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Exam 13: Capital Budgeting

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Question 61

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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%.

A) True
B) False

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Question 62

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Assume a project has normal cash flows (i.e. ,the initial cash flow is negative,and all other cash flows are positive) .Which of the following statements is most correct?

A) All else equal,a project's IRR increases as the required rate of return declines.
B) All else equal,a project's NPV increases as the required rate of return declines.
C) All else equal,a project's IRR is unaffected by changes in the required rate of return.
D) Answers a and b are both correct.
E) Answers b and c are both correct.

F) A) and C)
G) A) and E)

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Question 63

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Only the incremental after-tax cash flows associated with a capital project are relevant in capital budgeting.

The NPV and IRR methods,when used to evaluate an independent project,will lead to different accept/reject decisions unless the IRR is greater than the required rate of return.

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

Which of the following statements is most correct?

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?

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. -Refer to Real Time Inc.What is the initial investment outlay required at t = 0?

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.

One of the disadvantages of the payback method for evaluating capital budgeting projects is that it does not adjust for the riskiness of different projects.

Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this,they should be excluded from the financial analyses.

If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal),we can conclude that the firm will select X rather than Y if X has a NPV > 0.

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.

Which of the following statements is correct?

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.

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

In its most general sense,capital budgeting is concerned both with the demand for and the supply of funds for long-term investment.

Truck Acquisition You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. -Refer to Truck Acquisition.The truck's required rate of return is 10 percent.What is its NPV?

An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay premiums of $100 per year at the end of each year of the 20 years.Find the internal rate of return to the nearest whole percentage point.