Principles of Finance Quiz 3: Chapters 10-11

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A corporation is selling an existing asset for $1,700. The asset when purchased cost $10,000 was being depreciated under MACRS using a five year recovery period and has been depreciated for four full years. If the assume tax rate is 40% on ordinary income and capital gains, the tax effect of this transaction is

$0 tax liability

The tax effect on the sale of the existing asset results in (Table 11.3)

$1,100 tax liability

For proposal 1, the initial outlay equals (Table 11.2)

$1,500,000

What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost if $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 2, $1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?

$1,700,000

For proposal 2, the book value of the existing asset at the end of the fifth year is (Table 11.2)

$13,600

A corporation is selling an existing asset for $5,000. The asset when purchased cost $10,000 was being depreciated under MACRS using a five year recovery period and has been depreciated for four full years. If the assume tax rate is 40% on ordinary income and capital gains, the tax effect of this transaction is

$1320 tax liability

For proposal 2, the tax effect on the sale of the existing asset t the end of the fifth year results in (Table 11.2)

$14,560 tax liability

For proposal 3, the incremental depreciation expense for year 6 is (Table 11.2)

$15,750

For proposal 1, the depreciation expense for year 1 is (Table 11.2)

$150,000

A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $15,000. The machine has an original purchase price of $80,000 installation cost of $20,000 and will be depreciated under five year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40% tax rate on income and capital gain. The terminal cash flow is

$16,000

For proposal 3, the tax effect on the sale of the existing asset results in (Table 11.2)

$16,000 tax liability

The annual incremental after tax cash flow from operations for year 1 is (Table 11.3)

$16,600

For proposal 2, the initial outlay equals (Table 11.2)

$164,560

For proposal 1, the annual incremental after tax cash flow from operations for year 1 is (Table 11.2)

$210,000

For proposal 3, the initial outlay equals (Table 11.2)

$211,000

A corporation is selling an existing asset for $1,000. The asset when purchased cost $10,000 was being depreciated under MACRS using a five year recovery period and has been depreciated for four full years. If the assume tax rate is 40% on ordinary income and capital gains, the tax effect of this transaction is

$280 tax benefit

The NPV of the project is (Table 11.5)

$3815

The initial outlay equals (Table 11.3)

$44,100

The initial outlay for the project is (Table 11.5)

$47,820

For proposal 3, the incremental depreciation expense for year 3 is (Table 11.2)

$47,850

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset cost $70,000 and was being depreciated under MACRS using a five year recovery period. The existing asset can be sold for $30,000. The new asset will cost $80,000 and will also be depreciated under MACRS using five year recovery period. If the assumed tax is 40% on income and capital gains, the initial investment is

$48,560

The present value of the projects annual cash flows is (Table 11.5)

$51,635

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset cost $30,000 and was being depreciated under MACRS using a five year recovery period. The existing asset can be sold for $25,000. The new asset will cost $75,000 and will also be depreciated under MACRS using five year recovery period. If the assumed tax is 40% on income and capital gains, the initial investment is

$54,240

For proposal 2, the annual incremental after tax cash flow from operations for year 2 is (Table 11.2)

$56,000

The incremental depreciation expense for year 5 is (Table 11.3)

$6,360

For proposal 2, the incremental depreciation expense for year 2 is (Table 11.2)

$60,000

The book value of the existing asset is (Table 11.3)

$7,250

The incremental depreciation expense for year 1 is (Table 11.3)

$7,600

A corporation is selling an existing asset for $21,000. The asset when purchased cost $10,000 was being depreciated under MACRS using a five year recovery period and has been depreciated for four full years. If the assume tax rate is 40% on ordinary income and capital gains, the tax effect of this transaction is

$7720 tax liability

For proposal 3, the book value of the existing asset is (Table 11.2)

$80,000

A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $2,000. The machine has an original purchase price of $80,000 installation cost of $20,000 and will be depreciated under five year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40% tax rate on income and capital gain. The terminal cash flow is

$8200

For proposal 3, the annual incremental after tax cash flow from operations for year 3 is (Table 11.2)

$93,800

What is the NPV for a project if its cost of capital is 12 percent and its initial after-tax cost if $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 2, $1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?

-$1,494,336

A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000. The net present value of the investment is _________.

-$1000

What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is $5,000,000 and is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and 1,300,000 in year 4?

-$137,053

Which of the following is an example of a nonconventional pattern of cash flows?

0-200, 1-100, 2--100, 3-200, 4--300

Using the net present value approach to ranking projects, which projects should the firm accept?

1, 2, 3, 5, and 6

Using the internal rate of return approach to ranking projects, which project(s) should the firm accept? (See Table 10.4)

1, 2, 3, and 5

What is the profitability index of a project that has an initial cash outflow of $600, an inflow of $250 for the next 3 years and a cost of capital of 10 percent?

1.036

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?

13.57%

A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. The payback period of the project is ________.

3.3 years

What is the payback period for Tangshan Mining company's new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

3.33 years

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1, $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

5.83%

Which of the following is a strength of payback period?

A measure of risk exposure

The cash flow pattern depicted is associated with a capital investment and may be characterized as ______.

A mixed stream and a conventional cash flow (random/-100000)

An annuity is ___________.

A series of equal annual cash flows

A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. Project Z has an initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should ________.

Accept Project Y because its IRR is higher than Project Z

A firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows: 1 - 12%, 2 - 15%, 3 - 13% The firm should ________.

Accept project 2, and reject projects 1 and 3.

If the firm in Table 10.3 has a required payback of two years, it should ________.

Accept project A and reject project B.

A firm is evaluating three capital projects. The net present values are as follows: 1-$100, 2-$10, 3--$100. The firm should ________.

Accept projects 1 & 2, and reject project 3.

The cash flow patter depicted is associated with a capital investment and may be characterized as _______.

An annuity and a conventional cash flow (1000/2500)

nonconventional cash flow pattern

An initial outflow followed by a series of inflows and outflows.

conventional cash flow pattern

An initial outflow followed by a series of inflows.

operating expenditure

An outlay of funds by the firm resulting in benefits received within 1 year.

capital expenditure

An outlay of funds by the firm that is expected to produce benefits over a period of time great than 1 year.

installation costs

Any added costs that are necessary to place an asset into operation.

Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Sketch a net present value profile for each of these projects. Which project should the firm choose if the cost of capital is 10 percent? What if the cost of capital is 25 percent?

