision analysis of

All of the answers are correct.

What is a challenge that the long-term aspect of capital budgeting presents to an accountant?

Capital projects affect multiple accounting periods.

Net present value as used in investment decision-making is stated in terms of which of the following options?

Cash flow.

What is the formula for calculating the profitability index of a project?

Divide the present value of the annual after-tax cash flows by the original cash invested in the project.

North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit. Belle's quick ratio is significantly better than the industry average. Which of the following factors should North consider as a possible limitation of using this ratio when evaluating Belle's creditworthiness?

Fluctuating market prices of short-term investments may adversely affect the ratio.

The accounting rate of return

Focuses on income as opposed to cash flows.

A weakness of the internal rate of return (IRR) approach for determining the acceptability of investments is that it

Implicitly assumes that the firm is able to reinvest project cash flows at the project's internal rate of return.

How are the following used in the calculation of the internal rate of return of a proposed project? Ignore income tax considerations.

Include Exclude

An increase in the market supply of beef would result in a(n)

Increase in the quantity of beef demanded.

If the present value of expected cash inflows from a project equals the present value of expected cash outflows, the discount rate is the

Internal rate of return.

Which of the following metrics equates the present value of a project's expected cash inflows to the present value of the project's expected costs?

Internal rate of return.

Russell, Inc., is evaluating four independent investment proposals. The expected returns and standard deviations for each of these proposals are presented below. Which one of the investment proposals has the least risk per unit of return?

Investment III.

The profitability index (present value index)

Is the ratio of the discounted net cash flows to initial investment.

Which of the following statements is true regarding the payback method?

It does not consider the time value of money.

A service auditor's report on internal control may be issued on management's description of a service organization system and the suitability of the design of controls or management's description of a service organization system and the suitability and operating effectiveness of controls. Which of the following is true about a type 1 report?

It should state that the auditor did not test the effectiveness of the controls.

A major problem arising from the use of fiscal policy to help stimulate an economy is that there

May be an expansionary and, therefore, inflationary bias to such policies.

A company has unlimited capital funds to invest. The decision rule for the company to follow in order to maximize shareholders' wealth is to invest in all projects having a(n)

Net present value greater than zero.

Future, Inc., is in the enviable situation of having unlimited capital funds. The best decision rule, in an economic sense, for it to follow would be to invest in all projects in which the

Net present value is greater than zero.

If the internal rate of return (IRR) of an investment is greater than its cost of capital, the

Net present value is greater than zero.

If an investment project has a profitability index of 1.15, the

Net present value of the project is positive.

The discount rate is determined in advance for which of the following capital budgeting techniques?

Net present value.

The profitability index is a variation on which of the following capital budgeting models?

Net present value.

Skytop Co., a nonprofit entity, is considering acquiring a machine for $80,000 that will produce uniform cash inflows of $25,000 for four years. Skytop evaluates capital projects using discounted cash flows at a cost of capital of 10% per year. Based upon the following table, what action should Skytop take regarding acquisition of the machine, and why?

No ($750)

An individual received an inheritance from a grandparent's estate. The money can be invested, and the individual can either (a) receive a $20,000 lump-sum amount at the end of 10 years or (b) receive $1,400 at the end of each year for the next 10 years. The individual wants a rate of return of 12% and uses the following information:

Option b; $7,910.

In equipment replacement decisions, which one of the following does not affect the decision-making process?

Original fair value of the old equipment.

An investor is comparing the options to lease or directly purchase an asset (without borrowing). Using the symbols below, which expression indicates that an investor is indifferent between the two options?

P = L + (I × T)

A client wants to know how many years it will take before the accumulated cash flows from an investment exceed the initial investment, without taking the time value of money into account. Which of the following financial models should be used?

Payback period.

Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year: Which projects should Maloney undertake during the upcoming year if it has only $12,000,000 of investment funds available?

Projects 1 and 2.

