Fin 301 module 12
'Space Invader' has an investment project has expected cash flows of $70,000 per year, has a cost of $195,000 and an expected life of five years. The project is in the 30% tax bracket and is associated with a previous sunk cost property purchase of $100,000. The project has a payback of 3.98 years.
F False, the project has a cost of 2.8 years. $195,000/$70,000
When the cash flows of a project change sign more than once, the internal rate of return model is the model preferred for project analysis.
F False, the internal rate of return model cannot be used in these situations of unconventional cash flows as there may be more than one internal rate of return due to the number of sign changes.
If the Internal Rate of Return for a project exceeds the cost of financing the project, the project is acceptable.
F False, the internal rate of return must exceed the cost of capital not the cost of project financing to be acceptable.
Projects such as parking lots, daycare centers, and employee gyms, though not the primary business of a firm, must be evaluated for capital budgeting effects on the value of the firm or for any other reason because they should only be accepted if they have positive net present values.
F False, these projects will not add specifically defined value to a firm, but should be evaluated for the level of value reduction they may provide as well as for other reasons that may add to employee, supplier, or customer happiness.
Projects with positive net present values increase the value of the firm because the cost of financing the project is less than the firm's cost of capital.
F False, a positive net present value will increase the value of the firm because the return earned exceeds the cost of capital.
A profitability index of .85 means that the present value of the benefits provided by a project being evaluated for acceptability exceed the present value of the project's costs by 85%.
F False, an index of .85 would imply the project is returning only $.85 per dollar of cost or that the project is reducing NPV by $.15 [$1 - $.85] per dollar of cost.
Capital budgeting project investment costs should include the purchase of the project as well as installation but not delivery costs as these are normally considered sunk costs since projects must always be delivered in some way.
F False, delivery costs are considered as a part of a project cost.
The acceptance of an independent project must include the effect that project has on other projects under consideration and their acceptability.
F False, independent projects do not affect other projects under consideration.
A positive net present value of a project occurs when the cost of the money to finance a project is less than the firm's cost of capital.
F False, it occurs when the return earned on the project exceeds the firm's cost of capital.
Internal rate of return is the capital budgeting methodology viewed by most academicians as the theoretically best model for project acceptance or rejection.
F False, net present value is viewed as the best theoretically as it provides the value added to the firm.
Costs which are not directly related to projects or products, but which are still incurred by the firm in order to operate are called sunk costs.
F False, overhead costs.
The internal rate of return model may provide more than one solution when the sign of the project's cash flows only changes one time.
F False, the internal rate of return model may provide more than one solution when the sign of the project's cash flows changes more than once.
'Space Invader' has an investment project has expected cash flows of $70,000 per year, has a cost of $195,000 and an expected life of five years. The project is in the 30% tax bracket and is associated with a previous sunk cost property purchase of $100,000. The project has a payback of 4.2 years.
F False, the project has a cost of 2.8 years. $195,000/$70,000
Depreciation and other non-cash expenditures, are non-cash in nature, and can thus be ignored in determining incremental project cash flows.
F False, these flows must be considered as they are a source of cash flow because they shelter profits from taxation.
In evaluating capital budgeting projects, incremental cash flows must be evaluated on a pre-tax basis to avoid financial financing effects.
F False, they should be evaluated on a post-tax basis.
Because it eliminates the multiple internal rates of return, and requires reinvestment at the cost of capital, the modified internal rate of return is the capital budgeting methodology viewed by most academicians as the theoretically best model for project acceptance or rejection.
F False, net present value is viewed as the best theoretically as it provides the value added to the firm.
Costs attributed to past investment and which cannot be recovered regardless of whether or not the new investment is undertaken are called overhead costs.
F False, sunk costs.
A positive net present value of a project occurs when the return earned on a project exceeds the firm's cost of capital.
T
A project with a positive net present value will always have an internal rate of return that exceeds the cost of capital.
T
Cash flow is defined as accounting income plus non-cash charges or expenses such as depreciation.
T
Costs attributed to past investment and which cannot be recovered regardless of whether or not the new investment is undertaken are called sunk costs.
T
Costs which are not directly related to projects or products, but which are still incurred by the firm in order to operate are called overhead costs.
T
Depreciation and other non-cash expenditures, are non-cash in nature, but they cannot be ignored in determining incremental project cash flows.
T
If the Internal Rate of Return for a project exceeds the cost of capital for the firm, the projects net present value will be positive.
T
In capital budgeting, the crossover Rate is that rate where the net present value's of alternative projects is the same.
T
Incremental flows are those specifically incurred by the project and do not include pre-project flows.
