Deck 13: Pricing Decisions

Question 1

The accrual accounting rate of return method does not consider the time value of money.

Answer 1

True

Question 2

The time value of money is important in completing a net present value analysis.

Answer 2

True

Question 3

Under the general quantitative rule, a project with a net present value less than zero should not be accepted.

Answer 3

True

Question 4

The internal rate of return method assumes that future cash flows can be reinvested to earn the same return generated by a capital investment project.

Question 5

Cash flows for a capital budgeting analysis are often affected by inflation, but not by deflation.

Question 6

A capital investment's expected useful life is inversely correlated with the uncertainty of its cash flows.

Question 7

Managers responsible for proposing a project are likely to be favourably biased in their estimates of future project cash flows.

Question 8

In general, the initial project investment does not require discounting in a net present value analysis.

Question 9

Income taxes have a major effect on capital budgeting decisions.

Question 10

Uncertainty is very often a factor when estimating a project's terminal value for an NPV analysis.

Question 11

The first step in addressing capital budgeting decisions is to identify relevant cash flows.

Question 12

Incremental operating cash flows can be associated with changes in capacity or product quality in capital budgeting decisions.

Question 13

Sensitivity analysis is usually performed after applying quantitative analysis techniques in a capital budgeting decision.

Question 14

The effect of a strategic investment decision on a company's reputation is often difficult to quantify.

Question 15

In capital budgeting decisions, amortization shields part of operating income from the effect of income taxes.

Question 16

Because of its complex calculation, few managers rely on the payback period as a capital budgeting analysis tool.

Question 17

Cash flows to be considered in capital budgeting decisions generally fall into three major groups: initial investment, incremental operating cash flows, and terminal cash flows.

Question 18

The cost of disposing of an old asset is considered irrelevant in capital budgeting decisions.

Question 19

Capital budgeting is a process managers use when choosing investments with multi-year cash flows.

Question 20

Managers should consider qualitative information in making capital budgeting decisions.

Question 21

Early, Inc. has chosen four potential investment projects. Listed below are some relevant data on these projects: $\begin{array}{lrr}\text { Project }&\text { Investment }&\text { Net Present Value }\\\hline1 & \$ 125,000 & \$ 62,500 \\2 & 150,000 & 45,000 \\3 & 75,000 & 52,500 \\4 & 112,500 & 45,000\end{array}$ Use the profitability index to rank these investments in terms of preference:

A) 1, 3, 2, 4
B) 2, 1, 4, 3
C) 1, 2, 3, 4
D) 3, 1, 4, 2

Question 22

Phoxco is considering automating its production line at a cost of $40,000 to acquire the necessary equipment. The annual cost savings are expected to be $8,000 for 14 years. The firm requires a 20% rate of return. Ignore income taxes.
The net present value for this investment is:

A) Positive
B) Zero
C) Negative
D) Cannot be determined

Question 23

The nominal method of NPV analysis adjusts future cash flows for the impact of inflation.

Question 24

Phoxco is considering automating its production line. It will cost $40,000 to acquire the necessary equipment. The annual cost savings are expected to be $8,000 per year for 14 years.. The firm requires a 20% return.
Ignoring income taxes, what is the payback period?

A) 3 years
B) 4.2 years
C) 5 years
D) 6 years

Question 25

Elkins Co. is considering an investment in equipment for a new product line with a cost of $48,625, a terminal value of $6,283, and a useful life of 5 years. The project will provide an annual contribution margin of $12,500. The required rate of return is 12%. Ignore income taxes. This project is:

A) Unacceptable, because it earns a rate below 12%.
B) Acceptable, because it has a positive NPV.
C) Unacceptable, because it has a 0 NPV.
D) Acceptable, because it earns exactly 12%.

Question 26

The local school board is considering the purchase of a computer. It will cost $100,000 and will be sold back to the dealer at the end of 6 years for $8,000. If the required rate of return is 14%, what is the minimal annual cost saving required to justify the purchase? Ignore income taxes.

