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1. _________ is the process of evaluating and selecting long-term (d) commonly used to expand the level of operations. 11.

operations. 11. _________ projects do not compete with each other; the
investments consistent with the firm’s goal of owner wealth acceptance of one _________ the others from consideration.
maximization. 8. Which pattern of cash flow stream is the most difficult to use (a) Capital; eliminates
(a) Recapitalizing assets when evaluating projects?
(b) Independent; does not eliminate
(b) Capital budgeting (a) Mixed stream.
(c) Mutually exclusive; eliminates
(c) Ratio analysis (b) Conventional flow.
(d) Replacement; does not eliminate
(d) Restructuring debt (c) Nonconventional flow.
(d) Annuity. 12. _________ projects have the same function; the acceptance of
2. Fixed assets that provide the basis for the firm’s profit and value Table 8.1 one _________ the others from consideration.
are often called (a) Capital; eliminates
(a) tangible assets. Operating Cash Inflows
(b) Independent; does not eliminate
(b) non-current assets. $1,000 $1,000 $1,000 $1,000 $1,000 (c) Mutually exclusive; eliminates
(c) earning assets. (d) Replacement; does not eliminate
(d) book assets. 13. A firm with limited dollars available for capital expenditures is
3. The most common motive for adding fixed assets to the firm is subject to
$2,500
(a) expansion. Initial (a) capital dependency.
(b) replacement. Outlay (b) mutually exclusive projects.
(c) renewal. (c) working capital constraints.
(d) transformation. 9. The cash flow pattern depicted is associated with a capital (d) capital rationing.
investment and may be characterized as (See Table 8.1.)
14. A conventional cash flow pattern associated with
4. The final step in the capital budgeting process is (a) an annuity and conventional cash flow. capital investment projects consists of an initial
(a) implementation. (b) a mixed stream and non-conventional cash flow. (a) outflow followed by a broken cash series.
(b) follow-up monitoring. (c) an annuity and non-conventional cash flow. (b) inflow followed by a broken series.
(c) re-evaluation. (d) a mixed stream and conventional cash flow. (c) outflow followed by a series of inflows.
(d) education. Table 8.2 (d) inflow followed by a series of outflows.

5. The first step in the capital budgeting process is Operating Cash Inflows
15. A non-conventional cash flow pattern associated with capital
(a) review and analysis. $25,000 $10,00 $50,00 $10,00 $10,00 $60,00 investment projects consists of an initial
0 0 0 0 0
(b) implementation. (a) outflow followed by a series of cash inflows and outflows.
(c) decision-making. (b) inflow followed by a series of cash inflows and outflows.
(d) proposal generation. (c) outflow followed by a series of inflows.
– (d) inflow followed by a series of outflows.
6. A $60,000 outlay for a new machine with a usable life of 15 $100,00
years is called 0 16. _________ is a series of equal annual cash flows.
(a) capital expenditure. Initial (a) A mixed stream
(b) operating expenditure. Outlay
(b) A conventional
(c) replacement expenditure. (c) A non-conventional
10. The cash flow pattern depicted is associated with a capital
(d) none of the above. (d) An annuity
investment and may be characterized as (See Table 8.2.)
7. A capital expenditure is all of the following except 17. The cash flows of any project having a conventional pattern
(a) an annuity and conventional cash flow.
(a) an outlay made for the earning assets of the firm. include all of the basic components except
(b) a mixed stream and non-conventional cash flow.
(b) expected to produce benefits over a period of time greater (a) initial investment.
(c) an annuity and non-conventional cash flow.
than one year. (b) operating cash outflows.
(d) a mixed stream and conventional cash flow.
(c) an outlay for current asset expansion. (c) operating cash inflows.
(d) terminal cash flow. 22. Relevant cash flows for a project are best described as (a) an ordinary tax benefit.
(a) incidental cash flows. (b) no tax benefit or liability.
18. Projects that compete with one another, so that the acceptance
(b) incremental cash flows. (c) recaptured depreciation taxed as ordinary income.
of one eliminates the others from further consideration are
called (c) sunk cash flows. (d) a capital gain tax liability and recaptured depreciation
(d) accounting cash flows. taxed as ordinary income.
(a) independent projects.
(b) mutually exclusive projects. 23. In developing the cash flows for an expansion project, the 29. In evaluating the initial investment for a capital budgeting
(c) replacement projects. analysis is the same as the analysis for replacement projects project,
(d) None of the above. where (a) an increase in net working capital is considered a cash
(a) all cash flows from the old assets are equal. inflow.
19. A firm with unlimited funds must evaluate five projects. Projects (b) a decrease in net working capital is considered a cash
(b) prior cash flows are irrelevant.
