Capital Budgeting PDF

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CAPITAL BUDGETTINGMultiple Choiced 1. Calculating the payback period for a capital project requires knowing which of the following? a. Useful life of the project. b. The company's minimum required rate of return. c. The project's NPV. d. The project's annual cash flow.c 2. The payback criterion for ...

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CAPITAL BUDGETTING Multiple Choice d 1. Calculating the payback period for a capital project requires knowing which of the following? a. Useful life of the project. b. The company's minimum required rate of return. c. The project's NPV. d. The project's annual cash flow. c 2. The payback criterion for capital investment decisions a. is conceptually superior to the IRR criterion. b. takes into consideration the time value of money. c. gives priority to rapid recovery of cash. d. emphasizes the most profitable projects. a 3. Which of the following is NOT relevant in calculating annual net cash flows for an investment? a. Interest payments on funds borrowed to finance the project. b. Depreciation on fixed assets purchased for the project. c. The income tax rate. d. Lost contribution margin if sales of the product invested in will reduce sales of other products. a 4. If the present value of the future cash flows for an investment equals the required investment, the IRR is a. equal to the cutoff rate. b. equal to the cost of borrowed capital. c. equal to zero. d. lower than the company's cutoff rate of return. b 5. The relationship between payback period and IRR is that a. a payback period of less than one-half the life of a project will yield an IRR lower than the target rate. b. the payback period is the present value factor for the IRR. c. a project whose payback period does not meet the company's cutoff rate for payback will not meet the company's criterion for IRR. d. none of the above. c 6. Which of the following events is most likely to reduce the expected NPV of an investment? a. The major competitor for the product to be manufactured with the machinery being considered for purchase has been rated "unsatisfactory" by a consumer group. b. The interest rate on long-term debt declines. c. The income tax rate is raised by the Congress. d. Congress approves the use of faster depreciation than was previously available. a 7. If an investment has a positive NPV, a. its IRR is greater than the company's cost of capital. b. cost of capital exceeds the cutoff rate of return. c. its IRR is less than the company's cutoff rate of return. d. the cutoff rate of return exceeds cost of capital. c 8. Which of the following describes the annual returns that are discounted in determining the NPV of an investment? a. Net incomes expected to be earned by the project. b. Pre-tax cash flows expected from the project. c. After-tax cash flows expected from the project. d. After-tax cash flows adjusted for the time value of money.

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b 9. Which of the following capital budgeting methods does NOT consider the time value of money? a. IRR. b. Book rate of return. c. Time-adjusted rate of return. d. NPV. b 10. All other things being equal, as cost of capital increases a. more capital projects will probably be acceptable. b. fewer capital projects will probably be acceptable. c. the number of capital projects that are acceptable will change, but the direction of the change is not determinable just by knowing the direction of the change in cost of capital. d. the company will probably want to borrow money rather than issue stock. d 11. Which of the following is a basic difference between the IRR and the book rate of return (BRR) criteria for evaluating investments? a. IRR emphasizes expenses and BRR emphasizes expenditures. b. IRR emphasizes revenues and BRR emphasizes receipts. c. IRR is used for internal investments and BRR is used for external investments. d. IRR concentrates on receipts and expenditures and BRR concentrates on revenues and expenses. a 12. If a project has a payback period shorter than its life, a. its NPV may be negative. b. its IRR is greater than cost of capital. c. it will have a positive NPV. d. its incremental cash flows may not cover its cost. c 13. Cost of capital is a. the amount the company must pay for its plant assets. b. the dividends a company must pay on its equity securities. c. the cost the company must incur to obtain its capital resources. d. the cost the company is charged by investment bankers who handle the issuance of equity or longterm debt securities. d 14. The normal methods of analyzing investments a. cannot be used by not-for-profit entities. b. do not apply if the project will not produce revenues. c. cannot be used if the company plans to finance the project with funds already available internally. d. require forecasts of cash flows expected from the project. a 15. Which of the following is NOT a defect of the payback method? a. It ignores cash flows because it uses net income. b. It ignores profitability. c. It ignores the present values of cash flows. d. It ignores the pattern of cash flows beyond the payback period. b 16. A company with cost of capital of 15% plans to finance an investment with debt that bears 10% interest. The rate it should use to discount the cash flows is a. 10%. b. 15%. c. 25%. d. some other rate. c 17. Which of the following events will increase the NPV of an investment involving a new product? a. An increase in the income tax rate. b. An increase in the expected per-unit variable cost of the product. c. An increase in the expected annual unit volume of the product.

