Deck 12: Planning Investments: Capital Budgeting

Question 1

Capital budgeting is:

A)Considered a short-term financing decision
B)Part of long-term organizational planning
C)A type of short-term operating decision
D)Part of the marketing function

Answer 1

Part of long-term organizational planning

Question 2

In which of the following steps in the capital budgeting process would net present value be used?

A)Identifying long-term investment opportunities
B)Selecting the appropriate investments
C)Financing the selected investments
D)Evaluating the investments

Answer 2

Selecting the appropriate investments

Question 3

The weighted average cost of a firm's debt and equity financing is referred to as the firm's:

A)prime rate
B)hurdle rate
C)debt to equity ratio
D)time-adjusted rate of return

Answer 3

hurdle rate

Question 4

The capital budgeting process uses the four processes listed below,identify the sequence in which the processes occur starting with 1 and ending with 4.
_____
A.Financing the selected investment.
_____
B.Identifying long-term investment opportunities.
_____
C.Evaluating the investments.
_____
D.Selecting appropriate investment.

Question 5

All of the following are operational investments except an investment in:

A)corporate bonds
B)machinery
C)a building
D)a patent

Question 6

The last step in the capital budgeting process is:

A)Identifying long-term investment opportunities
B)Selecting the appropriate investments
C)Financing the selected investments
D)Evaluating the investments

Question 7

Which of the following is an operational investment?

A)Selling the company's own stock for cash
B)Buying the stock of another company
C)Buying a patent
D)Buying office supplies

Question 8

Horizons,Inc.paid $232,500 for a machine shipped FOB shipping point.Freight costs totaled $4,500,the sales tax was $11,300,and installation amounted to $9,800,with an additional $1,600 spent to repair the machine after a worker dropped it during installation.The total cost of the machine for accounting purposes was:

A)$232,500
B)$248,400
C)$258,100
D)$259,700

Question 9

A capital investment generates a satisfactory rate of return when its return is:

A)Less than the prime rate
B)Greater than or equal to the firm's cost of capital
C)Less than the current rate of a low risk corporate bond
D)Greater than or equal to the firm's preferred stock dividend rate

Question 10

The process used for analysis and selection of the long-term investments of a business is called:

A)Capital budgeting
B)Financial analysis
C)Operating analysis
D)Financial budgeting

Question 11

Calculating Net Present Value requires the four steps listed below,identify the sequence in which the steps occur starting with 1 and ending with 4.
_____
A.Calculate the present value of expected future cash flow using the cost of
capital
_____
B.Estimate the amount an timing of future cash flows associated with the
potential investment.
_____
C.Decide on whether or not to make the investment
_____
D.Calculate the Net Present Value

Question 12

Which of the following is the correct order of events in the capital budgeting process?

A)Identifying investment opportunities,selecting investments,financing investments,evaluating investments.
B)Financing investments,identifying investment opportunities,selecting investments,evaluating investments.
C)Identifying investment opportunities,financing investments,selecting investments,evaluating investments.
D)Identifying investment opportunities,evaluating investments,selecting investments,financing investments.

Question 13

All of the following are operational investments exept.

A)Buying equipment for the company
B)Buying land with the intent of selling it a higher price in two years
C)Buying a building for new manufacturing facility
D)Buying new computers for the company office.

Question 14

A firm's cost of capital represents all the following except.

A)The weighted average of the cost of both debt and equity financing.
B)The minimum rate that an investment is expected to generate before a company will buy the asset.
C)The cost of the long-term operating assets the firm acquires.
D)The hurdle rate of return.

Question 15

Which one of the following is not a reason for making an operational investment?

A)Need to replace worn-out equipment or facilities.
B)Need to keep up with technological advances.
C)To take advantage of low interest rate financing.
D)To expand operating capacity.
E)All of the above are reasons to acquire long-term operating investment.

Question 16

In which of the following steps in the capital budgeting process would sensitivity analysis be used?

A)Identifying long-term investment opportunities
B)Selecting the appropriate investments
C)Financing the selected investments
D)Evaluating the investments

Question 17

A capital investment generates a satisfactory rate of return when its return is:

A)Greater than or equal to the cost of capital
B)Equal to or less than the cost of capital
C)Less than the cost of capital
D)Greater than the internal rate of return

Question 18

The first step in the capital budgeting process is:

A)Evaluating the investments
B)Financing the selected investments
C)Selecting the appropriate investments
D)Identifying long-term investment opportunities

Question 19

Capital investments in operating assets are made:

A)For expansion purposes
B)To comply with government mandates
C)To replace unproductive operating assets
D)All of the above are correct

Question 20

Ness Corporation purchased a machine with a cost of $100,000 and paid $500 in freight charges and $1,000 to have it installed.Ness failed to take advantage of a $2,000 discount it would have received if it had paid $98,000 cash within ten days of the purchase.How much is the cost of the machine?

