978-0132757089 Chapter 11 Part 1

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Financial Management: Principles and Applications, 11e (Titman)

Chapter 11 Investment Decision Criteria

1) Which of the following are typical consequences of good capital budgeting decisions?

A) The firm increases in value.

B) The firm gains knowledge and experience that may be useful in future decisions.

C) Good capital budgeting decisions help a company define its core competencies.

D) All of the above.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

2) Errors in capital budgeting decisions:

A) tend to average out over time.

B) decrease the firm’s value.

C) are diminished because the time value of money makes future cash flows less important.

D) are easily reversed.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

3) Which of the following factors is least important to capital budgeting decisions.?

A) The time value of money

B) The risk-return tradeoff

C) Net income based on accrual accounting principles

D) Cash flows directly resulting from the decision

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

4) Which of the following would NOT be considered a capital budgeting decision?

A) Walmart purchases inventory for resale to customers.

B) Morgan Stanley installs elevators to comply with the Americans With Disabilities Act.

C) Caterpillar replaces manufacturing equipment with more efficient new equipment.

D) Pfizer develops a new therapy and brings it to market.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

5) Which of the following is a typical capital budgeting decision?

A) Purchase of office supplies

B) Granting credit to a new customer

C) Replacement of manufacturing equipment with more modern and efficient equipment

D) Financing the firm with more long-term debt and less equity

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

6) Good capital investment opportunities are most likely to exist when:

A) many firms compete to sell similar products.

B) interest rates are high and rising.

C) goods and services can be produced cheaply using readily available tools and technologies.

D) a line of business is expensive to enter and uses proprietary technology.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

7) Errors resulting from a capital budgeting decision are not considered major since the

consequences of such errors average out over the life of the investment.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

8) Competitive market forces make it imperative for a firm to have a systematic strategy for

generating capital-budgeting projects.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

9) The size of capital investments and the difficulty in reversing them once they are made make

capital-budgeting decisions very important to the firm.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

10) Capital budgeting is the decision-making process with respect to investment in working

capital.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

11) Why are capital budgeting decisions among the most important decisions made by any

company? Give a few examples from recent business developments.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

12) Distinguish between revenue enhancement investments, cost-reduction investments, and

mandated investments.

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

13) Why is it so difficult for firms to find good investment ideas?

Topic: 11.1 An Overview of Capital Budgeting

Keywords: capital budgeting

Principles: Principle 3: Cash Flows Are the Source of Value

1) Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta

requires an investment of $500,000 and has a NPV of $150,000. The projects involve unrelated

new product lines.

A) Both projects should be accepted because they have positive NPV’s.

B) Neither project should be accepted because they might compete with one another.

C) Only project Delta should be accepted. Alpha’s NPV is too low for the investment.

D) The company should look at other investment criteria, not just NPV.

Topic: 11.2 Net Present Value

Keywords: independent investment project

Principles: Principle 1: Money Has a Time Value

2) ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash

flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of

return is 12%. (Round your answer to the nearest $1.)

A) $1,056

B) $4,568

C) $7,621

D) $6,577

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

3) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will

provide an annual net cash flow of $50,000 per year for five years. Calculate the NPV of the

ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.)

A) $50,000

B) $(5,061)

C) $(5,517)

D) $5,517

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

4) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will

provide an annual net cash flow of $50,000 per year for five years. The salvage value of the

ambulance will be $25,000. Assume the ambulance is sold at the end of year 5. Calculate the

NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest

$1.)

A) $(10,731)

B) $10,731

C) $(5,517)

D) $5,517

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

5) Fitchminster Armored Car can purchase a new vehicle for $200,000 that will provide annual

net cash flow over the next five years of $40,000, $45,000, $50,000, $55,000, $60,000. The

salvage value of the vehicle will be $25,000. Assume that the vehicle is sold at the end of year 5.

Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to

the nearest $1.)

A) $7,390

B) $6,048

C) $6,780

D) $19,483

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

6) Project H requires an initial investment of $100,000 and the produces annual cash flows of

$50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the

produces annual cash flows of $30,000, $40,000, and $50,000. If the required rate of return is

greater than 0% and the projects are mutually exclusive:

A) H will always be preferable to T.

B) T will always be preferable to H.

C) H and T are equally attractive.

D) The project rankings will change with different discount rates.

Topic: 11.2 Net Present Value

Keywords: mutually exclusive project

Principles: Principle 1: Money Has a Time Value

7) Project H requires an initial investment of $100,000 and the produces annual cash flows of

$45,000 per year for each of the next 3 years. Project T also requires an initial investment of

3. If the discount rate is 10% and the projects are mutually exclusive:

A) Project H should be chosen.

B) Project T should be chosen.

C) H and T are equally attractive.

D) Both projects should be chosen.

Topic: 11.2 Net Present Value

Keywords: mutually exclusive project

Principles: Principle 1: Money Has a Time Value

8) Project H requires an initial investment of $100,000 and the produces annual cash flows of

$45,000 per year for each of the next 3 years. Project T also requires an initial investment of

3. If the discount rate is 10% and the projects are not mutually exclusive:

A) Project H should be chosen.

