Chapter 14Capital Budgeting

LEARNING OBJECTIVES
LO 1 Why do most capital budgeting methods focus on cash flows?
LO 2 How is payback period computed, and what does it measure?
LO 3 How are the net present alue and profitability inde! of a pro"ect measured?
LO # How is the internal rate of return on a pro"ect computed? What does it measure?
LO $ How do ta!ation and depreciation methods affect cash flows?
LO % What are the underlying assumptions and limitations of each capital pro"ect
ealuation method
LO & How do managers rank inestment pro"ects?
LO ' How is risk considered in capital budgeting analysis?
LO ( How and why should management conduct a postinestment audit of a capital
pro"ect?
LO 1) *+ppendi! 1, How are present alues calculated?
LO 11 *+ppendi! 2, What are the adantages and disadantages of the accounting rate
of return method?
QESTION GRI!
True/False
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&o'(letion
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Multi(le &)oice
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*)ort +ns,er
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-roble'
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TRE"#ALSE
1- .apital budgeting uses financial criteria e!clusiely when ealuating pro"ects-
+/01 2 3421 5oderate O671 1#81
2- .apital budgeting uses both financial and non8financial criteria when ealuating pro"ects-
+/01 9 3421 5oderate O671 1#81
3- 5ost capital budgeting techni:ues focus on cash flows-
+/01 9 3421 ;asy O671 1#81
#- <ro"ect funding is a financing decision-
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$- <ro"ect funding is an inesting decision-
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%- 9he decision concerning which assets to ac:uire to achiee an organi=ation>s ob"ecties is an inesting
decision-
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&- 9he payback period ignores the time alue of money-
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'- +n organi=ation>s discount rate should be less than the organi=ation>s cost of capital-
+/01 2 3421 5oderate O671 1#82
(- +n organi=ation>s discount rate should be e:ual to or e!ceed the organi=ation>s cost of capital-
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1)- 4f the net present alue is positie, the actual return on a pro"ect e!ceeds the re:uired rate of return-
+/01 9 3421 ;asy O671 1#83
11- 9he net present alue method proides the actual rate of return for a pro"ect-
+/01 2 3421 5oderate O671 1#83
12- 9he profitability inde! gauges the efficiency of a firm>s use of capital-
+/01 9 3421 5oderate O671 1#83
%
13- 4f a pro"ect>s internal rate of return is greater than or e:ual to an organi=ation>s hurdle rate, the pro"ect
is considered to be an acceptable inestment-
+/01 9 3421 5oderate O671 1#8#
1#- 4f a pro"ect>s internal rate of return is greater than or e:ual to an organi=ation>s hurdle rate, the pro"ect
is considered to be an unacceptable inestment-
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1$- 9he internal rate of return is the rate at which a pro"ect>s net present alue is =ero-
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1%- +n organi=ation>s hurdle rate should be at least e:ual to the organi=ation>s cost of capital-
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1&- 3epreciation e!pense proides a ta! shield against the payment of ta!es-
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1'- 9he ta! benefit from depreciation e!pense is the depreciation amount multiplied by the ta! rate-
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1(- 9he ta! benefit from depreciation e!pense is the depreciation amount diided by the ta! rate-
+/01 2 3421 5oderate O671 1#8$
2)- ?sing 5+.@0 depreciation for ta! purposes and straight8line depreciation for book purposes will
affect after8ta! cash flows during the life of a pro"ect-
+/01 9 3421 3ifficult O671 1#8$
21- + decision in which pro"ects are ranked according to their impact on achieing company ob"ecties is
a screening decision-
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22- + decision in which pro"ects are ranked according to their impact on achieing company ob"ecties is
a preference decision-
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23- 4n a mutually inclusie pro"ect situation, if one pro"ect is chosen, all related pro"ects are also chosen-
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2#- 4n a mutually inclusie pro"ect situation, if one pro"ect is chosen, all related pro"ects are eliminated
from further consideration-
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&
2$- 5anagers must often use multiple measures to effectiely rank capital pro"ects-
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2%- @einestment assumptions are different under each method of ranking capital pro"ects-
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2&- When considering risk, a manager will often use a "udgmental method of risk ad"ustment-
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2'- When using the risk8ad"usted discount rate method, a manager increases the rate used for discounting
future cash inflows-
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2(- When using the risk8ad"usted discount rate method, a manager increases the rate used for discounting
future cash outflows-
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3)- <ostinestment audits can proide feedback of the accuracy of original cash flow estimates-
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31- <resent alue and future alue computations assume the use of compound interest-
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32- 2or an ordinary annuity, the first cash flow occurs at the end of the period-
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33- 2or an annuity due, the first cash flow occurs at the end of the period-
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3#- 9he accounting rate of return considers the salage alue of an asset-
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3$- 9he accounting rate of return considers the time alue of money-
+/01 2 3421 5oderate O671 1#811
3%- +ccounting rate of return is based on cash flows-
+/01 2 3421 5oderate O671 1#811
'
CO$%LETION
1- 9he ealuation of future long8range pro"ects to allocate resources effectiely and efficiently is referred
to as AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 capital budgeting
3421 ;asy O671 1#81
2- + "udgment regarding an entity>s method of funding an inestment is considered to be a*n,
AAAAAAAAAAAAAAAAAAAAAAA decision-
+/01 financing
3421 ;asy O671 1#81
3- + "udgment regarding which assets an entity should ac:uire to achiee its stated ob"ecties is
considered to be a*n, AAAAAAAAAAAAAAAAAAAAAAA decision-
+/01 inesting
3421 ;asy O671 1#81
#- + capital budgeting method that measures the time re:uired for a pro"ect>s cash inflows to e:ual the
original inestment is referred to as the AAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 payback period
3421 ;asy O671 1#82
$- 9he rate of return re:uired by a company that is used to determine the imputed interest portion of
future cash receipts and disbursements is referred to as the AAAAAAAAAAAAAAAAAAAAAAA-
+/01 discount rate
3421 ;asy O671 1#82
%- 9he weighted aerage cost of an organi=ation>s arious sources of funds is referred to as
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 cost of capital
3421 5oderate O671 1#82
&- + capital budgeting techni:ue that compares a pro"ect>s rate of return with the desired rate of return for
an organi=ation is known as the AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA method-
+/01 net present alue
3421 ;asy O671 1#83
(
'- + ratio comparing the present alue of a pro"ect>s net cash inflows to the pro"ect>s net inestment is
referred to as the AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 profitability inde!
3421 ;asy O671 1#83
(- 9he discount rate that causes the present alue of a pro"ect>s net cash inflows to e:ual the present alue
of the cash outflows is referred to as the AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 internal rate of return
3421 ;asy O671 1#8#
1)- 9he rate of return specified as the lowest acceptable return on an inestment is referred to as the
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 hurdle rate
3421 5oderate O671 1#8#
11- + decision regarding whether a capital pro"ect is desirable based upon some preiously established
minimum criteria is referred to as a*n, AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 screening decision
3421 ;asy O671 1#8%
12- + decision in which pro"ects are ranked according to their impact on the achieement of company
ob"ecties is referred to as a*n, AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 preference decision
3421 ;asy O671 1#8%
13- When a pro"ect is chosen from a group and all other pro"ects are e!cluded from further consideration,
the pro"ect is referred to as AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 mutually e!clusie-
3421 5oderate O671 1#8%
1#- 4n a AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA pro"ect situation, if one pro"ect is chosen, all related
pro"ects are also chosen-
+/01 mutually inclusie
3421 5oderate O671 1#8%
1$- 9he process of determining the amount of change that must occur in a ariable before a different
decision would be made is referred to as AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 sensitiity analysis
1)
3421 5oderate O671 1#8'
1%- When information on actual pro"ect results is gathered and compared to actual results, the process is
referred to as a*n, AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 postinestment audit
3421 ;asy O671 1#8(
1&- 9he capital budgeting techni:ue that diides aerage annual profits from an inestment by the aerage
inestment in a pro"ect is referred to as the AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA-
+/01 accounting rate of return
3421 ;asy O671 1#811
$LTI%LE C&OICE
1- Which of the following capital budgeting techni:ues ign're( the time alue of money?
a- payback period
b- net present alue
c- internal rate of return
d- profitability inde!
