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Exam 13: Capital Budgeting

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Question 81

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Net present value and internal rate of return will always give the same accept or reject decision for mutually exclusive projects,but they might give different rankings for independent projects.

A) True
B) False

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Question 82

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Regarding the net present value of a replacement decision,which of the following statements is false?

A) The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow.
B) The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay) .
C) The present value of depreciation expenses on the new equipment,multiplied by the tax rate,is treated as an inflow.
D) Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay) .
E) An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow) .

F) D) and E)
G) B) and D)

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Question 83

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The primary function of the capital budget is to forecast the funds required for future investments that must be raised through external funding,that is,by selling stock or bonds.

Tech Engineering Company is considering the purchase of a new machine to replace an existing one.The old machine was purchased 5 years ago at a cost of $20,000,and it is being depreciated on a straight line basis to a zero salvage value over a 10-year life.The current market value of the old machine is $14,000.The new machine,which falls into the MACRS 5-year class,has an estimated life of 5 years,it costs $30,000,and Tech plans to sell the machine at the end of the 5th year for $1,000.The new machine is expected to generate before-tax cash savings of $3,000 per year.The company's tax rate is 40 percent.What is the IRR of the proposed project?

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.

Two mutually exclusive projects each have a cost of $10,000.The total,undiscounted cash flows from Project L are $15,000,while the undiscounted cash flows from Project S total $13,000.Their NPV profiles cross at a discount rate of 10 percent.Which of the following statements best describes this situation?

Net supplemental operating cash flow is calculated by adding back the change in depreciation to the change in income after taxes.

If a company uses the same discount rate for evaluating all projects,which of the following results is likely?

You are considering the purchase of an investment that would pay you $5,000 per year for Years 1−5,$3,000 per year for Years 6−8,and $2,000 per year for Years 9 and 10.If you require a 14 percent rate of return,and the cash flows occur at the end of each year,then how much should you be willing to pay for this investment?

Which of the following statements is most correct?

A project's market risk rises if the correlation of its cash flows with the economy decreases.

If a firm faces capital rationing,it should select that set of investments which has the highest total net present value,subject to the constraint that it does not require more capital than is available.

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?

If a project's NPV exceeds the project's IRR,then the project should be accepted.

Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity rate of return.The rule itself should not be affected by managers' tastes,the choice of accounting method,or the profitability of other independent projects.

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.

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Mars Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually.Mars will use the MACRS accelerated method to depreciate the machine,and it expects to sell the machine at the end of its 5-year operating life for $10,000.The firm expects to be able to reduce net working capital by $15,000 when the machine is installed,but required working capital will return to the original level when the machine is sold after 5 years.Mars' marginal tax rate is 40 percent,and it uses a 12 percent required rate of return to evaluate projects of this nature.If the machine costs $60,000,what is the NPV of the project?

In cash flow estimation,the presence of externalities has no direct cash flow effects.

Whitney Crane Inc.has the following independent investment opportunities for the coming year: The IRRs for Project A and C,respectively,are: