Deck 12: Capital Budgeting: Principles and Techniques

Question 1

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 1, the depreciation expense (CCA) for year 1 is___________

A) $112,500
B) $300,000
C) $150,000
D) $75,000

Answer 1

$75,000

Question 2

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent.
$\begin{array}{rrrr}\text { Project }&\text { Initial Investment }&IRR&NPV\\1 & \$ 200,000 & 19 \% & \$ 100,000 \\2 & 400,000 & 17 & 20,000 \\3 & 250,000 & 16 & 60,000 \\4 & 200,000 & 12 & -5,000 \\5 & 150,000 & 20 & 50,000 \\6 & 400,000 & 15 & 150,000\end{array}$

-Using the net present value approach to ranking projects, which projects should the firm accept? (See Figure 12.6)

A) 1, 2, 3, 5, and 6
B) 2, 3, 4, and 5
C) 1, 2, 3, 4, and 5
D) 1, 3, 5, and 6

Answer 2

1, 3, 5, and 6

Question 3

A loss on the sale of an asset which is depreciable and used in business is___________ sale of a non-depreciable asset is___________.

A) deductible from ordinary income; deductible only against capital gains
B) deductible from capital gains income; deductible from ordinary income
C) a credit against the tax liability; not deductible
D) not deductible; deductible only against capital gains

Answer 3

deductible from ordinary income; deductible only against capital gains

Question 4

A corporation is evaluating the relevant cash flows for a capital budgeting decision and mustestimate the terminal cash flow. The proposed machine will be disposed of at the end of its usablelife of five years at an estimated sale price of $15,000. The machine has an original purchase price of$80,000, installation cost of $20,000, and will be depreciated using a 30% CCA rate. The firm has a40 percent tax rate on ordinary income. The terminal cash flow is ___________. Assume the asset pool is closed at the end of the project.

A) $17,163.40
B) $14,010.12
C) $26,945.01
D) $24,007.11

Question 5

__________projects have the same function; the acceptance of one__________ the others from consideration.

A) Replacement; does not eliminate
B) Independent; does not eliminate
C) Capital; eliminates
D) Mutually exclusive; eliminates

Question 6

The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is

A) the reinvestment rate assumption regarding intermediate cash flows.
B) that neither method explicitly considers the time value of money.
C) the assumption made by the NPV method that intermediate cash flows are reinvested at the internal rate of return.
D) the assumption made by the IRR method that intermediate cash flows are reinvested at the cost of capital.

Question 7

The change in net working capital when evaluating a capital budgeting decision is

A) the increase in current liabilities.
B) the change in current assets minus the change in current liabilities.
C) current assets minus current liabilities.
D) the increase in current assets.

Question 8

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 1, the annual incremental after-tax cash flow from operations for year 1 is__________

A) $160,000
B) $180,000
C) $210,000
D) $100,000

Question 9

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 2, the initial outlay equals (See Figure 12.3)

A) $164,560 cash outflow.
B) $120,720 cash outflow.
C) $150,000 cash outflow.
D) $167,520 cash outflow.

Question 10

When evaluating projects using internal rate of return,

A) projects having higher early-year cash flows tend to be preferred at higher discount rates.
B) projects having higher early-year cash flows tend to be preferred at lower discount rates.
C) the discount rate and magnitude of cash flows do not affect internal rate of return.
D) projects having lower early-year cash flows tend to be preferred at higher discount rates.

Question 11

Among the reasons many firms use the payback period as a guideline in capital investment decisions are all of the following EXCEPT

A) it recognizes cash flows which occur after the payback period.
B) it gives an implicit consideration to the timing of cash flows.
C) it is easy to calculate.
D) it is a measure of risk exposure.

Question 12

Fixed assets that provide the basis for the firm's profit and value are often called

A) earning assets.
B) book assets.
C) tangible assets.
D) non-current assets.

Question 13

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called

A) mutually exclusive projects.
B) replacement projects.
C) independent projects.
D) none of the above.

Question 14

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of$10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is

A) between 2 and 3 years.
B) 1 year.
C) between 1 and 2 years.
D) 2 years.

Question 15

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:
$\begin{array}{rr}\text { Project: A }&&\text { Project: B }\\\hline\text { Initial } & \text { End-of-Year } & \text { Initial } & \text { End-of-Year } \\\text { Investment } & \text { Cash Flows } & \text { Investment } & \text { Cash Flows }\\\hline\$40,000&\$20,000&\$90,000&\$40,000\\&20,000 && 40,000 \\&20,000 && 80,000\end{array}$

-If the firm in Figure 12.5 has a required payback of two (2) years, they should

A) reject project A and accept B.
B) accept projects A and B.
C) accept project A and reject B.
D) reject both.

Question 16

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.

-The net present value of the project is__________

A) $9,761
B) $4,761
C) $4,614
D) $2,445

Question 17

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:
$\begin{array}{rr}\text { Project: A }&&\text { Project: B }\\\hline\text { Initial } & \text { End-of-Year } & \text { Initial } & \text { End-of-Year } \\\text { Investment } & \text { Cash Flows } & \text { Investment } & \text { Cash Flows }\\\hline\$40,000&\$20,000&\$90,000&\$40,000\\&20,000 && 40,000 \\&20,000 && 80,000\end{array}$

-The new financial analyst does not like the payback approach (See Figure 12.5) and determines that the firm's required rate of return is 15%. His recommendation would be to

A) accept project A and reject B.
B) reject project A and accept B.
C) accept projects A and B.
D) reject both.

Question 18

Consider an asset that costs $200,000 and has a CCA rate of 20% for tax purposes. The asset wasused for 5 years at which time it was sold for $150,000. If the relevant tax rate is 40%, what is theafter-tax cash flow from the sale of this asset? Assume the asset pool is closed upon sale of the asset.

A) $171,876
B) $144,167
C) $162,167
D) $119,491

Question 19

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.


-The present value of the project's five-year incremental after-tax operating income is___________

A) $32,820
B) $41,421
C) $36,769
D) $44,820

Question 20

When evaluating a capital budgeting project, the change in net working capital must be considered as part of

A) the operating cash outflows.
B) the incremental operating cash inflows.
C) the initial investment.
D) the operating cash inflows.

Question 21

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.


-The tax effect on the sale of the existing asset results in

A) a $4,400 recapture creating a tax liability.
B) a $2,200 capital loss that can be written off against future capital gains.
C) a $4,400 terminal loss being claimed.
D) no tax liability since the assets are pooled.

Question 22

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 1, the cash flow pattern for the expansion project is (See Figure 12.3)

A) a mixed stream and conventional.
B) a mixed stream and nonconventional.
C) an annuity and nonconventional.
D) an annuity and conventional.

Question 23

The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT

A) proceeds from the sale of the existing asset.
B) taxes on the sale of an existing asset.
C) incremental annual savings produced by the new asset.
D) cost of the new asset.

Question 24

Comparing net present value and internal rate of return analysis

A) is only necessary on mutually exclusive projects.
B) may give different accept/reject decisions.
C) always results in the same accept/reject decision.
D) always results in the same ranking of projects.

Question 25

Benefits expected from proposed capital expenditures must be on an after-tax basis because

A) it is common, accepted practice to do so.
B) taxes are cash outflows.
C) there may also be tax benefits to be evaluated.
D) no benefits may be used by the firm until tax claims are satisfied.

Question 26

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.

-The tax effect of the sale of the existing asset is

A) a tax liability of $2,340
B) a tax liability of $1,000
C) a tax benefit of $1,500
D) a tax liability of $2,000

Question 27

The first step in the capital budgeting process is

A) decision-making.
B) review and analysis.
C) implementation.
D) proposal generation.

Question 28

A firm is evaluating three capital projects. The net present values for the projects are as follows: $\begin{array}{rr}\text { Project }&NPV\\1 & \$ 100 \\2 & \$ 0 \\3 & -\$ 100\end{array}$ The firm should___________ .

A) accept Project 1 and reject Projects 2 and 3
B) accept Projects 1 and 3 and reject Project 2
C) accept Projects 1 and 2 and reject Project 3
D) reject all projects

Question 29

An important cash inflow in the analysis of initial cash flows for a replacement project is

A) the sale value of the old asset.
B) taxes.
C) installation cost.
D) the cost of the new asset.

Question 30

A corporation is evaluating the relevant cash flows for a capital budgeting decision and mustestimate the terminal cash flow. The proposed machine will be disposed of at the end of its usablelife of five years at an estimated sale price of $2,000. The machine has an original purchase price of$80,000, installation cost of $20,000, and will be depreciated using a 20% CCA rate. The firm has a40 percent tax rate on ordinary income. The terminal cash flow is ____________. Assume the asset pool is closed at the end of the project.