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2- Which of the following capital budgeting techni:ues may potentially ignore part of a pro"ectBs releant
cash flows?
a- net present alue
b- internal rate of return
c- payback period
d- profitability inde!
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3- 4n comparing two pro"ects, the AAAAAAAAAAA is often used to ealuate the relatie riskiness of the
pro"ects-
a- payback period
b- net present alue
c- internal rate of return
d- discount rate
+/01 + 3421 ;asy O671 1#82
#- Which of the following capital budgeting techni:ues does n't routinely rely on the assumption that all
cash flows occur at the end of the period?
a- internal rate of return
b- net present alue
c- profitability inde!
d- payback period
+/01 3 3421 ;asy O671 1#82
11
$- +ssume that a pro"ect consists of an initial cash outlay of C1)),))) followed by e:ual annual cash
inflows of C#),))) for # years- 4n the formula D E C1)),)))FC#),))), D represents the
a- payback period for the pro"ect-
b- profitability inde! of the pro"ect-
c- internal rate of return for the pro"ect-
d- pro"ectBs discount rate-
+/01 + 3421 ;asy O671 1#82
%- +ll other factors e:ual, a large number is preferred to a smaller number for all capital pro"ect
ealuation measures e)*ept
a- net present alue-
b- payback period-
c- internal rate of return-
d- profitability inde!-
+/01 6 3421 ;asy O671 1#82
&- 9he payback method assumes that all cash inflows are reinested to yield a return e:ual to
a- the discount rate-
b- the hurdle rate-
c- the internal rate of return-
d- =ero-
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'- 9he payback method measures
a- how :uickly inestment dollars may be recoered-
b- the cash flow from an inestment-
c- the economic life of an inestment-
d- the profitability of an inestment-
+/01 + 3421 ;asy O671 1#8%
(- 4f inestment + has a payback period of three years and inestment 6 has a payback period of four
years, then
a- + is more profitable than 6-
b- + is less profitable than 6-
c- + and 6 are e:ually profitable-
d- the relatie profitability of + and 6 cannot be determined from the information gien-
+/01 3 3421 ;asy O671 1#82
1)- 9he payback period is the
a- length of time oer which the inestment will proide cash inflows-
b- length of time oer which the initial inestment is recoered-
c- shortest length of time oer which an inestment may be depreciated-
d- shortest length of time oer which the net present alue will be positie-
+/01 6 3421 ;asy O671 1#82
12
11- Which of the following capital budgeting techni:ues has been critici=ed because it fails to consider
inestment profitability?
a- payback method
b- accounting rate of return
c- net present alue method
d- internal rate of return
+/01 + 3421 ;asy O671 1#8%
12- 9he time alue of money is e!plicitly recogni=ed through the process of
a- interpolating-
b- discounting-
c- annuiti=ing-
d- budgeting-
+/01 6 3421 ;asy O671 1#82
13- 9he time alue of money is considered in long8range inestment decisions by
a- assuming e:ual annual cash flow patterns-
b- inesting only in short8term pro"ects-
c- assigning greater alue to more immediate cash flows-
d- ignoring depreciation and ta! implications of the inestment-
+/01 . 3421 ;asy O671 1#83
1#- When using one of the discounted cash flow methods to ealuate the desirability of a capital budgeting
pro"ect, which of the following factors is generally n't important?
a- method of financing the pro"ect under consideration
b- timing of cash flows relating to the pro"ect
c- impact of the pro"ect on income ta!es to be paid
d- amounts of cash flows relating to the pro"ect
+/01 + 3421 ;asy O671 1#83
1$- With regard to a capital inestment, net cash inflow is e:ual to the
a- cost saings resulting from the inestment-
b- sum of all future reenues from the inestment-
c- net increase in cash receipts oer cash payments-
d- net increase in cash payments oer cash receipts-
+/01 . 3421 ;asy O671 1#81
1%- 4n a discounted cash flow analysis, which of the following would n't be consistent with ad"usting a
pro"ectBs cash flows to account for higher8than8normal risk?
a- increasing the e!pected amount for cash outflows
b- increasing the discounting period for e!pected cash inflows
c- increasing the discount rate for cash outflows
d- decreasing the amount for e!pected cash inflows
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13
1&- When a pro"ect has uneen pro"ected cash inflows oer its life, an analyst may be forced to use
AAAAAAA to find the pro"ectBs internal rate of return-
a- a screening decision
b- a trial8and8error approach
c- a post inestment audit
d- a time line
+/01 6 3421 ;asy O671 1#8#
1'- 9he interest rate used to find the present alue of a future cash flow is the
a- prime rate-
b- discount rate-
c- cutoff rate-
d- internal rate of return-
+/01 6 3421 ;asy O671 1#82
1(- + firmBs discount rate is typically based on
a- the interest rates related to the firmBs bonds-
b- a pro"ectBs internal rate of return-
c- its cost of capital-
d- the corporate +a bond yield-
+/01 . 3421 ;asy O671 1#82
2)- 4n capital budgeting, a firmBs cost of capital is fre:uently used as the
a- internal rate of return-
b- accounting rate of return-
c- discount rate-
d- profitability inde!-
+/01 . 3421 ;asy O671 1#82
21- 9he net present alue method assumes that all cash inflows can be immediately reinested at the
a- cost of capital-
b- discount rate-
c- internal rate of return-
d- rate on the corporationBs short8term debt-
+/01 6 3421 ;asy O671 1#83
22- Which of the following changes would n't decrease the present alue of the future depreciation
deductions on a specific depreciable asset?
a- a decrease in the marginal ta! rate
b- a decrease in the discount rate
c- a decrease in the rate of depreciation
d- an increase in the life e!pectancy of the depreciable asset
+/01 6 3421 5oderate O671 1#8$
1#
23- 9o reflect greater uncertainty *greater risk, about a future cash inflow, an analyst could
a- increase the discount rate for the cash flow-
b- decrease the discounting period for the cash flow-
c- increase the e!pected alue of the future cash flow before it is discounted-
d- e!tend the acceptable length for the payback period-
+/01 + 3421 ;asy O671 1#82
2#- + change in the discount rate used to ealuate a specific pro"ect will affect the pro"ectBs
a- life-
b- payback period-
c- net present alue-
d- total cash flows-
+/01 . 3421 ;asy O671 1#8%
2$- 2or a pro"ect such as plant inestment, the return that should leae the market price of the firmBs stock
unchanged is known as the
a- cost of capital-
b- net present alue-
c- payback rate-
d- internal rate of return-
+/01 + 3421 5oderate O671 1#8$
2%- 9he pre8ta! cost of capital is higher than the after8ta! cost of capital because
a- interest e!pense is deductible for ta! purposes-
b- principal payments on debt are deductible for ta! purposes-
c- the cost of capital is a deductible e!pense for ta! purposes-
d- diidend payments to stockholders are deductible for ta! purposes-
+/01 + 3421 ;asy O671 1#8$
2&- 9he basis for measuring the cost of capital deried from bonds and preferred stock, respectiely, is the
a- pre8ta! rate of interest for bonds and stated annual diidend rate less the e!pected earnings
per share for preferred stock-
b- pre8ta! rate of interest for bonds and stated annual diidend rate for preferred stock-
c- after8ta! rate of interest for bonds and stated annual diidend rate less the e!pected
earnings per share for preferred stock-
d- after8ta! rate of interest for bonds and stated annual diidend rate for preferred stock-
+/01 3 3421 5oderate O671 1#8$
2'- 9he combined weighted aerage interest rate that a firm incurs on its long8term debt, preferred stock,
and common stock is the
a- cost of capital-
b- discount rate-
c- cutoff rate-
d- internal rate of return-
+/01 + 3421 ;asy O671 1#82
1$
2(- 9he weighted aerage cost of capital that is used to ealuate a specific pro"ect should be based on the
a- mi! of capital components that was used to finance a pro"ect from last year-
b- oerall capital structure of the corporation-
c- cost of capital for other corporations with similar inestments-
d- mi! of capital components for all capital ac:uired in the most recent fiscal year-
+/01 6 3421 ;asy O671 1#82
3)- 3ebt in the capital structure could be treated as if it were common e:uity in computing the weighted
aerage cost of capital if the debt were
a- callable-
b- participating-
c- cumulatie-
d- conertible-
+/01 3 3421 5oderate O671 1#82
31- 9he weighted aerage cost of capital approach to decision making is n't directly affected by the
a- alue of the common stock-
b- current budget for capital e!pansion-
c- cost of debt outstanding-
d- proposed mi! of debt, e:uity, and e!isting funds used to implement the pro"ect-
+/01 6 3421 ;asy O671 1#82
32- 9he AAAAAAAAAAAAAAAAAAA is the highest rate of return that can be earned from the most attractie,
alternatie capital pro"ect aailable to the firm-
a- accounting rate of return
b- internal rate of return
c- hurdle rate
d- opportunity cost of capital
+/01 3 3421 5oderate O671 1#8%
33- 4f an analyst desires a conseratie net present alue estimate, heFshe will assume that all cash inflows
occur at
a- mid year-
b- the beginning of the year-
c- year end-
d- irregular interals-
+/01 . 3421 ;asy O671 1#83
3#- 9he salage alue of an old lathe is =ero- 4f instead, the salage alue of the old lathe was C2),))),
what would be the impact on the net present alue of the proposal to purchase a new lathe?
