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?
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TRE"#ALSE
1. /apital budgeting uses financial criteria e!clusiely when ealuating pro"ects.
+012 3 4532 6oderate O782 1#91
2. /apital budgeting uses both financial and non9financial criteria when ealuating pro"ects.
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3. 6ost capital budgeting techni;ues focus on cash flows.
+012 : 4532 <asy O782 1#91
#. =ro"ect funding is a financing decision.
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$. =ro"ect funding is an inesting decision.
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%. :he decision concerning which assets to ac;uire to achiee an organi>ation?s ob"ecties is an
inesting decision.
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&. :he payback period ignores the time alue of money.
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'. +n organi>ation?s discount rate should be less than the organi>ation?s cost of capital.
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(. +n organi>ation?s discount rate should be e;ual to or e!ceed the organi>ation?s cost of capital.
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1). 5f the net present alue is positie, the actual return on a pro"ect e!ceeds the re;uired rate of
return.
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11. :he net present alue method proides the actual rate of return for a pro"ect.
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&
12. :he profitability inde! gauges the efficiency of a firm?s use of capital.
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13. 5f a pro"ect?s internal rate of return is greater than or e;ual to an organi>ation?s hurdle rate, the
pro"ect is considered to be an acceptable inestment.
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1#. 5f a pro"ect?s internal rate of return is greater than or e;ual to an organi>ation?s hurdle rate, the
pro"ect is considered to be an unacceptable inestment.
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1$. :he 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&. 4epreciation e!pense proides a ta! shield against the payment of ta!es.
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1'. :he ta! benefit from depreciation e!pense is the depreciation amount multiplied by the ta!
rate.
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1(. :he ta! benefit from depreciation e!pense is the depreciation amount diided by the ta! rate.
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2). @sing 6+/A1 depreciation for ta! purposes and straight9line depreciation for book purposes
will affect after9ta! cash flows during the life of a pro"ect.
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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. 5n a mutually inclusie pro"ect situation, if one pro"ect is chosen, all related pro"ects are also
chosen.
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2#. 5n 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$. 6anagers must often use multiple measures to effectiely rank capital pro"ects.
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2%. Aeinestment assumptions are different under each method of ranking capital pro"ects.
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2&. When considering risk, a manager will often use a "udgmental method of risk ad"ustment.
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2'. When using the risk9ad"usted discount rate method, a manager increases the rate used for
discounting future cash inflows.
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2(. When using the risk9ad"usted discount rate method, a manager increases the rate used for
discounting future cash outflows.
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3). =ostinestment audits can proide feedback of the accuracy of original cash flow estimates.
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31. =resent alue and future alue computations assume the use of compound interest.
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32. 3or an ordinary annuity, the first cash flow occurs at the end of the period.
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33. 3or an annuity due, the first cash flow occurs at the end of the period.
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(
3#. :he accounting rate of return considers the salage alue of an asset.
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3$. :he accounting rate of return considers the time alue of money.
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3%. +ccounting rate of return is based on cash flows.
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1)
CO+7LETION
1. :he ealuation of future long9range pro"ects to allocate resources effectiely and efficiently is
referred to as BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 capital budgeting
4532 <asy O782 1#91
2. + "udgment regarding an entity?s method of funding an inestment is considered to be a*n,
BBBBBBBBBBBBBBBBBBBBBBB decision.
+012 financing
4532 <asy O782 1#91
3. + "udgment regarding which assets an entity should ac;uire to achiee its stated ob"ecties is
considered to be a*n, BBBBBBBBBBBBBBBBBBBBBBB decision.
+012 inesting
4532 <asy O782 1#91
#. + 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 BBBBBBBBBBBBBBBBBBBBBBBBB.
+012 payback period
4532 <asy O782 1#92
$. :he 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 BBBBBBBBBBBBBBBBBBBBBBB.
+012 discount rate
4532 <asy O782 1#92
%. :he weighted aerage cost of an organi>ation?s arious sources of funds is referred to as
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 cost of capital
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&. + 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 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB method.
+012 net present alue
11
4532 <asy O782 1#93
'. + 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 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 profitability inde!
4532 <asy O782 1#93
(. :he 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
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 internal rate of return
4532 <asy O782 1#9#
1). :he rate of return specified as the lowest acceptable return on an inestment is referred to as
the BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 hurdle rate
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11. + decision regarding whether a capital pro"ect is desirable based upon some preiously
established minimum criteria is referred to as a*n,
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 screening decision
4532 <asy O782 1#9%
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, BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 preference decision
4532 <asy O782 1#9%
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 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 mutually e!clusie.
4532 6oderate O782 1#9%
1#. 5n a BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB pro"ect situation, if one pro"ect is chosen, all
related pro"ects are also chosen.
12
+012 mutually inclusie
4532 6oderate O782 1#9%
1$. :he process of determining the amount of change that must occur in a ariable before a
different decision would be made is referred to as BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 sensitiity analysis
4532 6oderate O782 1#9'
1%. When information on actual pro"ect results is gathered and compared to actual results, the
process is referred to as a*n, BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 postinestment audit
4532 <asy O782 1#9(
1&. :he 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
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB.
+012 accounting rate of return
4532 <asy O782 1#911
+LTI7LE C8OICE
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!
+012 + 4532 <asy O782 1#92
2. Which of the following capital budgeting techni;ues may potentially ignore part of a pro"ectCs
releant cash flows?
a. net present alue
b. internal rate of return
c. payback period
d. profitability inde!
+012 / 4532 <asy O782 1#92
13
3. 5n comparing two pro"ects, the BBBBBBBBBBB 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
+012 + 4532 <asy O782 1#92
#. 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
+012 4 4532 <asy O782 1#92
$. +ssume that a pro"ect consists of an initial cash outlay of D1)),))) followed by e;ual annual
cash inflows of D#),))) for # years. 5n the formula - E D1)),)))FD#),))), - represents the
a. payback period for the pro"ect.
b. profitability inde! of the pro"ect.
c. internal rate of return for the pro"ect.
d. pro"ectCs discount rate.
+012 + 4532 <asy O782 1#92
%. +ll other factors e;ual, a large number is preferred to a smaller number for all capital pro"ect
ealuation measures e9&ept
a. net present alue.
b. payback period.
c. internal rate of return.
d. profitability inde!.
+012 7 4532 <asy O782 1#92
&. :he payback method assumes that all cash inflows are reinested to yield a return e;ual to
a. the discount rate.
b. the hurdle rate.
c. the internal rate of return.
d. >ero.