At a cost of capital of 10 percent, the firm would choose Project X. At a cost of capital of 25 percent, the firm would choose neither of the projects.

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is __________.

Between 2 and 3 years

is the process of evaluating and selecting long-term investments that are consistent with a firm's goal of maximizing owners' wealth.

Capital Budgeting

A $60,000 outlay for a new machine with a usable life of 15 years is called

Capital Expenditure

A firm with limited dollars available for capital expenditures is subject to

Capital Rationing

__________ is the process of evaluating and selecting long - term investments consistent with the firm's goal of owner wealth maximization

Capital budgeting

opportunity costs

Cash flows that could be realized from the best alternative use of an owned asset.

sunk costs

Cash outlays that have already been made (past outlays) and therefore have no effect on the cash flows relevant to a current decision.

Use the IRR approach to select the best group of projects, if the required rate of return is 23.5%. (See Table 10.5)

Choose Projects B and C, resulting in a NPV of $380,000.

Use the NPV approach to select the best group of projects. (See Table 10.5)

Choose Projects C and D, since this combination maximizes NPV at $410,000 and only requires $8,000,000 of initial investment.

Fixed assets that provide the basis for a firm's earning and value are often called

Earning Assets

The basic motive for capital expenditure is to

Expand Operations

One of the primary motives for adding fixed assets to a firm is

Expansion

A $60,000 outlay for a new machine with a usable life of 15 years is an operating expenditure that would appear as a current asset on a firm's balance sheet.

FALSE

A capital expenditure is an outlay of funds invested only in fixed assets that is expected to produce benefits over a period of time less than one year.

FALSE

A nonconventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows.

FALSE

A project must be rejected if its payback period is less than the maximum acceptable pay back period.

FALSE

A project's net present value profile is a graph that plots a projects IRR for various discount rates.

FALSE

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called net present value.

FALSE

A sophisticated capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called profitability index.

FALSE

An outlay for advertising and management consulting is considered to be a fixed asset expenditure.

FALSE

By measuring how quickly a firm recovers its initial investment, the payback period give implicit consideration to the time value of money and ignores the timing of cash flows.

FALSE

Capital budgeting is the process of evaluating and selecting short-term investments that are consistent with the firm's goal of maximizing owners' wealth.

FALSE

Economic value added is the difference between an investment's net operating profit after taxes and the accounting profit.

FALSE

For a project that has an initial cash outflow followed by cash inflows, the profitability index (PI) is equal to the present value of cash inflows divided by the cost of capital.

FALSE

For calculating payback period for an annuity, all cash flows must be adjusted for time value of money.

FALSE

For conventional projects, both NPV and IRR techniques will always generate the same accept-reject decision.

FALSE

If a firm has limited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria should be implemented.

FALSE

If a firm is subject to capital rationing, it is able to accept all independent projects that provide an acceptable return.

FALSE

If a project's IRR is greater than 0 percent, the project should be accepted.

FALSE

If a project's IRR is greater than the cost of capital, the project should be rejected.

FALSE

If a project's IRR is greater than zero, the project should be accepted.

FALSE

If a project's payback period is greater than the maximum acceptable payback period, we would accept it.

FALSE

If the NPV is greater than the initial investment, a project should be rejected.

FALSE

If the NPV is less than the initial investment, a project should be rejected

FALSE

In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value of money, risk and return considerations, and valuation concepts to select capital expenditures that are consistent with the firm's goal of maximizing owners' wealth.

FALSE

In general, projects with similar-sized investments and lower cash inflows in the early years rend to be preferred at higher discount rates.

FALSE

Independent projects are projects that compete with one another for a firm's resources, so that the acceptance of one eliminates the others from further consideration.

FALSE

Independent projects are those whose cash flows compete with one another and therefore more than one projects needs to be accepted in order to implement the capital budgeting decision.

FALSE

Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

FALSE

Mutually exclusive projects are those whose cash flows are constant over a specified period of time and more than one project needs to be accepted in order to implement capital budgeting decisions.

FALSE

Net present value profiles are most useful when selecting among independent projects.

FALSE

On a purely theoretical basis, IRR is a better approach when selecting among two mutually exclusive projects.

FALSE

On a purely theoretical basis, IRR is the better approach to capital budgeting than NPV because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

FALSE

One strength of payback period is that it fully accounts for the time value of money.

FALSE

The NPV of a project is the difference between an investment's net operating profit after taxes and the cost of funds used to finance the investment, which is found by multiplying the dollar amount of the funds used to finance the investment by the firm's weighted average cost of capital.

FALSE

The NPV of a project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15% is $856.49.

FALSE

The NPV of a project with an initial investment of $2,500 that provides after-tax operating cash flows of $500 per year for four years where the firm's cost of capital is 15% is $427.49.

FALSE

The accept-reject approach involves the ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return.

FALSE

The availability of funds for capital expenditures does not affect a firm's capital budgeting decisions.

FALSE

The capital budgeting process consists of four distinct but interrelated steps: proposal generation, review and analysis, decision making, and termination.

FALSE

The financial decision makers find NPV more intuitive because it measures benefits relative to the amount invested.

FALSE

The internal rate of return (IRR) is defined as the discount rate that equates the net present value with the initial investment associated with a project.

FALSE

The internal rate of return assumes that a project's intermediate cash inflows are reinvested at a rate equal to the firm's cost of capital.

FALSE

The net present value is found by subtracting a project's final initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.

FALSE

The payback period is the amount of time required for a firm to dispose a replaced asset.

FALSE

The payback period of a project that costs $1000 initially and promises after-tax cash inflows of $300 each year for the next three years is .333 years.

FALSE

The primary motive for capital expenditures is to refurbish fixed assets.

FALSE

Time value of money should be ignored in capital budgeting techniques to make accurate decisions.

FALSE

capital budgeting process

Five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up.

The final step in the capital budgeting process is

Follow-up

Which of the following statements is true of payback period?

If the payback period is less than the maximum acceptable payback period, accept the project.

Which of the following steps in the capital budgeting process follows the decision making step?

Implementation

_________ projects do not compete with each other; the acceptance of one _____________ the others from consideration.

Independent; does not eliminate

__________ projects do not compete with each other; the acceptance of one _________ the others from consideration

Independent; does not eliminate

The ________ is the compound annual rate of return that a firm will earn if it invests in the project and receives the given cash inflows.

