Capital Budgeting

Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project. a. "A" has a small, but negative, NPV. b. "B" has a positive NPV when discounted at 10%. c. "C's" cost of capital exceeds its rate of return. d. "D" has a zero NPV when discounted at 14%.

d. "D" has a zero NPV when discounted at 14%.

A project will generate $1 million net cash flow annually in perpetuity. If the project costs $7 million, what is the lowest WACC shown below that will make the NPV negative? a. 10% b. 12% c. 14% d. 16%

d. 16%

Which of the following statements is most likely correct for a project costing $50,000 and returning $14,000 per year for five years? a. NPV = $3,071.01. b. NPV = $20,000. c. IRR = 2.8%. d. IRR is greater than 10%.

d. IRR is greater than 10%.

Income that is measured after deduction of the cost of capital is called: a. operating income. b. operating profit. c. economic income. d. economic profit.

d. economic profit.

What is the undiscounted cash flow in the final year of an investment, assuming: $10,000 after-tax cash flows from operations, the fully depreciated machine is sold for $1,000, the project had required $2,000 in additional working capital, and a 35% tax rate?

$12,650

What is the NPV of a project that costs $100,000 and returns $50,000 annually for three years if the opportunity cost of capital is 14%?

$16,085.00

What is the equivalent annual cost for a project that requires a $40,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

$22,618.83 [ Use PV of Annuity formula ]

Your forecast shows $500,000 annually in sales for each of the next three years. If your second and third year predictions have failed to incorporate 2.5% expected annual inflation, how far off in total dollars is your three-year forecast?

$37,813

A firm generates sales of $250,000, depreciation expense of $50,000, taxable income of $50,000, and has a 35% tax rate. By how much does net cash flow deviate from net income?

$50,000

What is the approximate maximum amount that a firm should consider paying for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%?

$56,860 [ Price = PV of Future CFs ]

What is the net effect on a firm's working capital if a new project requires: $30,000 increase in inventory, $10,000 increase in accounts receivable, $35,000 increase in machinery, and a $20,000 increase in accounts payable?

Rise in WC by $20,000

Which of the following changes in working capital will result in an increase in cash flows? a. Increase in accounts payable b. Increase in inventories c. Increase in accounts receivable d. Decrease in other current liabilities

a. Increase in accounts payable

Which of the following statements is true for a project with $20,000 initial cost, cash inflows of $5,800 per year for six years, and a discount rate of 15%? a. Its payback period is roughly 3.5 years. b. Its NPV is $2,194. c. Its IRR is 1.85%. d. Its profitability index is 0.109.

a. Its payback period is roughly 3.5 years.

If a project's cash flows exceed the project's incremental cash flows, it is likely that the: a. project interacts with other aspects of the firm. b. project must have high depreciation expense. c. opportunity cost of capital must be high. d. project will have a negative NPV.

a. project interacts with other aspects of the firm.

What happens to the equivalent annual cost of a project as the opportunity cost of capital decreases? a. It increases. b. It decreases. c. It is not affected. d. It depends on whether or not the projects are mutually exclusive.

b. It decreases.

Which of the following is least likely to be responsible for a regional manager's conflict of interest in promoting a capital budgeting proposal? a. Desire for professional advancement b. Thorough knowledge of the region c. Overly optimistic economic forecasts d. The need for quick profitability

b. Thorough knowledge of the region

An increase in depreciation expense will (other things equal): a. increase net income. b. decrease net income. c. increase cash flow. d. decrease the market value of assets.

b. decrease net income.

When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the: a. project's initial cost. b. project's NPV. c. project's discounted cash flows. d. soft capital rationing budget.

b. project's NPV.

Firms that make investment decisions based upon the payback rule may be biased toward rejecting projects: a. with short lives. b. with long lives. c. with early cash inflows. d. that have negative NPVs.

b. with long lives.

Which of the following changes in working capital is least likely, given an increase in the overall level of sales? a. An increase in inventories b. An increase in accounts payable c. A decrease in accounts receivable d. A decrease in accruals

c. A decrease in accounts receivable

Which of the following descriptions is representative of scenario analysis? a. One variable at a time is allowed to change. b. It isolates the unknowns that belong in the model. c. Different combinations of variables are analyzed. d. It represents the "top-down" approach.

c. Different combinations of variables are analyzed.

If a project is expected to increase inventory by $17,000, increase accounts payable by $10,000, and decrease accounts receivable by $1,000, what effect does working capital have during the life of the project? a. Increases investment by $4,000. b. Increases investment by $5,000. c. Increases investment by $6,000. d. Working capital has no effect during the life of the project.

c. Increases investment by $6,000.

Which of the following is not subtracted from sales revenues to determine pretax profit? a. Depreciation b. Fixed costs c. Interest expense d. Variable costs

c. Interest expense

Project A has an IRR of 20% while Project B has an IRR of 30%. Under which of the following situations might you be inclined to select Project A, assuming the projects to be mutually exclusive, lending projects? a. Project A is more risky. b. Project A requires a smaller initial investment. c. Project A requires a larger initial investment. d. Project A requires cash outflows in the final period.

c. Project A requires a larger initial investment.

New projects or products can have an indirect effect on the firm as well as direct effect. Which of the following appears to be an indirect effect of launching a new product? a. Additional working capital is required. b. Salesforce will need to be increased. c. Sales of our similar product will decline. d. Additional machinery must be purchased.

c. Sales of our similar product will decline.

The opportunity to abandon a project loses some of its value when: a. fixed costs are high. b. markets are extremely competitive. c. the future is relatively certain. d. secondary markets exist and are active.

c. the future is relatively certain.

Positive NPV projects exist because: a. analysts select sufficiently low discount rates. b. most projects are unique and innovative. c. cash-flow projections are extended into the future. d. of competitive advantages held by firms.

d. of competitive advantages held by firms.

A firm with high operating leverage is expected to: a. have high variable costs. b. have low fixed costs. c. have a high degree of profitability. d. perform better when sales are high.

d. perform better when sales are high.