Question 1

When ranking two mutually exclusive investments with different initial amounts but approximately the same useful life, and assuming no capital rationing, management should give priority to the project:

Accepted Answer

A)  That generates cash flows for the longer period of time. 
B)  Whose net after-tax cash flows equal the initial investment outlay. 
C)  That has the greater accounting rate of return (ARR). 
D)  Whose cash flows vary the least. 
E)  That has the higher net present value (NPV).

Question 2

A characteristic of the payback method is that it

Accepted Answer

A)  Cannot incorporate into the calculation the time value of money. 
B)  Neglects total project profitability (i.e., profitability over the entire life of the project). 
C)  Uses accrual accounting numbers in the numerator of the calculation. 
D)  Uses the estimated life of the asset in the denominator of the calculation. 
E)  Uses the hurdle (i.e., discount) rate in the calculation.

Question 3

Which of the following statements regarding cost of capital is not true?

Accepted Answer

A)  It reflects the perceived level of risk for which investors in debt and equity securities expect to be compensated. 
B)  It is another term for "required rate of return." 
C)  It is typically defined as a weighted-average of all sources of capital for the company. 
D)  It is used to calculate the present value of anticipated after-tax cash flows for a project. 
E)  It is used when calculating the internal rate of return (IRR) of a proposed investment.

Question 4

The capital budgeting decision technique that reflects the time value of money and is calculated as the present value of the future after-tax cash inflows divided by the initial cash outlay for the investment is called the:

Accepted Answer

A)  Net present value (NPV) method. 
B)  Capital rationing method. 
C)  Average accounting rate of return (ARR) method. 
D)  Profitability index (PI) method. 
E)  Present value payback method.

Question 5

Results from the net present value (NPV) method and the internal rate of return (IRR) method may differ between projects if the projects differ in all the following except:

Accepted Answer

A)  Required initial investment. 
B)  Cash-flow pattern. 
C)  Cost of capital (i.e., discount rate). 
D)  Length of useful life of the two projects. 
E)  Book (accounting) rate of return on the two projects.

Question 6

In a discounted cash flow (DCF) analysis, a required incremental investment in net working capital:

Accepted Answer

A)  Should be amortized over the useful life of the equipment, to yield an improved estimate of the return on the proposed project. 
B)  Can be disregarded because the same amount of cash will be recovered at the end of the project's life. 
C)  Should be treated as a recurring cash outflow over the life of the project. 
D)  Should be treated as a reduction in the required cash outflow in period 0. 
E)  Should be treated as an immediate cash outflow that is later recovered when this incremental investment is no longer needed.

Question 7

Which one of the following capital budgeting decision models consists of dividing the total initial investment outlay by annual after-tax cash inflows (when such inflows are assumed equal over time)?

Accepted Answer

A)  Profitability index (PI). 
B)  Payback period. 
C)  Book (accounting) rate of return (ARR). 
D)  Internal rate of return (IRR). 
E)  Adjusted payback period.

Question 8

Marc Corporation wants to purchase a new machine for $400,000. Management predicts that the machine can produce sales of $275,000 each year for next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The company uses MACRS (modified accelerated cost recovery system) for depreciation. The machine is considered 3-year property and is not expected to have any significant residual at the end of its useful life. Marc's income tax rate, t, is 40%. Management estimates that the weighted-average cost of capital (WACC) is 10%. A partial MACRS depreciation table is reproduced below.$$\begin{array} { | l | l | l | } 
\hline \text { Year } & \text { 3-year property } & \text { 5-year property } \
\hline 1 & 33.33 & 20.00 \
\hline 2 & 44.45 & 32.00 \
\hline 3 & 14.81 & 19.20 \
\hline 4 & 7.41 & 11.52 \
\hline 5 & & 11.52 \
\hline 6 & & 5.76 \
\hline
\end{array}$$ Required:
1. What is the estimated net present value (NPV) of the investment (rounded to the nearest whole dollar)? (Note: PV $1 factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.) Assume that all estimated cash flows occur at year-end.
2. What is the present value payback period (rounded to two decimal places)?

Accepted Answer

The answer of Marc Corporation wants to purchase a new...

Question 9

Which of the following is not a characteristic of the payback method for making capital budgeting decisions?

Accepted Answer

A)  It is easy to calculate and comprehend. 
B)  It focuses primarily on liquidity, rather than profitability, of an investment project. 
C)  It can be considered a rough measure of risk. 
D)  It considers returns over the entire life of the project. 
E)  It requires estimates of after-tax cash inflows and after-tax cash outflows.

Question 10

If a company is faced with limited capital funds for investment (i.e., the company faces capital rationing), the best general method to employ to assess individual project profitability is:

Accepted Answer

A)  Cash-flow bailout. 
B)  Net present value (NPV). 
C)  Payback. 
D)  Discounted payback. 
E)  Profitability index (PI).

Question 11

Which one of the following is true for the internal rate of return (IRR) method?

Accepted Answer

A)  It assumes cash proceeds during the life of a project can be reinvested to earn the same rate of return as the weighted-average cost of capital. 
B)  Depending on the pattern of after-tax cash flows, multiple IRRs for a given proposed investment are possible. 
C)  IRRs of multiple projects are additive (that is, can be added together). 
D)  It can be used to make optimal decisions regarding mutually exclusive investment projects. 
E)  It makes it easy to incorporate multiple costs of capital.

