Full Test Bank Cash Flow And Capital Budgeting Chapter 10 - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 10 – Cash flow and capital budgeting
MULTIPLE CHOICE
1. Gamma Electronics is considering the purchase of testing equipment that will cost $510 000. The equipment has a five-year lifetime with no salvage value. Assume the new machine will generate after-tax savings of $100 000 per year for the five years.
If the company has a 15% cost of capital, what is the equivalent annual cost of the equipment?
a. | $32 924 |
b. | $42 746 |
c. | $49 158 |
d. | $ 52 140 |
NPV = –500 000 + 100 000/1.15 + 100 000/1.152 + 100 000/1.153 + 100 000/1.154 + 100 000/1.155
NPV = –174 784
Suppose the equivalent annual cost is x, then:
x/1.15 + x/1.152 + x/1.153 + x/1.154 + x/1.155 = -174 784
x = –52 140
PTS: 1 DIF: M
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
2. Thompson Manufacturing must choose between two types of furnaces to install. Model A has a six-year life and an NPV of $4800. Model B has a five-year life and an NPV of $4200. The relevant discount rate is 12%. Which model should be chosen? What’s the annual cash flow from that model?
a. | Model B; $1165 |
b. | Model B; $840 |
c. | Model A; $1167 |
d. | Model A; $1216 |
Suppose the annual annuity of Model A is x and that of Model B is y.
x/1.12 + x/1.122 + x/1.123 + x/1.124 + x/1.125 + x/1.126 = 4800
x = $1167
y/1.12 + y/1.122 + y/1.123 + y/1.124 + y/1.125 = 4000
y = $ 1109
PTS: 1 DIF: M
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
3. A company is evaluating two machines. Both machines meet the company’s quality standard. Machine A costs $40 000 initially and $1000 per year to maintain. Machine B costs $24 000 initially and $2000 per year to maintain. Machine A has a six-year useful life and Machine B has a three-year useful life. Both machines have zero salvage value. Assume the company will continue to replace worn-out machines with similar machines and that the discount rate is 7%. Which machine should the company purchase?
a. | Machine A |
b. | Machine B |
c. | The company is indifferent to the two machines. |
d. | There is not enough information to answer the question. |
Cash outflows for two machines:
Year | Machine A | Machine B |
0 | 40 000 | 24 000 |
1 | 1000 | 2000 |
2 | 1000 | 2000 |
3 | 1000 | 2000 |
4 | 1000 | 26 000 |
5 | 1000 | 2000 |
6 | 1000 | 2000 |
NPV: | $44 767 | $51 843 |
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
4. Capital budgeting must be placed on an incremental basis. This means that __________ must be ignored and __________ must be considered.
a. | sunk costs; opportunity costs |
b. | sunk costs; financing costs |
c. | cannibalisation; opportunity costs |
d. | opportunity costs; net working capital |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
5. Roger is considering the expansion of his business into a property he purchased two years ago. Which of the following items should not be included in his analysis of this expansion?
a. | Roger can lease the property to another company for $12 000 per year. |
b. | Costs of hiring additional staff should not be included. |
c. | The property was extensively renovated last year at a cost of $15 000. |
d. | The expansion will result in a slight increase of inventory carried. |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
6. Based on the following information, what is the initial cash outflow?
Purchase and installation of new equipment | $12 000 |
Sale price of replaced equipment | $ 4000 |
Book value of replaced equipment | $ 3000 |
When the new equipment is installed: | |
Inventory increase | $ 2000 |
Accounts payable increase | $ 1000 |
Tax rate | 40% |
a. | $9400 |
b. | $9000 |
c. | $13 000 |
d. | $10 600 |
12 000 – (4000 – 1000 × 0.4) + (2000 – 1000) = 9400
PTS: 1 DIF: M
REF: 10.2 Incremental Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
7. A machine costs $3 million and has zero salvage value. Assume a discount rate of 10% and a 35% tax rate. The machine is depreciated on a straight-line basis over three years for tax purposes. What is the present value of depreciation tax savings associated with this machine?