A)$98,500
B)$101,500
C)$99,500

Question 21

Donnelly Company is considering investing in a sizable piece of equipment and their analysis yielded a positive NPV of $23,500.Which of the following statements is not
True?

A)The new equipment will increase net income by $23,500
B)Donnelly should buy the machine
C)The new equipment is likely to generate a return greater than Donnelly's cost of
Capital.
D)The Donnelly Company should recover the cost of the new equipment.

Question 22

Santana Enterprises has $7,000,000 in debt and $18,000,000 in total assets.If the debt carries an interest rate of 9%,and the stockholders are demanding a 13% rate of return,Santana's cost of capital is:

A)11.0%
B)11.4%
C)11.8%
D)13.0%

Question 23

Beijing Corporation has $5,000,000 in debt and $12,500,000 in total assets.If the debt carries an interest rate of 10%,and the stockholders are demanding a 17% rate of return,Beijing's cost of capital is:

A)13.5%
B)14.2%
C)14.8%
D)17.0%

Question 24

Pro Care,Inc.sold equipment with a cost of $62,700 and accumulated depreciation of $39,500 for $24,800 cash.If Pro Care's income tax rate is 30%,the after-tax cash inflow from the sale of the equipment was:

A)$25,920
B)$25,280
C)$24,800
D)$24,320

Question 25

If the net-present-value of an investment is positive,which of the following is not true?

A)Purchasing the proposed investment is acceptable
B)The expected return is greater than the firm's cost of capital
C)The expected return is less than the firm's hurdle rate.
D)The cost of the asset is less than the maximum price the firm is willing to pay for the investment.

Question 26

Northstar,Inc.had sales of $650,000 and operating expenses of $480,000 for the year just ended.Included in the operating expenses was $35,000 of depreciation expense.If Northstar's income tax rate is 40%,its net after-tax cash flows amounted to:

A)$102,000
B)$135,000
C)$137,000
D)$170,000

Question 27

When calculating net present value of an investment,the present value of the expected future cash flows represents:

A)The market value of the investment
B)The cost of the investment
C)The maximum price the firm will pay for the investment given the firm's cost of capital
D)The price of the asset at the market rate of interest in effect at that point in time.

Question 28

Under the net-present-value method,if the cost of the asset is less than the present value of the future cash flows,the:

A)net-present-value is negative
B)investment should not be made
C)investment's expected return is greater than the firm's cost of capital
D)firm's cost of capital is greater than the rate of return on assets

Question 29

Roadmaster Corporation reported depreciation expense of $345,800 for the year just ended.Assuming a 35% income tax rate,the amount of the tax shield created by the depreciation was:

A)$121,030
B)$224,770
C)$345,800
D)cannot be determined from the information given

Question 30

The net-present-value method uses a discount rate equal to the:

A)prime rate
B)firm's cost of capital
C)firm's return on assets
D)rate of return demanded by stockholders

Question 31

If the net-present value of an investment is positive,which of the following is true?

A)The net-present-value represents the amount of profit the company will make if it buys the asset.
B)Describes the actual amount of the expected return.
C)Indicates that the return the new asset will generate is expected to exceed the cost of capital.
D)Describes the amount of difference between the expected return and the cost of capital.

Question 32

Parker Pacific,Inc.has $2,000,000 in debt and $3,000,000 in stockholders' equity.If the debt carries an interest rate of 14%,and the stockholders are demanding a 15% rate of return,Parker's cost of capital is:

A)14.2%
B)14.5%
C)14.6%
D)15.0%

Question 33

Burke Shoes sold machinery with a cost of $96,300 and accumulated depreciation of $54,200 for $32,500 cash.If Burke's income tax rate is 30%,the after-tax cash inflow from the sale of the machinery was:

A)$39,220
B)$32,500
C)$22,750
D)$35,380

Question 34

If the net-present value of an investment is negative,which of the following is true?

A)The negative amount represents the cash the company will lose if it makes the
Investment.
B)The negative amount represents the amount the price of the investment must decrease
Before the company would consider buying the operational asset.
C)The negative amount represents the difference between actual return and expected
Rate of return.
D)The negative amount represents the difference in the expected rate of return and the
Cost of capital.

