Exam 10: Capital Budgeting Techniques

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?

The final step in the capital budgeting process is

A firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows: The firm should

Payback is considered an unsophisticated capital budgeting because it

If its IRR is greater than 0 percent, a project should be accepted.

The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criteria is called

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 the firm's cost of capital is called net present value.

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 3.33 years.

________ is the process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization.

When evaluating projects using internal rate of return,

Table 10.5 Galaxy Satellite Co. is attempting to select the best group of independent projects competing for the firm's fixed capital budget of $10,000,000. Any unused portion of this budget will earn less than its 20 percent cost of capital. A summary of key data about the proposed projects follows. -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? Show all work.

Table 10.5 Galaxy Satellite Co. is attempting to select the best group of independent projects competing for the firm's fixed capital budget of $10,000,000. Any unused portion of this budget will earn less than its 20 percent cost of capital. A summary of key data about the proposed projects follows. -Use the IRR approach to select the best group of projects. (See Table 10.5)

If a firm has unlimited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria can be implemented.

Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could actually reinvest intermediate cash inflows, the use of NPV is in theory preferable to IRR.

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

Sophisticated capital budgeting techniques do not

Capital budgeting is the process of evaluating and selecting short-term investments consistent with the firm's goal of owner wealth maximization.

A non-conventional cash flow pattern associated with capital investment projects consists of an initial

The most common motive for adding fixed assets to the firm is

On a purely theoretical basis, NPV is a 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.