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d. A decrease in the expected salvage value of equipment. b 18. An investment has a positive NPV discounting the cash flows at a 14% cost of capital. Which statement is true? a. The IRR is lower than 14%. b. The IRR is higher than 14%. c. The payback period is less than 14 years. d. The book rate of return is 14%. a 19. The technique most concerned with liquidity is a. payback. b. NPV. c. IRR. d. book rate of return. d 20. The technique that does NOT use cash flows is a. payback. b. NPV. c. IRR. d. book rate of return. a 21. If there were no income taxes, a. depreciation would be ignored in capital budgeting. b. the NPV method would not work. c. income would be discounted instead of cash flow. d. all potential investments would be desirable. a 22. Two new products, X and Y, are alike in every way except that the sales of X will start low and rise throughout its life, while those of Y will be the same each year. Total volumes over their five-year lives will be the same, as will selling prices, unit variable costs, cash fixed costs, and investment. The NPV of product X a. will be less than that of product Y. b. will be the same as that of product Y. c. will be greater than that of product Y. d. none of the above. d 23. Which of the following events is most likely to increase the number of investments that meet a company's acceptance criteria? a. Top management raises the target rate of return. b. The interest rate on long-term debt rises. c. The income tax rate rises. d. The IRS allows companies to expense purchases of fixed assets, instead of depreciating them over their lives. d 24. Investment A has a payback period of 5.4 years, investment B one of 6.7 years. From this information we can conclude a. that investment A has a higher NPV than B. b. that investment A has a higher IRR than B. c. that investment A's book rate of return is higher than B's. d. none of the above. d 25. Investment A has a book rate of return of 26%, investment B one of 18%. From this information we can conclude a. that investment A has a higher NPV than B. b. that investment A has a higher IRR than B. c. that investment A has a shorter payback period than B.

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d. none of the above. c 26. A dollar now is worth more than a dollar to be received in the future because of a. inflation. b. uncertainty. c. the opportunity cost of waiting. d. none of the above. a 27. In contrast to the payback and book rate of return methods, the NPV and IRR methods a. consider the time value of money. b. ignore depreciation. c. use after-tax cash flows. d. all of the above. a 28. Which of the following is a discounted cash flow method? a. NPV. b. Payback. c. Book rate of return. d. All of the above. a 29. Which statement describes the relevance of depreciation in calculating cash flows? a. Depreciation is relevant only when income taxes exist. b. Depreciation is always relevant. c. Depreciation is never relevant. d. Depreciation is relevant only with discounted cash flow methods. b 30. As the discount rate increases a. present value factors increase. b. present value factors decrease. c. present value factors remain constant. d. it is impossible to tell what happens to the factors. a 31. As the length of an annuity increases a. present value factors increase. b. present value factors decrease. c. present value factors remain constant. d. it is impossible to tell what happens to present value factors. a 32. The only future costs that are relevant to deciding whether to accept an investment are those that will a. be different if the project is accepted rather than rejected. b. be saved if the project is accepted rather than rejected. c. be deductible for tax purposes. d. affect net income in the period that they are incurred. a 33. Which of the following is true of an investment? a. The lower the cost of capital, the higher the NPV. b. The lower the cost of capital, the higher the IRR. c. The longer the project's life, the shorter its payback period. d. The higher the project's NPV, the shorter its life. c 34. Which of the following methods FAILS to distinguish between return of investment and return on investment? a. NPV. b. IRR. c. Payback.