a- 4t would increase the net present alue of the proposal-
b- 4t would decrease the net present alue of the proposal-
c- 4t would not affect the net present alue of the proposal-
d- <otentially it could increase or decrease the net present alue of the new lathe-
+/01 + 3421 ;asy O671 1#83
1%
3$- 9he net present alue method of ealuating proposed inestments
a- measures a pro"ectBs internal rate of return-
b- ignores cash flows beyond the payback period-
c- applies only to mutually e!clusie inestment proposals-
d- discounts cash flows at a minimum desired rate of return-
+/01 3 3421 ;asy O671 1#83
3%- Which of the following statements is true regarding capital budgeting methods?
a- 9he 2isher rate can neer e!ceed a companyBs cost of capital-
b- 9he internal rate of return measure used for capital pro"ect ealuation has more
conseratie assumptions than the net present alue method, especially for pro"ects that
generate a positie net present alue-
c- 9he net present alue method of pro"ect ealuation will always proide the same ranking
of pro"ects as the profitability inde! method-
d- 9he net present alue method assumes that all cash inflows can be reinested at the
pro"ectBs cost of capital-
+/01 3 3421 ;asy O671 1#83
3&- 4f a pro"ect generates a net present alue of =ero, the profitability inde! for the pro"ect will
a- e:ual =ero-
b- e:ual 1-
c- e:ual 81-
d- be undefined-
+/01 6 3421 ;asy O671 1#83
3'- 4f the profitability inde! for a pro"ect e!ceeds 1, then the pro"ectBs
a- net present alue is positie-
b- internal rate of return is less than the pro"ectBs discount rate-
c- payback period is less than $ years-
d- accounting rate of return is greater than the pro"ectBs internal rate of return-
+/01 + 3421 ;asy O671 1#83
3(- 4f a pro"ectBs profitability inde! is less than 1, the pro"ectBs
a- discount rate is aboe its cost of capital-
b- internal rate of return is less than =ero-
c- payback period is infinite-
d- net present alue is negatie-
+/01 3 3421 ;asy O671 1#83
#)- 9he profitability inde! is
a- the ratio of net cash flows to the original inestment-
b- the ratio of the present alue of cash flows to the original inestment-
c- a capital budgeting ealuation techni:ue that doesnBt use discounted alues-
d- a mandatory techni:ue when capital rationing is used-
+/01 6 3421 ;asy O671 1#83
1&
#1- Which method of ealuating capital pro"ects assumes that cash inflows can be reinested at the
discount rate?
a- internal rate of return
b- payback period
c- profitability inde!
d- accounting rate of return
+/01 . 3421 5oderate O671 1#83
#2- 4f the total cash inflows associated with a pro"ect e!ceed the total cash outflows associated with the
pro"ect, the pro"ectBs
a- net present alue is greater than =ero-
b- internal rate of return is greater than =ero-
c- profitability inde! is greater than 1-
d- payback period is acceptable-
+/01 6 3421 ;asy O671 1#8#
#3- 9he net present alue and internal rate of return methods of decision making in capital budgeting are
superior to the payback method in that they
a- are easier to implement-
b- consider the time alue of money-
c- re:uire less input-
d- reflect the effects of sensitiity analysis-
+/01 6 3421 ;asy O671 1#8%
##- 4f an inestment has a positie net present alue, the
a- internal rate of return is higher than the discount rate-
b- discount rate is higher than the hurdle rate of return-
c- internal rate of return is lower than the discount rate of return-
d- hurdle rate of return is higher than the discount rate-
+/01 + 3421 ;asy O671 1#8%
#$- 9he rate of interest that produces a =ero net present alue when a pro"ectBs discounted cash operating
adantage is netted against its discounted net inestment is the
a- cost of capital-
b- discount rate-
c- cutoff rate-
d- internal rate of return-
+/01 3 3421 ;asy O671 1#8#
#%- 2or a profitable company, an increase in the rate of depreciation on a specific pro"ect could
a- increase the pro"ectBs profitability inde!-
b- increase the pro"ectBs payback period-
c- decrease the pro"ectBs net present alue-
d- increase the pro"ectBs internal rate of return-
+/01 3 3421 5oderate O671 1#8$
1'
#&- Which of the following capital e!penditure planning and control techni:ues has been critici=ed
because it might mistakenly imply that earnings are reinested at the rate of return earned by the
inestment?
a- payback method
b- accounting rate of return
c- net present alue method
d- internal rate of return
+/01 3 3421 ;asy O671 1#8#
#'- 4f the discount rate that is used to ealuate a pro"ect is e:ual to the pro"ectBs internal rate of return, the
pro"ectBs AAAAAAAAAAAAA is =ero-
a- profitability inde!
b- internal rate of return
c- present alue of the inestment
d- net present alue
+/01 3 3421 ;asy O671 1#8#
#(- +s the marginal ta! rate goes up, the benefit from the depreciation ta! shield
a- decreases-
b- increases-
c- stays the same-
d- can moe up or down depending on whether the firmBs cost of capital is high or low-
+/01 6 3421 5oderate O671 1#8$
$)- When a profitable corporation sells an asset at a loss, the after8ta! cash flow on the sale will
a- e!ceed the pre8ta! cash flow on the sale-
b- be less than the pre8ta! cash flow on the sale-
c- be the same as the pre8ta! cash flow on the sale-
d- increase the corporationBs oerall ta! liability-
+/01 + 3421 5oderate O671 1#8$
$1- 4n a typical *conseratie assumptions, after8ta! discounted cash flow analysis, depreciation e!pense is
assumed to accrue at
a- the beginning of the period-
b- the middle of the period-
c- the end of the period-
d- irregular interals oer the life of the inestment-
+/01 . 3421 ;asy O671 1#8$
$2- 9he pre8ta! and after8ta! cash flows would be the same for all of the following items e)*ept
a- the li:uidation of working capital at the end of a pro"ectBs life-
b- the initial *outlay, cost of an inestment-
c- the sale of an asset at its book alue-
d- a cash payment for salaries and wages-
+/01 3 3421 ;asy O671 1#8$
1(
$3- 9he after8ta! net present alue of a pro"ect is affected by
a- ta!8deductible cash flows-
b- non8ta!8deductible cash flows-
c- accounting accruals-
d- all of the aboe-
+/01 3 3421 5oderate O671 1#8$
$#- + pro"ectBs after8ta! net present alue is increased by all of the following e)*ept
a- reenue accruals-
b- cash inflows-
c- depreciation deductions-
d- e!pense accruals-
+/01 + 3421 ;asy O671 1#8$
$$- 5ultiplying the depreciation deduction by the ta! rate yields a measure of the depreciation ta!
a- shield-
b- benefit-
c- payable-
d- loss-
+/01 6 3421 ;asy O671 1#8$
$%- +nnual after8ta! corporate net income can be conerted to annual after8ta! cash flow by
a- adding back the depreciation amount-
b- deducting the depreciation amount-
c- adding back the :uantity *t depreciation deduction,, where t is the corporate ta! rate-
d- deducting the :uantity G*18 t, depreciation deductionH, where t is the corporate ta! rate-
+/01 + 3421 ;asy O671 1#8$
$&- 4ncome ta!es are leied on
a- net cash flow-
b- income as measured by accounting rules-
c- net cash flow plus depreciation-
d- income as measured by ta! rules-
+/01 3 3421 ;asy O671 1#8$
$'- Which of the following best represents a screening decision?
