Exam 13: Capital Budgeting

When considering two mutually exclusive projects,the financial manager should always select that project whose internal rate of return is the highest provided the projects have the same initial cost.

Which of the following statements is correct?

The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs)with the present value of the cash inflows.

Which of the following statements is correct?

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 supplemental operating cash flow in Year 2?

The internal rate of return (IRR)method of evaluating investment projects equates the present value of cash inflows with the present value of cash outflows by discounting all of the cash flows at the firm's required rate of return.

Which of the following methods involves calculating an average beta for firms in a similar business and then applying that beta to determine the beta of its own project?

Genuine Products Inc.requires a new machine.Two companies have submitted bids,and you have been assigned the task of choosing one of the machines.Cash flow analysis indicates the following: What is the internal rate of return for each machine?

Which of the following statements is correct?

Sun State Mining Inc. ,an all-equity firm,is considering the formation of a new division which will increase the assets of the firm by 50 percent.Sun State currently has a required rate of return of 18 percent,U.S.Treasury bonds yield 7 percent,and the market risk premium is 5 percent.If Sun State wants to reduce its required rate of return to 16 percent,what is the maximum beta coefficient the new division could have?

An all-equity firm is analyzing a potential project which will require an initial,after-tax cash outlay of $50,000 and after-tax cash inflows of $6,000 per year for 10 years.In addition,this project will have an after-tax salvage value of $10,000 at the end of Year 10.If the risk-free rate is 6 percent,the return on an average stock is 10 percent,and the beta of this project is 1.50,then what is the project's NPV?

Quantification of risk is the easiest part of incorporating risk into capital budgeting;treatment of that calculated risk measure is more difficult.

Exchange rate risk is the risk that the cash flows from a foreign project will be worth less than those same cash flows denominated in the parent company's home currency.

Normal Projects Q and R have the same NPV when the discount rate is zero.However,Project Q has larger early cash flows than R.Therefore,we know that at all discount rates greater than zero,Project R will have a greater NPV than Q.

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000.The old machine,which originally cost $40,000,has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000.Target's corporate tax rate is 40 percent.If Target sells the old machine at market value,what is the initial investment outlay (after-tax)for the new printing machine?

A company is analyzing two mutually exclusive projects,S and L,whose cash flows are shown below: The company's required rate of return is 12 percent,and it can get an unlimited amount of funds at that rate.What is the IRR of the better project,i.e. ,the project which the company should choose if it wants to maximize the price of its stock?

Arizona Rock,an all-equity firm,currently has a beta of 1.25,and r_RF = 7 percent and r_M = 14 percent.Suppose the firm sells 10 percent of its assets (beta = 1.25)and purchases the same proportion of new assets with a beta of 1.1.What will be the firm's new overall required rate of return,and what rate of return must the new assets produce in order to leave the stock price unchanged?

Which of the following capital budgeting techniques does not adjust for the riskiness of the cash flows?

It is extremely difficult to estimate the revenues and costs associated with large complex projects that take several years to develop.This is why subjective judgment is recommended for such projects instead of cash flow analysis.

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects which have different lives are being compared.