Internal Rate of Return

The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.

Internal Rate of Return

Which of the following is true of the accept-reject approach?

It can be used for making capital budgeting decisions when there is capital rationing.

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because __________.

It can be viewed as a measure of risk exposure due to its focus on liquidity.

Which of the following is a reason for firms not using the payback method as a guideline in capital investment decisions?

It cannot be specified in light of the wealth maximization goal.

Which of the following is true of NPV profile?

It charts the net present value of a project as a function of the cost of capital.

Payback is considered an unsophisticated capital budgeting because it ______________.

It does not explicitly consider the time value of money

Which of the following is a disadvantage of payback period approach?

It does not explicitly consider the time value of money.

Which of the following is TRUE of a capital expenditure?

It is commonly used to expand the level of operations.

Which of the following is an advantage of NPV?

It takes into account the time value of investors' money.

When the net present value is negative, the internal rate of return is ________ the cost of capital.

Less than

Comparing net present value and internal rate of return __________.

May give different accept-reject decisions

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called

Mutually exclusive projects

_________ projects have the same function; the acceptance of one ________ the others from consideration

Mutually exclusive; eliminates

_________ projects have the same function; the acceptance of one __________ the others from consideration.

Mutually exclusive; eliminates

Given the information in the Table 10.2 and 15 percent cost of capital, a) compute the net present value, b) should be project be accepted?

NPV = $98,820 - $100,000 - -$1,180 < 0 Since NPV < 0, the project should be rejected.

Tangshan Mining Company is considering investing in a new mining project. The firm's cost of capital is 12 percent and the project is expected to have an initial after-tax cost of $5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3, and ($1,300,000) in year 4? (a) Calculate the project's NPV. (b) Calculate the project's IRR. (c) Should the firm make the investment?

NPV = ($194,380) IRR = 11% No, the firm should not accept the project since it provides negative NPV

Given the information in Table 10.1 and 15 percent cost of capital, a) compute the net present value. b) should the project be accepted?

NPV = (1000/.15)x(1-1/(1.5)^5)-2500 = 1000 x (3.352) - 2500 = $852 Since NPV > 0, the project should be accepted.

Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?

Neither, since both projects have negative NPV

Which capital budgeting method is most useful for evaluating a project that has an initial after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

Net Present Value

In comparing the internal rate of return and net present value methods of evaluation,

Net present value is theoretically superior, but financial managers prefer to use internal rate of return.

Should Tangshan Mining company accept a new project if its maximum payback is 3.25 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

No, since the payback period of the project is more than the maximum acceptable payback period.

Which patter of cash flow stream is the most difficult to use when evaluating projects?

Nonconventional Flow

The pattern of cash flow stream that is the most difficult to use when evaluating projects?

Noncoventional Flow

The ___________ measures the amount of time it takes a firm to recover its initial investment.

Payback Period

Which of the following is an unsophisticated capital budgeting technique?

Payback Period

Which of the following capital budgeting techniques ignores the time value of money?

Payback Period Approach

Evaluate the following projects using the payback method assuming a rule of 3 years for payback.

Project A can be accepted because the payback period is 2.5 years but Project B cannot be accepted because its payback period is longer than 3 years.

Consider the following projects, X and Y, where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 10 percent?

Project X, since it has a higher NPV than project Y

Which projects should the firm implement? (See Table 10.5)

Projects C and D

When evaluating projects using NPV approach,

Projects having higher early-year cash flows tend to be preferred at higher discount rates

mutually exclusive projects

Projects that compete with one another, so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

independent projects

Projects whose cash flows are unrelated or independent of one another; the acceptance of one does not eliminated the others from further consideration.

The first step in the capital budgeting process is

Proposal Generation

The new financial analyst does not like the payback approach (Table 10.3) and determines that the firm's required rate of return is 15 percent. Based on IRR, his recommendation would be to ________.

Reject project A and accept project B.

A conventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows.

TRUE

A nonconventional cash flow pattern is one in which an initial inflow is followed by a series of inflows and outflows.

TRUE

A project's net present value profile is a graph that plots a project's NPV for various discount rates.

TRUE

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called internal rate of return.

TRUE

A sophisticated capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called net present value.

TRUE

Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques, the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows.

TRUE

An internal rate of return greater than the cost of capital guarantees that the firm will earn at least its required return.

TRUE

Capital budgeting techniques are used to evaluate a firm's fixed asset investments which provide the basis for the firm's earning power and value.

TRUE

Capital expenditure proposals are reviewed to assess their appropriateness in light of a firm's overall objectives and plans, and to evaluate their economic validity

TRUE

Certain mathematical properties may cause a project with a nonconventional cash flow pattern to have multiple IRRs; this problem does not occur with the NPV approach.

TRUE

Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often result from differences in the magnitude and/or timing of cash flows.

TRUE

If a firm has unlimited funds to invest in capital assets, all independent projects that meet its minimum investment criteria should be implemented.

TRUE

If a firm has unlimited funds, it is able to accept all independent projects that provide an acceptable return.

TRUE

If a firm is subject to capital rationing, it has only a fixed number of dollars available for capital expenditures and numerous projects compete for these dollars.

TRUE

If a project's payback period is greater than the maximum acceptable payback period we would reject it.

TRUE

If a project's payback period is less than the maximum acceptable payback period, we would accept it.

TRUE

If net present value of a project is greater than zero, the firm will earn a greater return than its cost of capital. The acceptance of such a project would enhance the wealth of the firm's owners.

TRUE

If the NPV is greater than $0, a project should be accepted.

TRUE

In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value procedures, risk and return considerations, and valuation concepts.

TRUE

In general, the greater the difference between the magnitude and/or timing of cash inflows, the greater the likelihood of conflicting ranking between NPV and IRR.

TRUE

In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

TRUE

Independent projects are those whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

TRUE

Large firms evaluate the merits of individual capital budgeting projects to ensure that the selected projects have the best chance of increasing the firm value.

TRUE

Mutually exclusive projects are those whose cash flows compete with one another; the acceptance of one eliminates the others from further consideration.

TRUE

Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

TRUE

Net present value is considered a sophisticated capital budgeting technique since it gives explicit consideration to the time value of money.

TRUE

Net present value profiles are most useful when selecting among mutually exclusive projects.