A) $25,714
B) $23,142
C) $24,776
D) $23,656

Question 27

The time value of money means:

A) A dollar received today will be worth more than a dollar received in the future
B) A dollar received today will be worth less than a dollar received in the future
C) Ignoring the profitability of a capital investment
D) The more you invest, the smaller your return is

Question 28

You are currently entering college and you want to buy your uncle's Mercedes when you graduate. He has promised to sell it to you for $18,000. How much will you have to deposit now, in an account earning 8%, to have enough money to buy the car in 4 years?

A) $6,122
B) $4,500
C) $13,230
D) $3,060

Question 29

Last semester a class gave a professor $810 to fly to Borneo. However, he decided not to go until he had enough money to fly back, an additional $690. If he invests the $810 at 8%, when can he make the trip, assuming no change in ticket prices?

A) 8 years
B) 6 years
C) 4 years
D) 2 years

Question 30

The Bonkers Corp. is contemplating the purchase of a piece of equipment with the following cash flow data: $$\begin{array} {cccc} &&&\text { Incremental } \\\text { Year } & \text { Initial Cost } & \text { Contribution }&\text { Terminal Value }\\\hline0&\$ 84,000 \\1 & & \$ 30,000 & \\2 & &25,000 & \\3 & & 20,000 & \\4 & &15,000 &\$9,000\end{array}$$ Ignoring income taxes, what is the payback period?

A) 3.00 years
B) 3.33 years
C) 3.60 years
D) 3.50 years

Question 31

Phoxco is considering automating its production line at a cost of $40,000 to acquire the necessary equipment. The annual cost savings are expected to be $8,000 for 14 years. The firm requires a 20% rate of return. Ignore income taxes.
What is the internal rate of return on this investment?

A) Less than 20%
B) Equal to 20%
C) More than 20%
D) Cannot be determined

Question 32

Green Inc. has invested in a project with a cost of $36,504, annual net cash flows of $12,000, a terminal value of $4,000, and a 5-year useful life. The firm uses a 16% discount rate. Compute the internal rate of return to the nearest tenth of a percent. Ignore income taxes.

A) 19.2%
B) 20.8%
C) 19.8%
D) 18.8%

Question 33

The net present value method is:

A) Used to appraise a capital project's qualitative factors
B) Used to show how long the initial investment will be at risk
C) The sum of the cash inflows, discounted to time zero
D) The sum of the projected cash inflows and outflows valued in today's dollars

Question 34

Alien Corp. is considering the purchase of a new truck which costs $14,340. The truck is expected to save $3,600 in operating costs annually for the next 7 years. How low can the annual cost savings be and still provide a 15% return? Ignore income taxes.

A) $5,967
B) $475
C) $7,458
D) $3,441

Question 35

For a particular investment project, the present value of the benefits is exactly equal to the present value of the investment. Given this, which of the following statements is true?

A) The net present value is positive
B) The internal rate of return is less than the required rate of return
C) The profitability index is less than one
D) The project is acceptable

Question 36

Phoxco would like to automate its calligraphy operation. The equipment will cost $150,000 plus freight, installation, and testing costs of $5,500. The expected life of the project is 8 years, with annual cost savings of $20,000. The minimum rate of return is 12% and estimated terminal value is $3,000. Ignore income taxes. The profitability index of the project is:

A) 1.55
B) 1.57
C) 0.67
D) 0.65

Question 37

A firm's required rate of return is the rate which makes the:

A) Net present value equal to zero.
B) Internal rate of return equal to the average rate of return.
C) Profitability index greater than zero.
D) Determination of the NPV possible.

Question 38

The Conroy Co. wants to purchase a machine for a new product line that costs $138,750. The company's engineering department estimates the machine will last 10 years and provide an annual contribution margin of $25,000. Ignore income taxes. The internal rate of return to the nearest tenth of a percent is:

A) 12.4%
B) 11.6%
C) 13.46%
D) 12.64%

Question 39

Walter borrows $10,000 from his mother. He will repay her $2,000 at the end of each of the next four years and the balance at the end of the fifth year. If the interest rate is 12%, what is the amount to be paid at the end of the fifth year?

