Deck 10: The Fundamentals of Capital Budgeting

Question 1

Projects that are classified as contingent could be mandatory or optional projects.

Answer 1

True

Question 2

The net present value technique is an approach that goes against the goal of shareholder wealth maximisation.

Answer 2

False

Question 3

Capital rationing refers to allocating an equal ratio of capital resources for each investment project.

Answer 3

False

Question 4

The cost of capital is the highest return a project can earn.

Question 5

The discounted payback period calculation calls for the future cash flows to be discounted by the company's cost of capital.

Question 6

Capital budgeting decisions are relatively easy to reverse.

Question 7

The cost of capital is an opportunity cost.

Question 8

The basis on which capital budgeting plans are made is a company's three- to five-year strategic plan.

Question 9

When two projects are mutually exclusive, accepting one project implicitly eliminates the other.

Question 10

If the payback period for a project exceeds the company's threshold period, then the project is accepted

Question 11

The payback method is called a discounted cash flow technique.

Question 12

The payback method is consistent with the goal of shareholder wealth maximisation.

Question 13

All contingent projects are mandatory projects.

Question 14

The discount rate used to determine the present value of future cash flows is called the cost of capital.

Question 15

Most of the information required to make capital budgeting decisions are internally generated, beginning with the sales force.

Question 16

The NPV method determines how much the present value of cash inflows exceeds the present value of costs.

Question 17

All capital budgeting projects are independent projects.

Question 18

Accepting a positive-NPV project increases shareholder wealth.

Question 19

The goal of the capital budgeting decisions is to select capital projects that will increase the value of the company.

Question 20

Projects are classified as independent when their cash flows are unrelated.

Question 21

Capital rationing implies that:

A) the company does not have enough resources to fund all of the available projects.
B) each investment needs equal funding resources.
C) the available capital will be allocated in an equal ratio to all available projects.
D) none of the above.

Question 22

Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project decreases shareholder wealth.
C) Accepting a zero NPV project has a negative impact on shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.

Question 23

The accounting rate of return is not a true return because it simply utilises some average figures from the company's balance sheet and income statement.

Question 24

Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project has no impact on shareholder wealth.
C) Accepting a negative-NPV project decreases shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.

Question 25

Which of the following are aspects of independent projects?

A) Their cash flows are related.
B) Their cash flows are unrelated.
C) Selecting one would automatically eliminate accepting the other.
D) None of the above.

Question 26

The IRR and NPV decisions are consistent with each other when a project's cash flows follow a conventional pattern.

Question 27

Two projects are considered to be mutually exclusive if:

A) the projects perform the same function.
B) selecting one would automatically eliminate accepting the other.
C) Both a and b.
D) None of the above.

Question 28

In computing the NPV of a capital budgeting project, one should NOT:

A) estimate the cost of the project.
B) discount the future cash flows over the project's expected life.
C) ignore the salvage value.
D) make a decision based on the project's NPV.

Question 29

When mutually exclusive projects are considered, both NPV and IRR will always produce the same acceptance decision.

Question 30

The decision criterion for the accounting rate of return is consistent with the goal of shareholder wealth maximisation.

Question 31

All but one of the following is NOT true about capital budgeting.

A) It involves identifying projects that will add to the company's value.
B) It involves large capital investments.
C) The large capital investments can be reversed at any time.
D) It allows the company's management to analyse potential business opportunities and decide on which ones to undertake.

Question 32

Capital rationing implies that:

A) funding resources exceed funding needs.
B) funding needs exceed funding resources.
C) funding needs equal funding resources.
D) none of the above.

Question 33

When evaluating two projects that require different outlays, the IRR does not recognise the difference in the size of the investments.

Question 34

Unlike the regular payback method, the discounted payback method does not ignore cash flows beyond the company's threshold period.

Question 35

Two projects are considered to be contingent projects if:

A) selecting one would automatically eliminate accepting the other.
B) the acceptance of one project is dependent on the acceptance of the other.
C) rejection of one project does not eliminate the selection of the other.
D) None of the above.

Question 36

The net present value:

A) uses the discounted cash flow valuation technique.
B) will provide a direct measure of how much the company value will change because of the capital project.
C) is consistent with shareholder wealth maximisation goals.
D) all of the above.

Question 37

A construction company is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the company owns adjacent to the airport. If both projects are positive-NPV projects, then the company should:

A) accept both projects because they are independent projects.
B) select the higher NPV project because they are mutually exclusive.
C) accept both projects because they are contingent projects.
D) Not enough information is given to make a decision.

Question 38

An example of a contingent product is:

A) choosing between one of two manufacturing sites.
B) building a new manufacturing plant with optional waste recycling.
C) adding manufacturing capacity to a plant.
D) None of the above.

Question 39

The cost of capital is:

A) the minimum return that a capital budgeting project must earn for it to be accepted.
B) the maximum return a project can earn.
C) the return that a previous project for the company had earned.
D) none of the above.

Question 40

Unconventional cash flow patterns could lead to conflicting decisions by NPV and IRR.