TRUE

On a purely theoretical basis, NPV is a better approach when selecting among two mutually exclusive projects.

TRUE

On a purely theoretical basis, NPV is preferred over IRR because NPV assumes a more conservative reinvestment rate and does not exhibit the mathematical problem of multiple IRRs that often occurs when IRRs are calculated for nonconventional cash flows.

TRUE

On a purely theoretical basis, NPV is the better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

TRUE

One weakness of payback period approach is its failure to recognize cash flows that occur after the payback period.

TRUE

Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost of capital and are therefore often acceptable at higher discount rates compared to projects with higher cash inflows that occur in the later years.

TRUE

Research and development is considered to be a motive for making capital expenditures.

TRUE

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a supplement to other decision techniques.

TRUE

The IRR is the discount rate that equates the NPV of an investment opportunity with $0.

TRUE

The IRR method assumes the cash flows are reinvested at the internal rate of return rather than the required rate of return.

TRUE

The appeal of the IRR technique is due to the general disposition of business people to think in terms of rates of return rather than actual dollar returns.

TRUE

The basic motives for capital expenditures are to expand operations, to replace or renew fixed assets, or to obtain some other, less tangible benefit over a long period.

TRUE

The capital budgeting process consists of five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up.

TRUE

The discount rate is the minimum return that must be earned on a project to leave a firm's market value unchanged.

TRUE

The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.

TRUE

The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.

TRUE

The payback period of a project that costs $1000 initally and promises after-tax cash inflows of $2000 each year for the next three years is .5 years.

TRUE

The payback period of a project that costs $1000 initially and promises after-tax cash inflows of $300 for the next three years is 3.33 years.

TRUE

The payback period of a project that costs $1000 initially and promises after-tax cash inflows of $3000 each year for the next three years is .333 years.

TRUE

The purchase of additional physical facilities, such as additional property or a new factory, is an example of a capital expenditure.

TRUE

The ranking approach involves the ranking of capital expenditure projects on the basis of some predetermined measure such as the rate of return.

TRUE

tax on sale of old asset

Tax that depends on the relationship between the old asset's sale price and book value, and on existing government tax rules.

incremental cash flows

The additinal cash flows - outflows or inflows - expected to result from a proposed capital expenditure.

terminal cash flow

The after-tax nonoperating cash flow occurring in the final year of a project. It is usually attributable to liquidation of the project.

net working capital

The amount by which a firm's current assets exceed its current liabilities.

proceeds from sale of old asset

The cash inflows, net of any removal or cleanup costs, resulting from the sale of an existing asset.

The minimum return that must be earned on a project in order to leave the firm's value unchanged is __________.

The cost of capital

installed cost of new asset

The cost of new asset plus its installation costs; equals the asset's depreciable value.

change in net working capital

The difference between a change in current assets and a change in current liabilities.

after-tax proceeds from sale of old asset

The difference between the old asset's sale proceeds and any applicable taxes or tax refunds related to its sale.

accept-reject approach

The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criterion

capital rationing

The financial situation in which a firm has only a fixed number of dollars available for capital expenditures, and numerous projects compete for these dollars.

unlimited funds

The financial situation in which a firm is able to accept all independent projects that provide an acceptable return.

operating cash inflows

The incremental after-tax cash inflows resulting from implementation of a project during its life.

relevant cash flows

The incremental cash outflow (investment) and resulting subsequent inflows associated with a proposed capital expenditure.

cost of new asset

The net outflow necessary to acquire a new asset.

recaptured depreciation

The portion of an asset's sale price that is above its book value and below its initial purchase price.

capital budgeting

The process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth.

A firm can accept a project with a net present value of zero because ______.

The project would maintain the wealth of the firm's owners

Unlike the net present value criteria, the internal rate of return approach assumes a reinvestment rate equal to _________.

The project's internal rate of return.

ranking approach

The ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return.

Which of the following is a reason that makes NPV a better approach to capital budgeting on a purely theoretical basis?

The reinvestment rate assumed by this method is reasonable.

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is ________.

The reinvestment rate assumption regarding intermediate cash flows.

initial investment

The relevant cash outflow for a proposed project at time zero.

book value

The strict accounting value of an asset, calculated by subtracting its accumulated depreciation from its installed cost.

foreign direct investment

The transfer of capital, managerial, and technical assets to a foreign country.

Should Tangshan Mining company accept a new project if its maximum payback is 3.5 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

Yes, since the payback period of the project is less than the maximum acceptable payback period.

The tax treatment regarding the sale of existing assets that are sold for more than the original purchase price results in

a capital gain tax liability

The tax treatment regarding the sale of existing assets that are sold for more than the original purchase price results in ________.

a capital gain tax liability

The portion of an asset's sale price that is below its book value and below its initial purchase price is called ________.

a capital loss

The portion of an assets sale price that is below its book value and below its initial purchase price is called

a capital loss

The tax treatment regarding the sale of existing assets that are sold for less than the book value results in

a capital loss tax benefit

The tax treatment regarding the sale of existing assets that are sold for less than the book value results in ________.

a capital loss tax benefit

A corporation is considering expanding operations to meet growing demand. With the capital expansion, the current accounts are expected to change. Management expects cash to increase by $10,000 accounts receivable by $20,000 and inventories by $30,000. At the same time accounts payable will increase by $40,000 accruals by $30,000 and long term debt by $80,000. The change in net working capital is

a decrease of $10,000

Which of the following is a strength of payback period?

a measure of risk exposure

For proposal 1, the cash flow patter for the expansion project is (Table 11.2)

a mixed stream and conventional

For proposal 2, the cash flow patter for the replacement project is (Table 11.2)

a mixed stream and conventional

For proposal 3, the cash flow patter for the replacement project is (Table 11.2)

a mixed stream and conventional

The cash flow patter for the capital investment proposal is (Table 11.3)

a mixed stream and conventional

An annuity is ________.

a series of equal annual cash flows

The tax effect of the sale of the existing asset is (Table 11.5)

a tax liability of $5320

One basic technique used to evaluate after tax operating cash flows is to

add non cash charges to net income

One basic technique used to evaluate after-tax operating cash flows is to ________.

add noncash charges to net income

Which of the following must be considered in computing the terminal value of a replacement project?

after tax process from the sale of a new asset

Which of the following must be considered in computing the terminal value of a replacement project?

