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Exam 12: The Capital Budgeting Decision

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Question 1

Multiple Choice

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The net present value profile:

A) doesn't work if projects have a negative net present value.
B) is a substitute for the IRR.
C) graphically portrays the relationship between the discount rate and the net present value.
D) is determined by the cost of debt.

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

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C

Question 2

Multiple Choice

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Assume a corporation has earnings before depreciation and taxes of $82,000,depreciation of $45,000,and that it has a 30 percent tax bracket.What are the after-tax cash flows for the company?

A) $70,900
B) $82,000
C) $42,000
D) $37,000

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

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Question 3

Multiple Choice

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Suppose that interest rates (and,therefore,the firm's Weighted Average Cost of Capital) increase.This would not change the capital budgeting choices a firm would make if it:

The investment tax credit,when applicable,changes the amortization base for tax purposes.

There are several disadvantages to the payback method,among them:

A rapid payback may be important to firms having rapid technological development.

The average accounting return (AAR)is fairly easy to calculate and makes use of information readily prepared by the accounting conventions.Why is the AAR method for evaluating investments flawed?

The net present value method is a better method of evaluation than the internal rate of return method because:

A good capital budgeting program requires that a number of steps be taken in the decision making process.The first step is the explanation of data.

It is not unusual for a corporate president,who deals with security analysts,to be as sensitive to after tax income as cash flow.

Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000.The current market value of the old machine is $25,000 but the book value is $32,000.What is the net cash outflow for the new machine with consideration for the sale of the old machine?

You buy a new piece of equipment for $7,360,and you receive a cash inflow of $1,000 per year for 10 years.What is the internal rate of return?

The Taylor Corporation is using a machine that originally cost $66,000.The machine has a book value of $66,000 and a current market value of $40,000.The asset is in the Class 8 CCA pool.It will have no salvage value after 5 years and the company tax rate is 40%. Jacqueline Elliott,the Chief Financial Officer of Taylor,is considering replacing this machine with a newer model costing $70,000.The new machine will cut operating costs by $10,000 each year for the next five years.Taylor's cost of capital is 8%. Should the firm replace the asset? (Use NPV methodology to solve this problem.)

The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected.

The investment tax credit:

The internal rate of return (IRR) assumes that funds are reinvested at the:

The Net Present Value (NPI)method of evaluating investment proposals is superior to the other methods discussed in the text.Do you agree or disagree with this statement? Explain.

Capital budgeting is primarily concerned with:

A&B Enterprises is trying to select the best investment from among four alternatives.Each alternative involves an initial outlay of $100,000.Their cash flows follow:B.Choose C only if required rate of return is below 7.9%. B.We would not select alternative

Capital budgeting is primarily concerned with: