MAS

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) an increase of $10,000. (b) a decrease of $10,000. (c) a decrease of $90,000. (d) an increase of $80,000.

B

A firm 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 assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is (a) $0 tax liability. (b) $1,320 tax liability. (c) $1,160 tax liability. (d) $2,000 tax benefit.

B

A firm with unlimited funds must evaluate five projects. Projects 1 and 2 are independent and Projects 3, 4, and 5 are mutually exclusive. The projects are listed with their returns. Project Status Return(%) 1 Independent 14 2 Independent 12 3 Mutually exclusive 10 4 Mutually exclusive 15 5 Mutually exclusive 12 A ranking of the projects on the basis of their returns from the best to the worst according to their acceptability to the firm would be (a) 4, 1, 2 or 5, and 3. (b) 4, 1, and 2. (c) 3, 2 or 5, 1, and 4. (d) 4, 1, 5, and 3.

B

A capital expenditure is all of the following except (a) an outlay made for the earning assets of the firm. (b) expected to produce benefits over a period of time greater than one year. (c) an outlay for current asset expansion. (d) commonly used to expand the level of operations.

C

A conventional cash flow pattern associated with capital investment projects consists of an initial (a) outflow followed by a broken cash series. (b) inflow followed by a broken series. (c) outflow followed by a series of inflows. (d) inflow followed by a series of outflows.

C

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset originally 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 a five year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains, the initial investment is _________. (a) $42,000 (b) $52,440 (c) $54,240 (d) $50,000

C

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 (a) 1.5 years. (b) 2 years. (c) 3.3 years. (d) 4 years.

C

All of the following are steps in the capital budgeting process except (a) implementation. (b) follow up. (c) transformation. (d) decision-making.

C

Cash flows that could be realized from the best alternative use of an owned asset are called (a) incremental costs. (b) lost resale opportunities. (c) opportunity costs. (d) sunk costs.

C

The minimum return that must be earned on a project in order to leave the firm's value unchanged is (a) the internal rate of return. (b) the interest rate. (c) the discount rate. (d) the compound rate.

C

The portion of an asset's sale price that is below its book value and below its initial purchase price is called (a) a capital gain. (b) recaptured depreciation. (c) a capital loss. (d) book value.

C

Which pattern of cash flow stream is the most difficult to use when evaluating projects? (a) Mixed stream. (b) Conventional flow. (c) Nonconventional flow. (d) Annuity.

C

The _________ is the discount rate that equates the present value of the cash inflows with the initial investment. (a) payback period (b) average rate of return (c) cost of capital (d) internal rate of return

D

A $60,000 outlay for a new machine with a usable life of 15 years is called (a) capital expenditure. (b) operating expenditure. (c) replacement expenditure. (d) none of the above.

A

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset originally 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 a five year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains, the initial investment is _________. (a) $48,560 (b) $44,360 (c) $49,240 (d) $27,600

A

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 assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is (a) $0 tax liability. (b) $840 tax liability. (c) $3,160 tax liability. (d) $3,160 tax benefit.

A

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 _________. (a) -$1,000 (b) $0 (c) $1,000 (d) $1.25

A

A firm would accept a project with a net present value of zero because (a) the project would maintain the wealth of the firm's owners. (b) the project would enhance the wealth of the firm's owners. (c) the return on the project would be positive. (d) the return on the project would be zero.

A

A non-conventional cash flow pattern associated with capital investment projects consists of an initial (a) outflow followed by a series of cash inflows and outflows. (b) inflow followed by a series of cash inflows and outflows. (c) outflow followed by a series of inflows. (d) inflow followed by a series of outflows.

A

All of the following would be used in the computation of an investment's initial investment except (a) the annual after tax inflow expected from the investment. (b) the initial purchase price of the investment. (c) the resale value of an old asset being replaced. (d) the tax on the sale of an old asset being replaced.

A

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 B 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? (a) Project X. (b) Project Y. (c) Neither. (d) Not enough information to tell.

A

On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all the following reasons EXCEPT (a) that it measures the benefits relative to the amount invested. (b) for the reasonableness of the reinvestment rate assumption. (c) that there may be multiple solutions for an IRR computation. (d) that it maximizes shareholder wealth.