a. | $1 200 000 |
b. | $8 699 |
c. | $1 090 900 |
d. | $400 000 |
PV = 0.35/1.1 + 0.35/1.12 + 0.35/1.13 = 0.8699
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
8. Alpha Car Rental purchased five cars for a total of $100 000 three years ago. Now it is replacing the cars with newer vehicles. The company depreciated 93.64% of the old cars and then sold these cars for a total of $25 000. Assume a tax rate of 40%. What is the cash inflow from the sale of these vehicles?
a. | $25 000 |
b. | $17544 |
c. | $17 964 |
d. | $16 500 |
25 000 – (25 000 – 100 000 × 0.0636) × 0.4 = 17544
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
9. Net working capital decreases when:
a. | inventory falls, accounts receivable falls or accounts payable increases |
b. | inventory increases, accounts receivable increases or accounts payable falls |
c. | cost of goods sold falls or interest rate falls |
d. | operating expenses fall or current assets increase |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
10. The cash flows associated with an investment project are as follows:
Cash flows | |
Initial outflow | –$7 000 000 |
Year 1 | $ 100 000 |
Year 2 | $ 200 000 |
Year 3 | $ 540 000 |
In year 4 and beyond, cash flows would continue to grow at 5% per year. Assume a discount rate of 10%. What is the NPV of this investment?
a. | $2 385 220 |
b. | $2 423 742 |
c. | $ 2 181 818 |
d. | $2 694 215 |
As of year 3, the present value of cash flows in year 4 and beyond is as follows:
PV = 540 000 × 1.05/(0.10 – 0.05) = 540 000/0.05
PV = 11 340 000
NPV = –7 000 000 + 100 000/1.1 + 200 000/1.12 + (540 000 + 11 340 000)/1.13
NPV = 2 181 818.18
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
11. Lygon Foods is exploring the possibility of bringing a new frozen pasta to the market. Which of the following items are not relevant for analysing this project?
a. | Cost of increasing shelf space at grocery stores |
b. | Lost revenue from its frozen pizza sales, as some customers will switch products |
c. | Cost of advertising the new product |
d. | Market research funds spent on testing the viability of the new product |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
12. A certain investment will require an immediate cash outflow of $2.8 million. At the end of each of the next three years, the investment will generate cash inflows of $1.3 million. If the discount rate is 10%, what is the project’s NPV?
a. | $ 432 907 |
b. | –$303 886 |
c. | $232 908 |
d. | –$276 260 |
NPV = –2.8 mil + 1.3 mil/1.1 + 1.3 mil/1.12 + 1.3 mil/1.13 = 0.432907 million
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
Use the following information to answer questions 13 to 15.
A project requires an initial investment in equipment and machinery of $10 million. The equipment is expected to have a five-year lifetime with no salvage value and will be depreciated on a straight-line basis. The project is expected to generate revenues of $5.1 million each year for the five years and have operating expenses (not including depreciation) amounting to one-third of revenues.
13. Refer to Exhibit 10-1. The tax rate is 40%. What is the net cash flow in year 1?
a. | $2.84 million |
b. | $3.40 million |
c. | $0.84 million |
d. | $2.04 million |
Revenue: | 5.1m |
Expense: | 1.7m |
Depreciation: | 2.0m |
Pretax income: | 1.4m |
Tax: | 0.56m |
NI: | 0.84m |
Depreciation: | 2m |
Net cash flow: | 2.84m |
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
14. Refer to Exhibit 10-1. Assume the tax rate is 40% and the cost of capital is 10%. What is the present value of cash inflows from year 1 to year 5? What percentage of this present value is attributed to the tax benefits accruing from depreciation?
a. | $12.89 million; 24% |
b. | $10.77 million; 28% |
c. | $3.18 million; 95% |
d. | $7.73 million; 39% |
Cash flow from year 1 to year 5 is the same.
Revenue: | 5.1m |
Expense: | 1.7m |
Depreciation: | 2.0m |
Pretax income: | 1.4m |
Tax: | 0.56m |
NI: | 0.84m |
Depreciation: | 2m |
Net cash flow: | 2.84m |
PV of cash flowsYears1–5 = 2.84/1.1 + 2.84/1.12 + 2.84/1.13 + 2.84/1.14 + 2.84/1.15
PV of cash flowsYears1–5 = 10.77m
PV of depreciation tax savingsYears1–5 = 0.8/1.1 + 0.8/1.12 + 0.8/1.13 + 0.8/1.14 + 0.8/1.15
PV of depreciation tax savingsYears1–5 = 3.03 million
3.03/10.77 = 28%
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
15. Refer to Exhibit 10-1. Assume the tax rate is 40% and the cost of capital is 10%. What is the net present value of the project?
a. | $2.89 million |
b. | $0.77 million |
c. | –$6.82 million |
d. | –$2.27 million |
Cash flow from year 1 to year 5 is the same.