1 and 2 are independent and Projects 3, 4, and 5 are mutually outflow.
exclusive. The projects are listed with their returns. (c) all cash flows from the old asset are zero.
(c) an increase in net working capital is considered a cash
(d) cash inflows equal cash outflows.
outflow.
Project Status Return(%) 24. When evaluating a capital budgeting project the change in net
(d) net working capital does not have to be considered.
working capital must be considered as part of
1 Independent 14
(a) the operating cash inflows. 30. The basic variables that must be considered in determining the
2 Independent 12
(b) the initial investment. initial investment associated with a capital expenditure are all of
3 Mutually exclusive 10 the following EXCEPT
(c) the incremental operating cash inflows.
4 Mutually exclusive 15 (d) the operating cash outflows. (a) incremental annual savings produced by the new asset.
5 Mutually exclusive 12 (b) cost of the new asset.
25. The change in net working capital when evaluating a capital (c) proceeds from the sale of the existing asset.
A ranking of the projects on the basis of their returns from the budgeting decision is
(d) taxes on the sale of an existing asset.
best to the worst according to their acceptability to the firm (a) current assets minus current liabilities.
would be (b) the increase in current assets. 31. The tax treatment regarding the sale of existing assets that are
(a) 4, 1, 2 or 5, and 3. (c) the increase in current liabilities. sold for more than the book value but less than the original
(b) 4, 1, and 2. (d) the change in current assets minus the change in current purchase price results in
(c) 3, 2 or 5, 1, and 4. liabilities. (a) an ordinary tax benefit.
(d) 4, 1, 5, and 3. (b) a capital gain tax liability.
26. The book value of an asset is equal to the (c) recaptured depreciation taxed as ordinary income.
20. Initial cash flows and subsequent operating cash flows for a
project are sometimes referred to as (a) fair market value minus the accounting value. (d) a capital gain tax liability and recaptured depreciation
(b) original purchase price minus annual depreciation expense. taxed as ordinary income.
(a) necessary cash flows.
(c) original purchase price minus accumulated depreciation. 32. The tax treatment regarding the sale of existing assets that are
(b) relevant cash flows.
(d) depreciated value plus recaptured depreciation. sold for their book value results in
(c) consistent cash flows.
(a) an ordinary tax benefit.
(d) ordinary cash flows. 27. An important cash inflow in the analysis of initial cash flows for
(b) no tax benefit or liability.
a replacement project is
21. When making replacement decisions, the development of (c) recaptured depreciation taxed as ordinary income.
relevant cash flows is complicated when compared to expansion (a) taxes.
(d) a capital gain tax liability and recaptured depreciation
decisions, due to the need to calculate _________ cash inflows. (b) the cost of the new asset. taxed as ordinary income.
(a) conventional (c) installation cost.
(b) non-conventional (d) the sale value of the old asset. 33. The tax treatment regarding the sale of existing assets that are
28. The tax treatment regarding the sale of existing assets that are not depreciable or used in business and are sold for less than
(c) incremental
sold for more than the book value and more than the original the book value results in
(d) initial
purchase price results in (a) an ordinary tax benefit.
(b) a capital gain tax benefit.
(c) recaptured depreciation taxed as ordinary income. (d) $7,720 tax liability.) 42. A corporation has decided to replace an existing asset with a
(d) a capital gain tax liability and recaptured depreciation newer model. Two years ago, the existing asset originally cost
taxed as ordinary income. 38. A corporation is selling an existing asset for $1,700. The asset, $30,000 and was being depreciated under MACRS using a
when purchased, cost $10,000, was being depreciated under five-year recovery period. The existing asset can be sold for
34. A corporation is considering expanding operations to meet MACRS using a five-year recovery period, and has been $25,000. The new asset will cost $75,000 and will also be
growing demand. With the capital expansion, the current depreciated for four full years. If the assumed tax rate is 40 depreciated under MACRS using a five-year recovery period. If
accounts are expected to change. Management expects cash to percent on ordinary income and capital gains, the tax effect of the assumed tax rate is 40 percent on ordinary income and
increase by $20,000, accounts receivable by $40,000, and this transaction is capital gains, the initial investment is _________.
