Deck 4: Capital Budgeting: Basic Techniques

Question 1

Which of these best describes capital budgeting process?

A)The process of selecting from a set of projects available for investment
B)The process of determining the form in which capital will be returned to investors
C)The process of determining the mix of debt and equity to be used by the firm
D)The process of acquiring the funding necessary to finance new projects

Answer 1

The process of selecting from a set of projects available for investment

Question 2

Project A has a negative NPV.If accepted,what would be its impact on the shareholder wealth?

A)To increase it
B)To maintain it at the existing level
C)To decrease it
D)Unclear as there is insufficient information to decide if the project will be beneficial to the shareholders

Answer 2

To decrease it

Question 3

XHZ Ltd is looking at establishing a new fashion retail outlet in a new shopping centre being built.To secure the outlet XHZ Ltd will have to pay an initial cash outlay of $100,000 now and another $250,000 is 4 years' time when the outlet opens.The outlet is then expected to generate after tax cash flows of $380,000 p.a.for a period of 5 years after it opens (the first cash flow will be at the end of year 5).At the end of that time the lease will expire and XHZ's board does not anticipate that it will extend the lease.If XHZ uses a cost of capital of 7.50% p.a. ,what is the NPV of this project?

A)$801,233.09
B)$720,914.50
C)$796,774.84
D)$864,032.96

Answer 3

$864,032.96

Question 4

The discounted payback period of a project will be:

A)The same as the project's payback period
B)Greater than the project's payback period
C)Less than the project's payback period
D)Always less than the company's maximum acceptable payback period

Question 5

Using and internal rate of return decision rule,a project will be accepted if .

A)It has an IRR greater than the hurdle rate
B)It has a positive IRR
C)It has an IRR less than the hurdle rate
D)It has a negative IRR

Question 6

Project A has an IRR of 12%.The appropriate hurdle rate is 10%.If this is an investment project,then what should the company do about Project A?

A)Accept Project A.
B)Reject Project A.
C)Either accept or reject Project A as it makes no difference to the wealth of shareholders.
D)Not make any decision as there is insufficient information to decide if the project will be beneficial to the shareholders.

Question 7

Capricorn Industries Ltd is considering three mutually exclusive projects.Their costs and cash flows are: If Capricorn's required rate of return is 14%,which project should the company choose?

A)Project A
B)Project B
C)Project C
D)None of the projects

Question 8

Project B has an IRR of 12%.The appropriate hurdle rate is 14%.If this is a financing project then what should the company do about Project B?

A)Accept Project B.
B)Reject Project B.
C)Either accept or reject Project B as it makes no difference to the wealth of shareholders.
D)Not make any decision as there is insufficient information to decide if the project will be beneficial to the shareholders.

Question 9

Which of the following capital budgeting evaluation techniques has the least limitations associated with it?

A)IRR
B)ARR
C)NPV
D)Payback

Question 10

Project Alpha has the following net cash flows: If the cost of the project was $62,000 and the company's required rate of return is 10%,the project's discounted payback period is:

A)1.79 years
B)2.76 years
C)1.98 years
D)2.17 years

Question 11

What is the numerator in the average accounting rate of return technique?

A)Required rate of return
B)Average invested capital
C)EBDIT
D)Average income

Question 12

Project T has the following set of cash flows: When evaluating Project T using an IRR technique,what problem will arise?

A)Projects cannot have negative cash flows in any year other than year 0.
B)The projects IRR is impossible to determine.
C)The project will have multiple IRRs.
D)No problem should arise.

Question 13

Which of the following is a limitation of the ARR method of capital budgeting?

A)It ignores depreciation.
B)It fails to account for all cash flows of the project.
C)It ignores the time value of money.
D)All of the above

Question 14

What is the difference between the normal payback technique and the discounted payback technique?

A)The discounted payback is calculated using the future value of cash flows.
B)The normal payback method ignores the time value of money.
C)The normal payback method discounts future cash flows.
D)The discounted payback method ignores the time value of money.

Question 15

TSR Ltd is considering investing in a new printing machine.The machine costs $150,000 and is projected to generate $25,200 cash inflows at the end of each year for a period of 10 years.TSR estimates the appropriate discount rate to be 7% p.a.What is the NPV of the new printing machine?