Revenue: | 5.1m |
Expense: | 1.7m |
Depreciation: | 2.0m |
Pretax income: | 1.4m |
Tax: | 0.56m |
NI: | 0.84m |
Depreciation: | 2m |
Net cash flow: | 2.84m |
NPV = –10 + 2.84/1.1 + 2.84/1.12 + 2.84/1.13 + 2.84/1.14 + 2.84/1.15 = 0.77m
PTS: 1 DIF: M
REF: 10.2 Incremental Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
16. Johnson Chemicals is considering an investment project. The project requires an initial $3 million outlay for equipment and machinery. Sales are projected to be $1.5 million per year for the next four years. The equipment will be fully depreciated on a straight-line basis by the end of year 4. The cost of goods sold and operating expense (not including depreciation) are predicted to be 30% of sales. The equipment can be sold for $400 000 at the end of year 4. Johnson Chemicals also needs to add net working capital of $100 000 immediately. The net working capital will be recovered in full at the end of the fourth year. Assume the tax rate is 40% and the cost of capital is 10%.
What is the NPV of this investment?
a. | $89 290 |
b. | $80 199 |
c. | $189 482 |
d. | $72 909 |
Year | 0 | 1 | 2 | 3 | 4 |
Rev | 1.5 | 1.5 | 1.5 | 1.5 | |
Expense | 0.45 | 0.45 | 0.45 | 0.45 | |
Depreciation | 0.75 | 0.75 | 0.75 | 0.75 | |
EBIT | 0.3 | 0.3 | 0.3 | 0.3 | |
NI | 0.18 | 0.18 | 0.18 | 0.18 | |
Depreciation | 0.75 | 0.75 | 0.75 | 0.75 | |
Operating cash flow | 0.93 | 0.93 | 0.93 | 0.93 | |
Change in NWC | –0.1 | 0.1 | |||
Net investment | –3 | ||||
Sale of equipment | 0.24 (= 0.4 – 0.4 × 0.4) | ||||
Net cash flow | –3.1 | 0.93 | 0.93 | 0.93 | 1.27 |
NPV = –3.1 + 0.93/1.1 + 0.93/1.12 + 0.93/1.13 + 1.27/1.14 = 0.080199m = 80 199
PTS: 1 DIF: H
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
17. Which of the following items will lead to a rise in net working capital?
a. | Raw materials are purchased prior to the sale of finished goods. |
b. | The company increases its cash balance. |
c. | The company makes a sale on credit. |
d. | The company buys inventory on credit. |
e. | Short-term interest rates fall. |
a. | A, B, C |
b. | A, B, D, E |
c. | A, C |
d. | A, B, C, D |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
18. A project will generate a real cash flow of $150000 three years from now. If the nominal discount rate is 10% and expected inflation is 3%, what is the nominal cash flow for year 3?
a. | $112 551 |
b. | $106 090 |
c. | $109 273 |
d. | $ 163 909 |
150 000 × 1.033 = 163 909
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
19. Paul earns $60 000 as an engineer, and he is considering quitting his job to go to graduate school. This $60 000 should be treated as a(n) ____________ if Paul runs an NPV analysis of his graduate degree.
a. | sunk cost |
b. | opportunity cost |
c. | fixed cost |
d. | cannibalisation cost |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
20. Fox Entertainment is evaluating the NPV of launching a new iPet product. Fox paid a market research company $120 000 last year to test the market viability of iPet. Fox Entertainment should treat this $120 000 as a(n) _____________ for the capital budgeting decision now confronting the company.
a. | fixed cost |
b. | opportunity cost |
c. | sunk cost |
d. | cannibalisation cost |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
Use the following information to answer questions 21 to 24.