Question 35

If the net-present-value of an investment is positive,the:

A)Purchasing the proposed investment is acceptable
B)Discount rate is greater than the firm's cost of capital
C)Investment's return is less than the firm's cost of capital
D)Cost of the asset is greater than the present value of the future cash flows

Question 36

If the net-present-value of an investment is negative,the:

A)Proposed investment should be rejected
B)Firm's cost of capital is greater than the discount rate
C)Investment's return is greater than the firm's cost of capital
D)Cost of the asset is less than the present value of the future cash flows

Question 37

Kaw Inc.had sales of $500,000 and cash operating expenses of $320,000 and depreciation expense of $50,000 for the year just ended.If Kaw's income tax rate is 40%,its net after-tax cash flows amounted to:

A)$108,000
B)$160,000
C)$130,000
D)$128,000

Question 38

Paderno Inc.had cash sales of $1,300,000 and operating expenses of $825,000 for the year just ended.Included in the operating expenses was $220,000 of depreciation expense with the rest being cash expenses.If Paderno's income tax rate is 35%,its net after-tax cash flows amounted to:

A)$308,750
B)$528,750
C)$166,250
D)$594,750

Question 39

Calcutta Industries has $4,500,000 in debt and $5,500,000 in stockholders' equity.If the debt carries an interest rate of 9%,and the stockholders are demanding a 16% rate of return,Calcutta's cost of capital is:

A)12.5%
B)12.85%
C)9%
D)16%

Question 40

All of the below are part of the capital budgeting process,which of them is not based on an estimate.

A)Amount of future cash flows
B)Cost of the asset
C)Timing of future cash flows
D)Cost of capital

Question 41

After arriving at a positive net present value,you recently presented an investment proposal to the CFO of your company.The CFO remarks that income tax rates are expected to decrease in the next few years.How will a decrease in estimated tax rates affect the net present value?

A)increase
B)decrease
C)no effect
D)unable to determine from the information given

Question 42

Use the following to answer questions
Briarwood Enterprises is considering the purchase of some new equipment that will cost the company $151,800. The equipment is estimated to have a 6 year life and no salvage value. The equipment is expected to generate $34,000 of cash inflows each year over the life of the asset. Briarwood's cost of capital is 10%.
Ignoring income taxes,the net-present-value of the investment in the equipment is:

A)$(41,270)
B)$(3,721)
C)$4,800
D)$40,130

Question 43

Use the following to answer questions
Forecaster Industries is considering the purchase of a new machine that will cost the company $65,750. The machine is estimated to have a 5 year life and no salvage value. The machine is expected to generate $23,000 of cash inflows each year over the life of the asset. Forecaster's cost of capital is 12%.
Ignoring income taxes,Forecaster should:

A)not purchase the machine since the net-present-value is negative
B)not purchase the machine since the net-present-value is positive
C)purchase the machine since the net-present-value is negative
D)purchase the machine since the net-present-value is positive

Question 44

If net present value is computed using after-tax cash flows which of following are included in the computation of the net present value?

A)
B)
C)
D)

Question 45

Use the following to answer questions
Briarwood Enterprises is considering the purchase of some new equipment that will cost the company $151,800. The equipment is estimated to have a 6 year life and no salvage value. The equipment is expected to generate $34,000 of cash inflows each year over the life of the asset. Briarwood's cost of capital is 10%.
Ignoring income taxes,Briarwood should:

A)not purchase the equipment since the net-present-value is negative
B)not purchase the equipment since the net-present-value is positive
C)purchase the equipment since the net-present-value is negative
D)purchase the equipment since the net-present-value is positive

Question 46

Use the following to answer questions
Union Company is contemplating the acquisition of a new computer that will cost the company $19,500. The computer is expected to last 4 years, after which time it will be discarded. Union's cost of capital is 10%, and use of the computer is expected to reduce the company's annual cash operating costs by the following amounts:

Ignoring income taxes,Union should:

A)not purchase the equipment since the net-present-value is negative
B)not purchase the equipment since the net-present-value is positive
C)purchase the equipment since the net-present-value is negative
D)purchase the equipment since the net-present-value is positive

Question 47

Londo Company has a zero net present value based on a 10% cost of capital.What is the expected rate of return for this project?

A)10%
B)less than 10%
C)more than 10%
D)unable to determine from the information given

Question 48

What are the four reasons a company will make operating investments and how does management know what investments to select?

