Deck 8: How Is Capital Budgeting Used to Make Decisions

Question 1

The payback method of evaluating long-term investments is the most popular method used by managers.

Answer 1

False

Question 2

A depreciation tax shield is the tax savings resulting from depreciation expense.

Answer 2

True

Question 3

If the IRR of a new machine investment proposal is 10% when the company's required rate of return is 18%,then the best decision would be to accept the investment.

Answer 3

False

Question 4

Incentive systems that pay managers for short-term results may keep them from accepting long-term proposals with a positive net present value.

Question 5

Working capital is defined as current assets plus current liabilities.

Question 6

Capital budgeting decisions focus on cash flows for projects requiring more than one year to complete.

Question 7

Revenue and expense cash flows must be multiplied by one minus the tax rate to get the after-tax cash flow.

Question 8

The required rate of return is typically based on the company's cost of capital.

Question 9

Cash flows that are not adjusted for inflation will likely underestimate future cash flows,thereby underestimating the net present value of the investment opportunity.

Question 10

An advantage of using the payback method for evaluating long-term investments is that it considers the time value of money.

Question 11

The internal rate of return (IRR)represents the cash flows required to get a net present value of zero.

Question 12

To evaluate long-term investments using the net present value approach,future cash flows of these investments must be stated in future value equivalents.

Question 13

When evaluating long-term investment proposals,firms that pay income taxes can ignore the impact these taxes have on cash flows.

Question 14

Both the net present value method and the payback method consider the time value of money.

Question 15

Managers often rank investment opportunities by internal rate of return.

Question 16

The hurdle rate used to evaluate an investment is also called the discount rate.

Question 17

There is a standard required rate of return for all companies,regardless of the industry.

Question 18

Most managers use spreadsheets to calculate the internal rate of return for an investment proposal.

Question 19

Post-audits offer an incentive for managers to provide accurate estimates for capital budgeting decisions.

Question 20

A firm would never choose to accept a long-term investment proposal if the net present value is below zero.

Question 21

Assume you receive $4,800 in two years and the annual interest rate is four percent.Using the present value formula,how much is that amount worth in today's dollars (rounded to the nearest dollar)?

A)$5,192
B)$4,438
C)$4,800
D)$4,416
E)None of the answer choices is correct.

Question 22

If a project's net present value is zero,the internal rate of return is:

A)less than the discount rate.
B)equal to the discount rate.
C)greater than the discount rate.
D)cannot be determined without more information.
E)None of the answer choices is correct.

Question 23

Thomas Inc.has two independent investment opportunities,each requiring an initial investment of $15,000.The company's hurdle rate is 14 percent.The cash inflows for each investment are provided below.

Without making any calculations,which investment will have the higher net present value?

A)Investment B because it generates most of the cash inflows early on.
B)Investment A because there is an increasing trend in cash inflows.
C)The net present values of Investment A and B are equal.
D)None of the answer choices is correct.

Question 24

Assume you receive $63,000 in three years and the annual interest rate is five percent.Using the present value formula,how much is that amount worth in today's dollars (rounded to the nearest dollar)?

A)$54,422
B)$72,945
C)$53,550
D)$63,000
E)None of the answer choices is correct.

Question 25

If a project's net present value is negative,the internal rate of return is:

A)less than the discount rate.
B)equal to the discount rate.
C)greater than the discount rate.
D)cannot be determined without more information.

Question 26

Inglewood Inc.would like to purchase a specialized production machine for $3,500,000.The machine is expected to have a life of three years,and a salvage value of $200,000.Annual maintenance costs will total $200,000.Annual material savings are predicted to be $900,000.The company's required rate of return is 20 percent.
Ignoring the time value of money,what is the net cash inflow or (outflow)resulting from this investment opportunity?

A)$2,300,000
B)$1,200,000
C)($1,200,000)
D)($2,300,000)
E)None of the answer choices is correct.

Question 27

Assume you receive $15,000 in four years and the annual interest rate is four percent.Using the present value formula,how much is that worth in today's dollars (rounded to the nearest dollar)?

A)$9,217
B)$17,400
C)$15,000
D)$12,822
E)None of the answer choices is correct.

Question 28

If a project's net present value is positive,the internal rate of return is:

A)less than the discount rate.
B)equal to the discount rate.
C)greater than the discount rate.
D)cannot be determined without more information.
E)None of the answer choices is correct.

Question 29

Which of the following statements is true regarding the time value of money concept?