The following data are projected for a possible investment project:
Year 1 | Year 2 | Year 3 | Year 4 | |
Revenues | $120 000 | $140 000 | $160 000 | $180 000 |
Cost of goods sold | $ 36 000 | $ 42 000 | $ 48 000 | $ 54 000 |
Depreciation | $ 80 000 | $ 60 000 | $ 40 000 | $ 20 000 |
EBIT | $ 4000 | $ 38 000 | $ 72 000 | $106 000 |
21. Refer to Exhibit 10-2. The project requires an initial investment of $300 000. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period and will be recaptured in full at the end of year 4. The tax rate is 40%.
What is the initial cash outlay?
a. | $300 000 |
b. | $312 000 |
c. | $232 000 |
d. | $220 000 |
Initial cash outlay = Working capital + Initial investment
Initial cash outlay = 12 000 + 300 000
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
22. Refer to Exhibit 10-2. The project requires an initial investment of $300 000. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period and will be recaptured in full at the end of year 4. The tax rate is 40%.
What is the net cash flow to the company in year 1?
a. | $400 |
b. | $82 400 |
c. | $68 400 |
d. | $80 400 |
e. | $2400 |
Operating cash flow = EBIT × NI + Depreciation
Operating cash flow = 4000 × 0.6 + 80 000 = 82 400
Change in working capital = 12 000 – 14 000 = –2000
Net cash flow = 82 400 – 2000 = 80 400
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
23. Refer to Exhibit 10-2. The project requires an initial investment of $300 000 on equipment. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period and will be recovered in full at the end of year 4. Equipment will be sold at its book value at the end of year 4. The tax rate is 40%.
What is the net cash flow to the company in year 4?
a. | $101 600 |
b. | $201 600 |
c. | $183 600 |
d. | $161 600 |
Operating cash flow = EBIT × NI + Depreciation
Operating cash flow = 106 000 × 0.6 + 20 000 = 83 600
Change in working capital = 18 000
Sale of equipment at book value = 300 000 – (80 000 + 60 000 + 40 000 + 20 000)
Sale of equipment at book value = 100 000
Net cash flow = 83 600 + 18 000 + 100 000 = 201 600
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
24. Refer to Exhibit 10-2. The project requires an initial investment of $300 000 on equipment. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period and will be recovered in full at the end of year 4. Equipment will be sold at its book value at the end of year 4. The tax rate is 40%.
What is the net present value of the project if the company’s discount rate is 10%?
a. | –$20 225 |
b. | –$41 731 |
c. | $24 155 |
d. | $26 570 |
Year | 0 | 1 | 2 | 3 | 4 |
Net income | 2400 | 22 800 | 43 200 | 63 600 | |
Depreciation | 80 000 | 60 000 | 40 000 | 20 000 | |
Operating cash flow | 82 400 | 82 800 | 83 200 | 83 600 | |
Change in NWC | –12 000 | –2000 | –2000 | –2000 | 18 000 |
Initial investment | –300 000 | ||||
Sale of equipment | 100 000 | ||||
Net cash flow | –312 000 | 80 400 | 80 800 | 81 200 | 201 600 |
NPV = –312 000 + 80 400/1.1 + 80 800/1.12 + 81 200/1.13 + 201 600/1.14 = 26 570
PTS: 1 DIF: H
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
25. Future Semiconductor is considering the purchase of photolithography equipment that will cost $3 million. The equipment requires maintenance of $5000 at the end of each of the next five years. After five years, it will be sold for $500 000. Assume a cost of capital of 15% and no taxes. What is the present value of the cost of the equipment? What is the equivalent annual cost of the equipment?
a. | present value: $3 016 761; equivalent annual cost: $899 947 |
b. | present value: $2 516 760; equivalent annual cost: $750 789 |
c. | present value: $ 2 968 172; equivalent annual cost: $ 885 452 |
d. | present value: $2 768 172; equivalent annual cost: $825 789 |
Present value of the equipment:
3 200 000 + 5000/1.15 + 5000/1.152 + 5000/1.153 + 5000/1.154 + 5000/1.155 – 500 000/1.155
Present value of the equipment = 2 968 172
If the EAC is x, then:
x/1.15 + x/1.152 + x/1.153 + x/1.154 + x/1.155 = 2 968 172
x = 885 452
PTS: 1 DIF: M
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
26. Sam’s Insurance must choose between two types of printers. Both printers meet the company’s quality standards. Printer A costs $3200 and is expected to last three years with operating costs of $380 per year. Printer B costs $2500 and is expected to last two years with operating costs of $400 per year. Assume a discount rate of 10%. Which printer should Sam’s Insurance purchase? What is the equivalent annual cost of this machine?