A

The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT (a) incremental annual savings produced by the new asset. (b) cost of the new asset. (c) proceeds from the sale of the existing asset. (d) taxes on the sale of an existing asset.

A

The most common motive for adding fixed assets to the firm is (a) expansion. (b) replacement. (c) renewal. (d) transformation.

A

The ordering of capital expenditure projects on the basis of some predetermined measure such as the rate of return is called (a) the ranking approach. (b) an independent investment. (c) the accept-reject approach. (d) a mutually exclusive investment.

A

The tax treatment regarding the sale of existing assets that are depreciable and used in business and are sold for less than the book value results in (a) a tax benefit from an ordinary loss. (b) a capital gain tax liability. (c) recaptured depreciation taxed as ordinary income. (d) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

A

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is (a) the reinvestment rate assumption regarding intermediate cash flows. (b) that neither method explicitly considers the time value of money. (c) the assumption made by the IRR method that intermediate cash flows are reinvested at the cost of capital. (d) the assumption made by the NPV method that intermediate cash flows are reinvested at the internal rate of return.

A

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? (a) 5.83%. (b) 9.67%. (c) 11.44%. (d) None of the above.

A

What is the NPV for the following project if its cost of capital is 0 percent 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, $1,700,000 in year 3 and $1,300,000 in year 4? (a) $1,700,000. (b) $371,764. (c) $137,053. (d) None of the above.

A

What is the NPV for the following project if its cost of capital is 12 percent and 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, $1,900,000 in year 2, $1,700,000 in year 3 and ($1,300,000) in year 4? (a) $(1,494,336). (b) $1,494,336. (c) Greater than zero. (d) Two of the above.

A

Which capital budgeting method is most useful for evaluating the following project? The project has an initial after tax cost of $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? (a) NPV. (b) IRR. (c) Payback. (d) Two of the above.

A

Which of the following capital budgeting techniques ignores the time value of money? (a) Payback. (b) Net present value. (c) Internal rate of return. (d) Two of the above.

A

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 _________. (a) deductible from capital gains income; deductible from ordinary income (b) deductible from ordinary income; deductible only against capital gains (c) a credit against the tax liability; not deductible (d) not deductible; deductible only against capital gains

B

Among the reasons many firms use, the payback period as a guideline in capital investment decisions are all of the following EXCEPT (a) it gives an implicit consideration to the timing of cash flows. (b) it recognizes cash flows which occur after the payback period. (c) it is a measure of risk exposure. (d) it is easy to calculate.

B

Benefits expected from proposed capital expenditures must be on an after tax basis because (a) taxes are cash outflows. (b) no benefits may be used by the firm until tax claims are satisfied. (c) there may also be tax benefits to be evaluated. (d) it is common, accepted practice to do so.

B

Comparing net present value and internal rate of return analysis (a) always results in the same ranking of projects. (b) always results in the same accept/reject decision. (c) may give different accept/reject decisions. (d) is only necessary on mutually exclusive projects.

B

Examples of sophisticated capital budgeting techniques include all of the following EXCEPT (a) internal rate of return. (b) payback period. (c) annualized net present value. (d) net present value.

B

In comparing the internal rate of return and net present value methods of evaluation, (a) internal rate of return is theoretically superior, but financial managers prefer net present value. (b) net present value is theoretically superior, but financial managers prefer to use internal rate of return. (c) financial managers prefer net present value, because it is presented as a rate of return. (d) financial managers prefer net present value, because it measures benefits relative to the amount invested.

B

In international capital budgeting decisions, political risks can be minimized using all of the following strategies except (a) structuring the investment as a joint venture and selecting well-connected local partner. (b) structuring the financing of such investments as equity rather than as debt. (c) structuring the financing of such investments as debt rather than as equity. (d) None of the above.

B

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as (a) necessary cash flows. (b) relevant cash flows. (c) consistent cash flows. (d) ordinary cash flows.

B

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called (a) independent projects. (b) mutually exclusive projects. (c) replacement projects. (d) None of the above.

B

Relevant cash flows for a project are best described as (a) incidental cash flows. (b) incremental cash flows. (c) sunk cash flows. (d) accounting cash flows.