+012 4 4532 <asy O782 1#9%
1#
'. :he payback method measures
a. how ;uickly inestment dollars may be recoered.
b. the cash flow from an inestment.
c. the economic life of an inestment.
d. the profitability of an inestment.
+012 + 4532 <asy O782 1#9%
(. 5f inestment + has a payback period of three years and inestment 7 has a payback period of
four years, then
a. + is more profitable than 7.
b. + is less profitable than 7.
c. + and 7 are e;ually profitable.
d. the relatie profitability of + and 7 cannot be determined from the information
gien.
+012 4 4532 <asy O782 1#92
1). :he payback period is the
a. length of time oer which the inestment will proide cash inflows.
b. length of time oer which the initial inestment is recoered.
c. shortest length of time oer which an inestment may be depreciated.
d. shortest length of time oer which the net present alue will be positie.
+012 7 4532 <asy O782 1#92
1$
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
+012 + 4532 <asy O782 1#9%
12. :he time alue of money is e!plicitly recogni>ed through the process of
a. interpolating.
b. discounting.
c. annuiti>ing.
d. budgeting.
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13. :he time alue of money is considered in long9range inestment decisions by
a. assuming e;ual annual cash flow patterns.
b. inesting only in short9term pro"ects.
c. assigning greater alue to more immediate cash flows.
d. ignoring depreciation and ta! implications of the inestment.
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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
+012 + 4532 <asy O782 1#93
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.
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1%
1%. 5n a discounted cash flow analysis, which of the following would n,t be consistent with
ad"usting a pro"ectCs cash flows to account for higher9than9normal 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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1&
1&. When a pro"ect has uneen pro"ected cash inflows oer its life, an analyst may be forced to
use BBBBBBB to find the pro"ectCs internal rate of return.
a. a screening decision
b. a trial9and9error approach
c. a post inestment audit
d. a time line
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1'. :he 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.
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1(. + firmCs discount rate is typically based on
a. the interest rates related to the firmCs bonds.
b. a pro"ectCs internal rate of return.
c. its cost of capital.
d. the corporate +a bond yield.
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2). 5n capital budgeting, a firmCs 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!.
+012 / 4532 <asy O782 1#92
21. :he 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 corporationCs short9term debt.
+012 7 4532 <asy O782 1#93
1'
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
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1(
23. :o 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.
+012 + 4532 <asy O782 1#92
2#. + change in the discount rate used to ealuate a specific pro"ect will affect the pro"ectCs
a. life.
b. payback period.
c. net present alue.
d. total cash flows.
+012 / 4532 <asy O782 1#9%
2$. 3or a pro"ect such as plant inestment, the return that should leae the market price of the
firmCs stock unchanged is known as the
a. cost of capital.
b. net present alue.
c. payback rate.
d. internal rate of return.
+012 + 4532 6oderate O782 1#9$
2%. :he pre9ta! cost of capital is higher than the after9ta! 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.
+012 + 4532 <asy O782 1#9$
2&. :he basis for measuring the cost of capital deried from bonds and preferred stock,
respectiely, is the
a. pre9ta! rate of interest for bonds and stated annual diidend rate less the e!pected
earnings per share for preferred stock.
b. pre9ta! rate of interest for bonds and stated annual diidend rate for preferred
stock.
c. after9ta! rate of interest for bonds and stated annual diidend rate less the e!pected
earnings per share for preferred stock.
d. after9ta! rate of interest for bonds and stated annual diidend rate for preferred
stock.
2)
+012 4 4532 6oderate O782 1#9$
2'. :he combined weighted aerage interest rate that a firm incurs on its long9term debt, preferred
stock, and common stock is the
a. cost of capital.
b. discount rate.
c. cutoff rate.
d. internal rate of return.
+012 + 4532 <asy O782 1#92
21
2(. :he 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.
+012 7 4532 <asy O782 1#92
3). 4ebt 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.
+012 4 4532 6oderate O782 1#92
31. :he 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.
+012 7 4532 <asy O782 1#92
32. :he BBBBBBBBBBBBBBBBBBB 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
+012 4 4532 6oderate O782 1#9%
33. 5f 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.
22
+012 / 4532 <asy O782 1#93
3#. :he salage alue of an old lathe is >ero. 5f instead, the salage alue of the old lathe was
D2),))), what would be the impact on the net present alue of the proposal to purchase a new
lathe?
a. 5t would increase the net present alue of the proposal.
b. 5t would decrease the net present alue of the proposal.
c. 5t 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.
+012 + 4532 <asy O782 1#93
23
3$. :he net present alue method of ealuating proposed inestments
a. measures a pro"ectCs 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.
+012 4 4532 <asy O782 1#93
3%. Which of the following statements is true regarding capital budgeting methods?
a. :he 3isher rate can neer e!ceed a companyCs cost of capital.
b. :he 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. :he net present alue method of pro"ect ealuation will always proide the same
ranking of pro"ects as the profitability inde! method.
d. :he net present alue method assumes that all cash inflows can be reinested at the
pro"ectCs cost of capital.
+012 4 4532 <asy O782 1#93
3&. 5f 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 91.
d. be undefined.
+012 7 4532 <asy O782 1#93
3'. 5f the profitability inde! for a pro"ect e!ceeds 1, then the pro"ectCs
a. net present alue is positie.
b. internal rate of return is less than the pro"ectCs discount rate.
c. payback period is less than $ years.
d. accounting rate of return is greater than the pro"ectCs internal rate of return.
+012 + 4532 <asy O782 1#93
3(. 5f a pro"ectCs profitability inde! is less than 1, the pro"ectCs
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.
+012 4 4532 <asy O782 1#93
2#
#). :he 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 doesnCt use discounted alues.
d. a mandatory techni;ue when capital rationing is used.
+012 7 4532 <asy O782 1#93
2$
#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
+012 / 4532 6oderate O782 1#93
#2. 5f the total cash inflows associated with a pro"ect e!ceed the total cash outflows associated
with the pro"ect, the pro"ectCs
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.
+012 7 4532 <asy O782 1#9#
#3. :he 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.
+012 7 4532 <asy O782 1#9%
##. 5f 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.
+012 + 4532 <asy O782 1#9%
#$. :he rate of interest that produces a >ero net present alue when a pro"ectCs discounted cash
operating adantage is netted against its discounted net inestment is the
a. cost of capital.
b. discount rate.
c. cutoff rate.
d. internal rate of return.
+012 4 4532 <asy O782 1#9#
2%
#%. 3or a profitable company, an increase in the rate of depreciation on a specific pro"ect could
a. increase the pro"ectCs profitability inde!.
b. increase the pro"ectCs payback period.
c. decrease the pro"ectCs net present alue.
d. increase the pro"ectCs internal rate of return.
+012 4 4532 6oderate O782 1#9$
2&
#&. 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
+012 4 4532 <asy O782 1#9#
#'. 5f the discount rate that is used to ealuate a pro"ect is e;ual to the pro"ectCs internal rate of
return, the pro"ectCs BBBBBBBBBBBBB is >ero.
a. profitability inde!
b. internal rate of return
c. present alue of the inestment
d. net present alue
+012 4 4532 <asy O782 1#9#
#(. +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 firmCs cost of capital is high or
low.
+012 7 4532 6oderate O782 1#9$
$). When a profitable corporation sells an asset at a loss, the after9ta! cash flow on the sale will
a. e!ceed the pre9ta! cash flow on the sale.
b. be less than the pre9ta! cash flow on the sale.
c. be the same as the pre9ta! cash flow on the sale.
d. increase the corporationCs oerall ta! liability.
+012 + 4532 6oderate O782 1#9$
$1. 5n a typical *conseratie assumptions, after9ta! discounted cash flow analysis, depreciation
e!pense is assumed to accrue at
a. the beginning of the period.
b. the middle of the period.
c. the end of the period.
d. irregular interals oer the life of the inestment.
2'
+012 / 4532 <asy O782 1#9$
$2. :he pre9ta! and after9ta! cash flows would be the same for all of the following items e9&ept
a. the li;uidation of working capital at the end of a pro"ectCs life.
b. the initial *outlay, cost of an inestment.
c. the sale of an asset at its book alue.
d. a cash payment for salaries and wages.
+012 4 4532 <asy O782 1#9$
2(
$3. :he after9ta! net present alue of a pro"ect is affected by
a. ta!9deductible cash flows.
b. non9ta!9deductible cash flows.
c. accounting accruals.
d. all of the aboe.
+012 4 4532 6oderate O782 1#9$
$#. + pro"ectCs after9ta! net present alue is increased by all of the following e9&ept
a. reenue accruals.
b. cash inflows.
c. depreciation deductions.
d. e!pense accruals.
+012 + 4532 <asy O782 1#9$
$$. 6ultiplying the depreciation deduction by the ta! rate yields a measure of the depreciation ta!
a. shield.
b. benefit.
c. payable.
d. loss.
+012 7 4532 <asy O782 1#9$
$%. +nnual after9ta! corporate net income can be conerted to annual after9ta! 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*19 t, depreciation deductionH, where t is the corporate
ta! rate.
+012 + 4532 <asy O782 1#9$
$&. 5ncome 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.
+012 4 4532 <asy O782 1#9$
$'. Which of the following best represents a screening decision?
3)
a. determining which pro"ect has the highest net present alue
b. determining if a pro"ectCs internal rate of return e!ceeds the firmCs cost of capital
c. determining which pro"ects are mutually e!clusie
d. determining which are the best pro"ects
+012 7 4532 <asy O782 1#9%
$(. Which of the following are ta! deductible under @.1. ta! law?
a. interest payments to bondholders
b. preferred stock diidends
c. common stock diidends
d. all of the aboe
+012 + 4532 <asy O782 1#9$
%). 1ensitiity analysis is
a. an appropriate response to uncertainty in cash flow pro"ections.
b. useful in measuring the ariance of the 3isher rate.
c. typically conducted in the post inestment audit.
d. useful to compare pro"ects re;uiring astly different leels of initial inestment.
+012 + 4532 6oderate O782 1#9'
%1. 5f 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.
+012 / 4532 <asy O782 1#9%
%2. +ll other factors e;ual, which of the following would affect a pro"ectCs 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
+012 / 4532 <asy O782 1#9%
%3. Hopwood /orporation bought a piece of machinery. 1elected data is presented below2
@seful life % years
Iearly net cash inflow D#$,)))
31
1alage alue 9 ) 9
5nternal rate of return 1'J
/ost of capital 1#J
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
:he initial cost of the machinery was
a. D1$&,3(2.
b. D1&#,((2.
c. D1%$,'12.
d. impossible to determine from the information gien.
+012 +
@se =K of +nnuity for % years and
1'J
D#$,))) L 3.#(&% E D1$&,3(2
4532 6oderate O782 1#9#
32
%#. 4atasoft 5ndustries is considering the purchase of a D1)),))) machine that is e!pected to
result in a decrease of D1$,))) per year in cash e!penses. :his machine, which has no residual
alue, has an estimated useful life of 1) years and will be depreciated on a straight9line basis.
3or this machine, the accounting rate of return would be
a. 1) percent.
b. 1$ percent.
c. 3) percent.
d. 3$ percent.
+012 /
D1$,)))F*D1)),)))F2, E
3)J
4532 6oderate O782 1#9$
%$. +n inestment pro"ect is e!pected to yield D1),))) in annual reenues, has D2,))) in fi!ed
costs per year, and re;uires an initial inestment of D$,))). 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$
+012 +
0et cash flow E D1),))) 9 D%,))) 9
D2,)))
0et cash flow E D2,)))
D$,)))FD2,))) E 2.$) years
4532 6oderate O782 1#92
%%. + pro"ect has an initial cost of D1)),))) and generates a present alue of net cash inflows of
D12),))). What is the pro"ectCs profitability inde!?
a. .2)
b. 1.2)
c. .')
d. $.))
+012 7
=rofitability 5nde! E D12),)))FD1)),))) E
1.2)
33
4532 6oderate O782 1#93
3#
%&. /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
D1),))) *after9ta!,. /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 pre9ta! amount of the
cash flow in year #? *Aound to the nearest dollar., 7re$ent (alue ta)le$ ,r a %inan&ial
&al&ulat,r are re:uired;
a. D1$,1'1
b. D23,3$%
c. D(,'%'
d. D#3,3&$
+012 7
D1),))) F).%$ E D1$,3'#.%1
@se =K :able for # years, 11J. /onstant E
).%$'&
D1$3'#.%1 F ).%$'& E D23,3$%.
4532 4ifficult O782 1#9$
Sea6,rth' C,rp,rati,n
1eaworthy /orporation is considering the purchase of a new ocean9going essel that could
potentially reduce labor costs of its operation by a considerable margin. :he new ship would
cost D$)),))) and would be fully depreciated by the straight9line method oer 1) years. +t the
end of 1) years, the ship will hae no alue and will be scuttled. 1eaworthy /ompany?s cost
of capital is 12 percent, and its marginal ta! rate is #) percent.
%'. Aefer to 1eaworthy /orporation. What is the present alue of the depreciation ta! benefit of
the new ship? *Aound to the nearest dollar., 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r
are re:uired;
a. D113,))#
b. D2'2,$1)
c. D1%(,$)%
d. D2)),)))
+012 +
+nnual depreciation E D$),)))
:a! saings E D2),)))
@se =K of +nnuity table 1) years, 12JN /onstant E
$.%$)2
D2),))) L $.%$)2 E D113,))#
4532 4ifficult O782 1#9$
3$
%(. Aefer to 1eaworthy /orporation. 5f the ship produces e;ual annual labor cost saings oer its
1)9year life, how much do the annual saings in labor costs need to be to generate a net
present alue of D) on the pro"ect? *Aound to the nearest dollar., 7re$ent (alue ta)le$ ,r a
%inan&ial &al&ulat,r are re:uired;
a. D%',#(2
b. D11#,1$#
c. D'',#(2
d. D1#&,#'&
+012 /
0=K of Labor 1aings E D$)),)))
@se =K of +nnuity :able 1) years, 12JN /onstant E
$.%$)2
D$)),))) F $.%$)2 E D'',#(2
4532 4ifficult O782 1#9$
&). 1tone /orporation recently sold a used machine for D#),))). :he machine had a book alue
of D%),))) at the time of the sale. What is the after9ta! cash flow from the sale, assuming the
companyCs marginal ta! rate is 2) percent?
a. D#),)))
b. D%),)))
c. D##,)))
d. D32,)))
+012 /
Loss of D2),))) generates a ta! saings of D#,))) *D2),))) L
2)J,
=roceeds O :a! 1aings E +fter9ta! cash flow
D#),))) O D#,))) E D##,)))
4532 6oderate O782 1#9$
#le5ing C,5pan'
3leming /ompany is considering an inestment in a machine that would reduce annual labor
costs by D3),))). :he machine has an e!pected life of 1) years with no salage alue. :he
machine would be depreciated according to the straight9line method oer its useful life. :he
companyCs marginal ta! rate is 3) percent.
3%
&1. Aefer to 3leming /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? 7re$ent (alue
ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D1'),)))
b. D21),)))
c. D1'&,$))
d. D1##,((%
+012 4
@se =K of +nnuity :ableN 1) years, 1%JN /onstant E
#.'33)
D3),))) L #.'33) E D1##,#(%
4532 6oderate O782 1#9#
&2. Aefer to 3leming /ompany. +ssume the company pays D2$),))) for the machine. What is the
e!pected internal rate of return on the machine? 7re$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
+012 7
D2$),)))FD3),))) E '.33
@sing =K of +nnuity :able and 1) years, this constant falls between 3J
and #J
4532 6oderate O782 1#9#
&3. + pro"ect under consideration by /lose /orporation would re;uire a working capital
inestment of D2)),))). :he working capital would be li;uidated at the end of the pro"ectCs
1)9year life. 5f /lose /orporation has an after9ta! 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)? 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D3%,'%'
b. D&&,1))
c. D$3,(&)
d. D23,13)
3&
+012 7
:he return of capital is ta!9free.
@se =K of D1 1) years, 1)JN /onstant E
).3'$$
D2)),))) L ).3'$$ E D&&,1))
4532 6oderate O782 1#9$
3'
&#. 7iggs 5ndustries is considering two alternatie ways to depreciate a proposed inestment. :he
inestment has an initial cost of D1)),))) and an e!pected fie9year life. :he two alternatie
depreciation schedules follow2
6ethod 1 6ethod 2
Iear 1 depreciation D2),))) D#),)))
Iear 2 depreciation D2),))) D3),)))
Iear 3 depreciation D2),))) D2),)))
Iear # depreciation D2),))) D1),)))
Iear $ depreciation D2),))) D)
+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? 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D&,1(%
b. D)
c. D2,'&'
d. D%,3#2
+012 /
Iear 4ifference
in
4epreciatio
n
+fter9:a!
4ifference
=K of D1
:able Kalue
4iscounted
Kalue
1 D 2),))) D ',))) ).()(1 D &,2&2
2 D 1),))) D #,))) ).'2%$ D 3,3)%
3 D 9)9 D )9 ).&$13 D 9)9
# D*1),))), D*#,))), ).%'3) D*2,&32,
$ D*2),))), D*',))), ).%2)( D*#,(%&,
:otal D 2,'&'
EEEEEE
4532 4ifficult O782 1#9$
Sea)ree<e Creati,n$
1eabree>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. :he computer would cost
D2),))) and hae an e!pected life of eight years. :he computer is e!pected to generate
additional annual net cash receipts *before9ta!, of D%,))) per year. :he computer will be
depreciated according to the straight9line method and the firmCs marginal ta! rate is 2$
percent.
3(
&$. Aefer to 1eabree>e /reations. What is the after9ta! payback period for the computer pro"ect?