a. | Printer B; $3194 |
b. | Printer A; $1667 |
c. | Printer B; $2904 |
d. | Printer A; $1787 |
Present value of the cost of Printer A = 3200 + 380/1.1 + 380/1.12 + 380/1.13 = $4145
Present value of the cost of Printer B = 2500 + 400/1.1 + 400/1.12 = $3194
If the EAC of Printer A is x, then:
x/1.1 + x/1.12 + x/1.13 = 4145
x = 1667
If the EAC of Printer B is y, then:
y/1.1 + y/1.12 = 3194
y = 1840
PTS: 1 DIF: M
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
27. Adelaide Truck Company (ATC) is considering replacing an old truck. The old truck can be sold for $7400 now. If it is sold in one year, the resale price will be $5500, but ATC will spend $2500 just before selling the truck to make it attractive to a buyer. Assume a cost of capital of 12%. What is the total cost of keeping the old truck for one more year? Express the cash flow in terms of its future value one year from now.
a. | $5121 |
b. | $5736 |
c. | $5287 |
d. | $5376 |
e. | $5500 |
Present value of the cost of keeping the old truck for one more year:
7400 – 5500/1.12 + 2500/1.12 = 4721
The future value one year from now:
4721 × 1.12 =5287
PTS: 1 DIF: M
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
28. A company that manufactures DVD players for automakers currently has excess capacity. The company expects that it will exhaust its excess capacity in three years. At that time, it will have to invest $2 million to build new capacity. Suppose that the company can accept additional work as a subcontractor for another company. By doing so, the company will receive a net cash inflow of $120 000 immediately and in each of the next two years. However, the company will have to begin expansion two years earlier than originally planned to bring new capacity on line. Assume a discount rate of 10%.
What is the NPV if the company accepts the subcontractor job?
a. | $328 264 |
b. | –$18 843 |
c. | $12 712 |
d. | $298 422 |
NPV = 120 000 + 120 000/1.1 + 120 000/1.12 – 2 000 000/1.1 + 2 000 000/1.13
NPV = 12 712
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
29. A project generates the following sequence of cash flows over two years:
Year | Cash flow ($ in millions) |
0 | –40.00 |
1 | 8.00 |
2 | 10.00 |
Assume that cash flows after the second year grow at 2% annually in perpetuity, and the discount rate is 12%. What is the NPV of the project?
a. | $56.4 million |
b. | $54.8 million |
c. | $47.7 million |
d. | $50.4 million |
The terminal value of the project at year 2:
10 × 1.02/(0.12 – 0.02) = 102
NPV = –40 + 8/1.12 + (10 + 102)/1.122 = 56.4
PTS: 1 DIF: H
REF: 10.2 Incremental Cash Flows NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
30. Kelley Group is considering an investment of $2 million in an asset with an economic life of four years. The cash revenues and expenses in year 1 are expected to be $1.8m and $0.5m, respectively. Both revenues and expenses are expected to grow at 3% per year. The asset will be fully depreciated to zero over its economic life based on the straight-line method. The salvage value of the asset is expected to be $0.3m at the end of the fourth year. Kelley Group also needs to add net working capital of $0.1m immediately, and this capital will be recovered in full at the end of the project’s life. The tax rate is 40%. What is the investment’s cash flow in year 4?