A) $3,926.00
B) $6,924.16
C) $5,869.65
D) $2,000.00

Question 40

Uniform cash flows from a capital project are necessary for which of the following calculations?
I) Net present value
II) Internal rate of return
III) Profitability index

A) I and II only
B) II and III only
C) I and III only
D) None of the above (not I, II, or III)

Question 41

Apex Co. has $100,000 available for long-term investment. Which projects should be selected from the list below? $\begin{array}{ccccc}\text { Proiect } & \text { Cost } & \text { IRR } & \text { NPV } & \text { Profitability Index }\\\hline1 & \$ 60,000 & 16 \% & \$ 3,413 & 1.057 \\2 & 40,000 & 20 \% & 7,563 & 1.190 \\3 & 40,000 & 24 \% & 8,036 & 1.201 \\4 & 20,000 & 14 \% & 1,313 & 1.066 \\5 & 60,000 & 18 \% & 14,583 & 1.243\end{array}$
.243

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

Question 42

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\\\text { Annual cost savings in cash expenses }&45,000\\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } & 5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the total tax savings from the amortization tax shield is:

A) $21,630.00
B) $46,432.40
C) $50,470.00
D) $19,899.60

Question 43

If the internal rate of return exceeds the discount rate, the net present value is:

A) Zero
B) Less than one
C) Positive
D) Negative

Question 44

A negative net present value means that the:

A) Internal rate of return is less than the required rate of return
B) Project is acceptable
C) Present value of the inflows exceeds the present value of the outflows
D) Company chose the wrong discount rate

Question 45

Capital budgeting decisions typically fall into which of the following major categories?
I) Developing or expanding products or services
II) Allocating costs to products or services
III) Replacing or reorganizing assets or services

A) I and II only
B) II and III only
C) I and III only
D) I, II, and III

Question 46

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\\\text { Annual cost savings in cash expenses }&45,000\\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } & 5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the cash flows for year 4, excluding the maintenance, is:

A) $21,319
B) $28,951
C) $23,545
D) $21,624

Question 47

Which of the following capital budgeting methods ignores the time value of money?

A) Internal rate of return
B) Net present value
C) Profitability index
D) Payback period

Question 48

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\\\text { Annual cost savings in cash expenses }&45,000\\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } & 5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the cash flows from the sale of the old machine is:

A) $15,000
B) $13,395
C) $16,340
D) $17,860

Question 49

The rate of return that results in a zero net present value for a project is called the:

A) Average rate of return
B) Internal rate of return
C) Required rate of return
D) Discount rate of return

Question 50

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine } & \$ 100,000 \\\text { Annual cost savings in cash expenses } &&45,000 \\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } &5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the total savings (excluding the maintenance in year 4) in annual cash operating costs is:

A) $48,667.50
B) $162,225.00
C) $113,557.50
D) $50,167.50

Question 51

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\\\text { Annual cost savings in cash expenses }&45,000\\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } & 5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the terminal cash flows is:

A) $8,000
B) $4,536
C) $1,361
D) $3,175

Question 52

The process that managers use when they evaluate multi-year investments is called

A) Capital budgeting
B) Activity-based budgeting
C) Short-term decision making
D) Breakeven analysis

Question 53

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x8. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The net cash flow associated with selling the old machine in January 20x5 (i.e., the value of the sale and any tax consequences) would be:

A) $5,000
B) $15,000
C) $20,000
D) $11,000

Question 54

Valley Hospital is considering the purchase of new medical equipment for $25,000. The old equipment has zero salvage value. The costs associated with operating the equipment are: $\begin{array}{lrr} & \underline{\text { Old Equipment}}& \underline{\text { New Equipment}}\\& \$ 9,000 & \$ 4,500 \\\text { Mabour } & 2,000 & 1,200 \\\text { Miscellaneous } & 1,500 & 1,300 \\\text { Amortization } & 8,000 & 4,750\end{array}$
If the new machine is purchased and ignoring income taxes, the payback period is:

