Question 1

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

Accepted Answer

A)  IRR 
B)  NPV 
C)  MIRR 
D)  Payback 
A)  IRR 
B)  NPV 
C)  MIRR 
D)  Payback

Question 2

Other things held constant, if a firm takes on a project that increases its beta coefficient, unless the increased beta is offset by a higher expected return, the firm's stock price will decline.

Accepted Answer

A) True 
 B)False

Question 3

One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk.

Accepted Answer

A) True 
 B)False

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Louisiana Enterprises, an all-equity firm, is considering a new capital investment.Analysis has indicated that the proposed investment has a beta of 0.5 and will generate an expected return of 7 percent.The firm currently has a required return of 10.75 percent and a beta of 1.25.The investment, if undertaken, will double the firm's total assets.If rRF = 7 percent and the market return is 10 percent, should the firm undertake the investment? (Choose the best answer.)

Accepted Answer

A)  Yes; the expected return of the asset (7%) exceeds the required return (6.5%). 
B)  Yes; the beta of the asset will reduce the risk of the firm. 
C)  No; the expected return of the asset (7%) is less than the required return (8.5%). 
D)  No; the risk of the asset (beta) will increase the firm's beta. 
E)  No; the expected return of the asset is less than the firm's required return, which is 10.75%. 
A)  Yes; the expected return of the asset (7%) exceeds the required return (6.5%). 
B)  Yes; the beta of the asset will reduce the risk of the firm. 
C)  No; the expected return of the asset (7%) is less than the required return (8.5%). 
D)  No; the risk of the asset (beta) will increase the firm's beta. 
E)  No; the expected return of the asset is less than the firm's required return, which is 10.75%.

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Your company must ensure the safety of its work force.Two plans are being considered for the next 10 years: (1) Install a high electrified fence around the property at a cost of $100,000.Maintenance and electricity would then cost $5,000 per year over the 10-year life of the fence.(2) Hire security guards at a cost of $25,000 paid at the end of each year.Because the company plans to build new headquarters with a "state of the art" security system in 10 years, the plan will only be in effect until that time.Your company's required rate of return is 15 percent for average projects, and that rate is normally adjusted up or down by 2 percentage points for high- and low-risk projects.Plan 1 is considered to be of low risk because its costs can be predicted quite accurately.Plan B, on the other hand, is a high-risk project because of the difficulty of predicting wage rates.What is the proper PV of costs for the better project?

Accepted Answer

A)  −$104,266.20 
B)  −$116,465.09 
C)  −$123,293.02 
D)  −$127,131.22 
E)  −$135,656.09 
A)  −$104,266.20 
B)  −$116,465.09 
C)  −$123,293.02 
D)  −$127,131.22 
E)  −$135,656.09

Question 8

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?

Accepted Answer

A)  −$61,019 
B)  $17,972 
C)  $28,451 
D)  −$44,553 
E)  $5,021 
A)  −$61,019 
B)  $17,972 
C)  $28,451 
D)  −$44,553 
E)  $5,021

Question 9

Your assistant has just completed an analysis of two mutually exclusive projects.You must now take her report to a board of directors meeting and present the alternatives for the board's consideration.To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects.However, she forgot to label the profiles, so you do not know which line applies to which project.Of the following statements regarding the profiles, which one is most reasonable?

Accepted Answer

A)  If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist. 
B)  If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision). 
C)  If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake. 
D)  Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows.However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost. 
E)  If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive. 
A)  If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist. 
B)  If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision). 
C)  If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake. 
D)  Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows.However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost. 
E)  If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.

Question 10

Mom's Cookies Inc.is considering the purchase of a new cookie oven.The original cost of the old oven was $30,000; it is now 5 years old, and it has a current market value of $13,333.33.The old oven is being depreciated over a 10-year life towards a zero estimated salvage value on a straight line basis, resulting in a current book value of $15,000 and an annual depreciation expense of $3,000.The old oven can be used for 6 more years but has no market value after its depreciable life is over.Management is contemplating the purchase of a new oven whose cost is $25,000 and whose estimated salvage value is zero.Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life.Depreciation is computed using MACRS over a 5-year life, and the required rate of return is 10 percent.Assume a 40 percent tax rate.What is the net present value of the new oven?

Accepted Answer

A)  −$2,418 
B)  −$1,731 
C)  $1,568 
D)  $163 
E)  $1,731 
A)  −$2,418 
B)  −$1,731 
C)  $1,568 
D)  $163 
E)  $1,731

Question 11

Which of the following statements is correct?

Accepted Answer

A)  The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the IRR. 
B)  The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the IRR. 
C)  The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the risk-free rate. 
D)  The NPV method does not consider the inflation premium. 
E)  The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period. 
A)  The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the IRR. 
B)  The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the IRR. 
C)  The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the risk-free rate. 
D)  The NPV method does not consider the inflation premium. 
E)  The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period.

Question 12

Which of the following statements is correct?

Accepted Answer

A)  An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project. 
B)  Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions. 
C)  It is unrealistic to expect that increases in net working capital that are required at the start of an expansion project are simply recovered at the project's completion.Thus, these cash flows are included only at the start of a project. 
D)  Equipment sold for more than its book value at the end of a project's life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value. 
E)  All of the above are false. 
A)  An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project. 
B)  Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions. 
C)  It is unrealistic to expect that increases in net working capital that are required at the start of an expansion project are simply recovered at the project's completion.Thus, these cash flows are included only at the start of a project. 
D)  Equipment sold for more than its book value at the end of a project's life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value. 
E)  All of the above are false.