inventories by $60,000. At the same time accounts payable will (a) $0 tax liability. (a) $42,000
increase by $50,000, accruals by $10,000, and long-term debt by (b) $840 tax liability. (b) $52,440
$100,000. The change in net working capital is
(c) $3,160 tax liability. (c) $54,240
(a) an increase of $120,000. (d) $3,160 tax benefit. (d) $50,000
(b) a decrease of $40,000. 39. A corporation is selling an existing asset for $1,000. The asset,
(c) a decrease of $120,000. when purchased, cost $10,000, was being depreciated under 43. A corporation has decided to replace an existing asset with a
(d) an increase of $60,000. MACRS using a five-year recovery period, and has been newer model. Two years ago, the existing asset originally cost
depreciated for four full years. If the assumed tax rate is 40 $70,000 and was being depreciated under MACRS using a
35. A corporation is considering expanding operations to meet percent on ordinary income and capital gains, the tax effect of five-year recovery period. The existing asset can be sold for
growing demand. With the capital expansion the current this transaction is $30,000. The new asset will cost $80,000 and will also be
accounts are expected to change. Management expects cash to depreciated under MACRS using a five-year recovery period. If
(a) $0 tax liability.
increase by $10,000, accounts receivable by $20,000, and the assumed tax rate is 40 percent on ordinary income and
(b) $1,100 tax liability. capital gains, the initial investment is _________.
inventories by $30,000. At the same time accounts payable will
increase by $40,000, accruals by $30,000, and long-term debt by (c) $3,600 tax liability.
(a) $48,560
$80,000. The change in net working capital is (d) $280 tax benefit.
(b) $44,360
(a) an increase of $10,000. (c) $49,240
40. A firm is selling an existing asset for $5,000. The asset, when
(b) a decrease of $10,000. purchased, cost $10,000, was being depreciated under MACRS (d) $27,600
(c) a decrease of $90,000. using a five-year recovery period and has been depreciated for Topic: Initial Investment (Equation 8.1)
(d) an increase of $80,000. four full years. If the assumed tax rate is 40 percent on ordinary
36. The tax treatment regarding the sale of existing assets that are income and capital gains, the tax effect of this transaction is 44. Benefits expected from proposed capital expenditures must be
depreciable and used in business and are sold for less than the (a) $0 tax liability. on an after-tax basis because
book value results in (b) $1,320 tax liability. (a) taxes are cash outflows.
(a) a tax benefit from an ordinary loss. (c) $1,160 tax liability. (b) no benefits may be used by the firm until tax claims are
(b) a capital gain tax liability. (d) $2,000 tax benefit. satisfied.
(c) recaptured depreciation taxed as ordinary income. (c) there may also be tax benefits to be evaluated.
(d) a capital gain tax liability and recaptured depreciation 41. A loss on the sale of an asset that is depreciable and used in (d) it is common, accepted practice to do so.
taxed as ordinary income. business is _________; a loss on the sale of a non-depreciable
asset is _________. 45. One basic technique used to evaluate after-tax operating cash
37. A corporation is selling an existing asset for $21,000. The asset, (a) deductible from capital gains income; deductible from flows is to
when purchased, cost $10,000, was being depreciated under ordinary income (a) add noncash charges to net income.
MACRS using a five-year recovery period, and has been (b) deductible from ordinary income; deductible only against (b) subtract depreciation from operating revenues.
depreciated for four full years. If the assumed tax rate is 40 capital gains (c) add cash expenses to net income.
percent on ordinary income and capital gains, the tax effect of
(c) a credit against the tax liability; not deductible (d) subtract cash expenses from noncash charges.
this transaction is
(d) not deductible; deductible only against capital gains
(a) $0 tax liability.
(b) $7,560 tax liability.
(c) $4,400 tax liability.
Computer Disk Duplicators, Inc. has been considering several capital (a) a mixed stream and conventional. (d) $16,600 tax liability.
investment proposals for the year beginning in 2004. For each (b) a mixed stream and non-conventional.
investment proposal, the relevant cash flows and other relevant 53. For Proposal 2, the initial outlay equals (See Table 8.3.)
(c) an annuity and conventional.
financial data are summarized in the table below. In the case of a (a) $120,720 cash outflow.
(d) an annuity and non-conventional.
replacement decision, the total installed cost of the equipment will be (b) $164,560 cash outflow.
partially offset by the sale of existing equipment. The firm is subject to a
47. For Proposal 1, the initial outlay equals _________. (See Table (c) $150,000 cash outflow.
40 percent tax rate on ordinary income and on long-term capital gains.
8.3.) (d) $167,520 cash outflow.
The firm’s cost of capital is 15 percent.
(a) $1,380,000
Table 8.3 (b) $1,440,000
(c) $1,500,000 54. For Proposal 2, the incremental depreciation expense for year 2
Proposal is _________. (See Table 8.3.)
(d) $1,620,000
Type of Capital 1 2 3 48. For Proposal 1, the depreciation expense for year 1 is (a) $16,800
Budgeting Expansion Replacement Replacement _________. (See Table 8.3.) (b) $26,400
Decision (a) $110,400 (c) $38,400
Mutually Mutually (b) $115,200 (d) $60,000
Exclusive Exclusive (c) $150,000
Type of Project Independent with 3 with 2 55. For Proposal 2, the annual incremental after-tax cash flow from
(d) $300,000 operations for year 2 is _________. (See Table 8.3.)