after-tax proceeds from the sale of a new asset

In developing the cash flows for an expansion project, the analysis is the same as the analysis for replacement projects where

all cash flows from the old asset are zero

In developing the cash flows for an expansion project, the analysis is the same as the analysis for replacement projects where ________.

all cash flows from the old asset are zero

In evaluating the initial investment for a capital budgeting project,

an increase in net working capital is considered a cash outflow

In evaluating the initial investment for a capital budgeting project, ________.

an increase in net working capital is considered a cash outflow

A corporation is considering expanding operations to meet growing demand. With the capital expansion, the current accounts are expected to change. Management expects cash to increase by $20,000 accounts receivable by $40,000 and inventories by $60,000. At the same time accounts payable will increase by $50,000 accruals by $10,000 and long term debt by $100,000. The change in net working capital is

an increase of $60,000

The __________ approach is used to convert the net present value of unequal - lived projects into an equivalent annual amount (in net present value terms)

annualized net present value

The payback period for the project is (Table 11.5)

between 3 and 4 years

________ is the process of evaluating and selecting long-term investments that are consistent with a firm's goal of maximizing owners' wealth.

capital budgeting

A $60,000 outlay for a new machine with a usable life of 15 years is called ________

capital expenditure

A $60,000 outlay for a new machine with a usable life of 15 years is called ________.

capital expenditure

A firm with limited dollars available for capital expenditures is subject to ________.

capital rationing

A firm with limited dollars available for capital expenditures is subject to _________

capital rationing

The ________ is the rate of return a firm must earn on its investments in projects in order to maintain the market value of its stock

cost of capital

A loss on the sale of an asset that is depreciable and used in business is ____; a loss on the sale of a non-depreciable asset is ____

deductible from ordinary income; deductible only against capital gains

A loss on the sale of an asset that is depreciable and used in business is ________; a loss on the sale of a non-depreciable asset is ________.

deductible from ordinary income; deductible only against capital gains

Fixed assets that provide the basis for a firm's earning and value are often called ________.

earning assets

The basic motive for capital expenditure is to ________.

expand operations

One of the primary motives for adding fixed assets to a firm is ________.

expansion

If accounts receivable increases by $1,000,000 inventory decreases by $500,000 and accounts payable increase by $500,000. Net working capital would

experience no change

TRUE OR FALSE: A $60,000 outlay for a new machine with a usable life of 15 years is an operating expenditure that would appear as a current asset on a firm's balance sheet.

false

TRUE OR FALSE: A capital expenditure is an outlay of funds invested only in fixed assets that is expected to produce benefits over a period of time less than one year.

false

TRUE OR FALSE: A nonconventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows.

false

TRUE OR FALSE: A project must be rejected if its payback period is less than the maximum acceptable payback period.

false

TRUE OR FALSE: A project's net present value profile is a graph that plots a project's IRR for various discount rates.

false

TRUE OR FALSE: A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called net present value.

false

TRUE OR FALSE: A sophisticated capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called profitability index.

false

TRUE OR FALSE: A sunk cost is a cash flow that could be realized from the best alternative use of an owned asset.

false

TRUE OR FALSE: An outlay for advertising and management consulting is considered to be a fixed asset expenditure.

false

TRUE OR FALSE: By measuring how quickly a firm recovers its initial investment, the payback period gives implicit consideration to the time value of money and ignores the timing of cash flows.

false

TRUE OR FALSE: Capital budgeting is the process of evaluating and selecting short-term investments that are consistent with the firm's goal of maximizing owners' wealth.

false

TRUE OR FALSE: Economic value added is the difference between an investment's net operating profit after taxes and the accounting profit.

false

TRUE OR FALSE: For a project that has an initial cash outflow followed by cash inflows, the profitability index (PI) is equal to the present value of cash inflows divided by the cost of capital.

false

TRUE OR FALSE: For calculating payback period for an annuity, all cash flows must be adjusted for time value of money.

false

TRUE OR FALSE: For conventional projects, both NPV and IRR techniques will always generate the same accept-reject decision.

false

TRUE OR FALSE: If a firm has limited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria should be implemented.

false

TRUE OR FALSE: If a firm is subject to capital rationing, it is able to accept all independent projects that provide an acceptable return.

false

TRUE OR FALSE: If a new asset is being considered as a replacement for an old asset, the relevant cash flows would be found by adding the operating cash flows from the old asset to the operating cash flows from the new asset.

false

TRUE OR FALSE: If a project's IRR is greater than 0 percent, the project should be accepted.

false

TRUE OR FALSE: If a project's IRR is greater than the cost of capital, the project should be rejected.

false

TRUE OR FALSE: If a project's IRR is greater than zero, the project should be accepted.

false

TRUE OR FALSE: If a project's payback period is greater than the maximum acceptable payback period, we would accept it.

false

TRUE OR FALSE: If an asset is depreciable and used in business, any loss on the sale of the asset is tax-deductible only against other capital gains income, not against ordinary income.

false

TRUE OR FALSE: If an asset is sold for book value, the gain on the sale is composed of two parts: a capital gain and accumulated depreciation.

false

TRUE OR FALSE: If the NPV is greater than the initial investment, a project should be rejected.

false

TRUE OR FALSE: If the NPV is less than the initial investment, a project should be rejected.

false

TRUE OR FALSE: In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value of money, risk and return considerations, and valuation concepts to select capital expenditures that are consistent with the firm's goal of maximizing owners' wealth.

false

TRUE OR FALSE: In computing after-tax operating cash flows, both operating costs and financing costs must be deducted from any cash inflows received.

false

TRUE OR FALSE: In general, projects with similar-sized investments and lower cash inflows in the early years tend to be preferred at higher discount rates.

false

TRUE OR FALSE: Independent projects are projects that compete with one another for a firm's resources, so that the acceptance of one eliminates the others from further consideration.

false

TRUE OR FALSE: Independent projects are those whose cash flows compete with one another and therefore more than one project needs to be accepted in order to implement the capital budgeting decision.

false

TRUE OR FALSE: Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

false

TRUE OR FALSE: Mutually exclusive projects are those whose cash flows are constant over a specified period of time and more than one project needs to be accepted in order to implement capital budgeting decisions.

false

TRUE OR FALSE: Net present value profiles are most useful when selecting among independent projects.

false

TRUE OR FALSE: Net working capital is the difference between a firm's total assets and its total liabilities.