a- determining which pro"ect has the highest net present alue
b- determining if a pro"ectBs internal rate of return e!ceeds the firmBs cost of capital
c- determining which pro"ects are mutually e!clusie
d- determining which are the best pro"ects
+/01 6 3421 ;asy O671 1#8%
$(- Which of the following are ta! deductible under ?-0- ta! law?
a- interest payments to bondholders
b- preferred stock diidends
c- common stock diidends
d- all of the aboe
+/01 + 3421 ;asy O671 1#8$
2)
%)- 0ensitiity analysis is
a- an appropriate response to uncertainty in cash flow pro"ections-
b- useful in measuring the ariance of the 2isher rate-
c- typically conducted in the post inestment audit-
d- useful to compare pro"ects re:uiring astly different leels of initial inestment-
+/01 + 3421 5oderate O671 1#8'
%1- 4f management "udges one pro"ect in a mutually inclusie set to be acceptable for inestment,
a- all the other pro"ects in the set are re"ected-
b- only one other pro"ect in the set can be accepted-
c- all other pro"ects in the set are also accepted-
d- only one pro"ect in the set will be re"ected-
+/01 . 3421 ;asy O671 1#8%
%2- +ll other factors e:ual, which of the following would affect a pro"ectBs internal rate of return, net
present alue, and payback period?
a- an increase in the discount rate
b- a decrease in the life of the pro"ect
c- an increase in the initial cost of the pro"ect
d- all of the aboe
+/01 . 3421 ;asy O671 1#8%
%3- Hopwood .orporation bought a piece of machinery- 0elected data is presented below1
?seful life % years
Iearly net cash inflow C#$,)))
0alage alue 8 ) 8
4nternal rate of return 1'J
.ost of capital 1#J
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
9he initial cost of the machinery was
a- C1$&,3(2-
b- C1&#,((2-
c- C1%$,'12-
d- impossible to determine from the information gien-
+/01 +
?se <K of +nnuity for % years and 1'J
C#$,))) L 3-#(&% E C1$&,3(2
3421 5oderate O671 1#8#
21
%#- 3atasoft 4ndustries is considering the purchase of a C1)),))) machine that is e!pected to result in a
decrease of C1$,))) per year in cash e!penses- 9his machine, which has no residual alue, has an
estimated useful life of 1) years and will be depreciated on a straight8line basis- 2or this machine, the
accounting rate of return would be
a- 1) percent-
b- 1$ percent-
c- 3) percent-
d- 3$ percent-
+/01 .
C1$,)))F*C1)),)))F2, E 3)J
3421 5oderate O671 1#8$
%$- +n inestment pro"ect is e!pected to yield C1),))) in annual reenues, has C2,))) in fi!ed costs per
year, and re:uires an initial inestment of C$,)))- Mien a cost of goods sold of %) percent of sales,
what is the payback period in years?
a- 2-$)
b- $-))
c- 2-))
d- 1-2$
+/01 +
/et cash flow E C1),))) 8 C%,))) 8 C2,)))
/et cash flow E C2,)))
C$,)))FC2,))) E 2-$) years
3421 5oderate O671 1#82
%%- + pro"ect has an initial cost of C1)),))) and generates a present alue of net cash inflows of C12),)))-
What is the pro"ectBs profitability inde!?
a- -2)
b- 1-2)
c- -')
d- $-))
+/01 6
<rofitability 4nde! E C12),)))FC1)),))) E 1-2)
3421 5oderate O671 1#83
22
%&- .lement .orporation- faces a marginal ta! rate of 3$ percent- One pro"ect that is currently under
ealuation has a cash flow in the fourth year of its life that has a present alue of C1),))) *after8ta!,-
.lement .orporation- assumes that all cash flows occur at the end of the year and the company uses 11
percent as its discount rate- What is the pre8ta! amount of the cash flow in year #? *@ound to the
nearest dollar-, %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C1$,1'1
b- C23,3$%
c- C(,'%'
d- C#3,3&$
+/01 6
C1),))) F)-%$ E C1$,3'#-%1
?se <K 9able for # years, 11J- .onstant E )-%$'&
C1$3'#-%1 F )-%$'& E C23,3$%-
3421 3ifficult O671 1#8$
Sea0'rth1 C'rp'rati'n
0eaworthy .orporation is considering the purchase of a new ocean8going essel that could potentially
reduce labor costs of its operation by a considerable margin- 9he new ship would cost C$)),))) and
would be fully depreciated by the straight8line method oer 1) years- +t the end of 1) years, the ship
will hae no alue and will be scuttled- 0eaworthy .ompany>s cost of capital is 12 percent, and its
marginal ta! rate is #) percent-
%'- @efer to 0eaworthy .orporation- What is the present alue of the depreciation ta! benefit of the new
ship? *@ound to the nearest dollar-, %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C113,))#
b- C2'2,$1)
c- C1%(,$)%
d- C2)),)))
+/01 +
+nnual depreciation E C$),)))
9a! saings E C2),)))
?se <K of +nnuity table 1) years, 12JN .onstant E $-%$)2
C2),))) L $-%$)2 E C113,))#
3421 3ifficult O671 1#8$
23
%(- @efer to 0eaworthy .orporation- 4f the ship produces e:ual annual labor cost saings oer its 1)8year
life, how much do the annual saings in labor costs need to be to generate a net present alue of C) on
the pro"ect? *@ound to the nearest dollar-, %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are
re.uired/
a- C%',#(2
b- C11#,1$#
c- C'',#(2
d- C1#&,#'&
+/01 .
/<K of Labor 0aings E C$)),)))
?se <K of +nnuity 9able 1) years, 12JN .onstant E $-%$)2
C$)),))) F $-%$)2 E C'',#(2
3421 3ifficult O671 1#8$
&)- 0tone .orporation recently sold a used machine for C#),)))- 9he machine had a book alue of
C%),))) at the time of the sale- What is the after8ta! cash flow from the sale, assuming the companyBs
marginal ta! rate is 2) percent?
a- C#),)))
b- C%),)))
c- C##,)))
d- C32,)))
+/01 .
Loss of C2),))) generates a ta! saings of C#,))) *C2),))) L 2)J,
<roceeds O 9a! 0aings E +fter8ta! cash flow
C#),))) O C#,))) E C##,)))
3421 5oderate O671 1#8$
#le2ing C'2pan1
2leming .ompany is considering an inestment in a machine that would reduce annual labor costs by
C3),)))- 9he machine has an e!pected life of 1) years with no salage alue- 9he machine would be
depreciated according to the straight8line method oer its useful life- 9he companyBs marginal ta! rate
is 3) percent-
2#
&1- @efer to 2leming .ompany- +ssume that the company will inest in the machine if it generates an
internal rate of return of 1% percent- What is the ma!imum amount the company can pay for the
machine and still meet the internal rate of return criterion? %re(ent +alue ta,le( 'r a -inan*ial
*al*ulat'r are re.uired/
a- C1'),)))
b- C21),)))
c- C1'&,$))
d- C1##,((%
+/01 3
?se <K of +nnuity 9ableN 1) years, 1%JN .onstant E #-'33)
C3),))) L #-'33) E C1##,#(%
3421 5oderate O671 1#8#
&2- @efer to 2leming .ompany- +ssume the company pays C2$),))) for the machine- What is the
e!pected internal rate of return on the machine? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are
re.uired/
a- between ' and ( percent
b- between 3 and # percent
c- between 1& and 1' percent
d- less than 1 percent
+/01 6
C2$),)))FC3),))) E '-33
?sing <K of +nnuity 9able and 1) years, this constant falls between 3J and #J
3421 5oderate O671 1#8#
&3- + pro"ect under consideration by .lose .orporation would re:uire a working capital inestment of
C2)),)))- 9he working capital would be li:uidated at the end of the pro"ectBs 1)8year life- 4f .lose
.orporation has an after8ta! cost of capital of 1) percent and a marginal ta! rate of 3) percent, what is
the present alue of the working capital cash flow e!pected to be receied in year 1)? %re(ent +alue
ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C3%,'%'
b- C&&,1))
c- C$3,(&)
d- C23,13)
+/01 6
9he return of capital is ta!8free-
?se <K of C1 1) years, 1)JN .onstant E )-3'$$
C2)),))) L )-3'$$ E C&&,1))
3421 5oderate O671 1#8$
2$
&#- 6iggs 4ndustries is considering two alternatie ways to depreciate a proposed inestment- 9he
inestment has an initial cost of C1)),))) and an e!pected fie8year life- 9he two alternatie
depreciation schedules follow1
5ethod 1 5ethod 2
Iear 1 depreciation
$20,000 $40,000
Iear 2 depreciation
$20,000 $30,000
Iear 3 depreciation
$20,000 $20,000
Iear # depreciation
$20,000 $10,000
Iear $ depreciation
$20,000 $0
+ssuming that the company faces a marginal ta! rate of #) percent and has a cost of capital of 1)
percent, what is the difference between the two methods in the present alue of the depreciation ta!