A) 3.57 years
B) 2.13 years
C) 2.86 years
D) 4.55 years

Question 55

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x48. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The tax effect of selling the new machine in 20x8 would be:

A) $5,000
B) $3,000
C) $2,000
D) $0

Question 56

The payback period is deficient as a decision criterion for capital projects because it:
I) Disregards relative profitability
II) Ignores income beyond the payback period
III) Does not take into account the time value of money

A) I only
B) II only
C) III only
D) I, II, and III

Question 57

Which of the following is not a step in the process for addressing capital budgeting decisions?

A) Identify decision alternatives
B) Identify financial statement effects
C) Apply quantitative analysis techniques
D) Perform sensitivity analysis

Question 58

Bailey Corporation is considering modernizing its production by purchasing a new machine and selling an old machine. The following data have been collected on this investment:

The income tax rate is 40%, and the required rate of return is 16%. Amortization is $5,000 per year for the old machine. The new machine would be amortized $7,600 in 20x5, $5,700 in 20x6, $3,800 in 20x7, and $1,900 in 20x8. Assume Bailey would purchase the new machine in December 20x4 and dispose of the old machine in January 20x5.
The relevant annual pretax cash operating cost associated with Bailey's decision will be:

A) $4,000
B) $14,000
C) $18,000
D) $2,400

Question 59

Which of the following is the best example of a capital budgeting decision?

A) Deciding the price of a product for the next six months
B) Forecasting accrual basis profits for the next five years
C) Purchasing a piece of equipment with an expected life of eight years
D) Deciding which product to emphasize when there are constrained resources

Question 60

Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\\\text { Annual cost savings in cash expenses }&45,000\\\text { Terminal value } & 8,000 \\\text { Maintenance required in the 4th year } & 5,000 \\\text { Book value of the old machine } & 20,000\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the maintenance cost in year 4 is:

A) $2,226
B) $3,180
C) $954
D) $420

Question 61

Which of the following NPV analysis methods requires adjustment of a project's terminal value for inflation? $\begin{array} { l l l } & \text { Real } & \text { Nominal } \\\end{array}$

A) $\begin{array} { l l l } & \text { Yes } & \text { Yes }\end{array}$
B) $\begin{array} { l l l } & \text { Yes } & \text { Nos } \\\end{array}$
C) $\begin{array} { l l l } & \text { Nos } & \text { No } \\\end{array}$
D) $\begin{array} { l l l }& \text { No } & \text { Yes }\end{array}$

Question 62

Bell Company is considering a project that would provide a single cash inflow eight years from now of $80,000. What is the most that Bell would be willing to spend on this project if the discount rate is 16%?

A) $262,295
B) $24,400
C) $288,400
D) $22,191

Question 63

Sebastian is presenting a capital budgeting project to Viola, his division manager. Which one of the following is likely to have the least amount of bias when evaluating this project?

A) Sebastian
B) Viola
C) The company's accountant
D) Cannot be determined

Question 64

In a capital budgeting analysis, nominal cash flow is generally calculated as:

A) Real cash flow × (1 + inflation rate)^t
B) Real cash flow / (1 + inflation rate)^t
C) Real cash flow ^{(1 + inflation rate)×t}
D) (1 + inflation rate) × t × real cash flow

Question 65

George Shaw & Co. invested in a project that was to last for 2 years. The project has an internal rate of return of 12%. The project is expected to produce cash inflows of $70,000 in the first year and $80,000 in the second year. The project cost is:

A) $143,760
B) $142,510
C) $150,000
D) $126,270

Question 66

If nominal cash flow is calculated as real cash flow × (1 + i)^t in an NPV analysis, i denotes the:

A) Weighted average cost of capital
B) Risk-free interest rate
C) Discount rate
D) Rate of inflation

Question 67

Some of the steps in the process for addressing capital budgeting decisions are listed below. Which lettered choice puts the steps in the proper order?
1) Identify relevant cash flows.
2) Perform sensitivity analysis.
3) Apply quantitative techniques.

