Exam 13: Capital Budgeting

The Ace Company is considering investing in a piece of property which costs $105,000.The property will return a constant cash flow forever.If the firm's required rate of return is 9 percent and the corporate tax rate is 40 percent, what is the minimum after-tax cash flow that would make the investment acceptable to Ace?

The internal rate of return for a project that has initial costs of $10,000 and generates cash flows of $7,000 in year one, $8,000 in year two, and $5,000 in year three is 35.7%.

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.

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

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk.In evaluating this asset, the decision maker should

Other things held constant, an increase in the required rate of return will result in a decrease of a project's IRR.

One problem with Monte Carlo simulation analysis is that, while the simulation may provide some insights into the riskiness of a project, the analysis does not lead to a clear-cut accept versus reject decision.

Capital budgeting is process of planning expenditures on assets whose cash flows are expected to end in less than one year.

The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects.The discount rate used for Project A is 12 percent.Further, Project A costs $15,000, and it would be depreciated using MACRS.It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years.Project B costs $14,815 and would also be depreciated using MACRS.B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years.The Unlimited's marginal tax rate is 40 percent.What risk-adjusted discount rate will equate the NPV of Project B to that of Project A?

If a firm is considering purchasing an asset whose beta is greater than the current beta of the firm, it should use a discount rate greater than the firm's average required rate of return to evaluate the possible investment.

Tapley Acquisition Inc.is considering the purchase of Target Company.The acquisition would require an initial investment of $190,000, but Tapley's after-tax net cash flows would increase by $30,000 per year and remain at this new level forever.Assume the required rate of return is 15 percent.Should Tapley buy Target?

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero.Also, the NPV of X is greater than the NPV of Y at the required rate of return.If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data.Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

The present value of the expected net cash inflows for a project will most likely exceed the present value of the expected net profit after tax for the same project because

Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows.Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000.Further, at a discount rate of 10 percent, the two projects have identical NPVs.Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.)

Woodson Inc.has two possible projects, Project A and Project B with the following cash flows: At what required rate of return do the two projects have the same net present value (NPV)? (In other words, what is the "crossover rate" of the projects' NPV profiles?)

Assume that you are comparing two mutually exclusive projects.Which of the following statements is most correct?

If a typical U.S.company uses the same discount rate to evaluate all projects, the firm will most likely become

Superior analytical techniques, such as NPV, used in combination with adjustments to the average required rate of return, can overcome the problem of poor cash flow estimation in decision making.

Which of the following statements is correct?

The depreciable base of an asset includes the purchase price and any additional expenditures required to make the asset operational, including shipping and installation.