a. &.%2 years
b. 3.() years
c. #.## years
d. 3.11 years
+012 7
=ayback =eriod E 5nestmentF+fter9:a! /ash 3lows
+fter :a! /ash 3lows E G*%,))) L).&$, O *2,$)) L).2$,H E
D$,12$
=ayback =eriod E D2),)))FD$,12$ E 3.() years
4532 6oderate O782 1#92,1#9$
&%. Aefer to 1eabree>e /reations. What is the after9ta! net present alue of the proposed pro"ect
*using a 1% percent discount rate,? 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are
re:uired;
a. D2,2%1
b. D*#$#,
c. D%,)%2
d. D*#,&(&,
+012 +
@se =K of +nnuity :able 1%J, ' yearsN /onstant E
#.3#3%
+fter9ta! inflows ED$,12$ L #.3#3% E D 22,2%1
D22,2%1 9 D2),))) E D2,2%1
4532 6oderate O782 1#93
=e))er C,rp,rati,n
Webber /orporation is considering an inestment in a labor9saing machine. 5nformation on
this machine follows2
/ost D3),)))
1alage alue in fie years D)
<stimated life $ years
+nnual depreciation D%,)))
+nnual reduction in e!isting costs D',)))
&&. Aefer to Webber /orporation. What is the internal rate of return on this pro"ect *round to the
nearest 1F2J,? 7re$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
+012 /
5AA E D3),))) F D',))) E 3.&$
@sing =K of +nnuity :able $ years. :he constant of 3.&$ corresponds to a rate of
1).$J
4532 6oderate O782 1#9#
&'. Aefer to Hefty 5nestment. +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"ectCs net present alue? 7re$ent
(alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D*%,2'3,
b. D*3,')%,
c. D*23,#$1,
d. D*22,))),
+012 7
@se =K of +nnuity :able 1%J, $ years. /orresponding constant is 3.2&#3
+nnual reduction in costs D',))) L 3.2&#3 D 2%,1(#
5nestment *3),))),
0et =resent Kalue * 3,')%,
EEEEEEE
4532 6oderate O782 1#93
&(. Aefer to Hefty 5nestment. What is the payback period on this inestment?
a. # years
b. 2.1# years
c. 3.&$ years
d. $ years
+012 /
=ayback =eriod E 5nitial 5nestmentF/ash
1aings
E D3),)))FD',)))
E 3.&$ years
4532 6oderate O782 1#92
#1
Ru$t,n Ir,n6,r>$
Auston 5ronworks is considering a proposal to sell an e!isting lathe and purchase a new
computer9operated lathe. 5nformation on the e!isting lathe and the computer9operated lathe
follow2
<!isting
lathe
/omputer9operated
lathe
/ost D1)),))) D3)),)))
+ccumulated depreciation %),))) )
1alage alue now 2),)))
1alage alue in # years ) %),)))
+nnual depreciation 1),))) &$,)))
+nnual cash operating costs 2)),))) $),)))
Aemaining useful life # years # years
#2
'). Aefer to Auston 5ronworks. What is the payback period for the computer9operated lathe?
a. 1.'& years
b. 2.)) years
c. 3.$3 years
d. 3.2( years
+012 +
=ayback =eriod E G*0ew Lathe /ost 9 Old Lathe 1alage,F/ost 1aings from 0ew
LatheH
=ayback =eriod E G*3)),))) 9 2),))),F1$),)))H E 1.'& years
4532 6oderate O782 1#92
'1. Aefer to Auston 5ronworks. 5f the company uses 1) percent as its discount rate, what is the net
present alue of the proposed new lathe purchase? 7re$ent (alue ta)le$ ,r a %inan&ial
&al&ulat,r are re:uired;
a. D23%,#%$
b. D2$%,#%$
c. D1($,#'$
d. D3),#22
+012 +
+mount
=K :able
/onstant =resent Kalue
+nnual /ost
1aings
D 1$),))) 3.1%(( D #&$,#'$
1alage Kalue %),))) ).%'3) #),(')
5nitial 5nestment *2'),))), 1.)))) *2'),))),
0et =resent Kalue D 23%,#%$
EEEEEEEE
4532 6oderate O782 1#93
=,rtha5 C,rp,rati,n
:he Wortham /orporation has recently ealuated a proposal to inest in cost9reducing
production technology. +ccording to the ealuation, the pro"ect would re;uire an initial
inestment of D1&,1%% and would proide e;ual annual cost saings for fie years. 7ased on a
1) percent discount rate, the pro"ect generates a net present alue of D1,&''. :he pro"ect is not
e!pected to hae any salage alue at the end of its fie9year life.
#3
'2. Aefer to Wortham /orporation. What are the e!pected annual cost saings of the pro"ect?
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D3,$))
b. D#,)))
c. D#,$))
d. D$,)))
+012 4
0et =resent Kalue E D 1,&''
5nitial 5nestment E 1&,1%%
=K of /ash 5nflows E 1',($#
@se =K of +nnuity :able *$ years, 1)J discount,N /onstant E
3.&()'
D1',($# F 3.&()' E D$,)))
4532 6oderate O782 1#93
'3. Aefer to Wortham /orporation. What is the pro"ectCs e!pected internal rate of return? 7re$ent
(alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. 1)J
b. 11J
c. 13J
d. 1#J
+012 4
5AA E 1&,1%%F$,))) E 3.#332
@se =K of +nnuity table $ years
/onstant corresponds to an 5AA of
1#J
4532 6oderate O782 1#9#
Rh,de$ C,rp,rati,n
Ahodes /orporation is inoled in the ealuation of a new computer9integrated manufacturing
system. :he system has a pro"ected initial cost of D1,))),))). 5t has an e!pected life of si!
years, with no salage alue, and is e!pected to generate annual cost saings of D2$),))).
7ased on Ahodes /orporationCs analysis, the pro"ect has a net present alue of D$&,%2$.
'#. Aefer to Ahodes /orporation. What discount rate did the company use to compute the net
present alue? 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. 1)J
b. 11J
c. 12J
##
d. 13J
+012 7
0=K E D $&,%2$
5nitial /ost E D1,))),)))
=K of /ash 5nflows E D1,)$&,%2$
+nnual /ost 1aings ED 2$),)))
D1,)$&,%2$FD2$),))) E #.23)$ =K of +nnuity /onstant
+t % years, the constant corresponds to a discount rate of
11J.
4532 6oderate O782 1#93
'$. Aefer to Ahodes /orporation. What is the pro"ectCs profitability inde!?
a. 1.)$'
b. .)$'
c. .(#$
d. 1.)))
+012 +
=5 E D1,)$&,%2$F1,))),))) E
1.)$'
4532 6oderate O782 1#93
'%. Aefer to Ahodes /orporation. What is the pro"ectCs internal rate of return? 7re$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
+012 +
D1,))),)))FD2$),))) E #.)))
@sing the =resent Kalue of +nnuity :able for % years, the rate falls between
12.$J and 13J
4532 6oderate O782 1#9#
'&. /arol 8ones recently inested in a pro"ect that promised an internal rate of return of 1$
percent. 5f the pro"ect has an e!pected annual cash inflow of D12,))) for si! years, with no
salage alue, how much did /arol pay for the pro"ect?
