Chapter 17
Capital Budgeting Analysis

TRUE-FALSE QUESTIONS

1. The typical capital budgeting project involves a large up-front cash outlay, followed by a series of smaller net cash outflows.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

2. The majority of capital budgeting projects are short-lived projects.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

3. A capital budgeting project’s cash flows, including the total up-front cost of the project, are typically known with certainty before the project starts.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

4. The net present value of an investment is the present value of a project’s future cash flows minus its initial cost.

Difficulty Level: Easy

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

5. The net present value of an investment is the present value of a project’s future cash flows.

Difficulty Level: Easy

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

6. Capital budgeting decisions can only involve mutually exclusive projects.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

7. To maximize shareholder wealth, a financial manager needs to find capital budgeting projects that have positive net present values.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

8. Projects with negative net present values will lead to a decrease in the value of the firm.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

9. Independent projects are not in direct competition with one another.

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

10. Mutually exclusive projects are projects that are not in direct competition with one another.

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

11. Project budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

12. The profitability of a firm is affected to the greatest extent by its management’s success in making capital budget investment decisions.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

13. MOGS is a review of a firm’s internal strengths and weaknesses, and its external opportunities and threats.

Difficulty Level: Easy

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

14. Information generation develops three types of data: internal financial data, external economic and political data, and non-financial data.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

15. Sound capital budgeting decisions require a variety of information including internal financial data, external economic and political data, and non-financial data.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

16. Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Process

L.O. 17.2

17. The identification stage in capital budgeting involves finding potential capital investment opportunities and determining whether a project involves a replacement decision and/or revenue expansion.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

18. The selection stage involves applying the appropriate capital budgeting techniques to help make a final decision.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

19. The development stage requires estimating relevant cash inflows and outflows.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

20. The identification stage requires estimating relevant cash inflows and outflows.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

21. The development stage involves discussing the pros and cons of each project.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

22. The development stage requires asking what the strategic impact will be of not doing the project.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

23. The first step in the capital budgeting process is

a. implementation

b. selection

c. follow-up

d. identification

Difficulty Level: Easy

Subject Heading: Capital Budgeting Process

L.O. 17.2

24. Which of the following is not considered a stage in the capital budgeting process?

a. development

b. production

c. implementation

d. selection

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

25. The capital budgeting process consists of all of the following stages except:

a. follow-up.

b. selection.

c. reversing.

d. development.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

26. All of the following are considered stages in the capital budgeting process EXCEPT:

a. invention

b. development

c. implementation

d. selection

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

27. The capital-budgeting process starts with which one of the following stages:

a. development

b. identification

c. implementation

d. selection

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

28. The final step in the capital budgeting process is

a. implementation

b. selection

c. follow-up

d. development

Difficulty Level: Medium

Subject Heading: Capital Payback Process

L.O. 17.2

29. The capital budgeting process consists of all of the following stages except:

a. follow-up.

b. selection.

c. refurbishing.

d. development.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

30. Stages of the capital budgeting include all of the following EXCEPT:

a. follow-up.

b. selection.

c. identification.

d. processing

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

31. The stage in the capital budgeting process that involves finding potential capital investment opportunities and determining whether a project involves a replacement decision and/or revenue expansion is called the _____________ stage.

a. follow-up.

b. selection.

c. identification.

d. development.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

32. The stage in the capital budgeting process that requires estimating relevant cash inflows and outflows and discussing the pros and cons of each project is called the _____________ stage.

a. follow-up.

b. selection.

c. identification.

d. development.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

33. The stage in the capital budgeting process that involves applying the appropriate capital budgeting techniques to help make a final accept or reject decision is called the _____________ stage.

a. follow-up.

b. selection.

c. identification.

d. development.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

34. The stage in the capital budgeting process in which projects that are accepted must be executed in a timely fashion is called the _____________ stage.

a. follow-up.

b. selection.