A) $15,945.60
B) $5,887.20
C) $16,200.00
D) $17,801.10

Question 31

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.


-The incremental depreciation expense (CCA) for year 1 is

A) $7,000
B) $4,300
C) $7,950
D) $2,250

Question 32

Sophisticated capital budgeting techniques do not

A) take into account an unconventional cash flow pattern.
B) examine the size of the initial outlay.
C) use net profits as a measure of return.
D) explicitly consider the time value of money.

Question 33

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 3, the annual incremental after-tax operating income is__________

A) $85,000
B) $150,000
C) $90,000
D) $114,000

Question 34

A capital expenditure is all of the following except

A) expected to produce benefits over a period of time greater than one year.
B) an outlay for current asset expansion.
C) commonly used to expand the level of operations.
D) an outlay made for the earning assets of the firm.

Question 35

In evaluating the initial investment for a capital budgeting project,

A) net working capital does not have to be considered.
B) a decrease in net working capital is considered a cash outflow.
C) an increase in net working capital is considered a cash outflow.
D) an increase in net working capital is considered a cash inflow.

Question 36

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.

-The book value (UCC) of the existing asset is__________

A) $15,000
B) $12,800
C) $25,000
D) $14,400

Question 37

___________is the process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization.

A) Ratio analysis
B) Recapitalizing assets
C) Restructuring debt
D) Capital budgeting

Question 38

The tax treatment regarding the sale of existing assets which are sold for more than the book valuebut less than the original purchase price results in

A) a capital gain and recaptured depreciation taxed as ordinary income.
B) recaptured depreciation taxed as ordinary income.
C) an ordinary tax benefit.
D) a capital gain tax liability.

Question 39

Examples of sophisticated capital budgeting techniques include all of the following EXCEPT

A) a discounted payback period.
B) the net present value.
C) an internal rate of return.
D) a payback period.

Question 40

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.

-The payback period for the project is (See Figure 12.7)

A) 2 years.
B) between 3 and 4 years.
C) 3 years.
D) between 4 and 5 years.

Question 41

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent. $\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 2, the annual incremental after-tax operating income is___________

A) $48,000
B) $42,000
C) $70,000
D) $89,000

Question 42

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because

A) it explicitly considers the time value of money.
B) it can take the place of the net present value approach.
C) the determination of payback is an objectively determined criteria.
D) it can be viewed as a measure of risk exposure.

Question 43

The__________ is the discount rate that equates the present value of the cash inflows with the initial investment.

A) average rate of return
B) internal rate of return
C) cost of capital
D) payback period

Question 44

A corporation is considering expanding operations to meet growing demand. With the capital expansion the current accounts are expected to change. Management expects cash to increase by$10,000, accounts receivable by $20,000, and inventories by $30,000. At the same time accounts payable will increase by $40,000, accruals by $30,000, and long-term debt by $80,000. The change in net working capital is __________.

A) an increase of $80,000
B) a decrease of $10,000
C) a decrease of $90,000
D) an increase of $10,000

Question 45

When making replacement decisions, the development of relevant cash flows is complicated whencompared to expansion decisions, due to the need to calculate __________cash inflows.

A) non-conventional
B) conventional
C) initial
D) incremental

Question 46

A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000. The net present value of the investment is __________.

A) $1.25
B) $0
C) -$1,000
D) $1,000

Question 47

A $60,000 outlay for a new machine with a usable life of 15 years is called

A) capital expenditure.
B) replacement expenditure.
C) operating expenditure.
D) none of the above.

Question 48

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 3, the cash flow pattern for the replacement project is (See Figure 12.3)

A) a mixed stream and non-conventional.
B) an annuity and non-conventional.
C) an annuity and conventional.
D) a mixed stream and conventional.

Question 49

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 1, the initial outlay equals__________

A) $1,380,000
B) $1,620,000
C) $1,500,000
D) $1,440,000

Question 50

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.


-The internal rate of return for the project is

A) between 9 and 10 percent.
B) less than 12 percent.
C) between 10 and 11 percent.
D) greater than 12 percent.

Question 51

All of the following are weaknesses of the payback period EXCEPT

A) a disregard for cash flows after the payback period.
B) the difficulty of specifying the appropriate payback period.
C) only an implicit consideration of the timing of cash flows.
D) it uses cash flows, not accounting profits.