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
#$
a. D3$,)))
b. D#$,#1#
c. D&2,)))
d. D31,&)'
+012 7
@se =resent Kalue of +nnuity :able *%
years,1$J,
D12,))) L 3.&'#$ E D#$,#1#
4532 6oderate O782 1#9#
''. 8ohn 7rowning recently inested in a pro"ect that has an e!pected annual cash inflow of
D&,))) for 1) years, and an e!pected payback period of 3.% years. How much did 8ohn inest
in the pro"ect?
a. D1(,###
b. D3%,)))
c. D2$,2))
d. D#),)))
+012 /
!FD&,))) E 3.% years
! E D2$,2))
4532 6oderate O782 1#92
'(. :he Aand /orporation is considering an inestment in a pro"ect that generates a profitability
inde! of 1.3. :he present alue of the cash inflows on the pro"ect is D##,))). What is the net
present alue of this pro"ect?
a. D1),1$#
b. D13,2))
c. D$&,2))
d. D33,'#%
+012 +
=K /ash 5nflowsF/ash Outflows E =rofitability
5nde!
D##,)))F/ash Outflows E 1.3
D##,)))F1.3 E D33,'#%
=K /ash 5nflows 9 /ash Outflows E 0et =resent
Kalue
D##,))) 9 D33,'#% E D1),1$#
#%
4532 6oderate O782 1#93
(). 5f 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.
+012 / 4532 <asy O782 1#91)
(1. 3uture alue is the
a. sum of dollars9in discounted to time >ero.
b. sum of dollars9out discounted to time >ero.
c. difference of dollars9in and dollars9out.
d. alue of dollars9in minus dollars9out for future periods ad"usted for any interest9
compounding factor.
+012 4 4532 6oderate O782 1#91)
(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.
+012 + 4532 <asy O782 1#91)
(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
+012 + 4532 <asy O782 1#91)
#&
(#. +ssume that - represents a sum of money that 7ill has aailable to inest in a pro"ect that will
yield a return of r. 5n the formula I E -*1 O r,, I represents the
a. future alue of - in one period.
b. future alue interest factor associated with r.
c. present alue of -.
d. present alue interest factor associated with r.
+012 + 4532 <asy O782 1#91)
($. :he 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
+012 4 4532 <asy O782 1#911
(%. 5n computing the accounting rate of return, the BBBBBBBBBB leel of inestment should be
used as the denominator.
a. aerage
b. initial
c. residual
d. cumulatie
+012 + 4532 <asy O782 1#911
C,d'?$ Retail
/ody?s Aetail is considering an inestment in a deliery truck. /ody has found a used truck
that he can purchase for D',))). He estimates the truck would last si! years and increase his
storeCs net cash reenues by D2,))) 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 straight9line
method.
(&. Aefer to /odyCs Aetail. 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
#'
+012 7
D2,)))FD#,))) E $)J
+erage 5nestment E *D',))) O ),F2 E
D#,)))
4532 6oderate O782 1#911
#(
('. Aefer to /odyCs Aetail. What is the payback period on the inestment in the new truck?
a. 12 years
b. % years
c. # years
d. 2 years
+012 /
D',)))FD2,))) E # years
4532 6oderate O782 1#92
((. Linda 1mith borrows D$),))) from her bank on 8anuary 1. 1he 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? 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D1,%%&
b. D#,2))
c. D2,'%$
d. D$,3)#
+012 4
@sing the =resent Kalue of +nnuity :able *1)J, 3) years,, the constant is
(.#2%(.
D$),)))F(.#2%( E D$,3)#
4532 6oderate O782 1#91)
1)). Willard 7oone has "ust turned %$. He has D1)),))) to inest in a retirement annuity. One
inestment company has offered to pay Willard D1),))) per year for 1$ years *payments to
begin in one year, in e!change for an immediate D1)),))) payment. 5f Willard accepts the
offer from the inestment company, what is his e!pected return on the D1)),))) inestment
*assume a return that is compounded annually,? 7re$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
+012 +
D1)),)))FD1),))) E 1).))) =K of annuity :able 3actor
3or 1$ years, this factor represents a return on inestment between $ and %
percent.
$)
4532 6oderate O782 1#91)
1)1. Mleason +rmored /ar /o. is considering the ac;uisition of a new armored truck. :he truck is
e!pected to cost D3)),))). :he companyCs discount rate is 12 percent. :he firm has
determined that the truck generates a positie net present alue of D1&,)22. Howeer, the firm
is uncertain as to whether its has determined a reasonable estimate of the salage alue of the
truck. 5n computing the net present alue, the company assumed that the truck would be
salaged at the end of the fifth year for D%),))). What e!pected salage alue for the truck
would cause the inestment to generate a net present alue of D)? 5gnore ta!es. 7re$ent (alue
ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. D3),)))
b. D)
c. D$$,2&'
d. D#2,(&'
+012 +
@sing the =resent Kalue of D1 table *12J and $ years,, the constant is ).$%&#.
D1&,)22F).$%&# E D3),))) salage alue that would yield a salage alue of ).
4532 6oderate O782 1#93
1)2. 1teele =ublishers is considering an inestment that would re;uire an initial cash outlay of
D#)),))) and would hae no salage alue. :he pro"ect would generate annual cash inflows
of D&$,))). :he firmCs discount rate is ' percent. How many years must the annual cash flows
be generated for the pro"ect to generate a net present alue of D)? 7re$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
+012 /
D#)),))) F D&$,))) E $.33
@sing the =resent Kalue of an +nnuity at 'J, the constant falls between & and '
years.
4532 6oderate O782 1#93
1)3. + capital budget is used by management to determine
in what to inest how much to inest
$1
a. no no
b. no yes
c. yes no
d. yes yes
+012 4 4532 <asy O782 1#91
1)#. :he 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.
+012 / 4532 <asy O782 1#91
$2
S8ORT ANS=ER
1. 5n a net present alue analysis, how can an analyst e!plicitly and formally consider the
influence of risk on the present alue of certain cash flows?
+012
+n analyst could do at least three different things to e!plicitly account
for risk. :he analyst could2 *1, ad"ust the discount rate to reflect the risk of the cash flow, *2,
ad"ust the discounting period of the cash flow, or *3, ad"ust the e!pected amount of the cash
flow up or down to reflect the risk.
4532 6oderate O782 1#9'
2. What factors influence the present alue of the depreciation ta! benefit?
+012
:he depreciation ta! benefit is primarily affected by three factors2 the depreciation rate or
method, the ta! rate, and the discount rate.