A)A dollar received today is worth the same as a dollar received in the future.
B)A dollar received today is worth more than a dollar received in the future.
C)A dollar received today is worth less than a dollar received in the future.
D)A dollar paid today is worth the same as a dollar paid in the future.
E)None of the answer choices is correct.

Question 30

Vista Company wants to replace one of its older production machines.The estimated cost is $180,000.Using a discount rate of 18%,the company calculates a net present value of the new machine to be negative $10,000.Based on this information which of the following statements is true?

A)The use of a higher discount rate would cause the net present value to be positive.
B)The guaranteed rate of return on the new purchase is 18%.
C)The net present value will be positive if the actual purchase price is less than $170,000.
D)The internal rate of return on the truck is negative.
E)None of the answer choices is correct.

Question 31

If a project has an internal rate of return of 25% and a negative net present value,which of the following statements is true regarding the discount rate used for the net present value computation?

A)The required rate of return must have been 0%.
B)The required rate of return must have been equal to 25%.
C)The required rate of return must have been less than 25%.
D)The required rate of return must have been greater than 25%
E)None of the answer choices is correct.

Question 32

Sanders Company would like to purchase a specialized production machine for $1,000,000.The machine is expected to have a life of five years,and a salvage value of $300,000.Annual maintenance costs will total $50,000.Annual labor savings are predicted to be $280,000.The company's required rate of return is 15 percent.
Ignoring the time value of money,what is the net cash inflow or (outflow)resulting from this investment opportunity?

A)($100,000)
B)$950,000
C)$1,450,000
D)$450,000
E)None of the answer choices is correct.

Question 33

The appropriate rate to be used for evaluating a long-term investment proposal can be referred to as all of the following except:

A)the required rate of return.
B)the discount rate.
C)the cash flow rate.
D)the hurdle rate.
E)None of the answer choices is correct.

Question 34

Fusion Inc.would like to purchase a new machine for $85,000.The machine is expected to generate a cost savings of $23,000 per year for five years.The company's cost of capital is 10 percent.Factors for a 10 percent interest rate for five years are shown below:
Future Value of $1 1.611
Present Value of $1 0.621
Future Value of an Annuity 6.105
Present Value of an Annuity 3.791
Using the net present value (NPV)to evaluate this proposal,the company should:

A)Invest in the proposal since the NPV is $2,193
B)Reject the proposal since the NPV is ($2,193).
C)Invest in the proposal since the NPV is $80,000.
D)Reject the proposal since the NPV is $87,193.
E)None of the answer choices is correct.

Question 35

Assume that you invest $100,000 today at an annual rate of eight percent for four years.How much will you have at the end of four years (rounded to the nearest dollar)?

A)$132,000
B)$124,000
C)$125,971
D)$136,049
E)None of the answer choices is correct.

Question 36

Under the net present value (NPV)method,cash flows are assumed to be reinvested at:

A)the company's discount rate.
B)the internal rate of return.
C)an average of the discount rate and the internal rate of return.
D)the prime lending rate.
E)None of the answer choices is correct.

Question 37

Assume you receive $60,000 in five years and the annual interest rate is six percent.Using the present value formula,how much is that worth in today's dollars (rounded to the nearest dollar)?

A)$42,000
B)$78,000
C)$44,835
D)$60,000
E)None of the answer choices is correct.

Question 38

Assume that you invest $10,000 today at an annual rate of five percent for three years.How much will you have at the end of three years (rounded to the nearest dollar)?

A)$11,576
B)$11,500
C)$10,000
D)$11,250
E)None of the answer choices is correct.

Question 39

Roske Company is considering a project with an initial investment of $40,000 and annual cash inflows of $8,000 per year for seven years.The company's cost of capital is 12 percent.Factors for a 12 percent interest rate for seven years are shown below:
Future Value of $1 2.211
Present Value of $1 0.452
Future Value of an Annuity 10.089
Present Value of an Annuity 4.564
Using the net present value (NPV)to evaluate this proposal,the company should:

A)invest in the proposal since the NPV is 36,512
B)reject the proposal since the NPV is ($3,488).
C)reject the proposal since the NPV is ($36,512).
D)invest in the proposal since the NPV is $3,488.
E)None of the answer choices is correct.

Question 40

Philly Company wants to buy a new machine and has narrowed its options to two choices.Both machines cost $160,000.The following data shows the expected cash inflows from each machine:

When calculating net present value,Philly uses the same cost of capital for both machines and both machines have a positive net present value.
Based on this information,which statement is true?