benefit? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C&,1(%
b- C)
c- C2,'&'
d- C%,3#2
+/01 .
Iear 3ifference in
3epreciation
+fter89a!
3ifference
<K of C1
9able Kalue
3iscounted
Kalue
1 C 2),))) C ',))) )-()(1 C &,2&2
2 C 1),))) C #,))) )-'2%$ C 3,3)%
3 C 8)8 C )8 )-&$13 C 8)8
# C*1),))), C*#,))), )-%'3) C*2,&32,
$ C*2),))), C*',))), )-%2)( C*#,(%&,
9otal C 2,'&'
EEEEEE
3421 3ifficult O671 1#8$
Sea,ree3e Creati'n(
0eabree=e .reations is considering an inestment in a computer that is capable of producing arious
images that are useful in the production of commercial art- 9he computer would cost C2),))) and hae
an e!pected life of eight years- 9he computer is e!pected to generate additional annual net cash
receipts *before8ta!, of C%,))) per year- 9he computer will be depreciated according to the straight8
line method and the firmBs marginal ta! rate is 2$ percent-
2%
&$- @efer to 0eabree=e .reations- What is the after8ta! payback period for the computer pro"ect?
a- &-%2 years
b- 3-() years
c- #-## years
d- 3-11 years
+/01 6
<ayback <eriod E 4nestmentF+fter89a! .ash 2lows
+fter 9a! .ash 2lows E G*%,))) L)-&$, O *2,$)) L)-2$,H E C$,12$
<ayback <eriod E C2),)))FC$,12$ E 3-() years
3421 5oderate O671 1#82,1#8$
&%- @efer to 0eabree=e .reations- What is the after8ta! net present alue of the proposed pro"ect *using a
1% percent discount rate,? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C2,2%1
b- C*#$#,
c- C%,)%2
d- C*#,&(&,
+/01 +
?se <K of +nnuity 9able 1%J, ' yearsN .onstant E #-3#3%
+fter8ta! inflows EC$,12$ L #-3#3% E C 22,2%1
C22,2%1 8 C2),))) E C2,2%1
3421 5oderate O671 1#83
4e,,er C'rp'rati'n
Webber .orporation is considering an inestment in a labor8saing machine- 4nformation on this
machine follows1
.ost C3),)))
0alage alue in fie years C)
;stimated life $ years
+nnual depreciation C%,)))
+nnual reduction in e!isting costs C',)))
&&- @efer to Webber .orporation- What is the internal rate of return on this pro"ect *round to the nearest
1F2J,? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- 3&-$J
b- 2$-)J
c- 1)-$J
d- 13-$J
+/01 .
4@@ E C3),))) F C',))) E 3-&$
?sing <K of +nnuity 9able $ years- 9he constant of 3-&$ corresponds to a rate of 1)-$J
3421 5oderate O671 1#8#
2&
&'- @efer to Hefty 4nestment- +ssume for this :uestion only that Hefty .o- uses a discount rate of 1%
percent to ealuate pro"ects of this type- What is the pro"ectBs net present alue? %re(ent +alue ta,le(
'r a -inan*ial *al*ulat'r are re.uired/
a- C*%,2'3,
b- C*3,')%,
c- C*23,#$1,
d- C*22,))),
+/01 6
?se <K of +nnuity 9able 1%J, $ years- .orresponding constant is 3-2&#3
+nnual reduction in costs C',))) L 3-2&#3 C 2%,1(#
4nestment *3),))),
/et <resent Kalue * 3,')%,
EEEEEEE
3421 5oderate O671 1#83
&(- @efer to Hefty 4nestment- What is the payback period on this inestment?
a- # years
b- 2-1# years
c- 3-&$ years
d- $ years
+/01 .
<ayback <eriod E 4nitial 4nestmentF.ash 0aings
E C3),)))FC',)))
E 3-&$ years
3421 5oderate O671 1#82
Ru(t'n Ir'n0'r5(
@uston 4ronworks is considering a proposal to sell an e!isting lathe and purchase a new computer8
operated lathe- 4nformation on the e!isting lathe and the computer8operated lathe follow1
;!isting
lathe
.omputer8operated
lathe
.ost
$100,000 $300,000
+ccumulated depreciation
60,000 0
0alage alue now
20,000
0alage alue in # years
0 60,000
+nnual depreciation
10,000 75,000
+nnual cash operating costs
200,000 50,000
@emaining useful life
4 years 4 years
2'
')- @efer to @uston 4ronworks- What is the payback period for the computer8operated lathe?
a- 1-'& years
b- 2-)) years
c- 3-$3 years
d- 3-2( years
+/01 +
<ayback <eriod E G*/ew Lathe .ost 8 Old Lathe 0alage,F.ost 0aings from /ew LatheH
<ayback <eriod E G*3)),))) 8 2),))),F1$),)))H E 1-'& years
3421 5oderate O671 1#82
'1- @efer to @uston 4ronworks- 4f the company uses 1) percent as its discount rate, what is the net present
alue of the proposed new lathe purchase? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are
re.uired/
a- C23%,#%$
b- C2$%,#%$
c- C1($,#'$
d- C3),#22
+/01 +
+mount
<K 9able
.onstant <resent Kalue
+nnual .ost 0aings C 1$),))) 3-1%(( C #&$,#'$
0alage Kalue %),))) )-%'3) #),(')
4nitial 4nestment *2'),))), 1-)))) *2'),))),
/et <resent Kalue C 23%,#%$
EEEEEEEE
3421 5oderate O671 1#83
4'rtha2 C'rp'rati'n
9he Wortham .orporation has recently ealuated a proposal to inest in cost8reducing production
technology- +ccording to the ealuation, the pro"ect would re:uire an initial inestment of C1&,1%% and
would proide e:ual annual cost saings for fie years- 6ased on a 1) percent discount rate, the pro"ect
generates a net present alue of C1,&''- 9he pro"ect is not e!pected to hae any salage alue at the
end of its fie8year life-
2(
'2- @efer to Wortham .orporation- What are the e!pected annual cost saings of the pro"ect? %re(ent
+alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C3,$))
b- C#,)))
c- C#,$))
d- C$,)))
+/01 3
/et <resent Kalue E C 1,&''
4nitial 4nestment E 1&,1%%
<K of .ash 4nflows E 1',($#
?se <K of +nnuity 9able *$ years, 1)J discount,N .onstant E 3-&()'
C1',($# F 3-&()' E C$,)))
3421 5oderate O671 1#83
'3- @efer to Wortham .orporation- What is the pro"ectBs e!pected internal rate of return? %re(ent +alue
ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- 1)J
b- 11J
c- 13J
d- 1#J
+/01 3
4@@ E 1&,1%%F$,))) E 3-#332
?se <K of +nnuity table $ years
.onstant corresponds to an 4@@ of 1#J
3421 5oderate O671 1#8#
Rh'de( C'rp'rati'n
@hodes .orporation is inoled in the ealuation of a new computer8integrated manufacturing system-
9he system has a pro"ected initial cost of C1,))),)))- 4t has an e!pected life of si! years, with no
salage alue, and is e!pected to generate annual cost saings of C2$),)))- 6ased on @hodes
.orporationBs analysis, the pro"ect has a net present alue of C$&,%2$-
'#- @efer to @hodes .orporation- What discount rate did the company use to compute the net present
alue? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- 1)J
b- 11J
c- 12J
d- 13J
+/01 6
/<K E C $&,%2$
4nitial .ost E C1,))),)))
<K of .ash 4nflows E C1,)$&,%2$
+nnual .ost 0aings EC 2$),)))
C1,)$&,%2$FC2$),))) E #-23)$ <K of +nnuity .onstant
+t % years, the constant corresponds to a discount rate of 11J-
3421 5oderate O671 1#83
3)
'$- @efer to @hodes .orporation- What is the pro"ectBs profitability inde!?