T
Net Present Value is the capital budgeting methodology viewed by most academicians as the theoretically best model for project acceptance or rejection.
T
One drawback to the use of the internal rate of return model is that there may be more than one internal rate of return for the project.
T
Projects with negative net present values reduce the value of the firm.
T
The acceptance of a mutually exclusive project must include the effect that project has on other projects under consideration and their acceptability.
T
The discounted payback model allows for risk to be assessed in two ways, the time it takes to discounted payback, and via a required rate of return commensurate with the risk of the project.
T
The internal rate of return model may provide more than one solution when the sign of the project's cash flows changes more than once.
T
The payback capital budgeting model assumes that all of the flows from the project have the same time value regardless of the timeframe in which they occur.
T
'Space Invader' has an investment project has expected cash flows of $70,000 per year, has a cost of $195,000 and an expected life of five years. The project is in the 30% tax bracket and is associated with a previous sunk cost property purchase of $100,000. The project has a payback of 2.8 years.
T True, the project has a cost of 2.8 years. $195,000/$70,000
The net present value: A. decreases as the required rate of return increases. B. is equal to the initial investment when the internal rate of return is equal to the required return. C. method of analysis cannot be applied to mutually exclusive projects. D. is directly related to the discount rate. E. is unaffected by the timing of an investment's cash flows.
a
The profitability index reflects the value created per dollar: A. invested. B. of sales. C. of net income. D. of taxable income. E. of shareholders' equity.
a
Which one of the following indicates that a project is definitely acceptable? A. Profitability index greater than 1.0 B. Negative net present value C. Modified internal rate return that is lower than the requirement D. Zero internal rate of return E. Positive average accounting return
a
Which one of the following is most closely related to the net present value profile? A. Internal rate of return B. Average accounting return C. Profitability index D. Payback E. Discounted payback
a
Which one of the following is the primary advantage of payback analysis? A. Incorporation of the time value of money concept B. Ease of use C. Research and development bias D. Arbitrary cutoff point E. Long-term bias
b
Generally, the simulation models for projects are developed using a: A. Pair of dice B. Roulette wheel C. Computer D. Pack of cards E. Casino
c
If an investment is producing a return that is equal to the required return, the investment's net present value will be: A. positive. B. greater than the project's initial investment. C. zero. D. equal to the project's net profit. E. less than, or equal to, zero.
c
Which one of the following indicates that a project is expected to create value for its owners? A. Profitability index less than 1.0 B. Payback period greater than the requirement C. Positive net present value D. Positive average accounting rate of return E. Internal rate of return that is less than the requirement
c
Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive? A. Internal rate of return B. Profitability index C. Net present value D. Modified internal rate of return E. Average accounting return
c
Which one of the following statements is correct? A. If the IRR exceeds the required return, the profitability index will be less than 1.0. B. The profitability index will be greater than 1.0 when the net present value is negative. C. When the internal rate of return is greater than the required return, the net present value is positive. D. Projects with conventional cash flows have multiple internal rates of return. E. If two projects are mutually exclusive, you should select the project with the shortest payback period.
c
The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? A. One of the time periods within the investment period has a cash flow equal to zero B. The initial cash flow is negative C. The investment has cash inflows that occur after the required payback period D. The investment is mutually exclusive with another investment under consideration E. The cash flows are conventional
d
Which one of the following methods of analysis ignores the time value of money? A. Net present value B. Internal rate of return C. Discounted cash flow analysis D. Payback E. Profitability index
d
You were recently hired by a firm as a project analyst. The owner of the firm is unfamiliar with financial analysis and only wants to know what the expected dollar return is per dollar spent on a given project. Which financial method of analysis will provide the information that the owner requests? A. Internal rate of return B. Modified internal rate of return C. Net present value D. Profitability index E. Payback
d
The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: A. produce a positive annual cash flow. B. produce a positive cash flow from assets. C. offset its fixed expenses. D. offset its total expenses. E. recoup its initial cost.
e
Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? A. Payback B. Profitability index C. Accounting rate of return D. Internal rate of return E. Net present value
e
Which one of the following methods of analysis has the greatest bias towards short-term projects? A. Net present value B. Internal rate of return C. Average accounting return D. Profitability index E. Payback
e
Today, Crunchy Snacks is investing $487,000 in a new oven. As a result, the company expects its cash flows to increase by $62,000 a year for the next two years and by $98,000 a year for the following three years. How long must the firm wait until it recovers all of its initial investment? A. 3.97 years B. 4.18 years C. 4.46 years D. 4.70 years E. The project never pays back.
e The project never pays back because the total cash inflow is only $418,000.