a. | $1.1323 million |
b. | $1.4523 million |
c. | $1.3323 million |
d. | $1.3579 million |
CFYear 4 = Operating cash flow + Change of working capital + Sale of equipment
CFYear 4 = [(1.8 × 1.033 – 0.5 × 1.033) × (1 – 0.4) + 0.5 × 0.4] + 0.1 + [0.3 × (1–0.4)]
CFYear 4 = 1.33230 million
PTS: 1 DIF: M
REF: 10.1 Types of Cash Flows NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
31. The value of a project at a given future point in time is known as:
a. | the terminal value |
b. | net working capital |
c. | an opportunity cost |
d. | a sunk cost |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
32. The percentage of taxes owed on an incremental dollar of income is called:
a. | the minimum tax rate |
b. | the marginal tax rate |
c. | the average tax rate |
d. | the maximum tax rate |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
33. Cash flows that occur if and only if a project is accepted are:
a. | sunk costs |
b. | terminal costs |
c. | incremental cash flows |
d. | current cash flows |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
34. Cash flows on an alternative investment that a company decides not to make are:
a. | an opportunity cost |
b. | a sunk cost |
c. | a terminal value |
d. | an incremental cash flow |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
35. A cash outlay that has already been committed whether a project is accepted or not is known as:
a. | an opportunity cost |
b. | a terminal value |
c. | a net cost |
d. | a sunk cost |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
36. The difference between current assets and current liabilities is known as:
a. | working capital |
b. | net working capital |
c. | terminal capital |
d. | marginal capital |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
37. When a company introduces a new product and some of the new product’s sales come at the expense of the company’s existing products, this is known as:
a. | sunk costs |
b. | incremental costs |
c. | marginal costs |
d. | cannibalisation |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
38. Accountants measure inflows and outflows of business operations on:
a. | a cash basis |
b. | a profit basis |
c. | an accrual basis |
d. | an expense basis |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
39. Financial analysts focus on _________ when evaluating potential investments.
a. | cash |
b. | profit |
c. | accruals |
d. | expenses |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
40. The relevant tax rate for capital budgeting purposes is the:
a. | average tax rate |
b. | maximum tax rate |
c. | minimum tax rate |
d. | marginal tax rate |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
41. An increase in net working capital represents:
a. | a cash inflow |
b. | a cash outflow |
c. | an increase in fixed assets |
d. | a decrease in fixed assets |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
42. An increase in inventory will __________ net working capital.
a. | increase |
b. | decrease |
c. | have no effect on |
d. | There is not enough information to answer the question. |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
43. A decrease in accounts receivable will __________ net working capital.
a. | increase |
b. | decrease |
c. | have no effect on |
d. | There is not enough information to answer the question. |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
44. When a company cannot invest in every positive NPV project because of limited funds, this is known as:
a. | capital budgeting |
b. | capital investing |
c. | capital rationing |
d. | capital financing |
REF: 10.4 Special Problems in Capital Budgeting NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
45. Sunk costs:
a. | are irrelevant |
b. | should be considered when determining an investment’s relevant cash flows |
c. | are equal to the company’s opportunity costs |
d. | are recoverable |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
46. Opportunity costs:
a. | are irrelevant |
b. | should be considered when determining an investment’s relevant cash flows |
c. | are equal to the company’s sunk costs |
d. | are recoverable to the company’s investment costs |
REF: 10.2 Incremental Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
47. To help rank projects in a capital rationing environment, managers often use the:
a. | profitability index |
b. | internal rate of return |
c. | payback method |
d. | accounting rate of return |
REF: 10.4 Special Problems in Capital Budgeting NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
48. The __________ makes capital budgeting __________ complicated.
a. | human element; less |
b. | human element; more |
c. | human analysis; more |
d. | human analysis; less |
REF: 10.5 The Human Face of Capital Budgeting NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
49. Which of the following statements is false with regard to cash flows resulting from financing costs?
a. | They should be included in cash flow calculations. |
b. | Financing cash flows can include dividend payments to shareholders and interest payments to bondholders. |
c. | Financing costs are captured in the discount of a project’s cash flows. |
d. | If cash outflows associated with financing costs were deducted from the cash flows for a project, it would be double-counting the financing costs of the investment. |
REF: 10.1 Types of Cash Flows NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
50. The idea that a company may be unable to accept all projects that are expected to have positive NPVs due to the lack of funds is known as:
a. | capital rationing |
b. | capital budgeting |
c. | capital constraints |
d. | cannibalisation |
REF: 10.4 Special Problems in Capital Budgeting NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
51. If a company is subject to capital rationing, the company, when choosing a set of potential investments, should rank the projects by __________ and choose the best ones until funding is exhausted.