A) 1, 2, 3
B) 2, 3, 1
C) 3, 1, 2
D) 1, 3, 2

Question 68

The tax savings cash flows are treated differently under the nominal and real methods. Which of the following reflects this treatment? $\begin{array} { l l l } && \text { Real } && \text { Nominal } \\\end{array}$

A) $\begin{array} { l l l } & \text { Inflated } & \text { Deflated } \\\end{array}$
B) $\begin{array} { l l l } & \text { Deflated } & \text { Used as is } \\\end{array}$
C) $\begin{array} { l l l } & \text { Used as is } & \text { Deflated } \\\end{array}$
D) $\begin{array} { l l l } & \text { Deflated } & \text { Inflated }\end{array}$

Question 69

The real and nominal methods are most closely associated with:

A) Internal rate of return
B) Payback
C) Net present value
D) Cost of capital

Question 70

DBR Corporation is considering the purchase and implementation of an enterprise-wide information system. Which of the following would be the least biased source of qualitative information about the project?

A) Information technology staff who would implement the system
B) The software vendor
C) Other companies that have implemented the same system
D) Experts in the industry

Question 71

Which of the following factors are subject to uncertainty in an NPV analysis?
I) Project life
II) Appropriate discount rate
III) Terminal value

A) I and II only
B) II and III only
C) I and III only
D) I, II, and III

Question 72

Benjamin Company invested in a 3-year project and expects a 15% rate of return. Annual cash inflows from the project are: year 1 $8,000; year 2 $8,500; and year 3 $9,500. The net present value is $4,000. What was the amount of the original investment? Ignore income taxes.

A) $17,637
B) $15,637
C) $19,637
D) $23,637

Question 73

Inflation refers to the:

A) Exchange rate between two different currencies
B) Decline in general purchasing power of a monetary unit
C) Increase in general purchasing power of a monetary unit
D) Time value of money

Question 74

Which of the following is not a quantitative technique commonly used in capital budgeting decisions?

A) Net present value
B) Activity-based budgeting
C) Internal rate of return
D) Payback

Question 75

An amortizable asset's taxable basis is calculated as its:

A) Cost
B) Net book value on the balance sheet
C) Market value at the time of disposal
D) Cost less accumulated tax amortization

Question 76

Which of the following is the best example of a tax shield for an asset?

A) Its periodic amortization
B) Its cost basis
C) Its disposal cost
D) Its trade-in value

Question 77

Qualitative factors often influence strategic investment decisions. Which of the following is the best example of such a factor?

A) Changes in product prices based on consumer demand
B) Changes in consumer demand based on product prices
C) Increased ability to ship product in a timely manner
D) Discount rate estimates

Question 78

The incremental cash tax flow for a capital budgeting project is calculated using which of the following formulas?

A) Annual amortization × marginal income tax rate
B) Annual amortization × (1 - marginal income tax rate)
C) (Operating cash flow + annual amortization) × marginal income tax rate
D) Operating cash flow × marginal income tax rate

Question 79

In completing a sensitivity analysis for a capital budgeting project, which of the following would typically be varied?
I) Discount rate
II) Future cash flows
III) Future accrual-basis revenues and expenses

A) I and III only
B) II and III only
C) I and II only
D) I, II, and III

Question 80

Which of the following statements regarding NPV analysis is true?

A) Uncertainties increase as the dollar value of an investment increases
B) The discount rate can be calculated with certainty if it is based on the weighted average cost of capital
C) Managers should generally accept projects with an NPV greater than zero
D) The timing of incremental revenues and costs is irrelevant in NPV analysis