B) Project T should be chosen.

C) H and T are equally attractive.

D) Both projects should be accepted.

Topic: 11.2 Net Present Value

Keywords: independent investment project

Principles: Principle 1: Money Has a Time Value

9) Project H requires an initial investment of $100,000 and the produces annual cash flows of

$45,000 per year for each of the next 3 years. Project T also requires an initial investment of

3. If the discount rate increases from 10% to 16%:

A) Project T should be chosen.

B) Both projects should be rejected.

C) H and T are equally attractive.

D) The project rankings will change.

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

10) A machine costs $1,000, has a three-year life, and has an estimated salvage value of $100. It

will generate after–tax annual cash flows (ACF) of $600 a year, starting next year. If your

required rate of return for the project is 10%, what is the NPV of this investment? (Round your

answer to the nearest $10.)

A) $490

B) $570

C) $900

D) -$150

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

11) Suppose you determine that the NPV of a project is $1,525,855. What does that mean?

A) In all cases, investing in this project would be better than investing in a project that has an

NPV of $850,000.

B) The project would add value to the firm.

C) Under all conditions, the project’s payback would be less than the profitability index.

D) Other investment criteria might need to be considered.

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

12) Project January has a NPV of $50,000, project December has a NPV of $40,000. Which of

the following circumstances could make it possible to choose December over January?

A) January has a shorter payback period.

B) The projects are mutually exclusive.

C) The projects have unequal lives.

D) The projects are mandated.

Topic: 11.2 Net Present Value

Keywords: equivalent annual cost

Principles: Principle 1: Money Has a Time Value

13) The present value of the total costs over a five year period for Project April is $50,000. The

net present value of total costs over a 4 year period for Project October is $40,000. The company

uses a discount rate of 9%. Which project should it choose and why?

A) April because it has a higher NPV.

B) April because is has a higher EAC.

C) October because it has a shorter life.

D) October because it has a lower EAC.

Topic: 11.2 Net Present Value

Keywords: equivalent annual cost

Principles: Principle 1: Money Has a Time Value

14) Warchester Inc. is considering the purchase of copying equipment that will require an initial

investment of $15,000 and $4,000 per year in annual operating costs over the equipment’s

estimated useful life of 5 years. The company will use a discount rate of 8.5%. What is the

equivalent annual cost?

A) $4,000

B) $7,000

C) $6,152.51

D) $7,806.49

Topic: 11.2 Net Present Value

Keywords: equivalent annual cost

Principles: Principle 1: Money Has a Time Value

15) Artie’s Soccer Ball Company is considering a project with the following cash flows:

Initial outlay = $750,000

Incremental after–tax cash flows from operations Years 1-4 = $250,000 per year

Compute the NPV of this project if the company’s discount rate is 12%.

A) $9,337

B) $7,758

C) $4,337

D) $2,534

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

Use the following to answer the following question(s).

The information below describes a project with an initial cash outlay of $10,000 and a required

return of 12%.

After-tax cash inflow

Year 1 $6,000

Year 2 $2,000

Year 3 $2,000

Year 4 $2,000

16) Which of the following statements is correct?

A) The project should be accepted since its NPV is $353.87.

B) The project should be rejected since its NPV is -$353.87.

C) The project should be accepted since it has a payback of less than four years.

D) The project should be rejected since its NPV is -$23.91.

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

17) You have been asked to analyze a capital investment proposal. The project’s cost is

$2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2;

$1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm

discounts capital projects at 15.5%. What is the project’s NPV?

A) $101,247

B) $285,106

C) $473,904

D) $582,380

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

18) Which of the following is a correct equation to solve for the NPV of the project that has an

initial outlay of $30,000, followed by incremental cash inflows in the next 3 years of $15,000,

$20,000, and $30,000? Assume a discount rate of 10%.

A) NPV = – $30,000 + $15,000(1.10)1 + $20,000(1.10)2 + $30,000(1.10)3

B) NPV = – $30,000 + $15,000/(1.10)1 + $20,000/(1.10)2 + $30,000/(1.10)3

C) NPV = – $30,000 + $15,000/(1.01).10 + $20,000/(1.02).10 + $30,000/(1.03).10

D) NPV = – $30,000 + $15,000/(1.1).10 + $20,000(1.2).10 + $30,000(1.3).10

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

19) Project EH! requires an initial investment of $50,000, and has a net present value of $12,000.

Project BE requires an initial investment of $100,000, and has a net present value of $13,000.

The projects are mutually exclusive. The firm should accept:

A) project EH!.

B) project BE.

C) both projects.

D) neither project.

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value

20) Project Eh! requires an initial investment of $50,000, and has a net present value of $12,000.

Project B requires an initial investment of $100,000, and has a net present value of $13,000. The

projects are proposals for increasing revenue and are not mutually exclusive. The firm should

accept:

A) project Eh!.

B) project B.

C) both projects.

D) neither project.

Topic: 11.2 Net Present Value

Keywords: net present value

Principles: Principle 1: Money Has a Time Value