978-0134730417 Test Bank Chapter 9 Part 1

Unlock access to all the studying documents.

View Full Document

Financial Management: Core Concepts, 4e (Brooks)

Chapter 9 Capital Budgeting Decision Models

1) ________ is at the heart of corporate finance, because it is concerned with making the best

choices about project selection.

A) Capital budgeting

B) Capital structure

C) Payback period

D) Short-term budgeting

2) The ________ model is usually considered the best of the capital budgeting decision-making

models.

A) internal rate of return (IRR)

B) net present value (NPV)

C) profitability index (PI)

D) discounted payback period

3) We can separate short-term and long-term decisions into three dimensions. Which of the

below is NOT one of these?

A) Degree of information gathering prior to the decision

B) Cost

C) Personality of CEO making the decisions

D) Length of effect

4) Because money is often limited, companies must be careful to choose projects that are feasible

and profitable.

5) Capital budgeting decisions are typically long-term decisions.

6) Name and describe three key observations that we can make about the capital budgeting

decision.

1) A capital budgeting decision is typically a go or no-go decision on a product, service, facility,

or activity of the firm. That is, we either accept the business proposal or we reject it. The choice

2) A capital budgeting decision will require sound estimates of the time and amount of

appropriate cash flow for the proposal. Thus, the appropriate future cash flow is a necessary

9.2 Payback Period

1) The ________ model answers one basic question: How soon will I recover my initial

investment?

A) payback period

B) IRR

C) NPV

D) profitability index

2) The ________ model determines at what point in time cash outflow is recovered by the

corresponding future cash inflow.

A) NPV

B) buyback

C) net present value

D) payback period

3) Consider the following three-year project. The initial after-tax outlay or after-tax cost is

$1,500,000. The future after-tax cash inflows for years 1, 2, 3 and 4 are: $800,000, $800,000,

$300,000 and $100,000, respectively. What is the payback period without discounting cash

flows?

A) 1.875 years

B) 2.0 years

C) 3.5 years

D) 4.125 years

4) Consider the following ten-year project. The initial after-tax outlay or after-tax cost is

$1,500,000. The future after-tax cash inflows each year for years 1 through 10 are $400,000 per

year. What is the payback period without discounting cash flows?

A) 10 years

B) 5 years

C) 3.75 years

D) 1.5 years

5) The initial outlay or cost is $1,500,000 for a four-year project. The respective future cash

inflows for years 1, 2, 3 and 4 are: $400,000, $500,000, $600,000 and $200,000. What is the

payback period without discounting cash flows?

A) About 2.50 years

B) About 2.67 years

C) About 3.00 years

D) About 3.50 years

6) Cranium, Inc. is considering a four-year project that has an initial outlay or cost of $100,000.

The respective future cash inflows from its project for years 1, 2, 3 and 4 are: $50,000, $40,000,

$30,000 and $20,000. Will it accept the project if it’s payback period is 26 months?

A) Yes, because it pays back in 25 months.

B) No, because it pays back in 28 months.

C) No, because it pays back in over 31 months.

D) No, because it pays back in over 35 months.

7) Which of the statements below is TRUE of the payback period method?

A) It ignores the cash flow after the initial outflow has been recovered.

B) It is biased against projects with early-term payouts.

C) It incorporates time-value-of-money principles.

D) It focuses on cash flows after the initial outflow has been recovered.

8) Which of the statements below is FALSE?

A) Firms rarely use the payback period for small-dollar decisions.

B) Many companies use the payback period for small-dollar decisions because the time spent

gathering the accurate cash flow may be lowered substantially if it is necessary to estimate only

through the first few years.

C) Many companies use the payback period for small-dollar decisions because the future cash

flows on these smaller projects may be quite difficult to accurately estimate far into the future.

D) Many companies use the payback period for small-dollar decisions because it does prevent a

serious error when the future cash flow is insufficient to recover the initial cash outlay.

9) The initial outlay or cost for a four-year project is $1,100,000. The respective cash inflows for

years 1, 2, 3 and 4 are: $500,000, $300,000, $300,000 and $300,000. What is the discounted

payback period if the discount rate is 10%?

A) About 2.67 years

B) About 3.35 years

C) About 3.84 years

D) About 3.98 years

10) Acme, Inc. is considering a four-year project that has initial outlay or cost of $100,000. The

respective cash inflows for years 1, 2, 3 and 4 are: $50,000, $40,000, $30,000 and $20,000.

Acme uses the discounted payback period method, and has a discount rate of 11.50%. Will Acme

accept the project if it’s payback period is 38 months?

A) Yes, because it pays back in less than 38 months.

B) No, because it pays back in over 38 months.

C) Yes, because it pays back in under 37 months.

D) No, because it pays back in over 37 months.

11) Which of the statements below is FALSE?

A) In order to account for the time value of money with the Payback Period Model, the future

cash flow needs to be restated in current dollars.

B) The Discounted Payback Period method is the time it takes to recover the initial investment in

current dollars.

