Principles of Finance Quiz 3: Chapters 10-11
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