Cost of new $1,500,000 $200,000 $300,000
49. For Proposal 1, the annual incremental after-tax cash flow from (a) $18,000
asset
operations for year 1 is _________. (See Table 8.3.) (b) $24,000
Installation costs $0 $0 $15,000
(a) $60,000 (c) $66,000
MACRS (new 10 years 5 years 5 years (d) $84,000
(b) $255,000
asset)
(c) $300,000 56. For Proposal 3, the cash flow pattern for the replacement
Original cost of N/A* $80,000 $100,000 project is (See Table 8.3.)
(d) $210,000
old asset (a) a mixed stream and conventional.
Purchase date N/A 1/1/97 1/1/2000 50. For Proposal 2, the cash flow pattern for the replacement (b) a mixed stream and non-conventional.
(old asset) project is (See Table 8.3.) (c) an annuity and conventional.
Sale proceeds N/A $50,000 $120,000 (a) a mixed stream and conventional. (d) an annuity and non-conventional.
(old asset) (b) a mixed stream and non-conventional.
57. For Proposal 3, the book value of the existing asset is
MACRS (old N/A 5 years 5 years (c) an annuity and conventional.
_________. (See Table 8.3.)
asset) (d) an annuity and non-conventional.
(a) $21,000
Annual net
profits before 51. For Proposal 2, the book value of the existing asset is (b) $43,000
_________. (See Table 8.3.) (c) $52,000
depreciation N/A $30,000 $25,000
& taxes (old) (a) $13,600 (d) $80,000
(b) $34,400
Annual net 58. For Proposal 3, the tax effect on the sale of the existing asset
profits before (c) $66,400 results in (See Table 8.3.)
(d) $80,000
depreciation $250,000 $100,000 $175,000 (a) $8,000 tax liability.
& taxes (new) 52. For Proposal 2, the tax effect on the sale of the existing asset
(b) $16,000 tax liability.
results in (See Table 8.3.)
*Not applicable (c) $20,000 tax liability.
(a) $12,000 tax liability.
(d) $23,200 tax liability.
46. For Proposal 1, the cash flow pattern for the expansion project (b) $14,560 tax liability.
is (See Table 8.3.) (c) $25,280 tax liability.
59. For Proposal 3, the initial outlay equals _________. (See Table 64. The book value of the existing asset is _________. (See Table 70. A corporation is evaluating the relevant cash flows for a capital
8.3.) 8.4.) budgeting decision and must estimate the terminal cash flow.
(a) $170,400 (a) $7,250 The proposed machine will be disposed of at the end of its
(b) $15,000 usable life of five years at an estimated sale price of $15,000.
(b) $211,000
The machine has an original purchase price of $80,000,
(c) $196,000 (c) $21,250
installation cost of $20,000, and will be depreciated under the
(d) $300,000 (d) $25,000 five-year MACRS. Net working capital is expected to decline by
65. The tax effect on the sale of the existing asset results in (See $5,000. The firm has a 40 percent tax rate on ordinary income
60. For Proposal 3, the incremental depreciation expense for year 3 Table 8.4.) and long-term capital gain. The terminal cash flow is
is _________. (See Table 8.3.)
(a) $800 tax benefit. (a) $24,000.
(a) $21,000
(b) $1,000 tax liability. (b) $16,000.
(b) $42,000
(c) $1,100 tax liability. (c) $14,000.
(c) $47,850
(d) $6,000 tax liability. (d) $26,000.
(d) $50,850
61. For Proposal 3, the incremental depreciation expense for year 6 66. The initial outlay equals _________. (See Table 8.4.) 71. A corporation is evaluating the relevant cash flows for a capital
is _________. (See Table 8.3.) (a) $41,100 budgeting decision and must estimate the terminal cash flow.
(a) $15,750 (b) $44,100 The proposed machine will be disposed of at the end of its
(b) $10,750 usable life of five years at an estimated sale price of $2,000. The
(c) $38,800
(c) $23,000 machine has an original purchase price of $80,000, installation
(d) $38,960 cost of $20,000, and will be depreciated under the five-year
(d) $36,150
MACRS. Net working capital is expected to decline by $5,000.
67. The incremental depreciation expense for year 1 is _________. The firm has a 40 percent tax rate on ordinary income and
62. For Proposal 3, the annual incremental after-tax cash flow from (See Table 8.4.)
operations for year 3 is _________. (See Table 8.3.) long-term capital gain. The terminal cash flow is
(a) $2,250 (a) $5,800.