C) When we discount a future cash flow with our standard time-value-of-money concepts, we

inherently assume that the entire cash flow was received at the end of the year.

D) The Payback Period method (with no discounting) is the dollar amount that it takes to recover

the initial investment in current dollars.

12) Which of the statements below is FALSE?

A) To account for the time value of money with the Payback Period Model, the future cash flow

needs to be restated in current dollars.

B) The Discounted Payback Period method is the time it takes to recover the initial investment in

future dollars.

C) When we discount a future cash flow with our standard time-value-of-money concepts, we

inherently assume that the entire cash flow was received at the end of the year.

D) The Discounted Payback Period method does not correct for the cash flow after the recovery

of the initial outflow.

13) Consider the following four-year project. The initial outlay or cost is $210,000. The

respective cash inflows for years 1, 2, 3 and 4 are: $100,000, $80,000, $80,000 and $20,000.

What is the discounted payback period if the discount rate is 11%?

A) About 1.667 years

B) About 2.000 years

C) About 2.427 years

D) About 2.94 years

14) A company usually establishes a short, arbitrary cutoff date for handling the initial screening

of many small-dollar opportunities.

15) By switching to monthly cash flows, we cannot get a more accurate estimate of the

discounted payback period.

16) The Discounted Payback Period method is a modified payback period model that considers

how long it takes to recover the initial investment in current dollars.

17) Identify and describe the shortcomings of the payback period model or method (without

discounting).

18) Acme, Inc. is considering a four-year project that has an initial outlay or cost of $80,000. The

respective future cash inflows for years 1, 2, 3 and 4 are: $40,000, $40,000, $30,000 and

$30,000. Acme uses the discounted payback period method and has a discount rate of 12%. Will

Acme accept the project if it’s payback period is two and one-half years?

9.3 Net Present Value

1) The capital budgeting decision model that utilizes all the discounted cash flow of a project is

the ________ model, which is one of the single most important models in finance.

A) net present value (NPV)

B) internal rate of return (IRR)

C) profitability index (PI)

D) discounted payback period

2) The net present value of an investment is ________.

A) the present value of all benefits (cash inflows)

B) the present value of all benefits (cash inflows) minus the present value of all costs (cash

outflows) of the project

C) the present value of all costs (cash outflows) of the project

D) the present value of all costs (cash outflow) minus the present value of all benefits (cash

inflow) of the project

3) In the NPV model, all cash flows are stated ________.

A) in future value dollars, and the total inflow is “netted” against the outflow to see if the net

amount is positive or negative

B) in present value or current dollars, and the outflow is “netted” against the total inflow to see if

the gross amount is positive or negative

C) in present value or current dollars, and the total inflow is “netted” against the initial outflow to

see if the net amount is positive or negative

D) in future dollars, and the initial outflow is “netted” against the total inflow to see if the net

amount is positive

4) In regard to the NPV method, which of the statements below is TRUE?

A) In the NPV model, if two projects are being compared, the one with the highest IRR is

selected.

B) In the NPV model, the present cash flows are discounted at the rate r, the cost of capital.

C) In the NPV model, most future cash flows are stated in present value or current dollars and

the inflow is “netted” against the outflow to see if the net amount is positive or negative.

D) In the NPV model, the net present value of an investment is the present value of all benefits

(cash inflow) minus the present value of all costs (cash outflow) of the project.

5) Which of the statements below is FALSE?

A) The NPV decision criterion is true when all projects are independent and the company has a

sufficient source of funds to accept all positive NPV projects.

B) Two projects are mutually exclusive if the acceptance of one project has no bearing on the

acceptance or rejection of the other project.

C) Projects are mutually exclusive if picking one project eliminates the ability to pick the other

project.

D) If a company has constrained capital, then it can only take on a limited number of projects.

6) Projects are mutually exclusive if picking one project eliminates the ability to pick the other

project. This mutually exclusive situation can arise for different reasons. Which of the statements

below is NOT one of these reasons?

A) One project will always have a negative NPV.

B) There is a scarce resource that both projects would need.

C) There is need for only one project, and both projects can fulfill that current need.

D) By using funds for one project, there are not enough funds available for the other project.

7) Which of the following may be TRUE regarding mutually exclusive capital budgeting

projects?

A) There is need for only one project, and both projects can fulfill that current need.

B) By using funds for one project, there are not enough funds available for the other project.

C) There is a scarce resource that both projects would need.

D) All of the above

8) Which of the statements below is FALSE?

A) The net present value decision model is an economically sound model when comparing

different projects across a wide variety of products, services, and activities under capital

constraint.

B) The greater the NPV of a project, the greater the “bag of money” for doing the project, and

more money is better. If a company is short of capital, it would choose those projects that

provide the largest “bag of money.”

C) Despite all of the advantages of using the NPV model, it is inconsistent with the concept of

the time-value-of-money.

D) By discounting all future cash flows to the present, adding up all inflows, and subtracting all

outflows, we are determining the net present value of the project.