A)Machine 1 and Machine 2 will have the same internal rates of return.
B)Machine 1 and Machine 2 will have the same net present values.
C)Machine 1 will have a lower net present value than Machine 2.
D)Machine 1 will have a higher net present value than Machine 2.
E)None of the answer choices is correct.

Question 41

Which of the following is a benefit of using the payback method?

A)It considers the time value of money.
B)It considers the cash inflows after the initial cash outflows are recovered.
C)It measures profitability.
D)It determines how long it will take to recover the initial investment.
E)None of the answer choices is correct.

Question 42

Exhibit 8-2
Liam Company has two independent investment opportunities,each requiring an initial investment of $130,000.The company's required rate of return is 12 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-2.Calculate the net present value for each investment.If the company can only invest in one project,which one should it be?

A)This cannot be determined because they both have the same net present value.
B)Neither Investment A nor B because they both have negative net present values.
C)Investment B.
D)Investment A.
E)None of the answer choices is correct.

Question 43

Exhibit 8-3
Yale Inc.has two independent investment opportunities,each requiring an initial investment of $260,000.The company's required rate of return is 10 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-3.What is the net present value of Investment B (rounded to the nearest dollar)?

A)($9,700)
B)$250,300
C)$100,000
D)($10,000)
E)None of the answer choices is correct.

Question 44

Exhibit 8-3
Yale Inc.has two independent investment opportunities,each requiring an initial investment of $260,000.The company's required rate of return is 10 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-3.Calculate the net present value for each investment.Should the company invest in both projects?

A)No,they should not invest in either project since both have negative net present values.
B)Yes,they should invest in both projects since both have positive net present values.
C)The company should only invest in Investment A,since it is the only project that has a positive net present value.
D)There is not enough information to answer this question.
E)None of the answer choices is correct.

Question 45

All of the following are qualitative factors to be considered when evaluating investments except:

A)providing new product lines to draw customers to other,more profitable product lines.
B)minimizing taxes.
C)maintaining a reputation as the industry leader in innovation.
D)considering the social benefits of investing in pollution control devices.
E)None of the answer choices is correct.

Question 46

Exhibit 8-3
Yale Inc.has two independent investment opportunities,each requiring an initial investment of $260,000.The company's required rate of return is 10 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-3.What is the net present value of Investment A (rounded to the nearest dollar)?

A)$1,104,688
B)$294,730
C)$34,730
D)$100,000
E)None of the answer choices is correct.

Question 47

Venture Company has two independent investment opportunities,each requiring an initial outflow of $35,000.The cash inflows for each investment are provided below.

Without making any calculations,which investment will have the higher net present value?

A)Investment A.
B)Investment B.
C)Both investments have the same net present value.
D)This cannot be determined with the information provided.
E)None of the answer choices is correct.

Question 48

Horizon Company produces a variety of boating products.Each division manager at Horizon is paid a base salary,and given an annual cash bonus if the division achieves profits of at least 12 percent of the value of assets invested in the division (this is often called return on investment).
Kathy Bainsley,manager of the Kayak Division,is considering investing in new production equipment.The net present value of the proposal is positive,and Kathy is convinced the new equipment will provide a competitive edge for future years.Even though short-term profits will reduce return on investment below the 12 percent requirement for the next two years,profits are expected to increase significantly beginning in year three.Unfortunately,Kathy is planning to retire in two years and this investment would prevent her from receiving her annual bonuses for the next two years.As a result,Kathy plans to reject the proposal to invest in new production equipment.
Which company action would increase the likelihood of Kathy accepting the proposal?

A)Offering stock options.
B)Providing short-term bonuses that adjust for the negative effects of new projects.
C)Establishing policies that require review teams for new projects.
D)All of the choices increase the likelihood of Kathy accepting the proposal.
E)None of the answer choices is correct.

Question 49

Lanyard Company is considering an investment that will generate $600,000 in cash inflows per year for 7 years and has $240,000 of cash outflows for the same period (before income taxes).The cost of the asset is $700,000 and it will be depreciated using straight-line depreciation over the 7 year life.The asset has no salvage value.Lanyard's tax rate is 40%.The cost of capital is 18%.

What is the net present value of this investment (rounded to the nearest dollar)?

A)$275,744
B)($105,406)
C)$504,434
D)$123,284
E)None of the answer choices is correct.

Question 50

Exhibit 8-2
Liam Company has two independent investment opportunities,each requiring an initial investment of $130,000.The company's required rate of return is 12 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-2.What is the net present value of Investment A (rounded to the nearest dollar)?

A)$72
B)$15,600
C)$30,000
D)$361,680
E)None of the answer choices is correct.

