Exam 13: Capital Budgeting

California Mining is evaluating the introduction of a new ore production process.Two alternatives are available.Production Process A has an initial cost of $25,000,a 4-year life,and a $5,000 net salvage value,and the use of Process A will increase net cash flow by $13,000 per year for each of the 4 years that the equipment is in use.Production Process B also requires an initial investment of $25,000,will also last 4 years,and its expected net salvage value is zero,but Process B will increase net cash flow by $15,247 per year.Management believes that a risk-adjusted discount rate of 12 percent should be used for Process A.If California Mining is to be indifferent between the two processes,what risk-adjusted discount rate must be used to evaluate B?

Two projects being considered are mutually exclusive and have the following projected cash flows: If the required rate of return on these projects is 10 percent,which would be chosen and why?

One of the advantages of the payback period (either regular or discounted)is that it considers all cash flows throughout the entire life of a project.

Many firms use more than one technique to evaluate capital budgeting projects because multiple measures can provide decision makers with somewhat different pieces of relevant information.

In theory,the decision maker should view market risk as being of primary importance.However,within-firm,or corporate,risk is relevant to a firm's

When a project's NPV exceeds zero,

Risk in a revenue producing project can best be adjusted for by

The change in net working capital that results from the acceptance of a project is an incremental cash flow that must be considered in capital budgeting analysis.

The cash flows relevant for the analysis of a foreign investment should,from the parent company's perspective,include the financial cash flows that the subsidiary can legally send back to the parent company and the cash flows which must remain in the foreign country.

A(n)____ is the return on the best alternative use of an asset,the highest return that will not be earned if funds are not invested in a particular project.

Uncertainty regarding the domestic flows that result from converting foreign cash flows is what type of risk?

Michigan Mattress Company is considering the purchase of land and the construction of a new plant.The land,which would be bought immediately (at t = 0),has a cost of $100,000 and the building,which would be erected at the end of the first year (t = 1),would cost $500,000.It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year,and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.What is the approximate payback period?

Assume the following: (1)A firm is considering two projects,one with a 5-year life and the other with a 10-year life;(2)the cash flows of the two projects are equally risky by all definitions of the word "risky";(3)the company uses 40 percent debt and 60 percent equity to finance the projects;(4)the debt used to finance any given project has a maturity equal to the life of the project;and (5)the term structure of interest rates has a sharp upward slope.This would suggest,other things held constant,that a lower discount rate should be used to find the NPV for the 5-year project than for the 10-year project.

Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase?

The IRR of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the IRR of a project whose cash flows come in more slowly.

Although it is difficult to make accurate forecasts,the initial outlays and subsequent costs of large projects are forecast with great accuracy,but revenues are more uncertain and large errors are not uncommon.

Which of the following is not discussed in the text as a method for analyzing risk in capital budgeting?

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm,based on any method for assessing risk.In evaluating this asset,the decision maker should

The internal rate of return of a capital investment

A(n)____ is a cash outlay that already has been incurred and that cannot be recovered regardless of whether the project is accepted or rejected.