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Exam 13: Capital Budgeting

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Question 41

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Given the following net cash flows, determine the IRR of the project:

A) 36%
B) 32%
C) 28%
D) 24%
E) 20%

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

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Question 42

Multiple Choice

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A major disadvantage of the payback period method is that it

A) Is useless as a risk indicator.
B) Ignores cash flows beyond the payback period.
C) Does not directly account for the time value of money.
D) All of the above are correct.
E) Only answers b and c are correct.

F) A) and B)
G) A) and C)

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Question 43

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Under certain conditions, a particular project may have more than one IRR.One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's life.

New Project NPV 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. [MACRS table required] -Refer to Truck Acquisition.What is the terminal (nonoperating) cash flow at the end of Year 3?

If an asset being considered for acquisition has beta of zero, its purchase will have no effect on the firm's market risk.

The change in net working capital that results from the acceptance of a project is an incremental cash flow that must be considered in capital budgeting analysis.

Given the following information, what is the required cash outflow associated with the acquisition of a new machine; that is, in a project analysis, what is the initial investment outlay at t = 0?

A company is analyzing two mutually exclusive projects, S and L, whose cash flows are shown below: The company's required rate of return is 12 percent, and it can get an unlimited amount of funds at that rate.What is the IRR of the better project, i.e., the project which the company should choose if it wants to maximize the price of its stock?

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000.The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000.Target's corporate tax rate is 40 percent.If Target sells the old machine at market value, what is the initial investment outlay (after-tax) for the new printing machine?

Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.

Which of the following statements is false?

Klott Company encounters significant uncertainty with its sales volume and price in its primary product.The firm uses scenario analysis in order to determine an expected NPV, which it then uses in its budget.The base case, best case, and worse case scenarios and probabilities are provided in the table below.What is Klott's expected NPV, standard deviation of NPV, and coefficient of variation of NPV?

Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for $100.To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when the machine is retired at the end of Year 3.The machine will produce sales revenues of $900/year for 3 years; variable operating costs (excluding depreciation) will be 50 percent of sales.Operating cash inflows will begin 1 year from today (at Time 1) .The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively.The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund from this project if the project's income is negative, and a 10 percent required rate of return.Inflation is zero.What is the project's NPV?

If the calculated NPV is negative, then which of the following must be true? The discount rate used is

Normal Projects Q and R have the same NPV when the discount rate is zero.However, Project Q has larger early cash flows than R.Therefore, we know that at all discount rates greater than zero, Project R will have a greater NPV than Q.

Small businesses probably make less use of the DCF capital budgeting techniques than large businesses.This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms.

Virus Stopper Inc., a supplier of computer safeguard systems, uses a required rate of return of 12 percent to evaluate average risk projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk.Currently, two mutually exclusive projects are under consideration.Both have a cost of $200,000 and will last 4 years.Project A, a riskier-than-average project, will produce annual end of year cash flows of $71,104.Project B, of less than average risk, will produce cash flows of $146,411 at the end of Years 3 and 4 only.Virus Stopper should accept

Risk-Adjusted Discount Rate 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. [MACRS table required] -Refer to Real Time Inc.What is the project's NPV?

When evaluating a new project, the firm should consider all of the following factors except:

Which of the following statements is correct?