Question 51

When using Excel,all of the following are needed to calculate the internal rate of return except:

A)an estimate of the internal rate of return.
B)the net present value.
C)the annual cash inflows and outflows.
D)the initial cash outflows.
E)None of the answer choices is correct.

Question 52

Landscaping Inc.would like to purchase a tractor for $425,000.The tractor is expected to have a life of five years,and no salvage value.Annual maintenance costs will total $12,500.Annual labor and material savings are predicted to be $118,750.The company's required rate of return is 8 percent.
What is the payback period for this investment (round to the nearest month)?

A)3 years.
B)4 years.
C)5 years.
D)4 years,11 months.
E)None of the answer choices is correct.

Question 53

Before income taxes,Farley Company had revenues of $250,000 and expenses of $100,000 for the year excluding depreciation.Depreciation expense totaled $25,000 for the year.The company has an income tax rate of 40 percent.What is the company's after-tax cash flow for the year?

A)$90,000
B)$100,000
C)$75,000
D)$125,000
E)None of the answer choices is correct.

Question 54

For organizations that do not pay income taxes,the depreciation taken on a long-term asset in future periods:

A)must be multiplied by the tax rate for the IRR and NPV.
B)must be multiplied by one minus the tax rate for the IRR and NPV calculations.
C)is not included in the IRR and NPV calculations.
D)is only included in the payback calculation.
E)None of the answer choices is correct.

Question 55

Reinhart Company would like to purchase a new machine for $5,000,000.The machine is expected to have a life of five years,and a salvage value of $1,000,000.Annual maintenance costs will total $300,000.Annual labor and material savings are predicted to be $2,000,000.The company's required rate of return is 26 percent.
What is the payback period for this investment (round to the nearest month)?

A)1 year,11 months.
B)1 year,9 months.
C)2 years,9 months.
D)2 years,11 months.
E)None of the answer choices is correct.

Question 56

The payback period is typically stated :

A)in days,months,or years.
B)as a percent.
C)as a dollar amount.
D)in the same format as the required rate of return.
E)None of the answer choices is correct.

Question 57

Exhibit 8-2
Liam Company has two independent investment opportunities,each requiring an initial investment of $130,000.The company's required rate of return is 12 percent.The cash inflows for each investment are provided below.

Refer to Exhibit 8-2.What is the net present value of Investment B (rounded to the nearest dollar)?

A)$30,000
B)($17,080)
C)$17,080
D)($15,600)
E)None of the answer choices is correct.

Question 58

Exhibit 8-1
A project requires an initial investment of $1,500,000 and will return $420,000 each year for six years.

Refer to Exhibit 8-1.If taxes are ignored and the required rate of return is 10%,what is the project's net present value (rounded to the nearest dollar)?

A)$1,262,910
B)$1,020,000
C)$329,226
D)$344,409
E)None of the answer choices is correct.

Question 59

Exhibit 8-1
A project requires an initial investment of $1,500,000 and will return $420,000 each year for six years.

Refer to Exhibit 8-1.Using the net present (NPV)to evaluate this proposal,the company should:

A)Reject the proposal since the NPV is ($329,226).
B)Invest in the proposal since the NPV is $1,020,000.
C)Invest in the proposal since the NPV is $3,329,226.
D)Invest in the proposal since the NPV is $329,226.
E)None of the answer choices is correct.

Question 60

Solutions Inc.would like to purchase a new production machine for $300,000.The machine is expected to have a life of four years,and a salvage value of $50,000.Annual maintenance costs will total $30,000.Annual labor and material savings are predicted to be $150,000.The company's required rate of return is 6 percent.
What is the payback period for this investment (round to the nearest month)?

A)3 year,5 months.
B)2 years,5 months.
C)2 years,6 months.
D)3 years,6 months.
E)None of the answer choices is correct.

Question 61

Niwot Inc.is considering an investment that will generate $600,000 in revenues per year for 7 years and has $360,000 of cash expenses for the same period (before income taxes).The cost of the asset is $420,000 and it will be depreciated using straight-line depreciation over the 7 year life.The asset has no salvage value.Niwot's tax rate is 30%.The cost of capital is 9%.
What is the annual after-tax cash flow associated with this investment?

A)$240,000
B)$186,000
C)$126,000
D)$150,000
E)None of the answer choices is correct.

Question 62

Rambus Inc.would like to purchase a production machine for $325,000.The machine is expected to have a life of three years,and a salvage value of $50,000.Annual maintenance costs will total $12,500.Annual savings are predicted to be $112,500.The company's required rate of return is 12 percent.
Ignoring the time value of money,calculate the net cash inflow or outflow resulting from this investment opportunity.