Question 13

Real Time Systems Inc.is considering the development of one of two mutually exclusive new computer models.Each will require a net investment of $5,000.The cash flow figures for each project are shown below:   Model B, which will use a new type of laser disk drive, is considered a high-risk project, while Model A is of average risk.Real Time adds 2 percentage points to arrive at a risk-adjusted discount rate when evaluating a high-risk project.The rate used for average risk projects is 12 percent.Which of the following statements regarding the NPVs for Models A and B is most correct?

Accepted Answer

A)  NPVA = $380; NPVB = $1,815. 
B)  NPVA = $197; NPVB = $1,590. 
C)  NPVA = $380; NPVB = $1,590. 
D)  NPVA = $5,380; NPVB = $6,590. 
E)  None of the above statements is correct. 
A)  NPVA = $380; NPVB = $1,815. 
B)  NPVA = $197; NPVB = $1,590. 
C)  NPVA = $380; NPVB = $1,590. 
D)  NPVA = $5,380; NPVB = $6,590. 
E)  None of the above statements is correct.

Question 14

A key difference between replacement and expansion project analyses is that with replacement, the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

Accepted Answer

A) True 
 B)False

Question 15

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets are not used for the project being evaluated.

Accepted Answer

A) True 
 B)False

Question 16

You have recently accepted a one year employment term by a firm.The firm has given you the option of receiving your salary as a lump sum value of $30,000 at the end of the year or as 12 monthly payments of $2,400 starting one month after you start work.If your relevant discount rate is 2 percent per month, then which salary options would you prefer? (Ignore taxes, risk, and consumption needs.) Choose the best answer.

Accepted Answer

A)  The lump sum payment, since it has the larger future value. 
B)  Monthly payments, since you do not have to wait so long to receive your money. 
C)  Either one, since they have the same present value. 
D)  The lump sum payment, since it has the larger present value. 
E)  Monthly payments, since it has the larger present value. 
A)  The lump sum payment, since it has the larger future value. 
B)  Monthly payments, since you do not have to wait so long to receive your money. 
C)  Either one, since they have the same present value. 
D)  The lump sum payment, since it has the larger present value. 
E)  Monthly payments, since it has the larger present value.

Question 17

The lower the correlation of a project's cash flows with those of the rest of the firm, the greater will be the benefits of the project with regard to reducing within-firm risk.

Accepted Answer

A) True 
 B)False

Question 18

The Seattle Corporation has been presented with an investment opportunity which will yield end of year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10.This investment will cost the firm $150,000 today, and the firm's required rate of return is 10 percent.What is the NPV for this investment?

Accepted Answer

A)  $135,984 
B)  $18,023 
C)  $219,045 
D)  $51,138 
E)  $92,146 
A)  $135,984 
B)  $18,023 
C)  $219,045 
D)  $51,138 
E)  $92,146

Question 19

Which of the following statements is correct?

Accepted Answer

A)  Because discounted payback takes account of the required rate of return, a project's discounted payback is normally shorter than its regular payback. 
B)  The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found. 
C)  If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur. 
D)  If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile. 
E)  If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods. 
A)  Because discounted payback takes account of the required rate of return, a project's discounted payback is normally shorter than its regular payback. 
B)  The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found. 
C)  If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur. 
D)  If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile. 
E)  If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.

Question 20

Repatriation of funds is not relevant in multinational capital budgeting analysis as the funds generated in foreign countries can be reinvested in that country generating larger cash flows for the parent company.

Accepted Answer

A) True 
 B)False

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

Other things held constant, if a firm takes on a project that increases its beta coefficient, unless the increased beta is offset by a higher expected return, the firm's stock price will decline.

One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk.

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.

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.

Which of the following statements is correct?

Which of the following statements is correct?

A key difference between replacement and expansion project analyses is that with replacement, the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets are not used for the project being evaluated.

The lower the correlation of a project's cash flows with those of the rest of the firm, the greater will be the benefits of the project with regard to reducing within-firm risk.

Which of the following statements is correct?

Repatriation of funds is not relevant in multinational capital budgeting analysis as the funds generated in foreign countries can be reinvested in that country generating larger cash flows for the parent company.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Structure and Dividend Policy Decisions

Working Capital Management

Investment Concepts

Security Valuation and Selection

Filters

Exam 13: Capital Budgeting

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

Other things held constant, if a firm takes on a project that increases its beta coefficient, unless the increased beta is offset by a higher expected return, the firm's stock price will decline.

One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk.

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.

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.

Which of the following statements is correct?

Which of the following statements is correct?

A key difference between replacement and expansion project analyses is that with replacement, the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets are not used for the project being evaluated.

The lower the correlation of a project's cash flows with those of the rest of the firm, the greater will be the benefits of the project with regard to reducing within-firm risk.

Which of the following statements is correct?

Repatriation of funds is not relevant in multinational capital budgeting analysis as the funds generated in foreign countries can be reinvested in that country generating larger cash flows for the parent company.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Structure and Dividend Policy Decisions

Working Capital Management

Investment Concepts

Security Valuation and Selection

Filters