Question 49

Use the following to answer questions
Forecaster Industries is considering the purchase of a new machine that will cost the company $65,750. The machine is estimated to have a 5 year life and no salvage value. The machine is expected to generate $23,000 of cash inflows each year over the life of the asset. Forecaster's cost of capital is 12%.
Ignoring income taxes,the net-present-value of the investment in the machine is:

A)$(16,500)
B)$(499)
C)$ 14,614
D)$ 17,160

Question 50

If a firm sells an asset at a gain,this indicates that the sales proceeds exceeded the

A)cost of the asset
B)fair value of the asset
C)book value of the asset
D)accumulated depreciation on the asset

Question 51

If income taxes are not considered,how are the following used in the computation of the net present value?

A)
B)
C)
D)

Question 52

Use the following to answer questions
Union Company is contemplating the acquisition of a new computer that will cost the company $19,500. The computer is expected to last 4 years, after which time it will be discarded. Union's cost of capital is 10%, and use of the computer is expected to reduce the company's annual cash operating costs by the following amounts:

Ignoring income taxes,the net-present-value of the investment in the computer is:

A)$(3,791)
B)$(709)
C)$3,500
D)$10,781

Question 53

Use the following to answer questions
Forecaster Industries is considering the purchase of a new machine that will cost the company $65,750. The machine is estimated to have a 5 year life and no salvage value. The machine is expected to generate $23,000 of cash inflows each year over the life of the asset. Forecaster's cost of capital is 12%.
Ignoring income taxes,the maximum price Forecaster should pay for this machine is:

A)$82,910
B)$80,364
C)$65,251
D)$49,250

Question 54

Which of the following must be estimated in order to compute the net present value of an investment?

A)Cost of capital,future cash flows,and initial cost
B)Cost of capital,future cash flows,or initial cost
C)Initial cost,future cash flows,and residual value
D)Initial cost,future income tax rates,and residual value

Question 55

Use the following to answer questions
Briarwood Enterprises is considering the purchase of some new equipment that will cost the company $151,800. The equipment is estimated to have a 6 year life and no salvage value. The equipment is expected to generate $34,000 of cash inflows each year over the life of the asset. Briarwood's cost of capital is 10%.
Ignoring income taxes,the maximum price Briarwood should pay for this equipment is:

A)$110,530
B)$148,079
C)$156,600
D)$191,930

Question 56

If income taxes are not considered,which of the following is true when computing net present value? INCLUDE EXCLUDE

A)Depreciation Losses
B)Gains Residual Value
C)Residual Value Losses
D)Disposal Cost Gains

Question 57

Which of the following statements about the effect of depreciation on cash flows is correct?

A)It does not affect cash flows because it is a non-cash expense
B)It directly increases cash outflows,just like any other expense
C)It decreases cash outflows because it reduces a firm's income tax liability
D)It affects cash flows only in those cases where an investment produces future revenues

Question 58

After arriving at a positive net present value,you recently presented an investment proposal to the investment committee at your company.The committee directs you to recompute the net present value after adjusting the required rate of return for the higher-than-normal riskiness of the proposal.How would you change the rate of return?

A)increase
B)decrease
C)no change
D)unable to determine from the information given

Question 59

A method for assessing how changes in cash flows and/or cost of capital would affect a investment decision is

A)capital budgeting
B)sensitivity analysis
C)net present value analysis
D)time-adjusted rate of return analysis

Question 60

Spivey Corp just conducted a NPV analysis on a $2,000,000 project that resulted in a negative $1,000 NPV.Which of the factors below might make you reconsider the
Decision to reject the investment?

A)The person who forecasted the cash flows is very optimistic when making forecast.
B)The price of the investment might increase
C)The cost of capital is expected to increase
D)The period over which the asset is depreciated could be decreased.

Question 62

Depreciation expense taken on plant assets does not directly decrease cash.However,depreciation does provide a "tax shield".Explain the concept of a "tax shield" as it relates to depreciation expense.

Question 63

The Psychic Cookie Company is considering the purchase of a new machine to produce fortune cookies in January 2010.The fortune cookie machine will cost $270,000 and Psychic's management expects it to last 6 years.If it purchases the new machine it will sell its old machine with a book value of $20,000 for $25,000 cash.At the end of six years the new machine is expected to have no salvage value.Depreciation each year on the fortune cookie machine will be $45,000 and Psychic's tax rate is 30%.The Pretax cash flows expected from the machine at the end of the following year are:
Required:
(A.)Calculate the net present of the new machine if the cost of capital is 15%.
(B.)Indicate whether or not Psychic should buy the new machine and explain the basis for your decision (do not use positive or negative NPV as an explanation):

Question 64

Mendocino Company is contemplating the acquisition of a new copier that will cost the company $10,900.The copier is expected to last 6 years,after which it will be discarded.Mendocino's cost of capital is 9%,and the copier is expected to reduce annual cash expenditures by the following amounts:
Ignoring income taxes,determine the net-present-value of the investment in the copier.Should Mendocino purchase the copier?