false

TRUE OR FALSE: On a purely theoretical basis, IRR is a better approach when selecting among two mutually exclusive projects.

false

TRUE OR FALSE: On a purely theoretical basis, IRR is the better approach to capital budgeting than NPV because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

false

TRUE OR FALSE: One strength of payback period is that it fully accounts for the time value of money.

false

TRUE OR FALSE: Recaptured depreciation is the portion of the sale price that is below the book value.

false

TRUE OR FALSE: Recaptured depreciation is the portion of the sale price that is in excess of the initial purchase price.

false

TRUE OR FALSE: The NPV of a project is the difference between an investment's net operating profit after taxes and the cost of funds used to finance the investment, which is found by multiplying the dollar amount of the funds used to finance the investment by the firm's weighted average cost of capital.

false

TRUE OR FALSE: The NPV of a project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $856.49.

false

TRUE OR FALSE: The NPV of a project with an initial investment of $2,500 that provides after-tax operating cash flows of $500 per year for four years where the firm's cost of capital is 15 percent is $427.49.

false

TRUE OR FALSE: The accept-reject approach involves the ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return.

false

TRUE OR FALSE: The availability of funds for capital expenditures does not affect a firm's capital budgeting decisions.

false

TRUE OR FALSE: The capital budgeting process consists of four distinct but interrelated steps: proposal generation, review and analysis, decision making, and termination.

false

TRUE OR FALSE: The financial decision makers find NPV more intuitive because it measures benefits relative to the amount invested.

false

TRUE OR FALSE: The internal rate of return (IRR) is defined as the discount rate that equates the net present value with the initial investment associated with a project.

false

TRUE OR FALSE: The internal rate of return assumes that a project's intermediate cash inflows are reinvested at a rate equal to the firm's cost of capital.

false

TRUE OR FALSE: The net present value is found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.

false

TRUE OR FALSE: The payback period is the amount of time required for a firm to dispose a replaced asset.

false

TRUE OR FALSE: The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 each year for the next three years is 0.333 years.

false

TRUE OR FALSE: The primary motive for capital expenditures is to refurbish fixed assets.

false

TRUE OR FALSE: The three major cash flow components include the initial investment, nonoperating cash flows, and terminal cash flow.

false

TRUE OR FALSE: Time value of money should be ignored in capital budgeting techniques to make accurate decisions.

false

TRUE OR FALSE: Under MACRS depreciation, the depreciable value of an asset is equal to the asset's purchase price minus any installation costs.

false

Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after-tax operating cash flows? Why or why not?

financing costs are not an incremental cash flow for capital budgeting purposes, financing costs are a direct consequence of how the project is financed, not whether the project is economically viable, financing costs are embedded in the required rate of return used to discount project cash flows

The final step in the capital budgeting process is ________.

follow-up

The IRR for the project is (Table 11.5)

greater that 12%

Which of the following statements is true of payback period?

if the payback period is less than the maximum acceptable payback period, accept the project

Which of the following steps in the capital budgeting process follows the decision making step?

implementation

When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions, due to the need to calculate ____ cash inflows

incremental

When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions, due to the need to calculate ________ cash inflows.

incremental

Relevant cash flows for a project are best described as

incremental cash flows

Relevant cash flows for a project are best described as ________.

incremental cash flows

Relevant cash flows for a project are best described as _________

incremental cash flows

________ projects do not compete with each other; the acceptance of one ________ the others from consideration.

independent; does not eliminate

The ________ is the compound annual rate of return that a firm will earn if it invests in the project and receives the given cash inflows.

internal rate of return

The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.

internal rate of return

All of the following are motives for capital budgeting expenditures EXCEPT

invention

Which of the following is true of the accept-reject approach?

it can be used for making capital budgeting decisions when there is capital rationing

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because

it can be viewed as a measure of risk exposure because of its focus on liquidity

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because ________.

it can be viewed as a measure of risk exposure due to its focus on liquidity

Which of the following is a reason for firms not using the payback method as a guideline in capital investment decisions?

it cannot be specified in light of the wealth maximization goal

Which of the following is true of NPV profile?

it charts the net present value of a project as a function of the cost of capital

Payback is considered an unsophisticated capital budgeting because it ________.

it does not explicitly consider the time value of money

Which of the following is a disadvantage of payback period approach?

it does not explicitly consider the time value of money

Which of the following is true of a capital expenditure?

it is commonly used to expand the level of operations

Which of the following is an advantage of NPV?

it takes into account the time value of investors' money

When the net present value is negative, the internal rate of return is ________ the cost of capital.

less than

A tax adjustment must be made in determining the cost of _________

long - term debt

Comparing net present value and internal rate of return ________.

may give different accept-reject decisions

Benefits expected from proposed capital expenditures

must be on an after tax basis because no benefits may be used until tax claims are satisfied

Benefits expected from proposed capital expenditures ________.

must be on an after-tax basis because no benefits may be used until tax claims are satisfied

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called ________.

mutually exclusive projects

________ projects have the same function; the acceptance of one ________ the others from consideration.

mutually exclusive; eliminates

Which capital budgeting method is most useful for evaluating a project that has an initial after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

net present value (NPV)

In comparing the internal rate of return and net present value methods of evaluation, ________.

net present value is theoretically superior, but financial managers prefer to use internal rate of return

The tax treatment regarding the sale of existing assets that are sold for their book value results in

no tax benefit or liability

The tax treatment regarding the sale of existing assets that are sold for their book value results in ________.

no tax benefit or liability

Should Tangshan Mining company accept a new project if its maximum payback is 3.25 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

no, since the payback period of the project is more than the maximum acceptable payback period

Which pattern of cash flow stream is the most difficult to use when evaluating projects?

nonconventional flow

Cash flows that could be realized from the best alternative use of an owned asset are called

opportunity costs

Cash flows that could be realized from the best alternative use of an owned asset are called ________.

opportunity costs

The book value of an asset is equal to the ________.

original purchase price minus accumulated depreciation

The book value of an asset is equal to the

orignial purchase price minus accumulated depreciation

A non - conventional cash flow pattern associated with capital investment projects consists of an initial

outflow followed by a series of both cash inflows and outflows

A nonconventional cash flow pattern associated with capital investment projects consists of an initial

outflow followed by a series of both cash inflows and outflows

A nonconventional cash flow pattern associated with capital investment projects consists of an initial ________.