Question 63

Davies Inc.would like to purchase a new machine for $300,000.The machine will have a life of four years with no salvage value,and is expected to generate annual cash revenue of $180,000.Annual cash expenses,excluding depreciation,will total $20,000.The company uses the straight-line depreciation method,has a tax rate of 30 percent,and requires a 12 percent rate of return.
(1)Find the net present value of this investment using the following factors.

(2)Should the company purchase the machine? Explain.

Question 64

Idlewood Production Company would like to purchase a production machine for $450,000.The machine is expected to have a life of four years,and a salvage value of $50,000.Annual maintenance costs will total $12,500.Annual savings are predicted to be $175,000.The company's required rate of return is 12 percent.

(1)Calculate the net present value of this investment (ignore income taxes).Round all calculations to the nearest dollar.
(2)Based on your answer in requirement 1,should Idlewood purchase the production machine?

Question 65

Lockwood Company would like to purchase a production machine for $900,000.The machine is expected to have a life of five years,and a salvage value of $100,000.Annual maintenance costs will total $40,000.Annual savings are predicted to be $350,000.The company only accepts projects that have a payback period of less than three years.
(1)Calculate the payback period for this project rounded to the nearest month.Show your work.
(2)Should the company accept this proposal? Explain.

Question 66

Lanyard Company is considering an investment that will generate $600,000 in cash inflows per year for 7 years and has $240,000 of cash outflows for the same period (before income taxes).The cost of the asset is $700,000 and it will be depreciated using straight-line depreciation over the 7 year life.The asset has no salvage value.Lanyard's tax rate is 40%.The cost of capital is 18%.
What is the annual after-tax cash flow associated with this investment?

A)$176,000
B)$260,000
C)$216,000
D)$256,000
E)None of the answer choices is correct.

Question 67

Nolan Company would like to open an office for five years in Southern California.The initial investment required to purchase an office building is $1,500,000,and Nolan needs $400,000 in working capital for the new office.Working capital will be released back to the company at the end of five years.The company expects to remodel the office at the end of 2 years at a cost of $180,000.The company only accepts projects that have a payback period of less than three years.Annual net cash receipts from daily operations (cash receipts minus cash payments)are expected to be as follows:

(1)Calculate the payback period for this project rounded to the nearest month.Show your work.
(2)Should the company accept this proposal? Explain.

Question 68

Before income taxes,McFadden Company had revenues of $200,000 and expenses of $75,000 for the year.The expenses include $25,000 of depreciation.The company pays taxes at a 30% rate.What is the company's after-tax cash flow for the year?

A)$125,000
B)$97,500
C)$100,000
D)$112,500
E)None of the answer choices is correct.

Question 69

Niwot Inc.is considering an investment that will generate $600,000 in cash inflows per year for 7 years and has $360,000 of cash outflows for the same period (before income taxes).The cost of the asset is $420,000 and it will be depreciated using straight-line depreciation over the 7 year life.The asset has no salvage value.Niwot's tax rate is 30%.The cost of capital is 9%.

What is the net present value of this investment (rounded to the nearest dollar)?

A)$516,138
B)$953,400
C)$999,180
D)$485,940
E)None of the answer choices is correct.

Question 70

The Law Offices of Nguyen and Kline would like to open an office for six years in New Mexico.The initial investment required to purchase an office building is $2,600,000,and Nguyen and Kline needs $75,000 in working capital for the new office.Working capital will be released back to the company at the end of six years.Nguyen and Kline expects to remodel the office at the end of 4 years at a cost of $250,000.Annual net cash receipts from daily operations (cash receipts minus cash payments)are expected to be as follows:

Although the company's cost of capital is 7 percent,management set a required rate of return of 13 percent due to the high risk associated with this project.
(Use the following factors for your solutions. )

(1)Calculate the net present value (NPV)of this investment.
(2)Use trial and error to approximate the internal rate of return (IRR)for this investment proposal.
(3)Based on the analyses in (1)and (2),should Nguyen and Kline open the new office? Explain.

Question 71

Rambus Inc.would like to purchase a production machine for $325,000.The machine is expected to have a life of three years,and a salvage value of $50,000.Annual maintenance costs will total $12,500.Annual savings are predicted to be $112,500.The company's required rate of return is 12 percent.

(1)Using the Present Value Factors for $1,calculate the net present value of this investment (ignoring taxes).
(2)Based on your answer in requirement 1,should Rambus purchase the production machine?