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Exam 15: Capital Budgeting

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Question 1

Multiple Choice

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When using one of the discounted cash flow methods to evaluate the desirability of a capital budgeting project, which of the following factors is generally not important?

A) method of financing the project under consideration
B) timing of cash flows relating to the project
C) impact of the project on income taxes to be paid
D) amounts of cash flows relating to the project

E) B) and C)
F) A) and B)

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Question 2

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If the net present value is positive, the actual return on a project exceeds the required rate of return.

A) True
B) False

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Question 3

Multiple Choice

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The net present value method of evaluating proposed investments

The evaluation of future long-range projects to allocate resources effectively and efficiently is referred to as ______________________________________.

Bailey Corporation is interested in purchasing a state-of-the-art widget machine for its manufacturing plant. The new machine has been designed to basically eliminate all errors and defects in the widget-making production process. The new machine will cost $150,000, and have a salvage value of $70,000 at the end of its seven-year useful life. Bailey has determined that cash inflows for years 1 through 7 will be as follows: $32,000; $57,000; $15,000; $28,000; $16,000; $10,000, and $15,000, respectively. Maintenance will be required in years 3 and 6 at $10,000 and $7,000 respectively. Bailey uses a discount rate of 11 percent and wants projects to have a payback period of no longer than five years. Present value tables or a financial calculator are required.

Why is the profitability index a better basis than net present value to compare projects that require different levels of investment?

Michele Miller borrows $50,000 from her bank on January 1. She is to repay the loan in equal annual installments over 30 years. How much is her annual repayment if the bank charges 10 percent interest? Present value tables or a financial calculator are required.

Zachary Adams has an opportunity to invest in a project that will yield four annual payments of $12,000 with no salvage. The first payment will be received in exactly one year. On low-risk projects of this type, Adams requires a return of 6 percent. Based on this requirement, the project generates a profitability index of 1.03953. Present value tables or a financial calculator are required.

Why is it important for managers to be able to rank projects?

Depreciation expense provides a tax shield against the payment of taxes.

The capital budgeting technique that divides average annual profits from an investment by the average investment in a project is referred to as the _____________________________________.

If an investment has a positive net present value, the

Tilemaster Industries is considering the purchase of a $100,000 machine that is expected to result in a decrease of $15,000 per year in cash expenses. This machine, which has no residual value, has an estimated useful life of 10 years and will be depreciated on a straight-line basis. For this machine, the accounting rate of return would be

The time value of money is explicitly recognized through the process of

When a profitable corporation sells an asset at a loss, the after-tax cash flow on the sale will

A decision in which projects are ranked according to their impact on achieving company objectives is a screening decision.

The weighted average cost of capital that is used to evaluate a specific project should be based on the

For an ordinary annuity, the first cash flow occurs at the end of the period.

McDonald's Retail McDonald's Retail is considering an investment in a delivery truck. McDonald has found a used truck that he can purchase for $8,000. He estimates the truck would last six years and increase his store's net cash revenues by $2,000 per year. At the end of six years, the truck would have no salvage value and would be discarded. McDonald will depreciate the truck using the straight-line method. Refer to McDonald's Retail. What is the payback period on the investment in the new truck?

Assume that X represents a sum of money that Bill has available to invest in a project that will yield a return of r. In the formula Y = X(1 + r) , Y represents the