c. identification.

d. implementation.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

35. The stage in the capital budgeting process in which implemented projects are periodically reviewed is called the _____________ stage.

a. follow-up.

b. selection.

c. identification.

d. implementation.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

36. A positive NPV suggests that a project produces sufficient cash flows to cover not only its initial cost, but also all financing costs.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

37. A higher-risk project needs to be evaluated using a lower required rate of return.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

38. In a capital budgeting context, a project’s required rate of return is called the yield to maturity.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

39. A firm’s cost of capital is the discount rate used in the evaluation of capital budgeting projects using payback and IRR.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

40. To calculate the net present value in Excel, you use the “=PV()” function.

Difficulty Level: Easy

Subject Heading: Using Spreadsheet Functions

L.O. 17.3

41. Excel calculates NPV exactly the same way as it is calculated in the textbook.

Difficulty Level: Easy

Subject Heading: Using Spreadsheet Functions

L.O. 17.3

42. A NPV profile shows how NPV varies given alternative IRRs.

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

43. The internal rate of return is the return that caused the net present value to be zero.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

44. The net present value and internal rate of return methods will always agree on whether a project enhances or harms shareholder wealth.

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

45. The internal rate of return measures the return on the project’s initial cost.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

46. A firm’s cost of capital is discount rate used in the evaluation of capital budgeting projects using NPV and IRR.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

47. When applied to the analysis of independent projects, NPV and IRR never provide conflicting accept or reject decisions.

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

48. An NPV profile is a table used to select the appropriate discount rate to use in calculating the NPV.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

49. In Excel, you find the IRR using the net present value function with a discount rate of zero.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

50. In Excel, you find the IRR using the “=IRR()” function with a discount rate of zero.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

51. In Excel, you find the IRR using the “=IRR()” function.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

52. It is possible for a set of financial data to have more than one IRR value.

Difficulty Level: Hard

Subject Heading: NPV and IRR

L.O. 17.4

53. Modern internal rate of return (MIRR) solves some of the problems presented by IRR.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

54. MIRR and IRR will always agree on their rankings of projects.

Difficulty Level: Hard

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

55. MIRR rankings of mutually exclusive projects with comparably sized initial investments will agree with the NPV rankings of those projects.

Difficulty Level: Hard

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

56. In Excel, you find the MIRR ranking for a project using the “=MIRR()” function.

Difficulty Level: Hard

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

57. In Excel, finding the MIRR ranking for a project is a multi-step process.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

58. The profitability index is also sometimes referred to as the benefit/cost ratio.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

59. The profitability index is calculated by subtracting the net investment from the present value of the cash flows.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

60. The profitability index measures the present value of benefits received for each dollar invested.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

61. A profitability index of two means that the project returns a present value of $2 for every $1 invested.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

62. A profitability index of two means that the project returns a value of $2 for every $1 invested.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

63. The profitability index is the least preferable method to use to evaluate capital budgeting projects because it does not take the time value of money into account.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

64. Whenever the net present value of a project is positive, the profitability index is greater or equal to 1.0.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

65. The NPV, IRR, and PI always agree on which projects would enhance shareholder wealth and which would diminish it.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

66. Payback explicitly considers the time value of money.

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

67. One weakness of the payback period method is that all cash flows beyond the payback period are ignored.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

68. Projects favored using payback techniques will be ranked the same using net present value.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

69. The net present value, internal rate of return and payback period methods always agree on which project would enhance shareholder wealth and which would diminish it.

Difficulty Level: Medium

Subject Heading: Difference Between Theory and Practice

L.O. 17.8

70. A project with a lower IRR or PI may add more to shareholder value than another mutually exclusive project if the projects have different cash flow patterns, time horizons, or sizes.

Difficulty Level: Hard

Subject Heading: Conflicts Between Discounted Cash Flow Techniques

L.O. 17.8

71. Projects with smaller initial investments may have higher PIs and IRRs, but their small size may appear to make them less attractive from an NPV perspective.