4532 6oderate O782 1#9$
3. Why is it important for managers to be able to rank pro"ects?
+012
6anagers need to be able to rank pro"ects for two primary reasons. 3irst, 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,. 1econd, 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.
4532 6oderate O782 1#9&
#. 5f 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?
+012
5t 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,.
4532 6oderate O782 1#91
$. 4oes a pro"ect that generates a positie internal rate of return also hae a positie net present
alue? <!plain.
+012
$3
0o. + positie 5AA does not necessarily mean that a pro"ect will also hae a positie 0=K.
Only if the 5AA is greater than the discount rate that is used in the 0=K calculation will the
0=K be positie.
4532 6oderate O782 1#9%
%. Why is the profitability inde! a better basis than net present alue to compare pro"ects that
re;uire different leels of inestment?
+012
:he profitability inde! relates the magnitude of the net present alue to the magnitude of the
initial inestment. :hus, the =5 gies some indication of relatie profitability. :he 0=K itself
proides no direct indication of the leel of inestment that is re;uired to generate the 0=K
and therefore proides no indication of relatie profitability.
4532 6oderate O782 1#9%
&. 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?
+012
:he accounting rate of return has two ma"or adantages relatie to the other capital budgeting
techni;ues. 3irst, 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 AO5 or A5 basis. 1econd, the accounting rate of return can be generated
from accounting data and is therefore easy to track oer the life of the inestment.
4532 6oderate O782 1#911
'. Why is it important for organi>ations to conduct post inestment audits of capital pro"ects?
+012
:he post inestment audit proides management with an opportunity to ealuate the actual
performance of the inestment relatie to e!pected performance. 5f possible, management can
take correctie action when actual performance is poor relatie to the e!pected performance.
6anagement 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. 5n addition, management may use the information from the post inestment audit
to improe the ealuation process of future capital pro"ects.
4532 6oderate O782 1#9(
(. How are capital budgeting models affected by potential inestments in automated e;uipment
inestment decisions?
+012
$#
4iscount rates for present alue calculations often far e!ceed a firmCs 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. 3inally, there is the
opportunity cost of not automating when competitors automate and your firm doesnCt.
4532 6oderate O782 1#9'
$$
1). What are the limitations of the payback period as a capital budgeting techni;ue?
+012
:he payback period ignores the time alue of money. 5t also ignores a company?s desired rate
of return. 3inally, the payback period ignores cash inflows occurring after the payback period
has been reached.
4532 6oderate O782 1#92
7ROBLE+
S5all C,rp,rati,n
1mall /orporation is considering an inestment that will re;uire an initial cash outlay of
D2)),))) to purchase non9depreciable assets. :he pro"ect promises to return D%),))) per year
*after9ta!, for eight years with no salage alue. :he companyCs cost of capital is 11 percent.
1. Aefer to 1mall /orporation. :he company is uncertain about its estimate of the life
e!pectancy of the pro"ect. How many years must the pro"ect generate the D%),))) per year
return for the company to at least be indifferent about its acceptance? *4o not consider the
possibility of partial year returns.,
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
+012
4iiding D2)),)))FD%),))), 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 $.
4532 6oderate O782 1#91)
Ser>in C,rp,rati,n
1erkin /orporation is considering an inestment in a new product line. :he inestment would
re;uire an immediate outlay of D1)),))) for e;uipment and an immediate inestment of
D2)),))) in working capital. :he inestment is e!pected to generate a net cash inflow of
D1)),))) in year 1, D1$),))) in year 2, and D2)),))) in years 3 and #. :he e;uipment would
be scrapped *for no salage, at the end of the fourth year and the working capital would be
li;uidated. :he e;uipment would be fully depreciated by the straight9line method oer its
four9year life.
2. Aefer to 1erkin /orporation. 5f 1erkin uses a discount rate of 1% percent, what is the 0=K of
the proposed product line inestment?
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
$%
+012
/ash flow Iear +mount 4iscount factor =resent alue
5nestment ) D*1)),))), 1.)) D*1)),))),
Working cap. ) D*2)),))), 1.)) *2)),))),
/ash inflow 1 1)),))) .'%21 '%,21)
/ash inflow 2 1$),))) .&#32 111,#')
/ash inflow 3 2)),))) .%#)& 12',1#)
/ash inflow # 2)),))) .$$23 11),#%)
Working cap. # 2)),))) .$$23 11),#%)
0et present alue D2#%,&$)
4532 6oderate O782 1#93
3. Aefer to 1erkin /orporation. What is the payback period for the inestment?
+012
+fter the first two years, D2$),))) of the original D3)),))) inestment would be recouped. 5t
would take one9;uarter of the third year *D$),)))FD2)),))), to recoup the last D$),))). :hus,
the payback period is 2.2$ years.
4532 6oderate O782 1#92
#. +dam 7all has an opportunity to inest in a pro"ect that will yield four annual payments of
D12,))) with no salage. :he first payment will be receied in e!actly one year. On low9risk
pro"ects of this type, 7all re;uires a return of % percent. 7ased on this re;uirement, the pro"ect
generates a profitability inde! of 1.)3($3.
7re$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?
+012
a. :he present alue of the D12,))) annuity is found by multiplying D12,))) by
the annuity discount factor associated with % percent interest for four years2
D12,))) 3.#%$1 E D#1,$'1.2).
3rom the information on the profitability inde!, it is known that the present
alue of the cash inflows is 1.)3($3 times the initial inestment. :hus, the
initial inestment is D#1,$'1.2)F1.)3($3 E D#),))).
b. 7y diiding D#),))) by the annual cash inflow of D12,))), it is determined
that the discount factor associated with the 5AA is 3.3333. :his discount factor
is associated with an interest rate that lies between & and ' percent. @sing
$&
interpolation, the 5AA is computed to be appro!imately &.&2 percent.
4532 6oderate O782 1#9#
$. =itt =roductions is considering the purchase of a new moie camera, which will be used for
ma"or motion pictures. :he new camera will cost D3),))), hae an eight9year life, and create
cost saings of D$,))) per year. :he new camera will re;uire D&)) of maintenance each year.
=itt =roductions uses a discount rate of ( percent.
7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r are re:uired;
a. /ompute the net present alue of the new camera.
b. 4etermine the payback period.