Question 65

Why should qualitative factors be considered in the capital budgeting process?

Question 66

Standard Corporation is considering the purchase of a new truck that will cost the company $48,780.The truck is estimated to have a 5 year life and no salvage value.The truck is expected to save the company $13,532 of operating costs per year over its useful life.Standard's cost of capital is 12%.Ignoring income taxes,determine the net present value of the truck.Should Standard purchase the truck?

Question 67

After computing a net present value that indicated that the return would be in excess of the cost of capital,you presented an investment proposal to the CFO of your company.The CFO notices that you assumed that the cost of the asset would be written off evenly over its economic life.She comments that the firm often uses accelerated depreciation (a method under which more depreciation is recorded in the early years of an asset's life and less later).How will this change in depreciation methods affect the net present value? Explain.

Question 68

What constitutes sensitivity analysis when using net present value as a tool for selecting investment decisions?

Question 69

Explain why both the timing and quantity of cash flows are significant in determining net present value.

Question 70

Barton Inc had assets of $15,350,000 and owners' equity of $4,975,000 at December 31,2010.Their net income for the year was $750,000 and their interest expense for the year was $830,000.Given the amount of leverage of the firm the stockholders demanded a 17% rate of return.Given this information what is the firm's cost of capital?

Question 71

At the end of 2010,Bezdek Corporation is planning to buy a new machine for $70,000 The new machine has a useful life of 7 years and is expected to have a salvage value of $5,000.The pretax cash flow and the depreciation for tax purposes are described below.Bezdek's tax rate is 30 percent and its cost of capital is 15 percent.
Required:
(A.)Calculate the net present value for the new machine.
(B.)Should Bezdek but the new machine?

Question 72

Late in 2010,the Spencer K Corporation has projected the pretax cash flows shown below for a dabblemaster that cost $460,000.If Spencer K Corp's tax rate is 40% and its cost of capital is 14 percent.The projected cash flows and depreciation for the dabblemaster are described below.
Required:
(A.)Calculate the net present value of the dabblemaster given the pretax cash flows and depreciation described above and indicate whether you would recommend purchasing the assets.
(B.)If Spencer K Corp used straight-line depreciation of $94,000 per year for 5 years would your answer be the same?

Question 73

Weimer Systems,Inc.is considering the purchase of a new machine that will cost the company $350,700.The machine is estimated to have an 8 year life and no salvage value.The machine is expected to generate $81,500 of net cash inflows each year over its useful life.Weimer's cost of capital is 15%.Ignoring income taxes,determine the maximum price Weimer should pay for this machine.What is the net-present-value of the investment in the machine? Should Weimer purchase the machine?

Question 74

Gfeller Brothers had earnings before interest of $1,650,000 for its most recent year-end.Total debt amounted to $10,600,000 and total assets were $19,800,000.The debt carried an interest rate of 9%,while stockholders were demanding an 18% rate of return.Ignoring income taxes,determine the firm's cost of capital.

Question 75

The Katrina Corp is considering the purchase of a new machine that produces hurricane proof windows in January 2010.The window machine will cost $300,000 and Katrina's management expects it to last 6 years.At the end of six years the new machine is expected to have a zero book value but could be sold for $25,000.Depreciation each year on the window machine will be $50,000 and Katrina's tax rate is 30%.The Pretax cash flows expected from the machine are as follows:
Required:
(A.)Calculate the net present of the new machine if the cost of capital is 15%.
(B.)Indicate whether or not Katrina should buy the new machine and explain the basis for your decision (do not use positive or negative NPV as an explanation):

Question 76

Champion Contractors had earnings before interest of $3,500,000 for its most recent year-end.Total debt amounted to $5,000,000 and total stockholders' equity was $20,000,000.The debt carried an interest rate of 7%,while stockholders were demanding an 15% rate of return.Ignoring income taxes,determine the firm's cost of capital.

Question 77

Huntel Systems,Inc.is considering the purchase of a new machine that will cost the company $309,700.The machine is estimated to have a 7 year life and no salvage value.The machine is expected to generate $61,500 of net cash inflows each year over its useful life.Huntel's cost of capital is 12%.Ignoring income taxes,determine the maximum price Huntel should pay for this machine.What is the net-present-value of the investment in the machine? Should Huntel purchase the machine?

Question 78

Explain how performance evaluation based on accrual accounting may lead to investment decisions that are not in the best interests of the firm.