Exam

Name___________________________________

 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


1)


A sophisticated capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital is called net present value.


1)


_______





 


2)


The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.


2)


_______





 


ESSAY.  Write your answer in the space provided or on a separate sheet of paper.


Table 9.7

 

Galaxy Satellite Co. is attempting to select the best group of independent projects competing for the firm's fixed capital budget of $10,000,000. Any unused portion of this budget will earn less than its 20 percent cost of capital. A summary of key data about the proposed projects follows.

 

 


3)


Use the IRR approach to select the best group of projects. (See Table 9.7)





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


4)


Which of the following capital budgeting techniques ignores the time value of money?


4)


_______


A)


Internal rate of return.


B)


Payback.


C)


Net present value.


D)


Two of the above





 


ESSAY.  Write your answer in the space provided or on a separate sheet of paper.


Table 9.3

 

Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.

 

 

 

The firm pays 40 percent taxes on ordinary income and capital gains.

 


5)


Given the information in Table 9.3, compute the incremental annual cash flows.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


6)


The discount rate (which is also known as the required return, cost of capital, or opportunity cost) is the minimum return that must be earned on a project to leave the firm's market value unchanged.


6)


_______





 


ESSAY.  Write your answer in the space provided or on a separate sheet of paper.


Table 9.1

 

 


7)


Given the information in Table 9.1 and 15 percent cost of capital,

(a)   compute the net present value.

(b)   should the project be accepted?





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


8)


By measuring how quickly the firm recovers its initial investment, the payback period gives implicit (though not explicit) consideration to the timing of cash flows and therefore to the time value of money.


8)


_______





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


Table 9.6

 

Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The gluing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated under MACRS using a five-year recovery schedule and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by $17,000 per year. Training costs of employees who will operate the new machine will be a one-time cost of $5,000 which should be included in the initial outlay. The new machine will be depreciated under MACRS using a five-year recovery period. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains.

 


9)


The tax effect of the sale of the existing asset is (See Table 9.6)


9)


_______


A)


a tax liability of $2,340.


B)


a tax liability of $3,320.


C)


a tax liability of $5,320.


D)


a tax benefit of $1,500.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


10)


The IRR is the compound annual rate of return that the firm will earn if it invests in a project and receives the estimated cash inflows.


10)


______





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


11)


The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is


11)


______


A)


the assumption made by the NPV method that intermediate cash flows are reinvested at the internal rate of return.


B)


the assumption made by the IRR method that intermediate cash flows are reinvested at the cost of capital.


C)


that neither method explicitly considers the time value of money.


D)


the reinvestment rate assumption regarding intermediate cash flows.





 


12)


On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all the following reasons EXCEPT


12)


______


A)


for the reasonableness of the reinvestment rate assumption.


B)


that there may be multiple solutions for an IRR computation.


C)


that it measures the benefits relative to the amount invested.


D)


that it maximizes shareholder wealth.





 


ESSAY.  Write your answer in the space provided or on a separate sheet of paper.


Table 9.3

 

Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.

 

 

 

The firm pays 40 percent taxes on ordinary income and capital gains.

 


13)


Given the information in Table 9.3, compute the payback period.





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


14)


Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project B also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?


14)


______


A)


Project X.


B)


Project Y.


C)


Neither.


D)


Not enough information to tell.





 


15)


Examples of sophisticated capital budgeting techniques include all of the following EXCEPT


15)


______


A)


net present value.


B)


annualized net present value.


C)


payback period.


D)


internal rate of return.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


16)


For conventional projects, both NPV and IRR techniques will always generate the same accept-reject decision, but differences in their underlying assumptions can cause them to rank mutually exclusive projects differently.


16)


______





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


17)


What is the IRR for the following project if its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4?


17)


______


A)


13.57%.


B)


15.57%.


C)


0.00%.


D)


None of the above.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


18)


Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could actually reinvest intermediate cash inflows, the use of NPV is in theory preferable to IRR.


18)


______





 


19)


The net present value is found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.


19)


______





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


Table 9.4

 

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:

 

 

 


20)


The new financial analyst does not like the payback approach (Table 9.4) and determines that the firm's required rate of return is 15 percent. His recommendation would be to


20)


______


A)


accept projects A and B.


B)


reject project A and accept B.


C)


accept project A and reject B.


D)


reject both.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


21)


If a project's payback period is greater than the maximum acceptable payback period, we would reject it.


21)


______





 


22)


A project must be rejected if its payback period is less than the maximum acceptable payback period.


22)


______





 


23)


If net present value of a project is greater than zero, the firm will earn a return greater than its cost of capital.  The acceptance of such a project would enhance the wealth of the firm's owners.


23)


______





 


ESSAY.  Write your answer in the space provided or on a separate sheet of paper.


Table 9.7

 

Galaxy Satellite Co. is attempting to select the best group of independent projects competing for the firm's fixed capital budget of $10,000,000. Any unused portion of this budget will earn less than its 20 percent cost of capital. A summary of key data about the proposed projects follows.

 

 


24)


Which projects should the firm implement? (See Table 9.7)





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


25)


The ________ is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cash inflows.


25)


______


A)


opportunity cost


B)


internal rate of return


C)


cost of capital


D)


discount rate





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


26)


One weakness of payback is its failure to recognize cash flows that occur after the payback period.


26)


______





 


MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question.


27)


A firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows:

 

               

The firm should


27)


______


A)


accept Project 3 and reject Projects 1 and 2.


B)


accept Projects 2 and 3 and reject Project 1.


C)


accept Project 2 and reject Projects 1 and 3.


D)


accept Project 1 and reject Projects 2 and 3.





 


TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false.


28)


If the NPV is greater than $0.00, a project should be accepted.


28)


______





 


29)


The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.


29)


______





 


30)


The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $856.49.


30)


______






 


1)


TRUE


 


2)


TRUE


 


3)


IRR Approach

 

Choose Projects B and C, resulting in a NPV of $380,000.


 


4)


B


 


5)


 

 

 


 


6)


TRUE


 


7)


(a)   NPV = 1,000 (PVIFA15%,5) - 2,500

                  = 1,000 (3.352) - 2,500 = $852

(b)   Since NPV > 0, the project should be accepted.


 


8)


TRUE


 


9)


C


 


10)


TRUE


 


11)


D


 


12)


C


 


13)


 

 

PP = 3 + [(87,800 - 67,080)/24,160] = 3.86 years.


 


14)


C


 


15)


C


 


16)


TRUE


 


17)


A


 


18)


TRUE


 


19)


FALSE


 


20)


B


 


21)


TRUE


 


22)


FALSE


 


23)


TRUE


 


24)


Projects C and D


 


25)


B


 


26)


TRUE


 


27)


B


 


28)


TRUE


 


29)


TRUE


 


30)


FALSE