A company requires a rate of return of at least 15% for four potential projects. The company has a maximum of $1,000,000 each year for investment. Uninvested amounts can be rolled forward indefinitely, and no other capital is available. The company's policy is not to invest in projects with a net present value (NPV) lower than $40,000. The following are details about the four projects: If the uninvested amount at the beginning of the current year is $200,000, which projects are acceptable?

Projects 1, 2, and 3 only.

Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year: Which project(s) should Maloney undertake during the upcoming year assuming it has no budget restrictions?

Projects 1, 2, and 4.

A company requires a rate of return of 15% for four potential projects. The company has a maximum of $1,000,000 each year for investment. No other capital is available. The following are details about the four projects: Which projects should be accepted?

Projects 2, 3, and 4.

A company has a required rate of return of 15% for five potential projects. The company has a maximum of $500,000 available for investment and cannot raise any capital. Details about the five projects are as follows: The company should choose which of the following projects?

Projects 2, 4, and 5 only.

In considering the payback period for three projects, Fly Corp. gathered the following data about cash flows: Which of the projects will achieve payback within 3 years?

Projects B and C.

Wood, Inc., is considering four independent investment proposals. Wood has $3 million available for investment during the present period. The investment outlay for each project and its projected net present value (NPV) is presented below. Which of the following project options should be recommended to Wood's management?

Projects I, II, and III only.

Brown and Company uses the internal rate of return (IRR) method to evaluate capital projects. Brown is considering four independent projects with the following IRRs: Brown's cost of capital is 13%. Which one of the following project options should Brown accept based on IRR?

Projects III and IV only.

Management at MDK Corp. is deciding whether to replace a delivery van. A new delivery van costing $40,000 can be purchased to replace the existing delivery van, which cost the company $30,000 and has accumulated depreciation of $20,000. An employee of MDK has offered $12,000 for the old delivery van. Ignoring income taxes, which of the following correctly states relevant costs when making the decision on whether to replace the delivery vehicle?

Purchase price of new van, disposal price of old van.

Depreciation tax shields are considered by the lessee (buyer) in capital budgeting applications involving

Purchases with or without borrowing and finance leases.

X and Y are substitute products. If the price of product Y increases, the immediate impact on product X is that its

Quantity demanded will increase.

A company has a policy of frequently cutting prices to increase sales. Product demand is significantly elastic. What impact would this have on the company's situation?

Quantity increases proportionally more than the price declines.

All of the following are methods used to evaluate investments for capital budgeting decisions except

Required rate of return.

When using the net present value method for capital budgeting analysis, the required rate of return is called all of the following except the

Risk-free rate.

Relevant cash flows for a finance lease and a direct purchase of an asset without borrowing differ with respect to

Tax savings on interest expense, the purchase price of the asset, and lease payments.

The ABC Company is trying to decide between keeping an existing machine and replacing it with a new machine. The old machine was purchased just 2 years ago for $50,000 and had an expected life of 10 years. It now costs $1,000 a month for maintenance and repairs due to a mechanical problem. A new machine is being considered to replace it at a cost of $60,000. The new machine is more efficient, and it will only cost $200 a month for maintenance and repairs. The new machine has an expected life of 10 years. In deciding to replace the old machine, which of the following factors, ignoring income taxes, should ABC not consider?

The original cost of the old machine.

Each share of nonparticipating, 8%, cumulative preferred stock in a company that meets its dividend obligations has all of the following characteristics except

Voting rights in corporate elections.

For capital budgeting purposes, management would select a high hurdle rate of return for certain projects because management

Wants to factor risk into its consideration of projects.

The capital budgeting technique known as the accounting rate of return uses

Yes Yes

Using the payback method, how many years will it take to pay back Major's initial investment in the machine?

