Deck 10: The Fundamentals of Capital Budgeting

Question 1

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

Answer 1

True

Question 2

Accepting a negative-NPV project increases shareholder wealth.

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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

Question 5

The goal of the capital budgeting decisions is to select capital projects that will decrease the value of the firm.

Question 6

Accepting a positive-NPV project decreases shareholder wealth.

Question 7

All capital budgeting projects are independent projects.

Question 8

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

Question 9

Capital budgeting decisions, once made, are not easy to reverse because of the huge investments involved.

Question 10

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

Question 11

The payback method is called a discounted cash flow technique.

Question 12

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

Question 13

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

Question 14

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

Question 15

All contingent projects are mandatory projects.

Question 16

Accepting a positive-NPV project increases shareholder wealth.

Question 17

Capital rationing refers to the limiting of capital resources to underperforming divisions.

Question 18

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

Question 19

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

Question 20

When two projects have cash flows that are tied to each other, the projects may be classified as independent.

Question 21

Two projects are considered to be independent if

A) selecting one would have no bearing on accepting the other.
B) their cash flows are unrelated.
C) Both a and b.
D) None of the above.

Question 22

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

Question 23

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 firm had earned.
D) none of the above.

Question 24

Capital rationing implies that

A) the firm does not have enough resources to fund all of the available projects.
B) funding needs equal funding resources.
C) the available capital will be allocated equally to all available projects.
D) none of the above.

Question 25

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 26

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

Question 27

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 28

The firm's decision will be to

A)accept both projects because they are independent projects.
B)accept both projects because they are contingent projects.
C)pick the one that adds the most value because they are mutually exclusive projects.
D)pick neither project.

Question 29

Which of the following is NOT true about capital budgeting.

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

Question 30

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

Question 31

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

Question 32

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

Question 33

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

Question 34

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 35

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

Question 36

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

Question 37

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

Question 38

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

Question 39

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 40

If both projects are positive-NPV projects, then the firm 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 41

Disadvantages of the payback method include the following.

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

Question 42

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 43

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 44

In evaluating capital projects, the decisions using the NPV method and the IRR method may disagree if

A) the projects are independent.
B) the cash flows pattern is unconventional.
C) the projects are mutually exclusive.
D) both b and c.

Question 45

Advantages of the payback method include the following.

A) The technique is simple for managers to compute and interpret.
B) It is a good measure of liquidity risk.
C) Both a and b,
D) None of the above.

Question 46

To accept a capital project when using NPV,

A) the project NPV should be less than zero.
B) the project NPV should be greater than zero.
C) both a and b.
D) none of the above.

Question 47

Net present value: Cortez 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 48

Net present value: Gao 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 firm's required rate of return is 18 percent, what is the NPV of this project?

A) $2,875,000
B) $3,830,785
C) $580,785
D) $2,1225,875

Question 49

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 50

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 51

Net present value: Jenkins Corporation 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 firm'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 52

The net present value

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

Question 53

Net present value: Johnson 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) $4,669,806
D) $3,122, 607

Question 54

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 55

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

A) The payback method is consistent with the goal of shareholder wealth maximization
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 rational that links the payback method to shareholder wealth maximization.
D) None of the above statements are true.

Question 56

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 57

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 58

Payback: Binder Corp. 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 59

Net present value: The Cyclone Golf Resorts 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 firm 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 60

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 61

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 62

Discounted payback: Roswell 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

Internal rate of return: Casa Del Sol 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 firm earn from this project? (Round to the nearest percent.)

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

Question 64

Discounted payback: Kathleen Dancewear 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 firm'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 65

Accounting rate of return (ARR): LaGrange Corp. 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 66

Internal rate of return: Quick Sale 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 67

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 68

Internal rate of return: Modern Federal 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 firm'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 69

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 70

Accounting rate of return (ARR): Stump 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 71

Payback: Carmen 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 72

Internal rate of return: Signet Pipeline 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 Signet's internal rate of return? (Round to the nearest percent.)

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

Question 73

Internal rate of return: Lowell Communications, Inc., has been installing a fiber-optic network at a cost of $18 million. The firm 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 74

Payback: Kathleen Dancewear 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 75

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 76

Discounted payback: Carmen 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 firm's cost of capital is 12 percent. What is the discounted payback period for this project? If the firm'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 77

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 78

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 79

Payback: Elmer Sporting Goods is getting ready to produce a new line of golf 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 80

Payback: Creighton, Inc., has invested $2,165,800 on equipment. The firm 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 firm's payback criteria?

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