outflow followed by a series of both cash inflows and outflows

A conventional cash flow pattern associated with capital investment projects consists of an initial

outflow followed by a series of inflows

A conventional cash flow pattern associated with capital investment projects consists of an initial ________.

outflow followed by a series of inflows

A conventional cash flow pattern associated with capital investment projects consists of an initial ___________

outflow followed by a series of inflows

The cost of capital reflects the cost of funds

over a long - run time period

Examples of sophisticated capital budgeting techniques include all of the following EXCEPT

payback period

The ________ measures the amount of time it takes a firm to recover its initial investment.

payback period

Which of the following is an unsophisticated capital budgeting technique?

payback period

Which of the following capital budgeting techniques ignores the time value of money?

payback period approach

Which of the following basic variables must be considered in determining the initial investment associated with a capital expenditure?

proceeds from the sale of an existing asset

When evaluating projects using NPV approach, ________.

projects having higher early-year cash flows tend to be preferred at higher discount rates

The first step in the capital budgeting process is

proposal generation

The first step in the capital budgeting process is ________.

proposal generation

The portion of an asset's sale price that is above its book value and below its initial purchase price is called ________.

recaptured depreciation

The portion of an assets sale price that is above its book value and below its initial purchase price is called

recaptured depreciation

The tax treatment regarding the sale of existing assets that are sold for more than the book value but less than the original purchase price results in a

recaptured depreciation taxed as ordinary income

The tax treatment regarding the sale of existing assets that are sold for more than the book value but less than the original purchase price results in a(n) ________.

recaptured depreciation taxed as ordinary income

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as

relevant cash flows

Initial cash outflows and subsequent operating cash inflows for a project are referred to as

relevant cash flows

Initial cash outflows and subsequent operating cash inflows for a project are referred to as ________.

relevant cash flows

The _________ reflects the return that must be earned on the given project to compensate the firm's owners adequately according to the project's variability of cash flows

risk - adjusted discount rate

Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called

sunk cost

Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called _________

sunk cost

Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called ________.

sunk costs

Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost.

sunk costs are cash outlays that have already been made (past outlays) and cannot be recovered, sunk costs have no effect on the cash flows relevant to the current decision, as a result, sunk costs should not be included in a project's incremental cash flows; opportunity costs are cash flows that could be realized from the best alternative use of an asset that is already in place, they, therefore, represent cash flows that will not be realized as a result of employing that asset in the proposed project, thus, any opportunity costs should be included as cash outflows when one is determining a project's incremental cash flows

The __________ is the firm's desired optimal mix of debt and equity financing

target capital structure

The change in net working capital when evaluating a capital budgeting decision is

the change in current assets minus the change in current liabilities

The change in net working capital when evaluating a capital budgeting decision is ________.

the change in current assets minus the change in current liabilities

The minimum return that must be earned on a project in order to leave the firm's value unchanged is ________.

the cost of capital

When evaluating a capital budgeting project, installation costs of a new machine must be considered as part of ________.

the initial investment

When evaluating a capital budgeting project, installation costs of a new machine must be considered part of

the initial investment

Which of the following would be used in the computation of an initial investment?

the initial purchase price of an existing asset

Which of the following would be used in the computation of an initial investment?

the initial purchase price of the investment

A firm can accept a project with a net present value of zero because ________.

the project would maintain the wealth of the firm's owners

Unlike the net present value criteria, the internal rate of return approach assumes a reinvestment rate equal to ________.

the project's internal rate of return

Which of the following is a reason that makes NPV a better approach to capital budgeting on a purely theoretical basis?

the reinvestment rate assumed by this method is reasonable

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is ________.

the reinvestment rate assumption regarding intermediate cash flows

An important cash inflow in the analysis of initial cash flows for a replacement project is

the sale value of the old asset

An important cash inflow in the analysis of initial cash flows for a replacement project is ________.

the sale value of the old asset

TRUE OR FALSE: A conventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows.

true

TRUE OR FALSE: A nonconventional cash flow pattern is one in which an initial inflow is followed by a series of inflows and outflows.

true

TRUE OR FALSE: A project's net present value profile is a graph that plots a project's NPV for various discount rates.

true

TRUE OR FALSE: A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called internal rate of return.

true

TRUE OR FALSE: A sophisticated capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called net present value.

true

TRUE OR FALSE: A sunk cost is a cash outlay that has already been made and cannot be recovered.

true

TRUE OR FALSE: Accounting figures and cash flows are not necessarily the same due to the presence of certain non-cash expenditures on a firm's income statement.

true

TRUE OR FALSE: All benefits expected from a proposed project must be measured on a cash flow basis which may be found by adding any non-cash charges deducted as an expense on a firm's income statement back to net profits after taxes.

true

TRUE OR FALSE: Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques, the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows.

true

TRUE OR FALSE: An internal rate of return greater than the cost of capital guarantees that the firm will earn at least its required return.

true

TRUE OR FALSE: An opportunity cost is a cash flow that could be realized from the best alternative use of an owned asset.

true

TRUE OR FALSE: Capital budgeting techniques are used to evaluate a firm's fixed asset investments which provide the basis for the firm's earning power and value.

true

TRUE OR FALSE: Capital expenditure proposals are reviewed to assess their appropriateness in light of a firm's overall objectives and plans, and to evaluate their economic validity.

true

TRUE OR FALSE: Capital gain is the portion of the sale price that is in excess of the initial purchase price.

true

TRUE OR FALSE: Certain mathematical properties may cause a project with a nonconventional cash flow pattern to have multiple IRRs; this problem does not occur with the NPV approach.

true

TRUE OR FALSE: Companies involved in international capital budgeting projects can minimize political risks by structuring the investment as a joint venture and selecting a well-connected local partner.

true

TRUE OR FALSE: Companies involved in international capital budgeting projects can minimize the long-term currency risk by financing the foreign investment at least partly in the local capital markets.

true

TRUE OR FALSE: Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often result from differences in the magnitude and/or timing of cash flows. Answer: TRUE

true

TRUE OR FALSE: If a firm has unlimited funds to invest in capital assets, all independent projects that meet its minimum investment criteria should be implemented.

true

TRUE OR FALSE: If a firm has unlimited funds, it is able to accept all independent projects that provide an acceptable return.