9) There are two ways to correct for projects with unequal lives when using the NPV approach.

Which of the answers below is one of these ways?

A) One way is to find a common life, without the need to extend the projects to the least

common multiple of their lives.

B) One way is to find the present value factors and then compare them.

C) One way is to compare the lengths of the projects and take the project with the shortest life.

D) One way is to find a common life by extending the projects to the least common multiple of

their lives.

10) Which of the statements below is FALSE?

A) We calculate the equivalent annual annuity by taking the NPV of the project and find the

annuity stream that equates to the NPV, using the appropriate discount rate for the project and

life of the project.

B) In dealing with mutually exclusive projects of unequal lives, we can compute the EAA for the

NPV of the project over the life of the project.

C) One of the advantages of NPV over other decision models is that we can select the

appropriate discount rate for each individual project and still compare the resulting NPVs across

different projects.

D) By using the EAA approach for mutually exclusive projects, we overcome all potential

problems.

11) Sandstone, Inc. is considering a four-year project that has an initial after-tax outlay or after-

tax cost of $80,000. The future cash inflows from its project are $40,000, $40,000, $30,000 and

$30,000 for years 1, 2, 3 and 4, respectively. Sandstone uses the net present value method and

has a discount rate of 12%. Will Sandstone accept the project?

A) Sandstone accepts the project because the NPV is greater than $30,000.

B) Sandstone rejects the project because the NPV is less than -$4,000.

C) Sandstone rejects the project because the NPV is -$3,021.

D) Sandstone accepts the project because it has a positive NPV of over $28,000.

12) Idaho Industries Inc. is considering a project that has an initial after-tax outlay or after-tax

cost of $350,000. The respective future cash inflows from its five-year project for years 1

through 5 are $75,000 each year. Idaho expects an additional cash flow of $50,000 in the fifth

year. The firm uses the net present value method and has a discount rate of 10%. Will Idaho

accept the project?

A) Idaho accepts the project because it has an NPV greater than $5,000.

B) Idaho rejects the project because it has an NPV less than $0.

C) Idaho accepts the project because it has an NPV greater than $18,000.

D) There is not enough information to make a decision.

13) Sportswear Online, Inc. is considering a project that has an initial after-tax outlay or after-tax

cost of $220,000. The respective future cash inflows from its four-year project for years 1

through 4 are: $50,000, $60,000, $70,000 and $80,000. Sportswear Online uses the net present

value method and has a discount rate of 11%. Will Sportswear Online accept the project?

A) Sportswear Online accepts the project because the NPV is greater than $10,000.00.

B) Sportswear Online rejects the project because the NPV is about -$22,375.73.

C) Sportswear Online rejects the project because the NPV is about -$12,375.60.

D) Sportswear Online rejects the project because the NPV is about -$2,375.60.

14) Frameworks, Inc. is considering a five-year project that has an initial after-tax outlay or

after-tax cost of $80,000. The respective future cash inflows from its project for years 1, 2, 3, 4

and 5 are: $15,000, $25,000, $35,000, $45,000 and $55,000. Frameworks uses the net present

value method and has a discount rate of 9%. Will Frameworks accept the project?

A) Frameworks accepts the project because the NPV is $129,455.25.

B) Frameworks accepts the project because the NPV is 79,455.25.

C) Frameworks accepts the project because the NPV is $49,455.25.

D) Frameworks accepts the project because the NPV is less than zero.

15) Leonard, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax

cost of $70,000. The future after-tax cash inflows from its project for years 1, 2, 3, 4 and 5 are all

the same at $35,000. Leonard uses the net present value method and has a discount rate of 10%.

Will Leonard accept the project?

A) Leonard accepts the project because the NPV is about $69,455.

B) Leonard accepts the project because the NPV is about $62,678.

C) Leonard rejects the project because the NPV is about -$13,382.

D) Leonard rejects the project because the NPV is less than -$33,021.

16) Rocket Red, Inc. is considering a five-year project that has initial after-tax outlay or after-tax

cost of $170,000. The future after-tax cash inflows from its project for years 1 through 5 are

$45,000 for each year. Rocket Red uses the net present value method and has a discount rate of

11.25%. Will Rocket Red accept the project?

A) Rocket Red accepts the project because the NPV is about $5,455.

B) Rocket Red accepts the project because the NPV is about $165,275.

C) Rocket Red rejects the project because the NPV is about -$4,725.

D) Rocket Red rejects the project because the NPV is about -$154,725.

17) Webster, Inc. is considering an eight-year project that has an initial after-tax outlay or after-

tax cost of $180,000. The future after-tax cash inflows from its project for years 1 through 8 are

the same at $35,000. Webster uses the net present value method and has a discount rate of 12%.

Will Webster accept the project?

A) Webster accepts the project because the NPV is over $10,000.

B) Webster accepts the project because the NPV is about $6,141.

C) Webster rejects the project because the NPV is about -$6,133.

D) Webster rejects the project because the NPV is below -$7,000.