2.50

Jorelle Company's financial staff has been requested to review a proposed investment in new capital equipment. Applicable financial data is presented below. There will be no salvage value at the end of the investment's life and, due to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at the end of each year. All cash flows are assumed to take place at the end of each year. For investment proposals, Jorelle uses a 12% after-tax target rate of return. The net present value for the investment proposal is

$106,160

Benjamin invests $10,000 in a treasury note that matures in 6 years. The treasury note yields 2% per annum. How much will the treasury bill repay at maturity?

$11,261

The principle that protects corporate directors from personal liability for acts performed in good faith on behalf of the corporation is known as the

Business judgment rule.

The relevance of a particular cost to a decision is determined by

Potential effect on the decision.

A company purchased property that it expects to sell for $14,000 next year. The net present value of the investment is $1,000. The company is guaranteed an interest rate of 12% by the bank. What amount did the company pay for the property?

$11,500

Conrad has leased an apartment. The interest rate stated in the lease is 1% per month, and rent is due at the first of each month. At the beginning of every year, the landlord estimates the price of the apartment a year from the date of assessment. Total rent payments for the year will have a future value equal to 10% of the assessment. At the beginning of the year, with the first rent payment of $2,000 due immediately, what is the estimated price of the apartment in 1 year?

$256,200

Smith Legal Services has offered to represent a plaintiff in a lawsuit for a retainer of $20,000 plus 40% of any award over $20,000. Smith expects to incur out-of-pocket expenditures of $15,000 in litigating the suit. Possible court awards with their associated probabilities are: What is the expected value to Smith of the lawsuit?

$27,400

Aaron Co. needs a machine for a 5-year project. It can either (1) buy a machine without borrowing for $500,000 or (2) enter into a 5-year operating lease for an annual payment of $105,000. The machine has an estimated useful life of 5 years, after which it can be sold for $15,000. The average tax rate is 30%, and the discount rate for the project is 6%. What is the present value of the relevant net cash outflows of the operating lease?

$309,582

Rosie Co. prepared the following payoff table for the supply and demand of its product for the next year. What is the expected value with perfect information?

$32

Lin Co. is buying machinery it expects will increase average annual operating income by $40,000. The initial increase in the required investment is $60,000, and the average increase in required investment is $30,000. To compute the accrual accounting rate of return, what amount should be used as the numerator in the ratio?

$40,000

Dan Corporation's options for acquiring a new machine are a 5-year operating lease or a purchase. The machine will increase unit output for an after-tax incremental profit of $50,000 in Year 1, $70,000 in Year 2, $70,000 in Year 3, $100,000 in Year 4, and $100,000 in Year 5. The lease rent is $90,000 payable on the first day of each year. Dan uses straight-line depreciation, which is acceptable under both financial and tax accounting. The applicable tax rate is 40%, and the weighted average cost of capital is 11%. What is the net present value of leasing the new machine?

$42,091

Wilkinson, Inc., which has a cost of capital of 12%, invested in a project with an internal rate of return (IRR) of 14%. The project is expected to have a useful life of 4 years, and it will produce net cash inflows as follows: The initial cost of this project amounted to

$7,483

Morton Company needs to pay a supplier's invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance. Assuming Morton Company borrows the money on the last day of the discount period and repays it 30 days later, the effective interest rate on the loan is

13.33%

A company purchases an item for $43,000. The salvage value of the item is $3,000. The cost of capital is 8%. Pertinent information related to this purchase is as follows: What is the discounted payback period in years?

3.25

A project has an initial outlay of $1,000. The projected cash inflows are What is the investment's payback period?

3.5 years.

Fitzgerald Company is planning to acquire a $250,000 machine that will provide increased efficiencies, thereby reducing annual operating costs by $80,000. The machine will be depreciated by the straight-line method over a 5-year life with no salvage value at the end of 5 years. Assuming a 40% income tax rate, the machine's payback period is

3.68 years.

A company is investing in a machine costing $365,000. The following table shows selected financial data for the company for the next 5 years: What is the payback period on this machine?

3.8 years.