true

TRUE OR FALSE: If a firm is subject to capital rationing, it has only a fixed number of dollars available for capital expenditures and numerous projects compete for these dollars.

true

TRUE OR FALSE: If a project's payback period is greater than the maximum acceptable payback period, we would reject it.

true

TRUE OR FALSE: If a project's payback period is less than the maximum acceptable payback period, we would accept it.

true

TRUE OR FALSE: If an asset is sold for less than its book value, the loss on the sale may be used to offset ordinary operating income provided the asset is used in the business.

true

TRUE OR FALSE: If an asset is sold for more than its initial purchase price, the gain on the sale is composed of two parts: a capital gain and recaptured depreciation.

true

TRUE OR FALSE: If an investment in a new asset results in a change in current assets that exceeds the change in current liabilities, this change in net working capital represents an initial cash outflow.

true

TRUE OR FALSE: If net present value of a project is greater than zero, the firm will earn a return greater than its cost of capital. The acceptance of such a project would enhance the wealth of the firm's owners.

true

TRUE OR FALSE: If the NPV is greater than $0, a project should be accepted.

true

TRUE OR FALSE: In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value procedures, risk and return considerations, and valuation concepts.

true

TRUE OR FALSE: In case of an existing asset which is depreciable and is used in business and is sold for a price equal to its initial purchase price, the difference between the sales price and its book value is considered as recaptured depreciation and will be taxed as ordinary income.

true

TRUE OR FALSE: In computing after-tax operating cash flows, only operating costs but not financing costs must be deducted from any cash inflows received.

true

TRUE OR FALSE: In evaluating a proposed project, incremental operating cash inflows are relevant cash flows.

true

TRUE OR FALSE: In general, the greater the difference between the magnitude and/or timing of cash inflows, the greater the likelihood of conflicting ranking between NPV and IRR.

true

TRUE OR FALSE: In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

true

TRUE OR FALSE: Incremental cash flows represent the additional cash flows expected as a direct result of the proposed project.

true

TRUE OR FALSE: Independent projects are those whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

true

TRUE OR FALSE: Large firms evaluate the merits of individual capital budgeting projects to ensure that the selected projects have the best chance of increasing the firm value.

true

TRUE OR FALSE: Mutually exclusive projects are those whose cash flows compete with one another; the acceptance of one eliminates the others from further consideration.

true

TRUE OR FALSE: Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

true

TRUE OR FALSE: Net present value is considered a sophisticated capital budgeting technique since it gives explicit consideration to the time value of money.

true

TRUE OR FALSE: Net present value profiles are most useful when selecting among mutually exclusive projects.

true

TRUE OR FALSE: On a purely theoretical basis, NPV is a better approach when selecting among two mutually exclusive projects.

true

TRUE OR FALSE: On a purely theoretical basis, NPV is preferred over IRR because NPV assumes a more conservative reinvestment rate and does not exhibit the mathematical problem of multiple IRRs that often occurs when IRRs are calculated for nonconventional cash flows.

true

TRUE OR FALSE: On a purely theoretical basis, NPV is the better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

true

TRUE OR FALSE: One weakness of payback period approach is its failure to recognize cash flows that occur after the payback period.

true

TRUE OR FALSE: Opportunity costs should be included as cash outflows when determining a project's incremental cash flows.

true

TRUE OR FALSE: Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost of capital and are therefore often acceptable at higher discount rates compared to projects with higher cash inflows that occur in the later years.

true

TRUE OR FALSE: Relevant cash flows are the incremental cash outflows and inflows associated with a proposed capital expenditure.

true

TRUE OR FALSE: Research and development is considered to be a motive for making capital expenditures.

true

TRUE OR FALSE: Since the payback period can be viewed as a measure of risk exposure, many firms use it as a supplement to other decision techniques.

true

TRUE OR FALSE: Sunk costs are cash outlays that have already been made and therefore have no effect on the cash flows relevant to the current decision.

true

TRUE OR FALSE: The IRR is the compounded annual rate of return that a firm will earn if it invests in a project and receives the estimated cash inflows.

true

TRUE OR FALSE: The IRR is the discount rate that equates the NPV of an investment opportunity with $0.

true

TRUE OR FALSE: The IRR method assumes the cash flows are reinvested at the internal rate of return rather than the required rate of return.

true

TRUE OR FALSE: The appeal of the IRR technique is due to the general disposition of business people to think in terms of rates of return rather than actual dollar returns.

true

TRUE OR FALSE: The basic cash flows that must be considered when determining the initial investment associated with a capital expenditure are the installed cost of the new asset, the after-tax proceeds (if any) from the sale of an old asset, and the change (if any) in net working capital.

true

TRUE OR FALSE: The basic motives for capital expenditures are to expand operations, to replace or renew fixed assets, or to obtain some other, less tangible benefit over a long period.

true

TRUE OR FALSE: The book value of an asset is equal to its installed cost of asset minus the accumulated depreciation.

true

TRUE OR FALSE: The capital budgeting process consists of five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up.

true

TRUE OR FALSE: The change in net working capital—regardless of whether an increase or decrease—is not taxable because it merely involves a net buildup or net reduction of current accounts.

true

TRUE OR FALSE: The discount rate is the minimum return that must be earned on a project to leave a firm's market value unchanged.

true

TRUE OR FALSE: The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.

true

TRUE OR FALSE: The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.

true

TRUE OR FALSE: The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $2,000 each year for the next three years is 0.5 years.

true

TRUE OR FALSE: The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $3,000 each year for the next three years is 0.333 years.

true

TRUE OR FALSE: The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 for the next three years is 3.33 years.

true

TRUE OR FALSE: The purchase of additional physical facilities, such as additional property or a new factory, is an example of a capital expenditure.

true

TRUE OR FALSE: The ranking approach involves the ranking of capital expenditure projects on the basis of some predetermined measure such as the rate of return.

true

TRUE OR FALSE: The relevant cash flows for a proposed capital expenditure are the incremental after-tax cash outflows and resulting subsequent inflows.

true

TRUE OR FALSE: The three major cash flow components include the initial investment, operating cash flows, and terminal cash flow.

true

TRUE OR FALSE: To calculate the initial investment, we subtract all cash inflows occurring at time zero from all cash outflows occurring at time zero.

true

Should Tangshan Mining company accept a new project if its maximum payback is 3.5 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?

yes, since the payback period of the project is less than the maximum acceptable payback period


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