+012
a. /ost saings per year D$,)))
6aintenance per year *&)),
0et cash flows per year D#,3))
/ash 4iscount factor =resent alue
D3),))) 1.)))) D*3),))).)),
#,3)) $.$3#' 23,&((.%#
0et present alue of inestment D *%,2)).3%,
b. =ayback e;uals D3),)))FD#,3)) E %.(&% years
4532 6oderate O782 1#93
%. Aiordan /orporation is interested in purchasing a state9of9the9art widget machine for its
manufacturing plant. :he new machine has been designed to basically eliminate all errors and
defects in the widget9making production process. :he new machine will cost D1$),))), and
hae a salage alue of D&),))) at the end of its seen9year useful life. Aiordan has
determined that cash inflows for years 1 through & will be as follows2 D32,)))N D$&,)))N
D1$,)))N D2',)))N D1%,)))N D1),))), and D1$,))), respectiely. 6aintenance will be re;uired
in years 3 and % at D1),))) and D&,))) respectiely. Aiordan uses a discount rate of 11 percent
and wants pro"ects to hae a payback period of no longer than fie years.
7re$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 firmCs profitability inde!.
$'
c. /ompute the payback period.
d. <aluate this inestment proposal for -IQ /o.
$(
+012
a. Iear /ash flow 4iscount factor =resent alue
1 D1$),))) 1.)))) D*1$),))).)),
1 32,))) .())( 2','2'.')
2 $&,))) .'11% #%,2%1.2)
3 $,))) .&312 3,%$%.))
# 2',))) .%$'& 1',##3.%)
$ 1%,))) .$(3$ (,#(%.))
% 3,))) .$3#% 1,%)3.')
& 1$,))) .#'1& &,22$.$)
& &),))) .#'1& 33,&1(.))
0et present alue D *&%%.1),
b. =rofitability inde! e;uals present alue of cash flows diided by inestment2
D1#(,233.()FD1$),))) E .(($
c. =ayback period is %.11 years, computed as follows2
Iear /ash 3low /umulatie /ash 3low
1 D32,))) D 32,)))
2 $&,))) '(,)))
3 $,))) (#,)))
# 2',))) 122,)))
$ 1%,))) 13',)))
% 3,))) 1#1,)))
& '$,))) 22%,)))
D1$),))) 9 D1#1,))) E D(,)))FD'$,))) E .11
d. :he pro"ect is ;uantitatiely unacceptable because it has a negatie 0=K, a
less9than9one =5, and a payback period of oer si! years. Howeer, the 0=K
and =5 are e!tremely close to being acceptable. 7ecause the new machine will
proide -IQ >ero9defect 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.
-IQ may want to attempt to ;uantify these benefits and reealuate the
machineCs acceptability as an inestment.
4532 4ifficult O782 1#93
%)
&. :he Aeed /ompany has been operating a small lunch counter for the conenience of
employees. :he counter occupies space that is not needed for any other business purpose. :he
lunch counter has been managed by a part9time employee whose annual salary is D3,))).
Iearly operations hae consistently shown a loss as follows2
Aeceipts D2),)))
<!penses for food, supplies *in cash, D1(,)))
1alary 3,))) 22,)))
0et Loss D*2,))),
+ company has offered to sell Aeed /ompany automatic ending machines for a total cost of
D12,))). 1ales terms are cash on deliery. :he old e;uipment has >ero disposal alue.
:he predicted useful life of the e;uipment is 1) years, with >ero scrap alue. :he 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. :he catering company will pay $ percent of
gross receipts to the Aeed /ompany and will bear all costs of food, repairs, and so forth. :he
part9time employee will be discharged. :hus, Aeed /ompany?s only cost will be the initial
outlay for the machines.
/onsider only the two alternaties mentioned. 7re$ent (alue ta)le$ ,r a %inan&ial &al&ulat,r
are re:uired;
Re:uired@
a. What is the annual income difference between alternaties?
b. /ompute the payback period.
c. /ompute2
1. :he net present alue if releant cost of capital is 2) percent.
2. 5nternal rate of return.
d. 6anagement is ery uncertain about the prospectie reenue from the
ending e;uipment. 1uppose that the gross receipts amounted to D1#,)))
instead of D2),))). Aepeat 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? 1how
computations.
+012
a. Old loss D*2,))),
0ew receipts D2),))) $J E D 1,)))
4epr. D12,)))F1) yrs. E *1,2)),
0ew *Loss, D *2)),
%1
b. /hange in annual cash inflow is D3,)))
=ayback E D12,)))FD3,))) E # yrs.
c. 1. =K of inflow D3,))) #.1(2$ E D12,$&&.$)
=K of outflow D12,))) 1.) E *12,))).)),
0=K D $&&.$)
2. 5AA is appro!imately 23J
d. /hange in inflow E D2,&))
=K inflow D2,&)) #.1(2$ E D11,31(.&$
=K outflow D12,))) 1.) E *12,))).)),
0=K D *%').2$,
e. D12,)))F#.1(2$ E D2,'%2.2$
Aeceipts E *D2,'%2.2$ 9 D2,))),F.)$ E D1&,2#$
4532 6oderate O782 1#9#
'. :he 1potless +utomobile /orporation is contemplating the ac;uisition of an automatic car
wash. :he following information is releant2
:he cost of the car wash is D1%),)))
:he anticipated reenue from the car wash is D1)),))) per annum.
:he useful life of the car wash is 1) years.
+nnual operating costs are e!pected to be2
1alaries D3),)))
@tilities (,%))
Water usage #,#))
1upplies %,)))
AepairsFmaintenance 1),)))
:he firm uses straight9line depreciation.
:he salage alue for the car wash is >ero.
:he companyCs cutoff points are as follows2
=ayback 3 years
+ccounting rate of return 1'J
5nternal rate of return 1'J
5gnore income ta!es.
Re:uired@
a. /ompute the annual cash inflow.
b. /ompute the net present alue.
c. /ompute internal rate of return.
%2
d. /ompute the payback period.
e. /ompute the profitability inde!.
f. 1hould the car wash be purchased?
%3
+012
a. Aeenue D1)),)))
9 cash e!penses *%),))),
+nnual inflow D #),)))
b. =K inflow D#),))) #.#(#1 E D1&(,&%#
=K outflow D1%),))) 1.) E *1%),))),
0=K E D 1(,&%#
c. 5AA factor E D1%),)))FD#),))) E #.) which is appro!imately 23J
d. =ayback E D1%),)))FD#),))) E # yrs.
e. D1&(,&%#FD1%),))) E 1.123$2$
f. /ar wash e!ceeds minimum on 1AA and 5AA, but not payback.
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