a. | NPV |
b. | IRR |
c. | PI |
d. | ARR |
REF: 10.4 Special Problems in Capital Budgeting NAT: Reflective thinking
LOC: acquire knowledge of capital budgeting and the cost of capital
52. If you have an increase in accounts receivable of $20 000, an increase in inventory of $10 000 and an increase in accounts payable of $6000, what is the change in net working capital?
a. | –$24 000.00 |
b. | $36 000.00 |
c. | $24 000.00 |
d. | –$16 000.00 |
A/R | 20 000.00 | Cash | –20 000.00 |
Inv. | 10 000.00 | Cash | –10 000.00 |
A/P | 6000.00 | Cash | 6000.00 |
Net Working capital | –24 000.00 |
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows NAT: Analysis
LOC: acquire knowledge of capital budgeting and the cost of capital
53. You are considering buying carpet for your university. Grade A carpet costs $17.10 a square metre and lasts five years; Grade B costs $12.50 a square metre and lasts five years; and Grade C costs $8 a square metre and lasts two years. Assume that due to a large endowment given by a local carpet magnate, the university is committed to continued carpet use. Which carpet should be chosen if the discount rate is 10%?
a. | Grade A |
b. | Grade B |
c. | Grade C |
d. | Grade D |
EAC | |||
NPVA | $17.10 | 5 | –$4.51 |
NPVB | $12.50 | 3 | –$5.03 |
NPVC | $8.00 | 2 | –$4.61 |
i | 10% |
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
54. You are considering buying carpet for your university. Grade A carpet costs $19.25 a square metre and lasts five years; Grade B costs $12.25 a square metre and lasts three years; and Grade C costs $9.25 a square metre and lasts two years. Assume that due to a large endowment given by the local carpet magnate, the university is committed to continued carpet use. Which carpet should be chosen if the discount rate is 10%?
a. | Grade A |
b. | Grade B |
c. | Grade C |
d. | Grade D |
EAC | ||||
NPVA | $19.25 | 5 | –$5.08 | |
NPVB | $12.25 | 3 | –$4.93 | |
NPVC | $9.25 | 2 | –$5.33 | |
i | 10% | |||
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
55. You are considering buying carpet for your university. Grade A carpet costs $25.25 a square metre and lasts five years; Grade B costs $18.25 a square metre and lasts three years; and Grade C costs $12.10 a square metre and lasts two years? Assume that due to a large endowment given by the local carpet magnate, the university is committed to continued carpet use. What is the EAC of Grade B carpet?
a. | –$4.44 |
b. | –$4.36 |
c. | –$4.22 |
d. | –$4.59 |
EAC | |||
NPVA | $25.25 | 7 | –$4.36 |
NPVB | $18.25 | 5 | –$4.22 |
NPVC | $12.10 | 3 | –$4.44 |
i | 5% |
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
56. You are considering buying carpet for your university. Grade A carpet costs $25.25 a square metre and lasts five years; Grade B costs $18.25 a square metre and lasts three years; and Grade C costs $12.10 a square metre and lasts two years. Assume that due to a large endowment given by the local carpet magnate, the university is committed to continued carpet use. What is the EAC of Grade C carpet?
a. | –$4.44 |
b. | –$4.36 |
c. | –$4.22 |
EAC | |||
NPVA | $25.25 | 7 | –$4.36 |
NPVB | $18.25 | 5 | –$4.22 |
NPVC | $12.10 | 3 | –$4.44 |
i | 5% |
PTS: 1 DIF: H
REF: 10.4 Special Problems in Capital Budgeting NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
SHORT ANSWER
1. What are non-cash expenses?
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows
2. List two methods of depreciation.
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows
3. What is capital rationing?
PTS: 1 DIF: E
REF: 10.4 Special Problems in Capital Budgeting
4. What are sunk costs? Should they be incorporated into cash flow?
PTS: 1 DIF: E
REF: 10.2 Incremental Cash Flows
5. What are opportunity costs? Should they be incorporated into cash flow?
PTS: 1 DIF: E
REF: 10.2 Incremental Cash Flows
6. Briefly explain the concept of terminal value.
PTS: 1 DIF: E
REF: 10.1 Types of Cash Flows