Finance Test 3 (Chapter 11)
The net present value of the project is ________. (See Table 11.5) A) $3,815 B) $2,445 C) $5,614 D) $7,500
A) $3,815
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) $0 tax liability
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) $48,560
The book value of the existing asset is ________. (See Table 11.3) A) $7,250 B) $15,000 C) $21,250 D) $25,000
A) $7,250
The cash flow pattern for the capital investment proposal is ________. (See Table 11.3) A) a mixed stream and conventional B) a mixed stream and nonconventional C) a perpetuity and conventional D) an annuity and nonconventional
A) a mixed stream and conventional
A(n) ________ allows management to avoid or minimize losses on projects that turn bad. A) abandonment option B) growth option C) timing option D) put option
A) abandonment option
One basic technique used to evaluate after-tax operating cash flows is to ________. A) add noncash charges to net income B) subtract depreciation from operating revenues C) add cash expenses to net income D) subtract cash expenses from noncash charges
A) add noncash charges to net income
The objective of ________ is to select the group of projects that provides the highest overall net present value and does not require more dollars than are budgeted. A) capital rationing B) scenario analysis C) real options D) sensitivity analysis
A) capital rationing
The option to develop follow-on projects, expand markets, expand or retool plants, and so on that would not be possible without implementation of the project that is being evaluated is called ________. A) growth option B) timing option C) flexibility option D) abandonment option
A) growth option
In capital budgeting, risk refers to ________. A) the degree of variability of the cash inflows B) the degree of variability of the initial investment C) the chance that the net present value will be greater than zero D) the chance that the internal rate of return will exceed the cost of capital
A) the degree of variability of the cash inflows
Breakeven cash inflow refers to ________. A) the minimum level of cash inflow necessary for a project to be acceptable, that is, NPV greater than zero B) the minimum level of cash inflow necessary for a project to be acceptable, that is, NPV less than zero C) the minimum level of cash inflow necessary for a project to be acceptable, that is, IRR less than zero cost of capital D) the minimum level of cash inflow necessary for a project to be acceptable, that is, IRR equals zero
A) the minimum level of cash inflow necessary for a project to be acceptable, that is, NPV greater than zero
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?
Answer: 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.
Compute the initial purchase price for an asset with book value of $34,800 and total accumulated depreciation of $85,200.
Answer: Initial purchase price = Book value + Accumulated depreciation = $34,800 + $85,200 = $120,000
Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost.
Answer: 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.
An approach to capital rationing that involves graphing project returns in descending order against the total dollar investment to determine the group of acceptable projects is called the ________. A) net present value approach B) internal rate of return approach C) payback approach D) profitability index approach
B) internal rate of return approach
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) $1,320 tax liability
Tangshan Mining Company, with a cost of capital of 10 percent, is considering investing in project A, with an initial investment of $1,000,000. Project A is expected to provide equal cash inflows over its 15 year useful life. Based on this information, the breakeven cash inflow for the project is ________. A) $1,000,000 B) $131,474 C) $100,000 D) $66,667
B) $131,474
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 the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is ________. A) $24,000 B) $16,000 C) $14,000 D) $26,000
B) $16,000
The annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 11.3) A) $13,950 B) $16,600 C) $25,600 D) $30,000
B) $16,600
The initial outlay equals ________. (See Table 11.3) A) $41,100 B) $44,100 C) $38,800 D) $38,960
B) $44,100
The incremental depreciation expense for year 1 is ________. (See Table 11.3) A) $2,250 B) $7,600 C) $7,000 D) $7,950
B) $7,600
The tax treatment regarding the sale of existing assets that are sold for less than the book value results in ________. A) an ordinary tax benefit B) a capital loss tax benefit C) recaptured depreciation taxed as ordinary income D) a capital gain tax liability and recaptured depreciation taxed as ordinary income
B) 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) 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 decrease of $10,000
Which of the following must be considered in computing the terminal value of a replacement project? A) operating cash flow for the final year B) after-tax proceeds from the sale of a new asset C) before-tax proceeds from the sale of an old asset D) before-tax proceeds from the sale of a new asset
B) after-tax proceeds from the sale of a new asset
Behavioral approaches ________. A) are used to explicitly recognize project risk B) are used to get a feel for project risk C) are not used by rational financial managers D) are used to quantify the risk
B) are used to get a feel for project risk
The advantage of using simulation in the capital budgeting process is the ________. A) ease of calculation over scenario analysis B) continuum of risk-return trade-offs for decision making C) single point estimate that helps the decision maker to choose the most accurate alternative D) use of several possible outcomes to asses risk
B) continuum of risk-return trade-offs for decision making
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) deductible from ordinary income; deductible only against capital gains
Relevant cash flows for a project are best described as ________. A) incidental cash flows B) incremental cash flows C) sunk cash flows D) contingent cash flows
B) incremental cash flows
Benefits expected from proposed capital expenditures ________. A) must be on a pre-tax basis because it provides the true position of profits by the firm B) must be on an after-tax basis because no benefits may be used until tax claims are satisfied C) may be valued either on pre-tax or after-tax basis based on the size of the firm D) are independent of interest and taxes
B) must be on an after-tax basis because no benefits may be used until tax claims are satisfied
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) no tax benefit or liability
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) recaptured depreciation
Initial cash outflows and subsequent operating cash inflows for a project are referred to as ________. A) necessary cash flows B) relevant cash flows C) perpetual cash flows D) ordinary cash flows
B) relevant cash flows
The difference by which the required discount rate exceeds the risk-free rate is called the ________. A) excess return B) risk premium C) inflation premium D) maturity premium
B) risk premium
A behavioral approach that evaluates the impact on a firm's return through simultaneous changes in a number variables of a project is called ________. A) sensitivity analysis B) scenario analysis C) simulation analysis D) Monte Carlo simulation
B) scenario analysis