(a) $45,000
(b) $7,600 (b) $7,800.
(b) $75,150
(c) $7,000 (c) $8,200.
(c) $90,150
(d) $7,950 (d) $6,200.
(d) $109,140
Table 8.4 68. The incremental depreciation expense for year 5 is _________. 72. All of the following are motives for capital budgeting
(See Table 8.4.) expenditures except
Cuda Marine Engines, Inc. must develop the relevant cash (a) expansion.
flows for a replacement capital investment proposal. The (a) $2,250
(b) $5,110 (b) replacement.
proposed asset costs $50,000 and has installation costs of
$3,000. The asset will be depreciated using a five-year (c) $7,950 (c) renewal.
recovery schedule. The existing equipment, which originally (d) $6,360 (d) invention.
cost $25,000 and will be sold for $10,000, has been
69. The annual incremental after-tax cash flow from operations for 73. All of the following are steps in the capital budgeting process
depreciated using an MACRS five-year recovery schedule and
year 1 is _________. (See except
three years of depreciation has already been taken. The new
Table 8.4.)
equipment is expected to result in incremental before-tax net (a) implementation.
profits of $15,000 per year. The firm has a 40 percent tax rate. (a) $13,950
(b) follow-up.
(b) $16,600
63. The cash flow pattern for the capital investment proposal is (See (c) transformation.
(c) $25,600
Table 8.4.) (d) decision-making.
(d) $30,000
(a) a mixed stream and conventional.
74. The evaluation of capital expenditure proposals to determine
(b) a mixed stream and non-conventional. whether they meet the firm’s minimum acceptance criteria is
(c) an annuity and conventional. called
(d) an annuity and non-conventional. (a) the ranking approach.
(b) an independent investment. (b) recaptured depreciation. 5. Among the reasons many firms use, the payback period as a
(c) the accept-reject approach. (c) a capital loss. guideline in capital investment decisions are all of the following
(d) a mutually exclusive investment. (d) book value. EXCEPT
(a) it gives an implicit consideration to the timing of cash
75. The ordering of capital expenditure projects on the basis of 81. If accounts receivable increase by $1,000,000, inventory flows.
some predetermined measure such as the rate of return is decreases by $500,000, and accounts payable increase by (b) it recognizes cash flows which occur after the payback
called $500,000, net working capital would period.
(a) the ranking approach. (a) decrease by $500,000. (c) it is a measure of risk exposure.
(b) an independent investment. (b) increase by $1,500,000. (d) it is easy to calculate.
(c) the accept-reject approach. (c) increase by $2,000,000. 6. Payback is considered an unsophisticated capital budgeting
(d) a mutually exclusive investment. (d) experience no change. technique, and as such
76. Cash outlays that had been previously made and have no effect (a) gives no consideration to the timing of cash flows and
on the cash flows relevant to a current decision are called 82. All of the following would be used in the computation of an therefore the time value of money.
investment’s initial investment except
(a) incremental historical costs. (b) gives no consideration to risk exposure.
(a) the annual after tax inflow expected from the investment. (c) does consider the timing of cash flows and therefore gives
(b) incremental past expenses.
(b) the initial purchase price of the investment. explicit consideration to the time value of money.
(c) opportunity costs foregone.
(c) the resale value of an old asset being replaced. (d) gives some implicit consideration to the timing of cash
(d) sunk costs.
(d) the tax on the sale of an old asset being replaced. flows and therefore the time value of money.
77. Cash flows that could be realized from the best alternative use 1. Examples of sophisticated capital budgeting techniques include
of an owned asset are called all of the following EXCEPT 7. Some firms use the payback period as a decision criterion or as a
supplement to sophisticated decision techniques, because
(a) incremental costs. (a) internal rate of return.
(a) it explicitly considers the time value of money.
(b) lost resale opportunities. (b) payback period.
(b) it can be viewed as a measure of risk exposure.
(c) opportunity costs. (c) annualized net present value.
(c) the determination of payback is an objectively determined
(d) sunk costs. (d) net present value.
criteria.
2. The _________ is the exact amount of time it takes the firm to
78. In international capital budgeting decisions, political risks can be (d) it can take the place of the net present value approach.
recover its initial investment.
minimized using all of the following strategies except
(a) average rate of return 8. A firm is evaluating a proposal which has an initial investment of
(a) structuring the investment as a joint venture and selecting
(b) internal rate of return $35,000 and has cash flows of $10,000 in year 1, $20,000 in year
well-connected local partner.
(c) net present value 2, and $10,000 in year 3. The payback period of the project is
(b) structuring the financing of such investments as equity
(d) payback period (a) 1 year.
rather than as debt.