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d. Book rate of return. c 35. If a company is NOT subject to income tax, which of the following is true of a proposed investment? a. The project's IRR equals the entity's cost of capital. b. The project's NPV is zero. c. Depreciation on assets required for the project is irrelevant to the evaluation. d. The expected annual increase in future cash flows equals the investment required to undertake the project. d 36. Which of the following increases NPV and IRR? a. An upward revision in expected annual net cash flows. b. An upward revision of expected life. c. An upward revision of the residual value of the long-lived assets being acquired for the project. d. All of the above. d 37. Qualitative issues could increase the acceptability of a project under which of the following conditions? a. The IRR is less than the company's cutoff rate. b. The project has a negative NPV. c. The payback period is longer than the company's cutoff period. d. All of the above. a 38. If Co. X wants to use IRR to evaluate long-term decisions and to establish a cutoff rate of return, X must be sure the cutoff rate is a. at least equal to its cost of capital. b. at least equal to the rate used by similar companies. c. greater than the IRR on projects accepted in the past. d. greater than the current book rate of return. a 39. Which of the following is NOT relevant in calculating net cash flows for Project N? a. Interest payments on funds that would be borrowed to finance Project N. b. Depreciation on assets purchased for Project N. c. The contribution margin the company would lose if sales of the product introduced by Project N will reduce sales of other products. d. The income tax rate applicable to the entity. b 40. If the IRR on an investment is zero, a. its NPV is positive. b. its annual cash flows equal its required investment. c. it is generally a wise investment. d. its cash flows decrease over its life. d 41. If depreciation on a new asset exceeds its savings in cash operating costs, which of the following is true? a. The project is usually unacceptable. b. The annual after-tax cash flow on the new asset will be greater than the savings in cash operating costs. c. The project has a negative NPV. d. All of the above. d 42. Cost of capital is a. the interest rate an entity must pay to borrow money. b. the return an entity's stockholders expect on their investment. c. the rate of return the entity can earn from investing available cash. d. a concept of managerial finance incorporating all of the above ideas.

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b 43.

An investment opportunity costing $75,000 is expected to yield net cash flows of $23,000 annually for five years. The NPV of the investment at a cutoff rate of 14% would be a. $(3,959). b. $3,959. c. $75,000. d. $78,959.

b 44. An investment opportunity costing $55,000 is expected to yield net cash flows of $22,000 annually for five years. The payback period of the investment is a. 0.4 years. b. 2.5 years. c. $33,000. d. some other number. c 45. An investment opportunity costing $180,000 is expected to yield net cash flows of $53,000 annually for five years. The IRR of the investment is between a. 10 and 12%. b. 12 and 14%. c. 14 and 16%. d. 16 and 18%. b 46. An investment opportunity costing $150,000 is expected to yield net cash flows of $45,000 annually for five years. The cost of capital is 10%. The book rate of return would be a. 10%. b. 20%. c. 30%. d. 33.3%. a 47.

An investment opportunity costing $150,000 is expected to yield net cash flows of $36,000 annually for six years. The NPV of the investment at a cutoff rate of 12% would be a. $(2,004). b. $2,004. c. $150,000. d. $147,996.

c 48. An investment opportunity costing $100,000 is expected to yield net cash flows of $22,000 annually for seven years. The payback period of the investment is a. 0.22 years. b. 3.08 years. c. 4.55 years. d. some other number. a 49. An investment opportunity costing $200,000 is expected to yield net cash flows of $39,000 annually for eight years. The IRR of the investment is between a. 10 and 12%. b. 12 and 14%. c. 14 and 16%. d. 16 and 18%. b 50.

An investment opportunity costing $80,000 is expected to yield net cash flows of $25,000 annually for four years. The cost of capital is 10%. The book rate of return would be a. 10.0%. b. 12.5%. c. 21.3%. d. 32.0%.

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c 1. Which of the following groups of capital budgeting techniques uses the time value of money? a. Book rate of return, payback, and profitability index. b. IRR, payback, and NPV. c. IRR, NPV, and profitability index. d. IRR, book rate of return, and profitability index. b 2. Discounted cash flow techniques for analyzing capital budgeting decisions are NOT normally applied to projects a. requiring no investment after the first year of life. b. having useful lives shorter than one year. c. that are essential to the business. d. involving replacement of existing assets. d 3. The profitability index a. does not use present values of cash flows. b. is generally preferable to any other approach for evaluating mutually exclusive investment alternatives. c. produces the same ranking of investment alternatives as does the IRR criterion. d. is a discounted cash flow method. a 4. Companies using MACRS for tax purposes and straight-line depreciation for financial reporting purposes usually find that the relationship between the tax basis and book value of their assets is a. the tax basis is lower than book value. b. the tax basis is higher than book value. c. the tax basis is the same as book value. d. none of the above. c 5. A company that wants to use MACRS for tax purposes must a. request permission from the IRS. b. acquire new assets at or near the middle of the year. c. ignore salvage value in calculating depreciation. d. do none of the above. c 6. The government could encourage increases in investment by a. increasing tax rates. b. lengthening the MACRS periods. c. letting a company expense fixed assets in the year acquired instead of through annual depreciation charges. d. taking actions that would increase interest rates. a 7. In choosing from among mutually exclusive investments the manager should normally select the one with the highest a. NPV. b. IRR. c. profitability index. d. book rate of return. a 8. In deciding whether to replace a machine, which of the following is NOT a sunk cost? a. The expected resale price of the existing machine. b. The book value of the existing machine. c. The original cost of the existing machine. d. The depreciated cost of the existing machine. a 9. A company is considering replacing a machine with one that will save $50,000 per year in cash operating costs and have $20,000 more depreciation expense per year than the existing machine. The tax rate is 40%. Buying the new machine will increase annual net cash flows of the

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company by a. $38,000. b. $30,000. c. $20,000. d. $12,000. c 10. Not-for-profit entities a. cannot use capital budgeting techniques because profitability is irrelevant to them. b. cannot use discounted cash flow techniques because the time value of money is irrelevant to them. c. might have serious problems in quantifying the benefits expected from an investment. d. should use the IRR method to make investment decisions. c 11. A major difference between an investment in working capital and one in depreciable assets is that a. an investment in working capital is never returned, while most depreciable assets have some residual value. b. an investment in working capital is returned in full at the end of a project's life, while an investment in depreciable assets has no residual value. c. an investment in working capital is not tax-deductible when made, nor taxable when returned, while an investment in depreciable assets does allow tax deductions. d. because an investment in working capital is usually returned in full at the end of the project's life, it is ignored in computing the amount of the investment required for the project. d 12. The proper treatment of an investment in receivables and inventory is to a. ignore it. b. add it to the required investment in fixed assets. c. add it to the required investment in fixed assets and subtract it from the annual cash flows. d. add it to the investment in fixed assets and add the present value of the recovery to the present value of the annual cash flows. a 13. If a company uses a five-year MACRS period to depreciate assets instead of a 10-year life with straight-line depreciation, a. the NPV of the investment is higher. b. the IRR of the investment is lower. c. there is no difference in either NPV or IRR. d. total cash flows over the useful life would be lower. a 14. The NPV and IRR methods give a. the same decision (accept or reject) for any single investment. b. the same choice from among mutually exclusive investments. c. different rankings of projects with unequal lives. d. the same rankings of projects with different required investments. d 15. An investment with a positive NPV also has a. a positive profitability index. b. a profitability index of one. c. a profitability index less than one. d. a profitability index greater than one. b 16. Classifying an asset in a MACRS life category is based on a. useful life estimated by the company. b. asset depreciation range (ADR) guidelines. c. the cost of the asset. d. any of the above factors. d 17. Which of the following makes investments more desirable than they had been? a. An increase in the income tax rate.

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b. An increase in interest rates. c. An increase in the number of years over which assets must be depreciated. d. None of the above. c 18. Which of the following statements is true? a. All revenue is taxed. b. All expenses are tax-deductible. c. Some revenues and expenses have no tax effects. d. Income taxes are based solely on revenues and expenses. b 19. The profitability index is the ratio of a. total cash inflows to the cost of the investment. b. the present value of cash inflows to the cost of the investment. c. the NPV of the investment to the cost of the investment. d. the IRR to the company's cost of capital. c 20. With respect to income taxes, the principal advantage of MACRS over straight-line depreciation is that a. total taxes will be lower under MACRS. b. taxes will be constant from year to year under MACRS. c. taxes will be lower in the earlier years under MACRS. d. taxes will decline in future years under MACRS. a 21. If the profitability index is less than one, a. the IRR is less than cost of capital. b. the IRR is the same as cost of capital. c. the IRR is greater than cost of capital. d. none of the above is true. c 22. Which of the following combinations is possible? Profitability Index NPV IRR ----------------------- -------- ------------------------a. greater than 1 positive equals cost of capital b. gr...