Difficulty Level: Hard

Subject Heading: Different Sizes

L.O. 17.8

72. The stand-alone principle suggests that a project must be viewed separately from the rest of the firm.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

73. Incremental cash flows represents a project’s cash flows summed together with the firm’s other cash flows to get a total firm view of the project.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

74. Sunk costs are relevant in capital budgeting analysis and should be considered in calculating a project’s initial investment.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

75. a sunk cost is a project-related expense that is dependent upon whether or not the project is undertaken.

Difficulty Level: Easy

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

76. The depreciation tax shield equals the amount of the depreciation expense multiplied by the firm’s tax rate.

Difficulty Level: Easy

Subject Heading: Approaches to Estimating Project Cash Flows

L.O. 17.9

77. The stand-alone principle focuses on the project’s own cash flows, uncontaminated by cash flows from the firm’s other activities.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

78. Enhancement occurs when a project robs cash flow from the firm’s existing line of business.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

79. Cannibalization occurs when a project robs cash flow from the firm’s existing line of business.

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

80. Expansion projects involving new areas and product lines are usually associated with greater cash inflow uncertainty.

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11

81. Nonfinancial information plays no part in capital budgeting.

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11

82. Opportunity costs reflect the cost of passing up the next best alternative and are irrelevant in capital budgeting analysis.

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11

83. The higher the risk of a project, the higher its risk-adjusted discount rate and thus the lower the net present value for a given stream of cash inflows.

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11

84. The risk-adjusted discount rate (RADR) is the risk adjustment factor that represents the percent of estimated cash inflows that investors would be satisfied to receive for certain rather than the cash inflows that are possible for each year.

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11

MULTIPLE-CHOICE QUESTIONS

85. The process of identifying, evaluating, and implementing a firm’s investment opportunities is referred to as:

a. capital expenditures

b. initial cash flow analysis

c. long-term forecasting

d. capital budgeting

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

86. Capital budgeting is

a. the process of identifying, evaluating, and implementing a firm’s investment opportunities.

b. the process of identifying, evaluating, and implementing a firm’s objectives.

c. the process of identifying, evaluating, and implementing a firm’s strategic plans.

d. the process of identifying, evaluating, and implementing a firm’s financing requirements.

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

87. Capital budgeting is not:

a. the process of identifying, evaluating, and implementing a firm’s working capital requirements.

b. the process of identifying, evaluating, and implementing a firm’s objectives.

c. the process of identifying, evaluating, and implementing a firm’s strategic plans.

d. the process of identifying, evaluating, and implementing a firm’s financing

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

88. The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:

a. MOGS.

b. SMOG.

c. OMGS.

d. GOMS.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

89. The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:

a. SWOT.

b. MOGS.

c. STOW.

d. GOMS.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

90. Which of the following statements is correct?

a. Capital budgeting analysis is not a framework for evaluating all business decisions; it is only a tool for the “financial” types.

b. Proper analysis will identify irrelevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project without considering the time value of money.

c. Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should not try to quantify the benefits and cost of these choices in order to evaluate them properly.

d. To achieve success over time, a firm’s managers must identify and invest in projects that provide positive net present values to maximize shareholder wealth.

Difficulty Level: Hard

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

91. All of the following statements are correct except:

a. Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.

b. Capital budgeting seeks to identify projects that will enhance a firm’s competitive advantage and by so doing increase shareholders’ wealth.

c. By its nature, capital budgeting involves long-term projects, although capital budgeting techniques also can be applied to working capital decisions

d. Capital budgeting projects usually require small initial investments and may involve acquiring or constructing plant and equipment.