A)$26,994.25
B)$4,843.09
C)- $27,315.85
D)- $14,189.91

Question 16

The net present value of a project discounted at the internal rate of return will be equal to:

A)$0
B)$1
C)Neither A nor B
D)Cannot be determined

Question 17

CMM Investments must choose one investment from four possible alternatives.The initial costs and cash flows produced by each alternative are given in the table below: CMM Investments has a cost of capital of 15% p.a.If CMM Investments prefers to use the NPV technique to make their investments decisions,which project will they choose?

A)Project A
B)Project B
C)Project C
D)Project D

Question 18

Kinloch Ltd has just purchased a new machine for $18,000.It will provide cash inflows of $5,000 per year for 5 years after which it will be sold as scrap for $1,000.If Kinloch's required rate of return is 10%,what is the NPV of this machine?

A)$5,993
B)$4,562
C)$1,576
D)$8,003

Question 19

Project Rosie is a two- year project that involves the purchase of new machinery for $10,000,that is expected to yield EBDIT of $7,800 in year 1 and $7,500 in year two.The machine can be depreciated on a straight- line basis.The current corporate tax rate is 30%.What is the project's ARR?

A)27.3%
B)19.5%
C)45.8%
D)39.1%

Question 20

Which of the following does not constitute a stage in the capital budgeting process?

A)Determining the mix of debt and equity to be used to finance the project
B)Forecast of costs and benefits associated with the project
C)Application of an investment evaluation technique to the cash flows of the project to determine acceptability
D)Choosing to accept or reject the project

Question 21

Which of the following investment evaluation techniques used in capital budgeting is based on the discounted cash flow model?

A)Accounting rate of return
B)Internal rate of return
C)Payback
D)Both B and C

Question 22

Outline the primary limitations of the payback technique.What variations exist of this technique that help address these problems?

Question 23

IRR is superior to NPV as an evaluation technique because the IRR decision rule is the same regardless of whether the project being evaluated is a financing project or an investment project.

Question 24

Project X has an initial cost of $2,000 and cash flows of $50 in year 1,$200 in year 2 and $3,490 in year three.What is the internal rate of return for the project?

Question 25

Studies have shown that DCF techniques are the most popular capital budgeting techniques in Australia.

Question 26

Project Y is a two- year project that involves the purchase of new machinery for $100 million,that is expected to yield EBDIT of $59 million in year 1 and $80 million in year two.For tax purposes the machine can be depreciated on a straight- line basis.The current corporate tax rate is 33%.What is the project's ARR?

A)39%
B)19%
C)46%
D)26%

Question 27

Which of the following projects would be chosen using the discounted payback technique with a hurdle payback period of 3.7 years? The appropriate discount rate is 10% p.a.

A)Projects A and C
B)Projects A and B
C)Projects B and C
D)Projects A,B and C

Question 28

taxis Industries is considering a project that would involve the purchase and refitting of a new manufacturing facility.The following information is known about this project: The initial cost of the purchase and refit of the facility is $300,000,000.There is expected to be no salvage value.
The facility can be depreciated using straight- line depreciation over a four- year life The current tax rate is 36%

A)What is the average accounting rate of return on the project?
B)Based upon this result should Tavis Industries accept this project?

Question 29

Project A has a positive NPV.What should the investment manager do in this situation?

A)Accept the project.
B)Reject the project.
C)Be indifferent between accepting or rejecting the project.
D)Not make any decision as there is insufficient information to decide if the project will be beneficial to the shareholders.

Question 30

Project Rocket costs $10,000 to invest in and provides for cash flows of $4,000 in year 1,$5,000 in year 2,$2,000 in year 3 and $3,000 in year 4.What is the payback period for Project Rocket?

A)3 years
B)2.5 years
C)2.8 years
D)None of the above

Question 31

Which of the following is not a benefit associated with using the NPV technique in capital budgeting?

A)The NPV technique takes into account the time value of money.
B)The NPV technique always selects projects that maximise shareholders' wealth.
C)The NPV technique provides evaluation in percentage format,making it easier to interpret.
D)The NPV technique considers all cash flows expected to be generated by the project and hence uses all available information.