Question 12

Fritz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash operating costs (before taxes) by a projected $80,000 for each of the next five years. The company requires a minimum rate of return of 8% on all capital investments. The machine will be depreciated using straight-line method over a five-year period with no salvage value at the end of five years. Fritz is subject to a combined 40% income tax rate.
Required:
1. What is the machine's payback period, in years (rounded to one decimal place, e.g., 4.2483 years = 4.2 years), under the assumption that cash flows occur evenly throughout the year?
2. What is the accounting (book) rate of return (ARR), based on the initial investment amount (rounded to one decimal place, that is, rounded to the nearest one-tenth of a percent, e.g., 12.342% = 12.3%)?

Accepted Answer

The answer of Fritz Company is planning to acquire a...

Question 13

Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine will produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 40%.

Management requires a minimum of 10% return on all investments. What is the approximate present value payback period, rounded to one-tenth of a year? (Note: PV $1 factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.) Assume that annual after-tax cash inflows occur evenly throughout the year.

Accepted Answer

A)  2.5 years. 
B)  3.0 years. 
C)  3.6 years. 
D)  4.1 years. 
E)  4.8 years.

Question 14

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

Assume that the hurdle rate for accepting new capital investment projects for the company is 4%, after-tax. (Note: PV $1 factors for 4% are as follows: for year 1 = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.) At an after-tax discount rate of 4%, the estimated net present value (NPV) of the proposed investment is (rounded to the nearest hundred dollars):

Accepted Answer

A)  ($15,000). 
B)  ($12,300). 
C)  ($9,300). 
D)  ($6,000). 
E)  $1,800.

Question 15

For capital budgeting purposes, a depreciation tax shield

Accepted Answer

A)  Is an example of an after-tax cash outflow. 
B)  Results in a reduction in income taxes otherwise due. 
C)  Refers to the expense caused by depreciation. 
D)  Equals the amount of depreciation expense × (1 − t), where t = the income tax rate. 
E)  Is caused by the fact that depreciation does not require a cash outflow.

Question 16

Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine is expected to generate a constant after-tax income of $100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual value. Its estimated weighted-average cost of capital (WACC) for evaluating capital expenditure proposals is 10%. Note: the PV $1 factor for 10 years, 10% is 0.386; the PV annuity factor for 10%, 10 years is 6.145; and, the PV annuity factor for 10%, 5 years is 3.791.
Required:
Using a discount rate of 10%, what is the estimated net present value (NPV) of the proposed investment (rounded to the nearest thousand)?

Accepted Answer

The answer of Omaha Plating Corporation is considering purchasing a...

Question 17

Which of the following is an example of a sunk cost in a capital budgeting decision regarding the replacement of an existing piece of equipment for a profitable business that pays taxes?

Accepted Answer

A)  The disposal (salvage) value of the equipment to be replaced. 
B)  The original purchase price of the equipment to be replaced. 
C)  The additional net working capital requirement. 
D)  The operating cost of the new equipment. 
E)  Income taxes on the disposal of the equipment to be replaced.

Question 18

Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen can sell all that it could manufacture for the next 10 years. To encourage capital investments, the government exempts taxes on profits from new investments in this type of machinery. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to have 10 years of useful life and no salvage value at the end of this 10-year period. The firm uses straight-line depreciation. The net cash inflow is expected to be $144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments.

The estimated net present value (NPV) of this proposed investment (rounded to the nearest thousand) is: (Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145.)

Accepted Answer

A)  ($105,000). 
B)  ($84,000). 
C)  $181,000. 
D)  $248,000. 
E)  $285,000.

Question 19

Harris Corporation provides the following data on a proposed capital project:Harris uses straight-line depreciation method with no salvage value.
Required:
Compute for the proposed investment project:
1. The project's estimated NPV (the PV annuity factor for 12%, 4 years is 3.037). Round your answer to nearest whole number (dollar).
2. The project's IRR (to the nearest tenth of a percent). Note: PV annuity factors for 4 years: @ 8% = 3.312; @ 9% = 3.240; @ 10% = 3.170; @ 11% = 3.102; @ 12% = 3.037; and, @ 13% = 2.974).
3. Payback period (assume that cash inflows occur evenly throughout the year); round answer to two decimal places (e.g., 4.459 years = 4.46 years, rounded).
4. Accounting rate of return (ARR) on the net initial investment, rounded to two decimal places (e.g., 10.4233% = 10.42%).
5. Discounted payback period (assume that the cash inflows occur evenly throughout the year; round your answer to 2 decimal places). The appropriate PV factors for 12% are as follows: year 1 = 0.893; year 2 = 0.797; year 3 = 0.712; year 4 = 0.636.

Accepted Answer

The answer of Harris Corporation provides the following data on...

Question 20

Kravitz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash operating costs (before taxes) by an estimated $80,000 for each of the next five years. The company's estimated weighted-average cost of capital (WACC) is 8%. The machine will be depreciated using straight-line method over a five-year period with no salvage value. Fritz is subject to a combined 40% income tax rate, t.
Note: at 8%, the PV annuity factor for five years is 3.993; at 8%, PV $1 factors are as follows: for year 1 = 0.926; for year 2 = 0.857; for year 3 = 0.794; for year 4 = 0.735; and, for year 5 = 0.681.
Required:
1. What is the estimated net present value (NPV) of the proposed investment, rounded to the nearest whole number?
2. What is the present value payback period, in years (rounded to one decimal place, that is, to tenth of a year, e.g., 4.085 years = 4.1 years)?
3. What is the estimated internal rate of return (IRR) on the proposed investment? Round your answer to one decimal place (i.e., tenth of a percent, e.g., 13.4%). (Note: to answer this question, you will need access to the tables presented in Chapter 12, Appendix C or to Excel.)

Accepted Answer

The answer of Kravitz Company is planning to acquire a...

Exam 12: Strategy and the Analysis of Capital Investments