The theoretical basis from which the concept of risk-adjusted discount rates is derived is ________. A) the Gordon model B) the capital asset pricing model C) simulation theory D) the basic cost of money
B) the capital asset pricing model
When evaluating a capital budgeting project, installation costs of a new machine 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) the initial investment
Which of the following would be used in the computation of an initial investment? A) the annual after-tax inflow expected from the investment B) the initial purchase price of the investment C) the historic cost of the existing investment D) the profits from the new investment
B) the initial purchase price of the investment
The present value of the project's annual cash flows is ________. (See Table 11.5) A) $ 47,820 B) $ 42,820 C) $ 51,635 D) $100,563
C) $ 51,635
The tax effect on the sale of the existing asset results in ________. (See Table 11.3) A) $800 tax benefit B) $1,000 tax liability C) $1,100 tax liability D) $6,000 tax liability
C) $1,100 tax liability
The initial outlay for this project is ________. (See Table 11.5) A) $42,820 B) $40,320 C) $47,820 D) $35,140
C) $47,820
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) $54,240
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 the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is ________. A) $5,800 B) $7,800 C) $8,200 D) $6,200
C) $8,200
________ reflects the return that must be earned on the given project to compensate the firm's owners adequately. A) Internal rate of return B) Cost of capital C) Risk-adjusted discount rate D) Average rate of return
C) Risk-adjusted discount rate
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) a capital loss
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) all cash flows from the old asset are zero
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) an increase in net working capital is considered a cash outflow
The payback period for the project is ________. (See Table 11.5) A) 2 years B) 3 years C) between 3 and 4 years D) between 4 and 5 years
C) between 3 and 4 years
If a firm has a limited capital budget to fund its capital projects, it is said to be facing the problem of ________. A) constrained capital B) wealth optimization C) capital rationing D) profitability
C) capital rationing
The shares traded publicly in an efficient market are ________. A) generally positively affected by diversification, because of the reduction in risk B) generally negatively affected by diversification, because of the increase in risk C) generally not affected by diversification, unless greater returns are expected D) generally negatively affected by diversification, because of the increase in the required rate of return
C) generally not affected by diversification, unless greater returns are expected
The internal rate of return for the project is ________. (See Table 11.5) A) between 7 and 8 percent B) between 9 and 10 percent C) greater than 12 percent D) between 10 and 11 percent
C) greater than 12 percent
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) opportunity C) incremental D) sunk
C) incremental
Firms do not usually get rewarded by diversifying investments in different lines of business because ________. A) the capital markets are efficient and they quickly respond to change in economic conditions B) cash flows from such projects tend to respond less to changing economic conditions C) investors themselves can diversify by holding securities in a variety of firms; they do not need the firm to do it for them D) it is not possible for a firm to diversify its risk as the inflation premium is different for different projects
C) investors themselves can diversify by holding securities in a variety of firms; they do not need the firm to do it for them
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) opportunity costs
The book value of an asset is equal to the ________. A) fair market value minus the accounting value B) original purchase price plus annual depreciation expense C) original purchase price minus accumulated depreciation D) depreciated value plus recaptured depreciation
C) original purchase price minus accumulated depreciation
Which of the following basic variables must be considered in determining the initial investment associated with a capital expenditure? A) incremental annual savings produced by the new asset B) cash flows generated by the new investment C) proceeds from the sale of an existing asset D) profits on the sale of an existing asset
C) proceeds from the sale of an existing asset
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) ________. A) ordinary tax benefit B) capital gain tax liability C) recaptured depreciation taxed as ordinary income D) capital gain tax liability and recaptured depreciation taxed as ordinary income
C) recaptured depreciation taxed as ordinary income
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) $280 tax benefit
The incremental depreciation expense for year 5 is ________. (See Table 11.3) A) $2,250 B) $5,110 C) $7,950 D) $6,360
D) $6,360
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) $7,720 tax liability
An IRR approach to capital rationing involves graphically plotting project IRRs in descending order against total dollar investment on an ________ graph. A) ANPV B) NPV C) RADR D) IOS
D) IOS
One type of simulation program made popular by the widespread use of personal computers is called ________. A) Monaco Simulation B) Lemans Simulation C) Cannes Simulation D) Monte Carlo Simulation
D) Monte Carlo Simulation
The tax treatment regarding the sale of existing assets that are sold for more than the original purchase price results in ________. A) an ordinary tax benefit B) no tax benefit or liability C) a recaptured depreciation taxed as ordinary income D) a capital gain tax liability
D) a capital gain tax liability
The tax effect of the sale of the existing asset is ________. (See Table 11.5) A) a tax liability of $2,340 B) a tax benefit of $1,500 C) a tax liability of $3,320 D) a tax liability of $5,320
D) a tax liability of $5,320
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 $60,000 C) a decrease of $120,000 D) an increase of $60,000
D) 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). A) internal rate of return B) investment opportunities schedule C) risk-adjusted discount rate D) annualized net present value
D) annualized net present value
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) experience no change
A preferred approach for risk adjustment of capital budgeting cash flows, from a practical viewpoint, is ________. A) sensitivity analysis B) simulation analysis C) scenario analysis D) risk-adjusted discount rates
D) risk-adjusted discount rates
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) sunk costs
The change in net working capital when evaluating a capital budgeting decision is ________. A) the change in fixed liabilities minus the change in fixed assets 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 change in current assets minus the change in current liabilities
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) the sale value of the old asset
In capital budgeting, risk refers to ________. A) the chance that a project will prove acceptable B) the conflicting IRR and NPV in a project C) the degree of variability of initial outlay D) the uncertainty of cash inflows
D) the uncertainty of cash inflows
