Exam 13: Capital Budgeting

Which of the following is not a cash flow that results from the decision to accept a project?

The net present value of capital budgeting project with an initial cost of $5,000 that generates $1,000 after-tax cash flows each year for ten years is $1,710 when discounted at 8 percent.

Conflicts between two mutually exclusive projects,where the NPV method chooses one project but the IRR method chooses the other,should generally be resolved in favor of the project with the higher NPV.

Your company is considering a machine which will cost $50,000 at Time 0 and which can be sold after 3 years for $10,000.$12,000 must be invested at Time 0 in inventories and receivables;these funds will be recovered when the operation is closed at the end of Year 3.The facility will produce sales revenues of $50,000/year for 3 years;variable operating costs (excluding depreciation)will be 40 percent of sales.No fixed costs will be incurred.Operating cash inflows will begin 1 year from today (at t = 1).By an act of Congress,the machine will have depreciation expenses of $40,000,$5,000,and $5,000 in Years 1,2,and 3,respectively.The company has a 40 percent tax rate,enough taxable income from other assets to enable it to get a tax refund on this project if the project's income is negative,and a 15 percent required rate of return.Inflation is zero.What is the project's NPV?

Suppose the firm's required rate of return is stated in nominal terms,but the project's expected cash flows are expressed in real dollars.In this situation,other things held constant,the calculated NPV would

The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist.

Lloyd Enterprises has a project which has the following cash flows: The required rate of return is 10 percent.What is the project's discounted payback?

When evaluating a new project,the firm should consider all of the following factors except:

Sensitivity analysis measures the stand-alone risk of a project by showing how much the project's NPV is affected by a small change in one of the input variables,such as sales.Other things held constant,with the independent variable graphed on the horizontal axis,the steeper the graph of the relationship line,the less risky the project.

The two cardinal rules which financial analysts follow to avoid capital budgeting errors are: (1)capital budgeting decisions must be based on accounting income,and (2)only incremental cash flows are relevant to accept/reject decisions.

Stanton Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually.Stanton will use the MACRS method to depreciate the machine,and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes.Stanton's marginal tax rate is 40 percent,and it uses a 9 percent required rate of return to evaluate projects of this type.If the machine's cost is $40,000,what is the project's NPV?

When calculating the cash flows for a project,you should include interest payments.

Internal rate of return assumes that all of the cash flows from a capital budgeting can be reinvested at the weighted average cost of capital.

Changes in net working capital do not need to be considered in capital budgeting cash flow analysis as long as the nominal (undiscounted)values of the changes are identical in each time period.

If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.

Real Time Inc. The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's required rate of return is 14 percent. -Refer to Real Time Inc.What is the project's NPV?

The net present value of a replacement item of equipment will decrease if the current market value of the equipment to be replaced is increased,other things held constant.

Small businesses probably make less use of the DCF capital budgeting techniques than large businesses.This may reflect a lack of knowledge on the part of small firms' managers,but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms.

Meals on Wings Inc.supplies prepared meals for corporate aircraft (as opposed to public commercial airlines),and it needs to purchase new broilers.If the broilers are purchased,they will replace old broilers purchased 10 years ago for $105,000 and which are being depreciated on a straight line basis to a zero salvage value (15-year depreciable life).The old broilers can be sold for $60,000.The new broilers will cost $200,000 installed and will be depreciated using MACRS over their 5-year class life;they will be sold at their book value at the end of the 5th year.The firm expects to increase its revenues by $18,000 per year if the new broilers are purchased,but cash expenses will also increase by $2,500 per year.If the firm's required rate of return is 10 percent and its tax rate is 34 percent,what is the NPV of the broilers?

Which of the following is not considered a relevant concern in determining incremental cash flows for a new product?