Difficulty Level: Hard

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

92. All of the following statements are correct except:

a. Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.

b. Capital budgeting seeks to identify projects that will enhance a firm’s competitive advantage and by so doing increase shareholders’ wealth.

c. By its nature, capital budgeting involves long-term projects, although capital budgeting techniques also can be applied to working capital decisions

d. Capital budgeting projects usually require small initial investments and may involve acquiring or constructing plant and equipment.

Difficulty Level: Hard

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

93. Which of the following statements is correct?

a. The typical capital budgeting project involves a small upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.

b. The typical capital budgeting project involves a large upfront cash outlay, followed by a series of larger cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.

c. The typical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.

d. The typical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, and the project’s cash flows, including the total upfront cost of the project, are known with certainty before the project starts.

Difficulty Level: Hard

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

94. Positive NPV projects may originate from cost saving projects such as those that

a. create economies of scale.

b. generate negative cost advantages.

c. ignore advantages in distribution channels.

d. always use new processes or equipment

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

95. Any positive economic profit or positive net present value must arise from

a. market imperfections or inefficiencies such as a monopoly situation.

b. cost-saving projects that allow the firm to increase costs above the current level such as economies of scale and access to distribution channels.

c. accelerated depreciation assisting in cash flow.

d. less actual risk than perceived risk

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

96. Any positive economic profit or positive net present value may arise from all of the following, except:

a. market imperfections or inefficiencies such as a monopoly situation.

b. economies of scale.

c. product development.

d. government policy.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

97. Two or more projects that perform the same function are said to be:

a. mutually exclusive projects

b. independent projects

c. joint projects

d. combined projects

Difficulty Level: Medium

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

98. In the case of independent projects:

a. the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.

b. they are to be evaluated based on their expected effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.

c. the financial manager is responsible for choosing the best of these alternatives since only one can be chosen; selecting one project precludes the other from being undertaken.

d. they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.

Difficulty Level: Hard

Subject Heading: Mission, Vision, and Capital Budgeting

L.O. 17.1

99. An examination of a firm’s opportunities, strengths, threats and weaknesses is often referred to by the following acronym:

a. WOTS.

b. OSTW.

c. SWOT.

d. TWOS.

Difficulty Level: Medium

Subject Heading: Identifying Potential Capital Budget Projects

L.O. 17.1

100. An examples of external economic data required for project analysis includes which of the following?

a. business cycle stages

b. labor-management relations

c. ethnic background of workers

d. changes in weather patterns – such as global warming

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

101. Examples of internal financial data required for project analysis include all of the following except:

a. investment costs

b. business cycle stages

c. financing costs

d. transportation costs

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

102. An examples of internal financial data required for project analysis include which of the following?

a. management stock options

b. number of employees

c. length of time the firm has been in business

d. transportation costs

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

103. Examples of non-financial data required for project analysis include which of the following?

a. financing costs

b. quantity and quality of labor force in different locations

c. transportation costs

d. business cycle stages

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

104. All of the following statements are correct except:

a. Capital budgeting analysis is a framework for evaluating all business decisions; it is the only a tool for the “financial” types.

b. Proper analysis will identify relevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project by considering the time value of money.

c. Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should try to quantify the benefits and cost of these choices in order to evaluate them properly.

d. To achieve success over time, a firm’s managers must identify and invest in projects that provide positive net present values to maximize shareholder wealth.

Difficulty Level: Hard

Subject Heading: Capital Budgeting Process

L.O. 17.2

105. Unlike other corporations undertaking the capital budgeting process, MNC’s need to consider which of the following?

a. the possibility of seizure of assets.

b. the development of new products.

c. construction techniques

d. selection of management

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

106. Examples of external economic data required for project analysis include all of the following except:

a. business cycle stages.

b. inflation trends

c. labor-management relations

d. exchange rate trends

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

107. Unlike other corporations undertaking the capital budgeting process, ___________ need to consider possible added political and economic risks such as the possibility of seizure of assets, unstable currencies, foreign exchange controls and foreign tax regulations.

a. MOGs.

b. MNCs.