(b) 2 years.
(c) structuring the financing of such investments as debt 3. Unsophisticated capital budgeting techniques do not
rather than as equity. (c) between 1 and 2 years.
(a) examine the size of the initial outlay. (d) between 2 and 3 years.
(d) None of the above.
(b) use net profits as a measure of return.
79. The portion of an asset’s sale price that is above its book value (c) explicitly consider the time value of money. 9. A firm is evaluating a proposal which has an initial investment of
and below its initial purchase price is called (d) take into account an unconventional cash flow pattern. $50,000 and has cash flows of $15,000 per year for five years.
The payback period of the project is
(a) a capital gain.
4. All of the following are weaknesses of the payback period (a) 1.5 years.
(b) recaptured depreciation.
EXCEPT (b) 2 years.
(c) a capital loss.
(a) a disregard for cash flows after the payback period. (c) 3.3 years.
(d) book value.
(b) only an implicit consideration of the timing of cash flows. (d) 4 years.
80. The portion of an asset’s sale price that is below its book value
and below its initial purchase price is called (c) the difficulty of specifying the appropriate payback period.
(d) it uses cash flows, not accounting profits.
(a) a capital gain.
10. A firm is evaluating three capital projects. The net (a) payback period (d) reject both.
present values for the projects are as follows: (b) average rate of return
19. The new financial analyst does not like the payback approach
Project NPV (c) cost of capital (Table 9.1) and determines that the firm’s required rate of
1 $100 (d) internal rate of return return is 15 percent. His recommendation would be to
2 $0 (a) accept projects A and B.
16. The _________ is the compound annual rate of return that the
3 –$100 firm will earn if it invests in the project and receives the given (b) accept project A and reject B.
cash inflows. (c) reject project A and accept B.
The firm should (a) discount rate (d) reject both.
(a) accept Projects 1 and 2 and reject Project 3. (b) internal rate of return A firm must choose from six capital budgeting proposals outlined
(b) accept Projects 1 and 3 and reject Project 2. (c) opportunity cost below. The firm is subject to capital rationing and has a capital budget
(c) accept Project 1 and reject Projects 2 and 3. of $1,000,000; the firm’s cost of capital is 15 percent.
(d) cost of capital
(d) reject all projects. 17. A firm with a cost of capital of 13 percent is evaluating three Table 9.2
capital projects. The internal rates of return are as follows:
11. Sophisticated capital budgeting techniques do not
Project Initial Investment IRR NPV
(a) examine the size of the initial outlay. Internal Rate
1 $200,000 19% $100,000
(b) use net profits as a measure of return. Project of Return
(c) explicitly consider the time value of money. 2 400,000 17 20,000
1 12%
(d) take into account an unconventional cash flow pattern. 2 15 3 250,000 16 60,000

3 13 4 200,000 12 –5,000
12. The minimum return that must be earned on a project in order
to leave the firm’s value unchanged is 5 150,000 20 50,000
The firm should 6 400,000 15 150,000
(a) the internal rate of return.
(a) accept Project 2 and reject Projects 1 and 3.
(b) the interest rate.
(b) accept Projects 2 and 3 and reject Project 1. 20. Using the internal rate of return approach to ranking projects,
(c) the discount rate.
(c) accept Project 1 and reject Projects 2 and 3. which projects should the firm accept? (See Table 9.2)
(d) the compound rate.
(d) accept Project 3 and reject Projects 1 and 2. (a) 1, 2, 3, 4, and 5
13. A firm would accept a project with a net present value of zero
(b) 1, 2, 3, and 5
because A firm is evaluating two projects that are mutually exclusive with initial
investments and cash flows as follows: (c) 2, 3, 4, and 6
(a) the project would maintain the wealth of the firm’s
owners. (d) 1, 3, 4, and 6
Table 9.1
(b) the project would enhance the wealth of the firm’s owners. 21. Using the net present value approach to ranking projects, which
(c) the return on the project would be positive. Project A Project B projects should the firm accept? (See Table 9.2)
(d) the return on the project would be zero. Initial End-of-Year Initial End-of-Year (a) 1, 2, 3, 4, and 5
Investment Cash Flows Investment Cash Flows (b) 1, 2, 3, 5, and 6
14. A firm is evaluating an investment proposal which has an initial
investment of $5,000 and cash flows presently valued at $4,000. $40,000 $20,000 $90,000 $40,000 (c) 2, 3, 4, and 5
The net present value of the investment is _________. 20,000 40,000 (d) 1, 3, 5, and 6
(a) –$1,000 20,000 80,000
22. When the net present value is negative, the internal rate of
(b) $0 return is _________ the cost of capital.