B

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because (a) it explicitly considers the time value of money. (b) it can be viewed as a measure of risk exposure. (c) the determination of payback is an objectively determined criteria. (d) it can take the place of the net present value approach.

B

Sophisticated capital budgeting techniques do not (a) examine the size of the initial outlay. (b) use net profits as a measure of return. (c) explicitly consider the time value of money. (d) take into account an unconventional cash flow pattern.

B

The _________ is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cash inflows. (a) discount rate (b) internal rate of return (c) opportunity cost (d) cost of capital

B

The cash flows of any project having a conventional pattern include all of the basic components except (a) initial investment. (b) operating cash outflows. (c) operating cash inflows. (d) terminal cash flow.

B

The final step in the capital budgeting process is (a) implementation. (b) follow up monitoring. (c) re evaluation. (d) education.

B

The portion of an asset's sale price that is above its book value and below its initial purchase price is called (a) a capital gain. (b) recaptured depreciation. (c) a capital loss. (d) book value.

B

The tax treatment regarding the sale of existing assets that are not depreciable or used in business and are sold for less than the book value results in (a) an ordinary tax benefit. (b) a capital gain tax benefit. (c) recaptured depreciation taxed as ordinary income. (d) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

B

The tax treatment regarding the sale of existing assets that are sold for their book value results in (a) an ordinary tax benefit. (b) no tax benefit or liability. (c) recaptured depreciation taxed as ordinary income. (d) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

B

Unlike the net present value criteria, the internal rate of return approach assumes an interest rate equal to (a) the relevant cost of capital. (b) the project's internal rate of return. (c) the project's opportunity cost. (d) the market's interest rate.

B

When evaluating a capital budgeting project the change in net working capital must be considered as part of (a) the operating cash inflows. (b) the initial investment. (c) the incremental operating cash inflows. (d) the operating cash outflows.

B

When evaluating projects using internal rate of return, (a) projects having lower early-year cash flows tend to be preferred at higher discount rates. (b) projects having higher early-year cash flows tend to be preferred at higher discount rates. (c) projects having higher early-year cash flows tend to be preferred at lower discount rates. (d) the discount rate and magnitude of cash flows do not affect internal rate of return.

B

_________ is the process of evaluating and selecting long term investments consistent with the firm's goal of owner wealth maximization. (a) Recapitalizing assets (b) Capital budgeting (c) Ratio analysis (d) Restructuring debt

B

_________ projects do not compete with each other; the acceptance of one _________ the others from consideration. (a) Capital; eliminates (b) Independent; does not eliminate (c) Mutually exclusive; eliminates (d) Replacement; does not eliminate

B

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? (a) 4.33 years. (b) 3.33 years. (c) 2.33 years. (d) None of the above. 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? (a) Yes. (b) No. (c) It depends. (d) None of the above. 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? (a) Yes. (b) No. (c) It depends (d) None of the above

B A B

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 B 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? (a) Project X. (b) Project Y. (c) Neither. (d) Not enough information to tell.

C

Fixed assets that provide the basis for the firm's profit and value are often called (a) tangible assets. (b) non current assets. (c) earning assets. (d) book assets.

C

In developing the cash flows for an expansion project, the analysis is the same as the analysis for replacement projects where (a) all cash flows from the old assets are equal. (b) prior cash flows are irrelevant. (c) all cash flows from the old asset are zero. (d) cash inflows equal cash outflows.

C

In evaluating the initial investment for a capital budgeting project, (a) an increase in net working capital is considered a cash inflow. (b) a decrease in net working capital is considered a cash outflow. (c) an increase in net working capital is considered a cash outflow. (d) net working capital does not have to be considered.

C

The book value of an asset is equal to the (a) fair market value minus the accounting value. (b) original purchase price minus annual depreciation expense. (c) original purchase price minus accumulated depreciation. (d) depreciated value plus recaptured depreciation.

C

The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criteria is called (a) the ranking approach. (b) an independent investment. (c) the accept-reject approach. (d) a mutually exclusive investment.

C

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) an ordinary tax benefit. (b) a capital gain tax liability. (c) recaptured depreciation taxed as ordinary income. (d) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

C

Unsophisticated capital budgeting techniques do not (a) examine the size of the initial outlay. (b) use net profits as a measure of return. (c) explicitly consider the time value of money. (d) take into account an unconventional cash flow pattern.