c. SWOTs.

d. LTDs.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Process

L.O. 17.2

108. When a project’s net present value (NPV) exceeds zero, then:

a. the project should be accepted

b. the project will be acceptable using the payback period method

c. the IRR should be calculated to ensure that the project’s IRR exceeds the cost of capital

d. the payback period is always less than one year

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

109. Which of the following is the best expression of the net present value (NPV) acceptance criterion?

a. positive cash flows total greater than negative flows

b. number of positive cash flows exceeds negative

c. payback within one third the life of the project

d. NPV is greater than or equal to zero

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

110. A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. If the firm’s required return or cost of capital is 10%, the NPV of the project is:

a. $5,000

b. $6,862

c. -$5,000

d. -$6,862

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

111. What is the NPV for the following project if its cost of capital is 12% and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?

a. ($1,494,336)

b. $1,494,336

c. $4,321,914

d. ($4,321,914)

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

112. Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm’s cost of capital is 10%. Based on this information, the NPV of the project is _________ million and the firm should _________ the project.

a. $151.63; accept

b. -$151.63, reject

c. $4.37, accept

d. -$4.37, reject

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

113. Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm’s cost of capital is 8%. Based on this information, the NPV of the project is _________ million and the firm should _________ the project.

a. $3.7; accept

b. -$3.7, reject

c. $159.37, accept

d. -$159.37, reject

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Net Present Value

L.O. 17.3

114. Internal rate of return (IRR) and net present value (NPV) methods:

a. generally arrive at the same accept/reject decisions

b. are less sophisticated than the payback period

c. cannot make use of the same cash flows

d. can be substituted for by the payback period

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

115. The internal rate of return concept is best explained by which of the following?

a. rate where NPV is equal to zero

b. point where initial investment has been returned

c. marginal cost of capital

d. average book value

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

116. The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.

a. payback period

b. average rate of return

c. cost of capital

d. internal rate of return

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

117. As a rule, independent projects are accepted if the internal rate of return is greater than or equal to:

a. 1.0

b. zero

c. marginal cost of capital

d. expected rate of return

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

118. When the net present value is negative, the internal rate of return is __________ the cost of capital.

a. greater than

b. greater than or equal to

c. less than

d. equal to

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

119. When the net present value for a project is negative, the internal rate of return is _________ the cost of capital.

a. greater than

b. greater than or equal to

c. less than

d. equal to

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

120. The IRR

a. shows the graphical relationship between a project’s NPV and cost of capital.

b. is the return that causes the NPV to be zero.

c. is the return that causes the NPV to be positive.

d. measures the firm and project’s required rate of return.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

121. A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. If the firm’s required return or cost of capital is 15%, should it accept the project using the IRR as a decision criteria?

a. yes

b. no

c. only if the NPV is less than 1

d. only if the PI is negative

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

122. Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm’s cost of capital is 10%. Based on this information, the IRR of the project is _________ percent and the firm should _________ the project.

a. 9.9; accept

b. 9.9, reject

c. 8.9, accept

d. 8.9, reject

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

123. Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years. The firm’s cost of capital is 8%. Based on this information, the IRR of the project is _________ percent and the firm should _________ the project.

a. 9.9; accept

b. 9.9, reject

c. 8.9, accept

d. 8.9, reject

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

124. All of the following statements are correct except:

a. The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.

b. If a project has a positive NPV, its IRR will always be greater than the cost of capital.

c. If a project has a negative NPV, its IRR will always be less than the cost of capital.

d. There is never a conflict between NPV and IRR in the case of mutually exclusive projects.

Difficulty Level: Hard

Subject Heading: NPV and IRR

L.O. 17.4

125. All of the following statements are correct except:

a. The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.

b. If a project has a positive NPV, its IRR will always be greater than the cost of capital.

c. If a project has a negative NPV, its IRR will always be less than the cost of capital.

d. There is always a conflict between NPV and IRR in the case of mutually exclusive projects.