a- 1-)$'
b- -)$'
c- -(#$
d- 1-)))
+/01 +
<4 E C1,)$&,%2$F1,))),))) E 1-)$'
3421 5oderate O671 1#83
'%- @efer to @hodes .orporation- What is the pro"ectBs internal rate of return? %re(ent +alue ta,le( 'r a
-inan*ial *al*ulat'r are re.uired/
a- between 12-$ and 13-) percent
b- between 11-) and 11-$ percent
c- between 11-$ and 12-) percent
d- between 13-) and 13-$ percent
+/01 +
C1,))),)))FC2$),))) E #-)))
?sing the <resent Kalue of +nnuity 9able for % years, the rate falls between 12-$J
and 13J
3421 5oderate O671 1#8#
'&- .arol 7ones recently inested in a pro"ect that promised an internal rate of return of 1$ percent- 4f the
pro"ect has an e!pected annual cash inflow of C12,))) for si! years, with no salage alue, how much
did .arol pay for the pro"ect?
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C3$,)))
b- C#$,#1#
c- C&2,)))
d- C31,&)'
+/01 6
?se <resent Kalue of +nnuity 9able *% years,1$J,
C12,))) L 3-&'#$ E C#$,#1#
3421 5oderate O671 1#8#
''- 7ohn 6rowning recently inested in a pro"ect that has an e!pected annual cash inflow of C&,))) for 1)
years, and an e!pected payback period of 3-% years- How much did 7ohn inest in the pro"ect?
a- C1(,###
b- C3%,)))
c- C2$,2))
d- C#),)))
+/01 .
!FC&,))) E 3-% years
! E C2$,2))
3421 5oderate O671 1#82
31
'(- 9he @and .orporation is considering an inestment in a pro"ect that generates a profitability inde! of
1-3- 9he present alue of the cash inflows on the pro"ect is C##,)))- What is the net present alue of
this pro"ect?
a- C1),1$#
b- C13,2))
c- C$&,2))
d- C33,'#%
+/01 +
<K .ash 4nflowsF.ash Outflows E <rofitability 4nde!
C##,)))F.ash Outflows E 1-3
C##,)))F1-3 E C33,'#%
<K .ash 4nflows 8 .ash Outflows E /et <resent Kalue
C##,))) 8 C33,'#% E C1),1$#
3421 5oderate O671 1#83
()- 4f r is the discount rate, the formula G1F*1 O r,H refers to the
a- future alue interest factor associated with r for one period-
b- present alue of some future cash flow-
c- present alue interest factor associated with r for one period-
d- future alue interest factor for an annuity with a duration of r periods-
+/01 . 3421 ;asy O671 1#81)
(1- 2uture alue is the
a- sum of dollars8in discounted to time =ero-
b- sum of dollars8out discounted to time =ero-
c- difference of dollars8in and dollars8out-
d- alue of dollars8in minus dollars8out for future periods ad"usted for any interest8
compounding factor-
+/01 3 3421 5oderate O671 1#81)
(2- +ll other things being e:ual, as the time period for receiing an annuity lengthens,
a- the related present alue factors increase-
b- the related present alue factors decrease-
c- the related present alue factors remain constant-
d- it is impossible to tell what happens to present alue factors from the information gien-
+/01 + 3421 ;asy O671 1#81)
(3- Which of the following indicates that the first cash flow is at the end of a period?
Ordinary annuity +nnuity due
a-
yes no
b-
yes yes
c-
no yes
d-
no no
+/01 + 3421 ;asy O671 1#81)
32
(#- +ssume that D represents a sum of money that 6ill has aailable to inest in a pro"ect that will yield a
return of r- 4n the formula I E D*1 O r,, I represents the
a- future alue of D in one period-
b- future alue interest factor associated with r-
c- present alue of D-
d- present alue interest factor associated with r-
+/01 + 3421 ;asy O671 1#81)
($- 9he capital budgeting techni:ue known as accounting rate of return uses
salage alue time alue of money
a-
no no
b-
no yes
c-
yes yes
d-
yes no
+/01 3 3421 ;asy O671 1#811
(%- 4n computing the accounting rate of return, the AAAAAAAAAA leel of inestment should be used as the
denominator-
a- aerage
b- initial
c- residual
d- cumulatie
+/01 + 3421 ;asy O671 1#811
C'd16( Retail
.ody>s @etail is considering an inestment in a deliery truck- .ody has found a used truck that he can
purchase for C',)))- He estimates the truck would last si! years and increase his storeBs net cash
reenues by C2,))) per year- +t the end of si! years, the truck would hae no salage alue and would
be discarded- .ody will depreciate the truck using the straight8line method-
(&- @efer to .odyBs @etail- What is the accounting rate of return on the truck inestment *based on aerage
profit and aerage inestment,?
a- 2$-)J
b- $)-)J
c- 1%-&J
d- '-3J
+/01 6
C2,)))FC#,))) E $)J
+erage 4nestment E *C',))) O ),F2 E C#,)))
3421 5oderate O671 1#811
33
('- @efer to .odyBs @etail- What is the payback period on the inestment in the new truck?
a- 12 years
b- % years
c- # years
d- 2 years
+/01 .
C',)))FC2,))) E # years
3421 5oderate O671 1#82
((- Linda 0mith borrows C$),))) from her bank on 7anuary 1- 0he is to repay the loan in e:ual annual
installments oer 3) years- How much is her annual repayment if the bank charges 1) percent interest?
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C1,%%&
b- C#,2))
c- C2,'%$
d- C$,3)#
+/01 3
?sing the <resent Kalue of +nnuity 9able *1)J, 3) years,, the constant is (-#2%(-
C$),)))F(-#2%( E C$,3)#
3421 5oderate O671 1#81)
1))- Willard 6oone has "ust turned %$- He has C1)),))) to inest in a retirement annuity- One inestment
company has offered to pay Willard C1),))) per year for 1$ years *payments to begin in one year, in
e!change for an immediate C1)),))) payment- 4f Willard accepts the offer from the inestment
company, what is his e!pected return on the C1)),))) inestment *assume a return that is compounded
annually,? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- between $ and % percent
b- between % and & percent
c- between & and ' percent
d- between ' and ( percent
+/01 +
C1)),)))FC1),))) E 1)-))) <K of annuity 9able 2actor
2or 1$ years, this factor represents a return on inestment between $ and % percent-
3421 5oderate O671 1#81)
1)1- Mleason +rmored .ar .o- is considering the ac:uisition of a new armored truck- 9he truck is e!pected
to cost C3)),)))- 9he companyBs discount rate is 12 percent- 9he firm has determined that the truck
generates a positie net present alue of C1&,)22- Howeer, the firm is uncertain as to whether its has
determined a reasonable estimate of the salage alue of the truck- 4n computing the net present alue,
the company assumed that the truck would be salaged at the end of the fifth year for C%),)))- What
e!pected salage alue for the truck would cause the inestment to generate a net present alue of C)?
4gnore ta!es- %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- C3),)))
b- C)
c- C$$,2&'
3#
d- C#2,(&'
+/01 +
?sing the <resent Kalue of C1 table *12J and $ years,, the constant is )-$%&#-
C1&,)22F)-$%&# E C3),))) salage alue that would yield a salage alue of )-
3421 5oderate O671 1#83
1)2- 0teele <ublishers is considering an inestment that would re:uire an initial cash outlay of C#)),)))
and would hae no salage alue- 9he pro"ect would generate annual cash inflows of C&$,)))- 9he
firmBs discount rate is ' percent- How many years must the annual cash flows be generated for the
pro"ect to generate a net present alue of C)? %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are
re.uired/
a- between $ and % years
b- between % and & years
c- between & and ' years
d- between ' and ( years
+/01 .