18. If the firm in Table 9.1 has a required payback of two (2) years,
(c) $1,000
they should (a) greater than
(d) $1.25
(a) accept projects A and B. (b) greater than or equal to
15. The _________ is the discount rate that equates the present (b) accept project A and reject B. (c) less than
value of the cash inflows with the initial investment. (c) reject project A and accept B. (d) equal to
23. A firm is evaluating two independent projects utilizing the (b) $40,320. 32. Comparing net present value and internal rate of return analysis
internal rate of return technique. Project X has an initial (c) $47,820. (a) always results in the same ranking of projects.
investment of $80,000 and cash inflows at the end of each of (d) $35,140. (b) always results in the same accept/reject decision.
the next five years of $25,000. Project Z has a initial investment
of $120,000 and cash inflows at the end of each of the next four (c) may give different accept/reject decisions.
27. The present value of the project’s annual cash flows is (See
years of $40,000. The firm should (d) is only necessary on mutually exclusive projects.
Table 9.3)
(a) accept both if their cost of capital is 15 percent at the (a) $ 47,820. 33. In comparing the internal rate of return and net present value
maximum.
(b) $ 42,820. methods of evaluation,
(b) accept only Z if their cost of capital is 15 percent at the
(c) $ 51,694. (a) internal rate of return is theoretically superior, but
maximum.
(d) $100,563. financial managers prefer net present value.
(c) accept only X if their cost of capital is 15 percent at the
(b) net present value is theoretically superior, but financial
maximum. 28. The net present value of the project is (See Table 9.3) managers prefer to use internal rate of return.
(d) reject both if their cost of capital is 12 percent at the
(a) $3,874. (c) financial managers prefer net present value, because it is
maximum.
(b) $2,445. presented as a rate of return.
Table 9.3
(c) $5,614. (d) financial managers prefer net present value, because it
Nuff Folding Box Company, Inc. is considering purchasing a new (d) $7,500. measures benefits relative to the amount invested.
gluing machine. The gluing machine costs $50,000 and requires 34. Unlike the net present value criteria, the internal rate of return
installation costs of $2,500. This outlay would be partially offset 29. The internal rate of return for the project is (See Table 9.3) approach assumes an interest rate equal to
by the sale of an existing gluer. The existing gluer originally cost (a) between 7 and 8 percent. (a) the relevant cost of capital.
$10,000 and is four years old. It is being depreciated under
(b) between 9 and 10 percent. (b) the project’s internal rate of return.
MACRS using a five-year recovery schedule and can currently
be sold for $15,000. The existing gluer has a remaining useful (c) greater than 12 percent. (c) the project’s opportunity cost.
life of five years. If held until year 5, the existing machine’s (d) between 10 and 11 percent. (d) the market’s interest rate.
market value would be zero. Over its five-year life, the new 30. The underlying cause of conflicts in ranking for projects by
machine should reduce operating costs (excluding internal rate of return and net present value methods is 35. When evaluating projects using internal rate of return,
depreciation) by $17,000 per year. Training costs of employees (a) the reinvestment rate assumption regarding intermediate (a) projects having lower early-year cash flows tend to be
who will operate the new machine will be a one-time cost of cash flows. preferred at higher discount rates.
$5,000 which should be included in the initial outlay. The new (b) projects having higher early-year cash flows tend to be
(b) that neither method explicitly considers the time value of
machine will be depreciated under MACRS using a five-year preferred at higher discount rates.
money.
recovery period. The firm has a 12 percent cost of capital and a (c) projects having higher early-year cash flows tend to be
40 percent tax on ordinary income and capital gains. (c) the assumption made by the IRR method that intermediate
cash flows are reinvested at the cost of capital. preferred at lower discount rates.
(d) the assumption made by the NPV method that (d) the discount rate and magnitude of cash flows do not
24. The payback period for the project is (See Table 9.3)
intermediate cash flows are reinvested at the internal rate affect internal rate of return.
(a) 2 years.
of return.
(b) 3 years. 36. Which of the following capital budgeting techniques ignores the
(c) between 3 and 4 years. 31. On a purely theoretical basis, the NPV is the better approach to time value of money?
(d) between 4 and 5 years. capital budgeting due to all the following reasons EXCEPT (a) Payback.
(a) that it measures the benefits relative to the amount (b) Net present value.
25. The tax effect of the sale of the existing asset is (See Table 9.3) invested. (c) Internal rate of return.
(a) a tax liability of $2,340. (b) for the reasonableness of the reinvestment rate (d) Two of the above.
(b) a tax benefit of $1,500. assumption.
