Exam 10: Capital Budgeting Techniques

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.

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

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.

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

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

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.

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

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 ________.

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.

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

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.

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

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

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

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?

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.

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.

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

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.

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