Exam 10: Capital-Budgeting Techniques and Practice

The most critical aspect in determining the acceptability of a capital budgeting project is the impact the project will have on the company's net income over the projects entire useful life.

Lithium,Inc.is considering two mutually exclusive projects,A and B.Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.Project B costs $120,000 and is expected to generate $64,000 in year one,$67,000 in year two,$56,000 in year three,and $45,000 in year four.Lithium,Inc.'s required rate of return for these projects is 10%.The internal rate of return for Project B is

Positive NPV projects may be rejected when capital must be rationed.

A project with a NPV of zero should be rejected since even the returns on U.S.Treasury bill are greater than zero.

If a project is acceptable using the NPV criteria,it will also be acceptable when using the profitability index and IRR criteria.

The net present value of a project will increase as the required rate of return is decreased (assume only one sign reversal).

Two projects are mutually exclusive if the accept/reject decision for one project has no impact on the accept/reject decision for the other project.

A significant disadvantage of the internal rate of return is that it

IRR should not be used to choose between mutually exclusive projects.

DYI Construction Co.is considering a new inventory system that will cost $750,000.The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,$325,000 in year two,$150,000 in year three,and $180,000 in year four.DYI's required rate of return is 8%.What is the modified internal rate of return of this project?

Many firms today continue to use the payback method but also employ the NPV or IRR methods especially when large projects are being analyzed.

The capital budgeting manager for XYZ Corporation,a very profitable high technology company,completed her analysis of Project A assuming 5-year depreciation.Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation.This change will

Because the NPV and PI methods both yield the same accept/reject decision,a company attempting to rank capital budgeting projects for funding consideration can use either method and get the same results.

A project's equivalent annual annuity (EAA)is the annuity cash flow that yields the same present value as the project's NPV.

Capital rationing generally leads to higher stock prices as management is doing the best job it can in selecting only the best capital budgeting projects.

The payback period may be more appropriate to use for companies experiencing capital rationing.

The advantages of NPV are all of the following EXCEPT

Lithium,Inc.is considering two mutually exclusive projects,A and B.Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.Project B costs $120,000 and is expected to generate $64,000 in year one,$67,000 in year two,$56,000 in year three,and $45,000 in year four.Lithium,Inc.'s required rate of return for these projects is 10%.The profitability index for Project B is

Finance theory suggests that the IRR criterion is the most favorable capital budgeting decision tool.

The profitability index is the ratio of the company's net income (or profits)to the initial outlay or cost of a capital budgeting project.