Difficulty Level: Hard

Subject Heading: NPV and IRR

L.O. 17.4

126. Which of the following statements is correct?

a. The NPV and IRR methods will only sometimes agree on whether a project enhances or harms shareholder wealth.

b. If a project has a positive NPV, its IRR will always be less than the cost of capital.

c. If a project has a negative NPV, its IRR will always be less than the cost of capital.

d. There is always a conflict between NPV and IRR in the case of mutually exclusive projects.

Difficulty Level: Hard

Subject Heading: NPV and IRR

L.O. 17.4

127. All of the following statements are correct except:

a. The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.

b. If a project has a positive NPV, its IRR will always be greater than the cost of capital.

c. If a project has a positive NPV, its IRR will always be less than the cost of capital.

d. There is sometimes a conflict between NPV and IRR in the case of mutually exclusive projects.

Difficulty Level: Hard

Subject Heading: NPV and IRR

L.O. 17.4

128. Which one of the following best explains the impact on a firm that accepts a project with a negative NPV?

a. negative cash flows

b. decrease in the value of the firm

c. high marginal cost of capital

d. low initial returns

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

129. With independent projects, NPV and IRR provide identical accept/reject decisions. If, however, you have two mutually exclusive projects to evaluate, the most accurate thing you could say about the eventual results is that:

a. NPV and IRR may give conflicting rankings

b. NPV and IRR never give the same rankings

c. NPV and IRR always give the same rankings

d. IRR is more lenient in accepting

Difficulty Level: Medium

Subject Heading: NPV and IRR

L.O. 17.4

130. Which one of the following capital-budgeting evaluation techniques is based on finding a discount rate which causes the net present value to be zero?

a. net present value

b. internal rate of return

c. profitability index

d. payback

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

131. What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1, $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?

a. 5.83%

b. 9.67%

c. 11.44%

d. 13.74%

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

132. Of the four options listed below and encountered in project evaluation, which one is likely to make a project seem less attractive?

a. underestimating negative cash flows

b. overestimating positive cash flows

c. using a higher cost of capital

d. ignoring the time value of money

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Internal Rate of Return

L.O. 17.4

133. A technique that solves some of the problems presented by IRR.

a. NPV

b. MIRR

c. Adjusted IRR

d. SWOT

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

134. MIRR is a three-step process. Which of the following is not one of those steps.

a. Find the present value (PV) of all cash outflows

b. Compute the future value (FV) of each cash inflow

c. Compute the present value (PV) of each cash inflow

d. Find the discount rate that equates the PV of the outflows and the terminal value

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Modified Internal Rate of Return

L.O. 17.5

135. If a project has a positive net present value (NPV), then the profitability index is:

a. greater than one

b. less than one

c. equal to one

d. negative

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

136. The ratio between the present value of a project’s cash inflows and the present value of its initial investment is called the:

a. MIRR.

b. IRR.

c. PI.

d. NPV.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Profitability Index

L.O. 17.6

137. The payback period concept is best explained by which of the following?

a. marginal cost of capital

b. point where initial investment has been returned

c. rate where NPV is equal to zero

d. accounting rate of return

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

138. Which of the following features is characteristic of a payback period?

a. uses discounting

b. ignores cash flows beyond the payback period

c. equivalent to net present value

d. considers time value of money

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

139. The time required for the cumulative cash flows from a project to equal zero is called the:

a. profitability index

b. cash flow time frame

c. project life

d. payback period

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

140. In calculation of a payback period, what use is made of cash flows occurring after the end of the payback period?

a. they are ignored.

b. they are discounted back to time zero.

c. they are included in the accept/reject decision.

d. they are normally canceled by initial negative cash flows.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

141. Which of the following statements is false?

a. If the payback period is less than the maximum acceptable payback period, accept the project.

b. If the payback period is less than the maximum acceptable payback period, reject the project.

c. If the payback period is greater than the maximum acceptable payback period, reject the project.

d. If the payback period is the same as the maximum acceptable payback period, accept the project.