Question 41

Net present value: Niche Entertainment Systems is setting up to manufacture a new line of video game consoles. The cost of the manufacturing equipment is $1,750,000. Expected cash flows over the next four years are $725,000, $850,000, $1,200,000, and $1,500,000. Given the company's required rate of return of 15 percent, what is the NPV of this project?

A) $1,169,806
B) $2,919,806
C) $2,525,000
D) $3,122, 607

Question 42

Advantages of the payback method include the following:

A) The technique is simple for managers to calculate and interpret.
B) It is a good measure of liquidity risk.
C) Both a and b, b.
D) Neither a nor

Question 43

Disadvantages of the payback method include the following:

A) It ignores the time value of money.
B) It is inconsistent with the goal of maximising shareholder wealth.
C) It ignores cash flows beyond the payback period.
D) All of the above.

Question 44

To accept a capital project when using NPV:

A) the project NPV should be less than zero.
B) the project NPV should be equal to zero.
C) the project NPV should be greater than zero.
D) a and b.

Question 45

Payback: Ouroboros Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. What is the payback period for this project? If their acceptance period is three years, will this project be accepted?

A) 2.67 years; yes
B) 2.67 years; no
C) 3.33 years; yes
D) 3.33 years; no

Question 46

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The company expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. Payback: What is the payback period for this project?

A) 2.8 years
B) 3.0 years
C) 3.2 years
D) 3.4 years

Question 47

Net present value: Lady Grey Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the company's required rate of return is 18 percent, what is the NPV of this project?

A) $2,785,000
B) $3,830,785
C) $580,785
D) $2,122,875

Question 48

Albury Company is adding a new assembly line at a cost of $8.5 million. The company expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. Payback: What is the payback period for this project?

A) 2.8 years
B) 2.9 years
C) 3.1 years
D) 3.4 years

Question 49

Which one of the following statements about the discounted payback method is NOT true?

A) The discounted payback method represents the number of years it takes a project to recover its initial investment.
B) The discounted payback method calls for the project to be accepted if the payback period is greater than a target period.
C) The discount payback method is a risk indicator.
D) The expected cash flows from the project are discounted at the cost of capital.

Question 50

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The company expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. Net present value: What is the net present value of this project?

A) $890,197
B) $1,213,909
C) $905,888
D) $777,713

Question 51

Albury Company is adding a new assembly line at a cost of $8.5 million. The company expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. Net present value: What is the net present value of this project?

A) $645,366
B) $1,213,909
C) $905,888
D) $777,713

Question 52

Which ONE of the following statements about the payback method is true?

A) The payback method is consistent with the goal of shareholder wealth maximisation
B) The payback method represents the number of years it takes a project to recover its initial investment plus a required rate of return.
C) There is no economic rationale that links the payback method to shareholder wealth maximisation.
D) None of the above statements are true.

Question 53

Net present value: Jenkins Roth Co. is investing in a new piece of equipment at a cost of $6 million. The project is expected to generate annual cash flows of $1,850,000 over the next six years. The company's cost of capital is 20 percent. What is the project's NPV?

A) $722,604
B) $351,097
C) $152,194
D) $261,008

Question 54

Net present value: The Kookaburra Golf Resort is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1,223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the company is 13 percent, what is the NPV of this project?

A) $7,581,072
B) $2,092,432
C) $4,836,752
D) $3,112,459

Question 55

Payback: Barcode Biz has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,250, $823,330, and $907,125 over the next four years. What is the payback period for this project?

A) 2.12 years
B) 1.88 years
C) 4.00 years
D) 3.00 years.

Question 56

Turnbull Company is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. Net present value: What is the net present value of this project? (Round to the nearest million dollars.)

A) $10 million
B) $12 million
C) $14 million
D) $16 million

Question 57

Net present value: Modena Art Gallery is adding to its existing buildings at a cost of $2 million. The gallery expects to bring in additional cash flows of $520,000, $700,000, and $1,000,000 over the next three years. Given a required rate of return of 10 percent, what is the NPV of this project?

A) $1,802,554
B) $197,446
C) -$1,802,554
D) -$197,446

Question 58

Payback: Kryton Ltd has invested $2,165,800 on equipment. The company uses payback period criteria of not accepting any project that takes more than four years to recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755, $764,997, $816,500, and $825,375 over the next six years. What is the payback period, and does this investment meet the company's payback criteria?

A) 4.13 years; no
B) 4.13 years; yes
C) 3.87 years; yes
D) 3.87 years; no

Question 59

Payback: Smart Sporting Goods is getting ready to produce a new line of gold clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project?

A) 3 years
B) 2.43 years
C) 1.57 years
D) More than 3 years

Question 60

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The company expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. Discounted payback: What is the discounted payback period for this project?

A) 3.9 years
B) 4.3 years
C) 4.7 years
D) 5.1 years

Question 61

Internal rate of return: Clydesdale Bank is setting up a brand new branch. The cost of the project will be $1.2 million. The branch will create additional cash flows of $235,000, $412,300, $665,000 and $875,000 over the next four years. The company's cost of capital is 12 percent. What is the internal rate of return on this branch expansion? (Round to the nearest percent.)

