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Exam 12: The Capital Budgeting Decision

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Question 1

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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?

A) 4%
B) 6%
C) 8%
D) 10%

E) C) and D)
F) B) and D)

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Question 2

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To find the exact internal rate of return for projects with uneven cash flows, we can interpolate between two factors from the time value of money table: present value of a $1. Annuity can't be used for uneven cash flows

A) True
B) False

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Question 3

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If a firm is experiencing no capital rationing, it should accept all investment proposals

The net present value profile allows a firm to examine the project's net present value over time without any adjustments. The method provides a comparison at the investment origin point between current cash flows and future discounted cash flows.

Technology Corp. is considering a $238,160 investment in a new marketing campaign that it anticipates will provide annual cash flows of $52,000 for the next five years. The firm has a 6% cost of capital. What should the analysis indicate to the firm's managers?

Capital budgeting decisions involve a minimum time horizon of five years. Project expenditures are planned for at least one year.

Under the net present value method, cash flows are assumed to be reinvested at the firm's weighted average cost of capital.

The reason cash flow is used in capital budgeting is because

The internal rate of return is the interest rate that equates the cash outflows of an investment with the subsequent cash inflows.

The internal rate of return assumes that funds are reinvested at the

The dollar amount of losses incurred when an old asset is sold below book value is added to the purchase price of a new asset in calculating the base for depreciation. All else being equal, the new asset is typically depreciated separately, although the tax benefits of writing off losses on older assets might provide a net benefit to the company.

Possibly the most overlooked part of the capital budgeting process is the search for new opportunities through innovation and creative thinking.

A project requires an investment of $2,500 and has a net present value of $430. If the internal rate of return is 10%, what is the profitability index for the project?

Non-mutually exclusive alternatives can be accepted at the same time.

In a replacement decision, a book loss on an old asset can be a valuable feature.

Capital budgeting is primarily concerned with

When net present value and internal rate of return analysis provide inconsistent rankings of projects, the financial manager should generally move forward with the project that has the highest internal rate of return. In the event of such a conflict, all facts must be reconsidered, including the discount rate.

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

An equipment replacement decision, under incremental analysis, requires

The longer the life of an investment