Deck 11: Managing Long-Lived Resources: Capital Budgeting

Question 1

Cost allocations ignore the "lumpy" nature of capacity resources, and estimate costs as if we can match supply and demand continuously and smoothly.

Answer 1

True

Question 2

Unlike the Cost-Volume-Profit method, the NPV method does not allow users to perform "what-if" sensitivity analysis with respect to various estimates and assumptions, and to examine alternative scenarios.

Answer 2

False

Question 3

The present value factor is also known as the discount factor.

Answer 3

True

Question 4

Under the payback method to evaluate investments, we compute how long it takes to recoup the initial investment using discounted cash flows.

Question 5

The initial outlay for an asset does not include the cost of installation and training charges.

Question 6

The greatest advantage of the payback method is that the payback period is easy to compute and to understand.

Question 7

The modified payback method accumulates the present value of future cash flows over time and compares the cumulative value with the initial cash outlay.

Question 8

Like the Net Present Value method, the Internal Rate of Return method assumes that the initial cash outflow takes place at the beginning of the period.

Question 9

When analyzing capital investments using the NPV method, the first step is to discount the initial investment.

Question 10

The salvage of an asset is the residual value from disposing of the asset at the end of its useful life.

Question 11

The opportunity of cash is the time value of money.

Question 12

It is not difficult to match the supply and demand for capacity resources over a period of months or even years.

Question 13

The two main discounted cash flow techniques used in capital budgeting are net present value (NPR) and cost-volume-profit (CVP).

Question 14

Setting an estimated life expectancy of an asset too low understates the profitability of the investment and could result in the firm rejecting profitable opportunities.

Question 15

Money is not a productive asset because it is not a long-lived resource.

Question 16

As it relates to capital expenditure decisions, cost of capital is the opportunity cost of capital required for the proposed investment.

Question 17

The greatest advantage of the modified payback method is that it considers all future cash flows from a project as does the NPV method.

Question 18

The cost of capital is measured as the total of all costs incurred to ready an asset for its intended use, including purchase price, shipping and delivery, taxes, and any installation and training costs.

Question 19

The accounting rate of return is relatively straightforward to compute, but ignores the time value of money.

Question 20

Strategic plans specify how the company intends to achieve its long-term objectives, and dictate what resources the firm needs to execute its plans.

Question 21

Which of the following is not one of the four elements of a capital expenditure decision about a single project?

A) Estimated life and salvage value.
B) Depreciation method.
C) Initial outlay.
D) Timing and amounts of operating cash flows.
E) Cost of capital.

Question 22

Net cash flows typically equal accounting income.

Question 23

Regardless of the method used to evaluate long-lived resources, firms need to consider one very important factor: present value.

Question 24

The hurdle rate reflects the minimum expected rate of return of the management from any project.

Question 25

Capital budgets allocate:

A) Cash flows to functioning activities.
B) Supply to demand.
C) Scarce capital among available investment opportunities.
D) Productive capacity among products.
E) None of the above.

Question 26

Real option analysis is a collection of mathematical techniques for valuing the flexibility associated with a project.

Question 27

Which of the following is not a factor in increasing cash inflows from external sales resulting from a capital investment in new equipment? a. Interest income.
B) Increased sales as a result of increased production.
C) Increased production as a result of fewer reworks.
D) Income from renting out the equipment's spare capacity.
E) All of the above are factors in increasing cash inflows.

Question 28

Which of the following is not a part of the initial outlay for a capital expenditure?

A) Salvage value.
B) Shipping costs.
C) Taxes.
D) Installation costs.
E) Training charges.

Question 29

Ignoring future benefits because they are hard to quantify can lead to lost opportunities.

Question 30

Capital budgeting is used to evaluate:

A) Whether the purchase of short-term assets such as securities will provide the company with an acceptable return
B) The best timing for the sale of an existing long-term assets such as buildings so it will be the most profitable
C) Whether the purchase of a long-term asset will provide the company a satisfactory return on their investment
D) The profitability of the addition or deletion of a product lines

Question 31

Estimating future cash inflows and outflows, and identifying the appropriate discount rate for present value calculations is generally all companies need to evaluate a given capital expenditure.

Question 32

Depreciation offers a tax shield that reduces the cash outflow associated with tax payments.

Question 33

Taxes affect both the amount and timing of cash flows.

Question 34

Some firms accept low rates of return to compensate for the risk from taking on long-lived capital investments.

Question 35

U.S. tax laws only allow depreciation deductions using the Modified Accelerated Cost Recovery System (MACRS).

Question 36

Money is a productive asset. Its opportunity cost is:

A) The time value of money.
B) Depreciation.
C) Inflation.
D) Replacement cost.
E) Valuation.

Question 37

Which of the following methods for evaluating project profitability uses the time value of money? a. Payback period.
B) Modified payback period.
C) Internal rate of return.
D) Accounting rate of return.
E) All of the above methods use the time value of money.

Question 38

Using a reasonable and realistic estimate of life expectancy of a capital expenditure is important because: a. Too low of an estimate understates the profitability of the investment.
B) Too high of an estimate could lead to a wasteful use of scarce capital.
C) A profitable opportunity could be rejected if the life expectancy is not reasonable or realistic.
D) Both A and
B) e. A, B and
C)

Question 39

The Fargas Company invested $90,000 in a two-year project in which net cash inflows for the first year totaled $57,000. Assume that the cash flows for the year all occur on the last day of the year. If the internal rate of return was exactly 10%, the cash flow for the second year must have been (without considering the effect of taxes):

A) $36,300
B) $30,562
C) $33,000
D) $46,231

Question 40

Which of the following is not a typical operating cash outflow from a capital investment in equipment? a. Hiring additional personnel.
B) Depreciation
C) Maintenance costs.
D) Repairs.
E) All of the above are typical operating cash outflows.

Question 41

The accounting rate of return is computed as: a. Average annual income from the project divided by average annual investment.
B) Average annual income from the project divided by the length of time it takes to recoup the initial investment.
C) Average annual investment divided by the average annual income from the project.
D) Average annual investment divided by the length of time it takes to recoup the initial investment.
E) The initial cash outlay divided by the average annual income from the project.

Question 42

Which of the following is not an advantage of the payback method? a. It focuses on a project's downside risk.
B) It takes into account the time value of money.
C) It is easy to compute.
D) It is easy to understand.
E) All of the above are advantages of the payback method.

Question 43

Which of the following capital budgeting analysis tools does not account for the time value of money?

A) Net present value
B) Internal rate of return
C) Payback
D) Modified payback LO

Question 44

Consider the following facts - do not consider the impact of income taxes: The net present value of the equipment is:

A) $14,895
B) $18,300
C) $63,300
D) $59,895

Question 45

A firm pays taxes on: a. Cash flows.
B) Accounting income.
C) Both A and
B)
B) d. Neither A nor

Question 46

Company X invested in a piece of equipment with an initial cost of $80,000. The equipment is expected to provide net cash flows of $18,000 per year with an estimated life of 10 years and no salvage value. The company's cost of capital is 14%. The payback period using the modified payback method and without considering the impact of taxes is:

A) 4.4 years
B) 7.4 years
C) 8 years
D) 9 years

Question 47

A project is profitable if its internal rate of return: a. Exceeds its discount rate.
B) Is zero.
C) Exceeds cash outflows of the project.
D) Exceeds its opportunity cost of capital.
E) None of the above.

Question 48

Which of the following statements describes the modified payback method? a. We compute how long it takes to recoup the initial investment using undiscounted cash flows.
B) The method accumulates the present value of future cash flows over time and compares the cumulative value with the salvage value of the capital expenditure.
C) The method accumulates the absolute value of future cash flows over time and compares the cumulative value with the present value of the capital expenditure.
D) The year in which the accumulated present value of future cash flows exceeds the initial cash outflow determines the modified payback period.
E) None of the above describes the modified payback method.

Question 49

Consider the following facts - do not consider the impact of income taxes: The number of years it will take to re-coup the initial investment using the payback method will be:

A) 2
B) 5
C) 4
D) 3

Question 50

Which of the following is not a tool for calculating net present value? a. Present value tables.
B) Spreadsheet programs.
C) Real option analysis.
D) Financial calculators.
E) All of the above are tools for calculating net present value.

Question 51

If the discount rate increases:

A) There will be no impact on the net present value
B) The annual cash inflows will need to increase in order to retain the same net present value
C) The present value of future cash flows will increase
D) The internal rate of return requirement will increase

Question 52

The internal rate of return measures:

A) How quickly the initial investment can be re-couped
B) The discount rate at which the net present value of the project is zero
C) The profitability of an investment
D) The rate at which future cash flows must be invested in order to obtain profitability LO

Question 53

The only method not used to evaluate capital projects is:

A) Payback/modified payback
B) Net present value
C) Internal rate of return
D) Regression analysis LO

Question 54

Consider the following information: Without considering the effect of income taxes, the net present value of the equipment is:

A) $26,788
B) $22,082
C) $33,757
D) $29,082

Question 55

Gator Manufacturing is considering the purchase of equipment at a cost of $7,000. Gator expects the equipment to generate cash inflows of $2,000 each year for the next ten years. The payback period for the equipment is: a. 35%.
B) 285%.
C) 3.5 years.
D) 2.85 years.
E) 10 years.

Question 56

Which of the following is not an assumption in performing NPV calculations found in Chapter 11? a. The initial cash outflow takes place at the beginning of the period.
B) The internal rate of return is zero.
C) Subsequent cash inflows and outflows occur at the end of the relevant period.
D) The mathematics of new present value calculations assume that firms reinvest future cash inflows in projects that yield a return that equals the cost of capital.
E) All of the above are assumptions discussed in Chapter 11.

Question 57

A project is considered acceptable if:

A) The net present value of the project is positive
B) The internal rate of return is greater than the hurdle rate
C) The modified payback period is less than the estimated useful life
D) All of these are true, however a company will still need to determine how to allocate capital resources and thus they may not choose a project based on a single criteria as listed above LO

Question 58

Which of the following is a disadvantage of the payback method? a. It overvalues the initial outlay.
B) It undervalues the initial outlay.
C) It overvalues future cash inflows.
D) It undervalues future cash inflows.
E) It is easy to compute but difficult to understand.

Question 59

Why do many people prefer the net present value method to the internal rate of return method? a. The net present value method is simpler to compute.
B) The internal rate of return method provides a unique value for each project.
C) The net present value method may produce multiple values of returns for the same projects.
D) Both A and
B) e. Both A and
C)

Question 60

Using the following data: (and ignoring the impact of income taxes) The internal rate of return on this investment is closest to:

A) 12%
B) 14%
C) 16%
D) 18%

Question 61

The minimum expected rate of return of the management from any project is referred to as the: a. The internal rate of return.
B) The hurdle rate.
C) A number greater than 1.
D) A number less than zero.
E) None of the above.

Question 62

The major reason net cash flows do not typically equal accounting income is: a. Present value.
B) Depreciation.
C) Taxes.
D) Discounted cash flows.
E) None of the above.

Question 63

Which of the following is the proper calculation to find the depreciation tax shield?

A) IRR times the depreciation deduction in a year
B) Tax rate times depreciation deduction in a year
C) IRR divided by the depreciation deduction in a year
D) Tax rate times the total depreciation deductions over the life of an asset

Question 64

The following information is available concerning a new piece of equipment: Based on the information, and without considering the impact of taxes, the initial cost of the equipment was:

A) $60,956
B) $64,722
C) $84,000
D) $75,600

Question 65

How are the following items considered in a net present value calculation?

Question 66

Consider the following information regarding the purchase of a piece of equipment: Assuming the company uses straight-line depreciation, the depreciation tax shield in year 1 would amount to:

A) $5,440
B) $1,632
C) $18,800
D) $13,600

Question 67

The reduction of cash outflows associated with tax payments because of depreciation is referred to as: a. Accrued taxes.
B) Deferred taxes.
C) Depreciation shield.
D) Tax shield.
E) None of the above.

Question 68

The depreciation tax shield is computed as: a. Accumulated depreciation x tax rate.
B) Cash outflows from project x tax rate.
C) Depreciation deduction for the year x tax rate.
D) Discounted cash outflows from project x tax rate.
E) None of the above.

Question 69

Redbird Corporation provides the following data: What is Redbird's tax shield?

A) $15,000.
B) $12,900.
C) $10,500.
D) $1,500.
E) $3,000.