Jodi purchases a financial security on January 1, Year 1. The security pays $3,000 monthly for a year, with the first payment due on February 1, Year 1. Assuming a monthly interest rate of 1%, what is the price of the security?

33,780

Given a 10% discount rate with cash inflows of $3,000 at the end of each year for 5 years and an initial investment of $11,000, what is the net present value?

370

The probabilities shown in the table below represent the estimate of sales for a new product. Using the midpoint of each range as the best estimate for that range, what is the best estimate of the expected sales of the new product?

380

Sonya is saving for the tuition of her daughter, who will enter college in 8 years. Each year, she will deposit $20,000 in a savings account. The first contribution will be made on December 31, Year 1, and the last payment on December 31, Year 8. At the beginning of Year 9, Sonya will withdraw 4 equal annual amounts, with the first received on January 1, Year 9. If the prevailing market interest rate is expected to remain at 2% for the next 10 years, what is the amount withdrawn each year?

44,227

A new venture will require an initial investment in fixed assets of $20,000 and in working capital of $10,000. The fixed assets will have no salvage value at the end of the project's 4-year life, and the working capital will be completely recovered at the end of the project. The organization's cost of capital is 16%. At a time value of money of 16%, the present value of an ordinary annuity of $1/year for 4 years is 2.8, and the present value of $1 at the end of 4 years is 0.6. What is the annual net cash inflow required for the project to break even on a time-adjusted basis?

8,571

Pena Company is considering a project that calls for an initial cash outlay of $50,000. The expected net cash inflows from the project are $7,791 for each of 10 years. What is the IRR of the project?

9

Elan Corporation is considering borrowing $100,000 from a bank for 1 year at a stated interest rate of 9%. What is the effective interest rate to Elan if this borrowing is in the form of a discounted note?

9.89%

A project should be accepted if the present value of cash flows from the project is

Greater than the initial investment.

The net present value of a proposed investment is negative; therefore, the discount rate used must be

Greater than the project's internal rate of return.

The NPV of a project has been calculated to be $215,000. Which one of the following changes in assumptions would decrease the NPV?

Increase the discount rate.

The use of an accelerated method instead of the straight-line method of depreciation in computing the net present value of a project has the effect of

Increasing the present value of the depreciation tax shield.

The term structure of interest rates is the relationship of

Interest rates over time.

Which of the following is a limitation of the profitability index?

It requires detailed long-term forecasts of the project's cash flows.

A project's net present value, ignoring income tax considerations, is normally affected by the

Proceeds from the sale of the asset to be replaced.

Which of the following should be used if capital rationing needs to be considered when comparing capital projects?

Profitability index.

Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year: Which project(s) should Maloney undertake during the upcoming year if it has only $6,000,000 of funds available?

Project 1.

A company is considering two projects, which have the following details: Which project would provide the larger after-tax cash inflow?

Project B because after-tax cash inflow equals $635.

Bennet, Inc., uses the net present value method to evaluate capital projects. Bennet's required rate of return is 10%. Bennet is considering two mutually exclusive projects for its manufacturing business. Both projects require an initial outlay of $120,000 and are expected to have a useful life of four years. The projected after-tax cash flows associated with these projects are as follows: Assuming adequate funds are available, which of the following project options would you recommend that Bennet's management undertake?

Project X only.

The internal rate of return (IRR) is the

Rate of interest for which the net present value is equal to zero.

Depreciation is incorporated explicitly in the discounted cash flow analysis of an investment proposal because it

Reduces the cash outlay for income taxes.

Capital investment projects include proposals for all of the following except

Refinancing existing working capital agreements.

When a 5% fall in the price of athletic shoes causes the quantity demanded to increase by 10%, the demand for athletic shoes is said to be

Relatively elastic.

The expected monetary value of an act is the

Sum of the conditional profit (loss) for each event times the probability of each event's occurrence.

The term that refers to costs incurred in the past that are not relevant to a future decision is

Sunk cost.