Question 32

Zoolander Industries is considering purchasing Tyco Manufacturing in a friendly takeover.Zoolander's board estimates the full purchase of Tyco will cost $250,000,000 and will generate for the firm cash inflows of $25,000,000 a year for the next 3 years and then $30,000,000 a year continuously after then.Zoolander's board believes the appropriate discount rate is 10% p.a.What is the NPV of this purchase decision?

A)$287,565,740.00
B)$362,171,299.80
C)$112,171,299.80
D)$37,565,740.00

Question 33

Project Emma cost $15,000 and has the following net cash flows: What is Emma's payback period?

A)4.5 years
B)3.25 years
C)3 years
D)3.75 years

Question 34

What is the denominator in the average accounting rate of return technique?

A)Average invested capital
B)Required rate of return
C)Average income
D)EBDIT

Question 35

ABC Ltd and DEF Ltd are each considering the same two investment projects;Project G and Project H.These two projects are mutually exclusive.The cash flows produced by each project are the same for both companies.These cash flows are given below: The required rate of return of ABC Ltd is 6.3% whilst the required rate of return of DEF ltd is 4.1% pa.The IRR is Project G is 7.27% whilst the IRR of Project H is 7.87%.Which project should each company invest in if they wish to maximise shareholder wealth?

A)ABC Ltd should chose Project G and DEF Ltd should chose Project G.
B)ABC Ltd should chose Project H and DEF Ltd should chose Project H.
C)ABC Ltd should chose Project H and DEF Ltd should chose Project G.
D)ABC Ltd should chose Project G and DEF Ltd should chose Project H.

Question 36

Which of the following is not a limitation of the IRR capital budgeting technique?

A)It does not take into account the size of the project.
B)It is difficult to calculate without using trial and error,a financial calculator or a spreadsheet.
C)The rule must be modified if it is an investing project or a financing project.
D)Multiple IRR values can arise if the project has both positive and negative future cash flows.
E)All of the above are limitations of the IRR technique.

Question 37

If the net present value is positive,the internal rate of return must be:

A)Equal to the required rate of return
B)Greater than the initial outlay
C)Less than the required rate of return
D)Greater than the required rate of return

Question 38

Which of the following projects would be chosen using the payback technique with a hurdle payback period of 5.5 years?

A)Projects A and C
B)Projects B and C
C)Projects A and B
D)Projects A,B and C

Question 39

Which of the following is likely if a project with an NPV value of zero is accepted?

A)Shareholders are likely to receive more future wealth than if they had invested in another project.
B)The company is likely to make more money by accepting the project than if they had paid the available cash back to the shareholders.
C)Shareholders are likely to receive the same future wealth as they would have if they had invested elsewhere.
D)There will be insufficient funds to complete the project.

Question 40

Project A has a cost of $1,260 and provides a cash inflow of $1,449 in one years' time.What is its IRR?

A)35%
B)0%
C)25%
D)15%

Question 41

One of the key benefits of using the payback technique is that it accounts for all cash flows,even those occurring after the payback period.

Question 42

If used correctly,NPV and IRR techniques will generally lead to the same decision.

Question 43

When calculating the ARR,the average income is determined by subtracting depreciation and tax from the EBDIT.

Question 44

The NPV technique is the only investment evaluation technique that does not take into account the time value of money.

Question 45

When examining investing projects using IRR,the decision rule is to accept those projects with an IRR less than the hurdle rate.

Question 46

If a project's net present value is zero,the project should be rejected because it does nothing for shareholders' wealth.

Question 47

One problem with IRR as an evaluation technique is that multiple IRRs can occur when the project has both positive and negative future cash flows.

Question 48

When calculating the ARR,the average invested capital is determined by adding depreciation back to the book value of the investment.

Question 49

A single project can have only one NPV and IRR.

Question 50

When examining financing projects using IRR,the decision rule is to accept those projects with an IRR greater than the hurdle rate.

Question 51

A disadvantage of IRR is the complexity of the calculations involved without the use of a financial calculator or spreadsheet package.

Question 52

Project R has an IRR of 15% p.a.Project S has an IRR of 12% p.a.If the appropriate hurdle rate is 14% p.a. ,then the company should definitely choose project R?

Question 53

The chosen capital budgeting method should always be accompanied by evaluation criteria to assess the acceptability of the method.