C#)),))) F C&$,))) E $-33
?sing the <resent Kalue of an +nnuity at 'J, the constant falls between & and ' years-
3421 5oderate O671 1#83
1)3- + capital budget is used by management to determine
in what to inest how much to inest
a-
no no
b-
no yes
c-
yes no
d-
yes yes
+/01 3 3421 ;asy O671 1#81
1)#- 9he weighted aerage cost of capital represents the
a- cost of bonds, preferred stock, and common stock diided by the three sources-
b- e:uialent units of capital used by the organi=ation-
c- oerall cost of capital from all organi=ation financing sources-
d- oerall cost of diidends plus interest paid by the organi=ation-
+/01 . 3421 ;asy O671 1#81
3$
S&ORT ANS4ER
1- 4n a net present alue analysis, how can an analyst e!plicitly and formally consider the influence of
risk on the present alue of certain cash flows?
+/01
+n analyst could do at least three different things to e!plicitly account
for risk- 9he analyst could1 *1, ad"ust the discount rate to reflect the risk of the cash flow, *2, ad"ust the
discounting period of the cash flow, or *3, ad"ust the e!pected amount of the cash flow up or down to
reflect the risk-
3421 5oderate O671 1#8'
2- What factors influence the present alue of the depreciation ta! benefit?
+/01
9he depreciation ta! benefit is primarily affected by three factors1 the depreciation rate or method, the
ta! rate, and the discount rate-
3421 5oderate O671 1#8$
3- Why is it important for managers to be able to rank pro"ects?
+/01
5anagers need to be able to rank pro"ects for two primary reasons- 2irst, managers need to be able to
select the best pro"ect from a set of pro"ects that are directly competing with each other *particularly in
the case of mutually e!clusie pro"ects,- 0econd, een when pro"ects are not directly competing with
each other, managers may hae a limited supply of capital that has to be allocated to the most worthy
of the pro"ects-
3421 5oderate O671 1#8&
#- 4f it is assumed that managers act to ma!imi=e the alue of the firm, what can also be assumed about
the e!isting mi! of capital components relatie to the set of all iable alternatie mi!es of capital
components?
+/01
4t can be assumed that the e!isting mi! of capital components is the one that minimi=es the cost of
capital *which, therefore, ma!imi=es the alue of the firm,-
3421 5oderate O671 1#81
$- 3oes a pro"ect that generates a positie internal rate of return also hae a positie net present alue?
;!plain-
+/01
/o- + positie 4@@ does not necessarily mean that a pro"ect will also hae a positie /<K- Only if the
4@@ is greater than the discount rate that is used in the /<K calculation will the /<K be positie-
3421 5oderate O671 1#8%
3%
%- Why is the profitability inde! a better basis than net present alue to compare pro"ects that re:uire
different leels of inestment?
+/01
9he profitability inde! relates the magnitude of the net present alue to the magnitude of the initial
inestment- 9hus, the <4 gies some indication of relatie profitability- 9he /<K itself proides no
direct indication of the leel of inestment that is re:uired to generate the /<K and therefore proides
no indication of relatie profitability-
3421 5oderate O671 1#8%
&- What is the ma"or adantage of the accounting rate of return relatie to the other techni:ues that can be
used to ealuate capital pro"ects?
+/01
9he accounting rate of return has two ma"or adantages relatie to the other capital budgeting
techni:ues- 2irst, it may be more compatible as an inestment criterion with criteria that are used to
ealuate managerial and segment performance particularly for inestment centers that are ealuated on
an @O4 or @4 basis- 0econd, the accounting rate of return can be generated from accounting data and is
therefore easy to track oer the life of the inestment-
3421 5oderate O671 1#811
'- Why is it important for organi=ations to conduct post inestment audits of capital pro"ects?
+/01
9he post inestment audit proides management with an opportunity to ealuate the actual
performance of the inestment relatie to e!pected performance- 4f possible, management can take
correctie action when actual performance is poor relatie to the e!pected performance- 5anagement
can also use the post inestment audit to ealuate the performance of those who proided the original
information about the inestment and those who are in charge of the inestment- 4n addition,
management may use the information from the post inestment audit to improe the ealuation
process of future capital pro"ects-
3421 5oderate O671 1#8(
(- How are capital budgeting models affected by potential inestments in automated e:uipment
inestment decisions?
+/01
3iscount rates for present alue calculations often far e!ceed a firmBs cost of capital- +utomated
machinery is ery costly and may be at a disadantage in discounted cash flow methods- Pualitatie
factors associated with automated e:uipment may not receie any weight or alue in current capital
budgeting methods- +utomated e:uipment is often interrelated with other inestments and should be
bundled to reflect this synergism- 2inally, there is the opportunity cost of not automating when
competitors automate and your firm doesnBt-
3421 5oderate O671 1#8'
3&
1)- What are the limitations of the payback period as a capital budgeting techni:ue?
+/01
9he payback period ignores the time alue of money- 4t also ignores a company>s desired rate of
return- 2inally, the payback period ignores cash inflows occurring after the payback period has been
reached-
3421 5oderate O671 1#82
%ROBLE$
S2all C'rp'rati'n
0mall .orporation is considering an inestment that will re:uire an initial cash outlay of C2)),))) to
purchase non8depreciable assets- 9he pro"ect promises to return C%),))) per year *after8ta!, for eight
years with no salage alue- 9he companyBs cost of capital is 11 percent-
1- @efer to 0mall .orporation- 9he company is uncertain about its estimate of the life e!pectancy of the
pro"ect- How many years must the pro"ect generate the C%),))) per year return for the company to at
least be indifferent about its acceptance? *3o not consider the possibility of partial year returns-,
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
+/01
3iiding C2)),)))FC%),))), gies the annuity discount factor *3-3333, for 11 percent associated with
the minimal re:uired time for this pro"ect to be successful- +ccording to the tables in +ppendi! +, the
pro"ect will hae a positie net present alue if the cash flows last through year $-
3421 5oderate O671 1#81)
Ser5in C'rp'rati'n
0erkin .orporation is considering an inestment in a new product line- 9he inestment would re:uire
an immediate outlay of C1)),))) for e:uipment and an immediate inestment of C2)),))) in working
capital- 9he inestment is e!pected to generate a net cash inflow of C1)),))) in year 1, C1$),))) in
year 2, and C2)),))) in years 3 and #- 9he e:uipment would be scrapped *for no salage, at the end of
the fourth year and the working capital would be li:uidated- 9he e:uipment would be fully depreciated
by the straight8line method oer its four8year life-
2- @efer to 0erkin .orporation- 4f 0erkin uses a discount rate of 1% percent, what is the /<K of the
proposed product line inestment?
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
3'
+/01
.ash flow Iear +mount 3iscount factor <resent alue
4nestment
0 $(100,000) 1.00 $(100,000)
Working cap-
0 $(200,000) 1.00 (200,000)
.ash inflow
1 100,000 .8621 86,210
.ash inflow
2 150,000 .7432 111,480
.ash inflow
3 200,000 .6407 128,140
.ash inflow
4 200,000 .5523 110,460
Working cap-
4 200,000 .5523 110,460
/et present alue
$246,750
3421 5oderate O671 1#83
3- @efer to 0erkin .orporation- What is the payback period for the inestment?
+/01
+fter the first two years, C2$),))) of the original C3)),))) inestment would be recouped- 4t would
take one8:uarter of the third year *C$),)))FC2)),))), to recoup the last C$),)))- 9hus, the payback
period is 2-2$ years-
3421 5oderate O671 1#82
#- +dam 6all has an opportunity to inest in a pro"ect that will yield four annual payments of C12,)))
with no salage- 9he first payment will be receied in e!actly one year- On low8risk pro"ects of this
type, 6all re:uires a return of % percent- 6ased on this re:uirement, the pro"ect generates a profitability
inde! of 1-)3($3-
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- How much is +dam re:uired to inest in this pro"ect?
b- What is the internal rate of return on +dam>s pro"ect?