A company is considering two mutually exclusive projects with the following projected cash flows: If the company's objective is to maximize shareholder wealth, which one of the following is the most valid reason for selecting one of the projects?

The net present value of Project A is greater than the net present value of Project B; therefore, select Project A.

Which one of the following items is least likely to directly impact an equipment replacement capital expenditure decision?

The net present value of the equipment that is being replaced.

In capital budgeting, which of the following items is included in the payback model calculation?

The total amount of the initial outlay for the project.

Employees of an entity feel peer pressure to do the right thing; management appropriately deals with signs that problems exist and resolves the issues; and dealings with customers, suppliers, employees, and other parties are based on honesty and fairness. According to COSO, the above scenario is indicative of which of the following?

Tone at the top.

Assume that the interest rate is greater than zero. Which of the following cash-inflow streams should you prefer?

Year 1 $400 Year 2 $300 Year 3 $200 Year 4 $100

Which of the following capital budgeting techniques implicitly assumes that the cash flows are reinvested at the company's minimum required rate of return?

Yes No

The following methods are used to evaluate capital investment projects: Internal rate of return Average rate of return Payback Net present value Which one of the following correctly identifies the methods that utilize discounted cash-flow (DCF) techniques?

Yes No No Yes

Polo Co. requires higher rates of return for projects with a life span greater than 5 years. Projects extending beyond 5 years must earn a higher specified rate of return. Which of the following capital budgeting techniques can readily accommodate this requirement?

Yes Yes

The capital budgeting technique known as net present value uses

Yes Yes

PB Company is evaluating an investment project based on its payback period. The policy is to reject the investment project if it has a payback period greater than 4 years. The project will generate cash flows as shown in the following table: The project is rejected because its payback period exceeds PB's standard by 0.625 years. What is the initial investment required for the project?

$1,600,000

Colter Corp. is conducting an analysis of a potential capital investment. The project is expected to increase sales by $100,000 and reduce costs by $50,000 annually. Depreciation expense is $30,000 per year. Colter's marginal tax rate is 40%. What is the annual operating cash flow for the project?

$102,000

Mesa Company is considering an investment to open a new banana processing division. The project involves an initial investment of $45,000, and cash inflows of $20,000 can be expected in each of the next 3 years. The hurdle rate is 10%. The present value of an ordinary annuity of 1 discounted at 10% for 3 periods is 2.487. The present value of 1 due in 3 periods discounted at 10% is .751. What is the profitability index for the project?

1.1053

What is the approximate IRR for a project that costs $50,000 and provides cash inflows of $20,000 for 3 years?

10%

The Dixon Corporation has an outstanding 1-year bank loan of $300,000 at a stated interest rate of 8%. In addition, Dixon is required to maintain a 20% compensating balance in its checking account. Assuming the company would normally maintain a zero balance in its checking account, the effective interest rate on the loan is

10.0%

Which of the following statements that relate to capital budgeting is true?

Accelerated methods of depreciation provide tax shields that are advantageous from a present-value point of view.

Which one of the following methods for evaluating capital projects is the least useful from an investment analysis point of view?

Accounting rate of return.

Which one of the following statements concerning cash flow determination for capital budgeting purposes is not correct?

Book depreciation is relevant because it affects net income.

Which of the following provisions must a for-profit corporation include in its articles of incorporation to obtain a corporate charter? Provision for the issuance of voting stock Name of the corporation

Both I and II.

For tax purposes, which of the following is a true statement comparing an operating lease and a finance lease?

Both leases ignore the purchase price of the leased asset.

The internal rate of return for a project can be determined

By finding the discount rate that yields a net present value of zero for the project.

A limitation of using the discounted payback method to evaluate a project is that it ignores which of the following?

Cash flows after the payback period.

The calculation of depreciation is used in the determination of the net present value of an investment for which of the following reasons?

Depreciation increases cash flow by reducing income taxes.