C

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? (a) 15.57%. (b) 0.00%. (c) 13.57%. (d) None of the above.

C

What is the NPV for the following project if its cost of capital is 15 percent 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, $1,700,000 in year 3 and $1,300,000 in year 4? (a) $1,700,000 (b) $371,764 (c) ($137,053) (d) None of the above

C

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. (a) conventional (b) non-conventional (c) incremental (d) initial

C

Which of the following statements is false? (a) If the payback period is less than the maximum acceptable payback period, accept the project. (b) If the payback period is greater than the maximum acceptable payback period, reject the project. (c) If the payback period is less than the maximum acceptable payback period, reject the project (d) Two of the above.

C

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 (a) an increase of $120,000. (b) a decrease of $40,000. (c) a decrease of $120,000. (d) an increase of $60,000.

D

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 assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is (a) $0 tax liability. (b) $1,100 tax liability. (c) $3,600 tax liability. (d) $280 tax benefit.

D

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 assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is (a) $0 tax liability. (b) $7,560 tax liability. (c) $4,400 tax liability. (d) $7,720 tax liability.

D

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 (a) 1 year. (b) 2 years. (c) between 1 and 2 years. (d) between 2 and 3 years.

D

A firm with limited dollars available for capital expenditures is subject to (a) capital dependency. (b) mutually exclusive projects. (c) working capital constraints. (d) capital rationing.

D

All of the following are motives for capital budgeting expenditures except (a) expansion. (b) replacement. (c) renewal. (d) invention.

D

All of the following are weaknesses of the payback period EXCEPT (a) a disregard for cash flows after the payback period. (b) only an implicit consideration of the timing of cash flows. (c) the difficulty of specifying the appropriate payback period. (d) it uses cash flows, not accounting profits.

D

An important cash inflow in the analysis of initial cash flows for a replacement project is (a) taxes. (b) the cost of the new asset. (c) installation cost. (d) the sale value of the old asset.

D

Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called (a) incremental historical costs. (b) incremental past expenses. (c) opportunity costs foregone. (d) sunk costs.

D

If accounts receivable increase by $1,000,000, inventory decreases by $500,000, and accounts payable increase by $500,000, net working capital would (a) decrease by $500,000. (b) increase by $1,500,000. (c) increase by $2,000,000. (d) experience no change.

D

Payback is considered an unsophisticated capital budgeting technique, and as such (a) gives no consideration to the timing of cash flows and therefore the time value of money. (b) gives no consideration to risk exposure. (c) does consider the timing of cash flows and therefore gives explicit consideration to the time value of money. (d) gives some implicit consideration to the timing of cash flows and therefore the time value of money.

D

The _________ is the exact amount of time it takes the firm to recover its initial investment. (a) average rate of return (b) internal rate of return (c) net present value (d) payback period

D

The change in net working capital when evaluating a capital budgeting decision is (a) current assets minus current liabilities. (b) the increase in current assets. (c) the increase in current liabilities. (d) the change in current assets minus the change in current liabilities.

D

The first step in the capital budgeting process is (a) review and analysis. (b) implementation. (c) decision making. (d) proposal generation.

D

The tax treatment regarding the sale of existing assets that are sold for more than the book value and more than the original purchase price results in (a) an ordinary tax benefit. (b) no tax benefit or liability. (c) recaptured depreciation taxed as ordinary income. (d) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

D

There is sometimes a ranking problem among NPV and IRR when selecting among mutually exclusive investments. This ranking problem only occurs when (a) the NPV is greater than the crossover point. (b) the NPV is less than the crossover point. (c) the cost of capital is to the right of the crossover point. (d) the cost of capital is to the left of the crossover point.

D

Which of the following statements is false? (a) If the payback period is greater than the maximum acceptable payback period, accept the project. (b) If the payback period is less than the maximum acceptable payback period, reject the project. (c) If the payback period is greater than the maximum acceptable payback period, reject the project. (d) Two of the above.

D

_________ is a series of equal annual cash flows. (a) A mixed stream (b) A conventional (c) A non-conventional (d) An annuity

D