A) 20%
B) 23%
C) 25%
D) 27%

Question 62

Discounted payback: Bendigo Energy Company is installing new equipment at a cost of $10 million. Expected cash flows from this project over the next five years will be $1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's discount rate for such projects is 14 percent. What is the project's discounted payback period?

A) 4.2 years
B) 4.4 years
C) 4.8 years
D) 5.0 years

Question 63

Accounting rate of return (ARR): Galaxy Co. has forecasted that over the next four years the average annual after-tax income will be $45,731. The average book value of the manufacturing equipment that is used is $167,095. What is the accounting rate of return?

A) 33.3%
B) 27.4%
C) 29.8%
D) 22.3%

Question 64

Accounting rate of return (ARR): Wattle Storage Co. is expecting to generate after-tax income of $155,708, $159,312, and $161,112 for each of the next three years. The equipment used will have an average book value of $251,575 over that period. What is the ARR?

A) 65.7%
B) 69.4%
C) 63.1%
D) 66.8%

Question 65

Discounted payback: Red Kite Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. The company's cost of capital is 10 percent. What is the discounted payback period for this project? If their acceptance period is three years, will this project be accepted?

A) 2.7 years; yes
B) 4.7 years; no
C) 2.3 years; yes
D) 4.3 years; no

Question 66

The internal rate of return is:

A) the discount rate that makes the NPV greater than zero.
B) the discount rate that makes the NPV equal to zero.
C) the discount rate that makes the NPV less than zero.
D) both a and c.

Question 67

Which one of the following statements about IRR is NOT true?

A) The IRR is the discount rate that makes the NPV greater than zero.
B) The IRR is a discounted cash flow method.
C) The IRR is an expected rate of return.
D) None of the above.

Question 68

Internal rate of return: National Internet Networks has been installing a fiber-optic network at a cost of $18 million. The company expects annual cash flows of $3.7 million over the next 10 years. What is this project's internal rate of return? (Round to the nearest percent.)

A) 10%
B) 12%
C) 14%
D) 16%

Question 69

When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if:

A) the projects are independent.
B) the cash flow pattern is conventional.
C) the projects are mutually exclusive.
D) both a and b.

Question 70

Turnbull Company is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. Internal rate of return: What is the internal rate of return that Turnbull can earn on this project? (Round to the nearest percent.)

A) 41%
B) 42%
C) 43%
D) 44%

Question 71

Turnbull Company is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. Modified Internal rate of return: What is the MIRR on this project? (Round to the nearest percent.)

A) 36%
B) 37%
C) 38%
D) 39%

Question 72

Internal rate of return: Arc Real Estate Company is planning to invest in a new development. The cost of the project will be $23 million and is expected to generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three years. The company's cost of capital is 20 percent. What is the internal rate of return on this project? (Round to the nearest percent.)

A) 22%
B) 20%
C) 24%
D) 28%

Question 73

Internal rate of return: Whitbird Co. is looking to install new equipment that will cost $2,750,000. The cash flows expected from the project are $612,335, $891,005, $1,132,000, and $1,412,500 for the next four years. What is Whitbird's internal rate of return? (Round to the nearest percent.)

A) 11%
B) 13%
C) 15%
D) 17%

Question 74

Internal rate of return: Western Gold Property Development Company is refurbishing a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead to expected annual cash flows of $415,350 for the next seven years. What internal rate of return can the company earn from this project? (Round to the nearest percent.)

A) 10%
B) 12%
C) 14%
D) 16%

Question 75

Which one of the following cash flow patterns is NOT an unconventional cash flow pattern?

A) A positive initial cash flow is followed by negative future cash flows.
B) Future cash flows from a project could include both positive and negative cash flows.
C) A negative initial cash flow is followed by positive future cash flows.
D) A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow.

Question 76

Turnbull Company is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. Payback: What is the payback period for this project?

A) 1.7 years
B) 2.2 years
C) 1.2 years
D) 2.7 years

Question 77

Discounted payback: Garland Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. The company's cost of capital is 12 percent. What is the discounted payback period for this project? If the company's acceptance period is five years, will this project be accepted?

A) 5.4 years; no
B) 6.1 years; no
C) 4.6 years; yes
D) 4.2 years; yes

Question 78

The ARR is not recommended as a capital expenditure tool because:

A) It is based upon accounting numbers.
B) It only provides numbers based upon average figures from the balance sheet.
C) It does not discount a project cash flow over time.
D) All of the above.

Question 79

Payback: Lister Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. What is the payback period for this project? If their acceptance period is five years, will this project be accepted?

A) 4.17 years; yes
B) 4.17 years; no
C) 3.83 years; yes
D) 3.83 years; no

Question 80

Albury Company is adding a new assembly line at a cost of $8.5 million. The company expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. Internal rate of return: What is the internal rate of return that Albury can earn on this project? (Round to the nearest percent.)

A) 18%
B) 19%
C) 20%
D) 21%