+/01
a- 9he present alue of the C12,))) annuity is found by multiplying C12,))) by the
annuity discount factor associated with % percent interest for four years1 C12,)))
3-#%$1 E C#1,$'1-2)-
2rom the information on the profitability inde!, it is known that the present alue of
the cash inflows is 1-)3($3 times the initial inestment- 9hus, the initial inestment
is C#1,$'1-2)F1-)3($3 E C#),)))-
b- 6y diiding C#),))) by the annual cash inflow of C12,))), it is determined that the
discount factor associated with the 4@@ is 3-3333- 9his discount factor is associated
with an interest rate that lies between & and ' percent- ?sing interpolation, the 4@@ is
computed to be appro!imately &-&2 percent-
3421 5oderate O671 1#8#
3(
$- <itt <roductions is considering the purchase of a new moie camera, which will be used for ma"or
motion pictures- 9he new camera will cost C3),))), hae an eight8year life, and create cost saings of
C$,))) per year- 9he new camera will re:uire C&)) of maintenance each year- <itt <roductions uses a
discount rate of ( percent-
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- .ompute the net present alue of the new camera-
b- 3etermine the payback period-
+/01
a- .ost saings per year
$5,000
5aintenance per year
(700)
/et cash flows per year
$4,300
.ash 3iscount factor <resent alue
$30,000 1.0000 $(30,000.00)
4,300 5.5348 23,799.64
/et present alue of inestment
$ (6,200.36)
b- <ayback e:uals C3),)))FC#,3)) E %-(&% years
3421 5oderate O671 1#83
%- @iordan .orporation is interested in purchasing a state8of8the8art widget machine for its manufacturing
plant- 9he new machine has been designed to basically eliminate all errors and defects in the widget8
making production process- 9he new machine will cost C1$),))), and hae a salage alue of C&),)))
at the end of its seen8year useful life- @iordan has determined that cash inflows for years 1 through &
will be as follows1 C32,)))N C$&,)))N C1$,)))N C2',)))N C1%,)))N C1),))), and C1$,))), respectiely-
5aintenance will be re:uired in years 3 and % at C1),))) and C&,))) respectiely- @iordan uses a
discount rate of 11 percent and wants pro"ects to hae a payback period of no longer than fie years-
%re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are re.uired/
a- .ompute the net present alue of the new machine-
b- .ompute the firmBs profitability inde!-
c- .ompute the payback period-
d- ;aluate this inestment proposal for DIQ .o-
#)
+/01
a- Iear .ash flow 3iscount factor <resent alue
1
$150,000 1.0000 $(150,000.00)
1
32,000 .9009 28,828.80
2
57,000 .8116 46,261.20
3
5,000 .7312 3,656.00
#
28,000 .6587 18,443.60
$
16,000 .5935 9,496.00
%
3,000 .5346 1,603.80
&
15,000 .4817 7,225.50
&
70,000 .4817 33,719.00
/et present alue
$ (766.10)
b- <rofitability inde! e:uals present alue of cash flows diided by inestment1
C1#(,233-()FC1$),))) E -(($
c- <ayback period is %-11 years, computed as follows1
Iear .ash 2low .umulatie .ash 2low
1 $32,000 $ 32,000
2 57,000 89,000
3 5,000 94,000
4 28,000 122,000
5 16,000 138,000
6 3,000 141,000
7 85,000 226,000
C1$),))) 8 C1#1,))) E C(,)))FC'$,))) E -11
d- 9he pro"ect is :uantitatiely unacceptable because it has a negatie /<K, a less8than8
one <4, and a payback period of oer si! years- Howeer, the /<K and <4 are
e!tremely close to being acceptable- 6ecause the new machine will proide DIQ
=ero8defect production, the inestment may be desirable if additional :ualitatie
factors are considered such as improed competitie position, customer satisfaction,
goodwill generated, improed product :uality and reliability, and a desire to be in the
forefront of manufacturing capability- DIQ may want to attempt to :uantify these
benefits and reealuate the machineBs acceptability as an inestment-
3421 3ifficult O671 1#83
#1
&- 9he @eed .ompany has been operating a small lunch counter for the conenience of employees- 9he
counter occupies space that is not needed for any other business purpose- 9he lunch counter has been
managed by a part8time employee whose annual salary is C3,)))- Iearly operations hae consistently
shown a loss as follows1
@eceipts
$20,000
;!penses for food, supplies *in cash,
$19,000
0alary
3,000 22,000
/et Loss
$(2,000)
+ company has offered to sell @eed .ompany automatic ending machines for a total cost of C12,)))-
0ales terms are cash on deliery- 9he old e:uipment has =ero disposal alue-
9he predicted useful life of the e:uipment is 1) years, with =ero scrap alue- 9he e:uipment will easily
sere the same olume that the lunch counter handled- + catering company will completely serice and
supply the machines- <rices and ariety of food and drink will be the same as those that preailed at
the lunch counter- 9he catering company will pay $ percent of gross receipts to the @eed .ompany and
will bear all costs of food, repairs, and so forth- 9he part8time employee will be discharged- 9hus,
@eed .ompany>s only cost will be the initial outlay for the machines-
.onsider only the two alternaties mentioned- %re(ent +alue ta,le( 'r a -inan*ial *al*ulat'r are
re.uired/
Re.uired7
a- What is the annual income difference between alternaties?
b- .ompute the payback period-
c- .ompute1
1- 9he net present alue if releant cost of capital is 2) percent-
2- 4nternal rate of return-
d- 5anagement is ery uncertain about the prospectie reenue from the ending
e:uipment- 0uppose that the gross receipts amounted to C1#,))) instead of C2),)))-
@epeat the computation in part c-1-
e- What would be the minimum amount of annual gross receipts from the ending
e:uipment that would "ustify making the inestment? 0how computations-
+/01
a- Old loss C*2,))),
/ew receipts C2),))) $J E
$ 1,000
3epr- C12,)))F1) yrs- E
(1,200)
/ew *Loss,
$ (200)
b- .hange in annual cash inflow is C3,)))
<ayback E C12,)))FC3,))) E # yrs-
c- 1- <K of inflow C3,))) #-1(2$ E
$12,577.50
<K of outflow C12,))) 1-) E
(12,000.00)
/<K
$ 577.50
#2
2- 4@@ is appro!imately 23J
d- .hange in inflow E C2,&))
<K inflow C2,&)) #-1(2$ E
$11,319.75
<K outflow C12,))) 1-) E
(12,000.00)
/<K
$ (680.25)
e- C12,)))F#-1(2$ E C2,'%2-2$
@eceipts E *C2,'%2-2$ 8 C2,))),F-)$ E C1&,2#$
3421 5oderate O671 1#8#
'- 9he 0potless +utomobile .orporation is contemplating the ac:uisition of an automatic car wash- 9he
following information is releant1
9he cost of the car wash is C1%),)))
9he anticipated reenue from the car wash is C1)),))) per annum-
9he useful life of the car wash is 1) years-
+nnual operating costs are e!pected to be1
0alaries
$30,000
?tilities
9,600
Water usage
4,400
0upplies
6,000
@epairsFmaintenance
10,000
9he firm uses straight8line depreciation-
9he salage alue for the car wash is =ero-
9he companyBs cutoff points are as follows1
<ayback
3 years
+ccounting rate of return
18%
4nternal rate of return
18%
4gnore income ta!es-
Re.uired7
a- .ompute the annual cash inflow-
b- .ompute the net present alue-
c- .ompute internal rate of return-
d- .ompute the payback period-
e- .ompute the profitability inde!-
f- 0hould the car wash be purchased?
#3
+/01
a- @eenue
$100,000
8 cash e!penses
(60,000)
+nnual inflow
$ 40,000
b- <K inflow C#),))) #-#(#1 E
$179,764
<K outflow C1%),))) 1-) E
(160,000)
/<K E
$ 19,764
c- 4@@ factor E C1%),)))FC#),))) E #-) which is appro!imately 23J
d- <ayback E C1%),)))FC#),))) E # yrs-
e- C1&(,&%#FC1%),))) E 1-123$2$
f- .ar wash e!ceeds minimum on 0@@ and 4@@, but not payback-
3421 5oderate O671 1#8#
##