Chapter 12

Capital budgeting decisions involve a minimum time horizon of five years.

• true

• false

In a general sense, "cash flow" can be said to equal

• operating income less taxes plus depreciation

• operating income less taxes

• operating income before depreciation and taxes plus depreciation

• operating income after taxes minus depreciation

The reason cash flow is used in capital budgeting is because

• cash rather than income is used to purchase new machines

• cash outlays need to be evaluated in terms of the present value of the resultant cash inflows

• to ignore the tax shield provided from depreciation would ignore the cash flow provided by the machine, which should be reinvested to replace older machines

• All of these options are true

4) Which of the following is not a step in the capital budgeting decision-making process?

• Search for and discovery of investment opportunities

• Collection of data

• Evaluation and decision making

• All of the above are steps used in this process

An appropriate capital budgeting process requires that the following steps be taken in which order?

a) Collection of data

b) Reevaluation and adjustment

c) Evaluation and decision making

d) Search for and discovery of investment opportunities

• d, a, c, b

• d, a, b, c

• d, b, a, c

• b, d, a, c

Which of the following is not a time-adjusted method for ranking investment proposals?

• The net present value method

• The payback method

• The internal rate of return method

• All of these options are time-adjusted methods

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

• Payback ignores the interest that is earned during the period of time the project is in place

• Payback emphasizes receiving money back as fast as possible for reinvestment

• Payback is basic to use and understand

• Payback can be used in conjunction with time-adjusted methods of evaluation

Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not mutually exclusive, the firm should accept all investment proposals

• for which it can obtain financing

• that have a positive net present value

• that have positive cash flows

• that provide returns greater than the after-tax cost of debt

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?

$238,160/52,000 = 4.580. Take that factor to table PV of annuity to find that 3% matches under n = 5.

Please note that this question can be solved by simple division and scanning the Present Value of an Annuity (Appendix D) because the cash inflows remain constant each period

• IRR is 8%. Accept the project

• IRR is 3%. Reject the project

• IRR is 4%. Reject the project

• IRR is 6%. Accept the project

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 6% cost of capital, what is the net present value of project A?

Project A:

−335,000 Factor @ 6% 349,520 14,520

140,000 0.943 132,020

150,000 0.89 133,500

100,000 0.84 84,000

________________________________________

Project B:

−365,000 Factor @ 6% 431,360 66,360

220,000 0.943 207,460

110,000 0.89 97,900

150,000 0.84 126,000

• $25,930

• $14,520

• $11,589

• $19,230