Question 52

Travel Limited currently sells 12,500 motor homes per year at $40,000 each and 6,000 luxury motorcoaches per year at $60,000 each. The company wants to introduce a new portable camper to fillout its product line; it hopes to sell 15,000 of these campers per year at $20,000 each. An independent consultant has determined that if Travel introduces the new campers, it should boost the sales of its existing motor homes to 13,500 units per year and reduce the sales of its motor coaches to 5,500 units per year. What is the amount to use as the annual sales figure when evaluating the project?

A) $300,000,000
B) $320,000,000
C) $285,000,000
D) $310,000,000

Question 53

-The cash flow pattern depicted is associated with a capital investment and may be characterized as(See Figure 12.2)

A) an annuity and conventional cash flow.
B) an annuity and non-conventional cash flow.
C) a mixed stream and conventional cash flow.
D) a mixed stream and non-conventional cash flow.

Question 54

The book value of an asset is equal to the

A) original purchase price minus an annual amortization expense.
B) depreciated value plus recaptured amortization.
C) original purchase price minus the accumulated amortization.
D) fair market value minus the accounting value.

Question 55

The tax treatment regarding the sale of existing assets which are not depreciable or used in businessand are sold for less than the book value results in

A) a capital gain and recaptured depreciation taxed as ordinary income.
B) recaptured depreciation taxed as ordinary income.
C) a capital loss.
D) an ordinary loss.

Question 56

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.

-The initial outlay for this project is __________

A) $42,820
B) $35,140
C) $43,500
D) $38,500

Question 57

Unlike the net present value criteria, the internal rate of return approach assumes an interest rateequal to

A) the project's opportunity cost.
B) the project's internal rate of return.
C) the relevant cost of capital.
D) the market's interest rate.

Question 58

The most common motive for adding fixed assets to the firm is

A) replacement.
B) transformation.
C) expansion.
D) renewal.

Question 59

A firm with limited dollars available for capital expenditures is subject to

A) mutually exclusive projects.
B) capital rationing.
C) working capital constraints.
D) capital dependency.

Question 60

A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of$15,000 per year for five years. The payback period of the project is

A) 1.5 years.
B) 2 years.
C) 4 years.
D) 3.3 years.

Question 61

The_________is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cash inflows.

A) internal rate of return
B) discount rate
C) opportunity cost
D) cost of capital

Question 62

A firm would accept a project with a net present value of zero because

A) the return on the project would be zero.
B) the project would maintain the wealth of the firm's owners.
C) the project would enhance the wealth of the firm's owners.
D) the return on the project would be positive.

Question 63

The tax treatment regarding the sale of existing assets which are sold for more than the book value and more than the original purchase price results in

A) no tax benefit or liability.
B) an ordinary tax benefit.
C) a capital gain tax liability and recaptured depreciation taxed as ordinary income.
D) recaptured depreciation taxed as ordinary income.

Question 64

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.

-The cash flow pattern for the capital investment proposal is

A) an annuity and non-conventional.
B) a mixed stream and conventional.
C) a mixed stream and non-conventional.
D) an annuity and conventional.

Question 65

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as

A) consistent cash flows.
B) necessary cash flows.
C) relevant cash flows.
D) ordinary cash flows.

Question 66

A non-conventional cash flow pattern associated with capital investment projects consists of aninitial

A) outflow followed by a series of cash inflows and outflows.
B) inflow followed by a series of cash inflows and outflows.
C) inflow followed by a series of outflows.
D) outflow followed by a series of inflows.

Question 67

In developing the cash flows for an expansion project, the analysis is the same as the analysis forreplacement projects where

A) all cash flows from the old assets are equal.
B) all cash flows from the old asset are zero.
C) prior cash flows are irrelevant.
D) cash inflows equal cash outflows.