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

142. A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. The payback of the project is:

a. 1.5 years

b. 2 years

c. 3.3 years

d. 4 years

e. none of the above

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

143. What is the payback period for Sweetbay Supermarket’s new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3 and $1,800,000 in year 4?

a. 4.33 years

b. 3.33 years

c. 2.33 years

d. 1.33

Difficulty Level: Medium

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

144. When considering the time value of money, which of the following four methods of project evaluation would appear to be the least satisfactory?

a. internal rate of return

b. profitability index

c. net present value

d. payback period method

Difficulty Level: Easy

Subject Heading: Capital Budgeting Techniques—Payback Period

L.O. 17.7

145. Reasons NPV, IRR, MIRR, and PI will sometimes disagree in the case of mutually exclusive investments include all of the following except:

a. different cash flow patterns.

b. different time horizons.

c. different sizes.

d. different locations.

Difficulty Level: Medium

Subject Heading: Conflicts Between Discounted Cash Flow Techniques

L.O. 17.8

146. In the case of mutually exclusive projects:

a. the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.

b. they are to be evaluated based on their expected effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.

c. the financial manager is responsible for choosing the best of these alternatives since only one can be chosen; selecting one project precludes the other from being undertaken.

d. they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.

Difficulty Level: Hard

Subject Heading: Conflicts Between Discounted Cash Flow Techniques

L.O. 17.8

147. In the case of mutually exclusive projects:

a. the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.

b. they are to be evaluated based on their expected effect on shareholder wealth; the project that enhances shareholder wealth the most should be included in the firm’s capital budget.

c. the financial manager is responsible for choosing the top three of these alternatives since only three can be chosen.

d. they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.

Difficulty Level: Hard

Subject Heading: Conflicts Between Discounted Cash Flow Techniques

L.O. 17.8

148. The stand-alone principle means that:

a. projects should not be evaluated against one another

b. projects must operate independently of the firm’s other projects

c. analysts should focus on the project’s cash flows, uncontaminated by cash flows from the firm’s other activities

d. projects should be rejected that have the same IRR

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

149. Two years ago, a company spent $450,000 on a consulting study that focused on the technology of the firm’s operations. Now it appears that technology is noncompliant with existing regulations. New technology must replace the old project. The $450,000 would represent:

a. an opportunity cost

b. an operating expenditure

c. a sunk cost

d. a revised cost

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

150. Which of the following is true of sunk costs?

a. not included in initial cash flow

b. similar to opportunity costs

c. often combined with terminal cash flow

d. deciding factor in most project decisions

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

151. The after-tax cash flows without the project are referred to as:

a. the net investment

b. incremental cash flows

c. the base case

d. the starting flow

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

152. All of the groups of cash flows from the firm’s statement of cash flows are also used in the analysis of project cash flows except:

a. cash flow from financing

b. cash flow from investment

c. cash flow from operations

d. cash flow from depreciation

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

153. The relevant cash flows of a project do not include which one of the following?

a. incremental after-tax cash flows

b. cannibalization effects

c. opportunity costs

d. sunk costs

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

154. Your company owns land in a busy shopping district. If the chair of the company’s board of directors thinks they can build a plant on that land and that the land will incur no additional cost, the chair fails to take into account:

a. capital expenditures

b. opportunity costs

c. sunk costs

d. depreciation

Difficulty Level: Medium

Subject Heading: Isolating Project Cash Flows

L.O. 17.9

155. Adjusts the required rate of return at which the analyst discounts a project’s cash flows based on the project’s risk.

a. IRR

b. MIRR

c. Adjusted IRR

d. RADR

Difficulty Level: Medium

Subject Heading: Risk-Related Considerations

L.O. 17.11