Exam 13: Capital Budgeting

Scott Corporation's new project calls for an investment of $10,000.It has an estimated life of 10 years.The IRR has been calculated to be 15 percent.If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)

Risk-Adjusted Discount Rate 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. [MACRS table required] -Refer to Real Time Inc.What is the terminal cash flow ?

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

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.

In capital budgeting analyses, it is possible that NPV and IRR will both involve assuming reinvestment of the project's cash flows at the same rate.

Which of the following statements is correct?

Any cash flow that can be classified as incremental is relevant in a capital budgeting project analysis.

After a long drought, the manager of Long Branch Farm is considering the installation of an irrigation system which will cost $100,000.It is estimated that the irrigation system will increase revenues by $20,500 annually, although operating expenses other than depreciation will also increase by $5,000.The system will be depreciated using MACRS over its depreciable life (5 years) to a zero salvage value.If the tax rate on ordinary income is 40 percent, what is the project's IRR?

____ projects are a set of projects where the acceptance of one project means that other projects cannot be accepted.

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.

As the director of capital budgeting for Raleigh/Durham Company, you are evaluating two mutually exclusive projects with the following net cash flows: Is there a crossover point in the relevant part of a NPV profile graph (the northeast, or upper right, quadrant)?

Your company is choosing between the following non-repeatable, equally risky, mutually exclusive projects with the cash flows shown below.Your required rate of return is 10 percent.How much value will your firm sacrifice if it selects the project with the higher IRR? Project S: Project L:

Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life.At the current required rate of return, normal Projects S and L have identical NPVs.Now suppose interest rates and money costs generally decline.Other things held constant, this change will cause L to become preferred to S.

Phoenix Products Inc.requires a new machine to produce a part for a solar air conditioner.Two companies have submitted bids, and you have been assigned the task of choosing one of the machines.Cash flow analysis indicates the following: If the required rate of return for Phoenix Products is 5 percent, which of the following is the most valid statement?

The internal rate of return of a capital investment

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

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.

If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true?

Two fellow financial analysts are evaluating a project with the following net cash flows: One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%, but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analyzing the project cash flows.Which statement best describes the IRR for this project?

Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity rate of return.The rule itself should not be affected by managers' tastes, the choice of accounting method, or the profitability of other independent projects.