Question 68

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent.
$\begin{array}{llll}&&\text { Proposal }\\\text { Type of Capital } & 1 & 2 & 3 \\\text { Budgeting Decision } & \text { Expansion } & \text { Replacement } & \text { Replacement }\\\hline&& \text { Mut Excl } & \text { Mut Excl } \\\text { Type of Project }&\text { Independent } & \text { with 3 } & \text { with 2 }\\\hline\text { Cost of new asset } & \$ 1,500,000 & \$ 200,000 & \$ 300,000 \\\text { Installation costs } & \$ 0 & \$ 0 & \$ 15,000 \\\text { CCA rate (new asset) } & 10 \% & 20 \% & 20 \%\\\text { Original cost of old asset } & \text { N/A* } & \$ 80,000 & \$ 100,000 \\\text { Purchase date (old asset) } & \text { N/A } & 1 / 1 / 1997 & 1 / 1 / 2000 \\\text { Sale proceeds (old asset) } & \text { N/A } & \$ 50,000 & \$ 120,000 \\\text { CCA rate (old asset) } & \text { N/A } & 20 \% & 20 \%\\\text { Annual net profits before }\\\text { depreciation \& taxes (old) }&N/A&\$30,000&\$25,000\\\text { Annual net profits before }\\\text { depreciation \& taxes (new) }&\$250,000&\$100,000&\$175,000\\\end{array}$
$\text { "Not applicable }$

-For Proposal 2, the cash flow pattern for the replacement project is

A) a mixed stream and conventional.
B) an annuity and non-conventional.
C) a mixed stream and non-conventional.
D) an annuity and conventional.

Question 69

Payback is considered an unsophisticated capital budgeting technique, and as such

A) gives no consideration to risk exposure.
B) gives no consideration to the timing of cash flows and therefore the time value of money.
C) gives some implicit consideration to the timing of cash flows and therefore the time value of money.
D) does consider the timing of cash flows and therefore gives explicit consideration to the time value of money.

Question 70

A corporation is considering expanding operations to meet growing demand. With the capitalexpansion, the current accounts are expected to change. Management expects cash to increase by$20,000, accounts receivable by $40,000, and inventories by $60,000. At the same time accounts payable will increase by $50,000, accruals by $10,000, and long-term debt by $100,000. The change in net working capital is __________.

A) an increase of $120,000
B) a decrease of $120,000
C) an increase of $60,000
D) a decrease of $40,000

Question 71

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by
$17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of
capital and a 40 percent tax on ordinary income and capital gains.


-The present value of the incremental CCA tax shield is___________

A) $10,765
B) $11,945
C) $12,654
D) $11,492

Question 72

The cash flows of any project having a conventional pattern include all of the basic components except

A) operating cash inflows.
B) operating cash outflows.
C) terminal cash flow.
D) initial investment.

Question 73

Which pattern of cash flow stream is the most difficult to use when evaluating projects?

A) annuity
B) nonconventional flow
C) conventional flow
D) mixed stream

Question 74

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.


-The initial outlay equals__________

A) $43,000
B) $41,100
C) $38,800
D) $38,960

Question 75

The final step in the capital budgeting process is

A) follow-up monitoring.
B) implementation.
C) re-evaluation.
D) education.

Question 76

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for
$10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.

-The incremental depreciation expense (CCA) for year 5 is____________

A) $5,114
B) $2,258
C) $3,963
D) $7,950

Question 77

Unsophisticated capital budgeting techniques do not

A) examine the size of the initial outlay.
B) explicitly consider the time value of money.
C) use net profits as a measure of return.
D) take into account an unconventional cash flow pattern.

Question 78

On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all thefollowing reasons EXCEPT

A) that it measures the benefits relative to the amount invested.
B) that it maximizes shareholder wealth.
C) that there may be multiple solutions for an IRR computation.
D) for the reasonableness of the reinvestment rate assumption.

Question 79

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent.
$\begin{array}{rrrr}\text { Project }&\text { Initial Investment }&IRR&NPV\\1 & \$ 200,000 & 19 \% & \$ 100,000 \\2 & 400,000 & 17 & 20,000 \\3 & 250,000 & 16 & 60,000 \\4 & 200,000 & 12 & -5,000 \\5 & 150,000 & 20 & 50,000 \\6 & 400,000 & 15 & 150,000\end{array}$

-Using the internal rate of return approach to ranking projects, which projects should the firm accept?

A) 2, 3, 4, and 6
B) 1, 2, 3, 4, and 5
C) 1, 2, 3, and 5
D) 1, 3, 4, and 6

Question 80

In comparing the internal rate of return and net present value methods of evaluation,

A) internal rate of return is theoretically superior, but financial managers prefer net present value.
B) financial managers prefer net present value, because it is presented as a rate of return.
C) net present value is theoretically superior, but financial managers prefer to use internal rate of return.
D) financial managers prefer net present value, because it measures benefits relative to the amount invested.