(c) a tax liability of $3,320. (c) that there may be multiple solutions for an IRR 37. Which of the following statements is false?
(d) a tax liability of $5,320. computation. (a) If the payback period is less than the maximum acceptable
26. The initial outlay for this project is (See Table 9.3) (d) that it maximizes shareholder wealth. payback period, accept the project.
(a) $42,820.
(b) If the payback period is greater than the maximum 42. What is the NPV for the following project if its cost of capital is (d) None of the above.
acceptable payback period, reject the project. 15 percent and its initial after tax cost is $5,000,000 and it is
(c) If the payback period is less than the maximum expected to provide after-tax operating cash inflows of 47. Which capital budgeting method is most useful for evaluating
acceptable payback period, reject the project $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 the following project? The project has an initial after tax cost of
and $1,300,000 in year 4? $5,000,000 and it is expected to provide after-tax operating cash
(d) Two of the above.
(a) $1,700,000 flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000
38. Which of the following statements is false? in year 3 and $2,300,000 in year 4?
(a) If the payback period is greater than the maximum (b) $371,764
(a) NPV.
acceptable payback period, accept the project. (c) ($137,053)
(b) IRR.
(b) If the payback period is less than the maximum acceptable (d) None of the above
(c) Payback.
payback period, reject the project.
43. What is the NPV for the following project if its cost of capital is 0 (d) Two of the above.
(c) If the payback period is greater than the maximum
percent and its initial after tax cost is $5,000,000 and it is
acceptable payback period, reject the project.
expected to provide after-tax operating cash inflows of 48. There is sometimes a ranking problem among NPV and IRR
(d) Two of the above. $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 when selecting among mutually exclusive investments. This
and $1,300,000 in year 4? ranking problem only occurs when
39. What is the payback period for Tangshan Mining company’s new
project if its initial after tax cost is $5,000,000 and it is expected (a) $1,700,000. (a) the NPV is greater than the crossover point.
to provide after-tax operating cash inflows of $1,800,000 in year (b) $371,764. (b) the NPV is less than the crossover point.
1, $1,900,000 in year 2, $700,000 in year 3 and $1,800,000 in (c) $137,053. (c) the cost of capital is to the right of the crossover point.
year 4? (d) None of the above. (d) the cost of capital is to the left of the crossover point.
(a) 4.33 years. 49. Consider the following projects, X and Y, where the firm can only
(b) 3.33 years. 44. What is the NPV for the following project if its cost of capital is choose one. Project X costs $600 and has cash flows of $400 in
12 percent and its initial after tax cost is $5,000,000 and it is each of the next 2 years. Project B also costs $600, and
(c) 2.33 years.
expected to provide after-tax operating cash flows of generates cash flows of $500 and $275 for the next 2 years,
(d) None of the above. $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 respectively. Which investment should the firm choose if the
and ($1,300,000) in year 4? cost of capital is 10 percent?
40. Should Tangshan Mining company accept a new project if its
maximum payback is 3.5 years and its initial after tax cost is (a) $(1,494,336). (a) Project X.
$5,000,000 and it is expected to provide after-tax operating cash (b) $1,494,336. (b) Project Y.
inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 (c) Greater than zero. (c) Neither.
in year 3 and $1,800,000 in year 4? (d) Two of the above. (d) Not enough information to tell.)
(a) Yes. 45. What is the IRR for the following project if its initial after tax
(b) No. cost is $5,000,000 and it is expected to provide after-tax 50. Consider the following projects, X and Y where the firm can only
(c) It depends. operating cash inflows of $1,800,000 in year 1, $1,900,000 in choose one. Project X costs $600 and has cash flows of $400 in
year 2, $1,700,000 in year 3 and $1,300,000 in year 4? each of the next 2 years. Project B also costs $600, and
(d) None of the above.
(a) 15.57%. generates cash flows of $500 and $275 for the next 2 years,
41. Should Tangshan Mining company accept a new project if its respectively. Which investment should the firm choose if the
(b) 0.00%.
maximum payback is 3.25 years and its initial after tax cost is cost of capital is 25 percent?
(c) 13.57%.
$5,000,000 and it is expected to provide after-tax operating cash (a) Project X.
inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 (d) None of the above.
(b) Project Y.
in year 3 and $1,800,000 in year 4?
46. What is the IRR for the following project if its initial after tax (c) Neither.
(a) Yes. cost is $5,000,000 and it is expected to provide after-tax (d) Not enough information to tell.
(b) No. operating cash flows of ($1,800,000) in year 1, $2,900,000 in
(c) It depends year 2, $2,700,000 in year 3 and $2,300,000 in year 4?
(d) None of the above (a) 5.83%.
(b) 9.67%.
(c) 11.44%.