CHAPTER 9: CAPITAL BUDGETING AND CASH FLOW ANALYSIS
1. Sale of an asset for less than book value creates an operating loss which effectively reduces the company’s
taxes by an amount equal to times .
a. one-half the loss, the company’s marginal tax rate
b. the loss, one minus the company’s marginal tax rate
c. one-half the loss, one minus the company’s marginal tax rate
d. the loss, the company’s marginal tax rate
2. The value of resources used in an investment project should be measured in terms of their
a. acquisition cost
b. historical cost
c. opportunity cost
d. depreciated cost
3. There is neither a gain or a loss on the sale of a depreciable asset for an amount exactly equal to its .
a. acquisition cost
b. tax book value
c. opportunity cost
d. historical cost
4. The is a schedule of projects arranged in order according to their expected rates of return.
a. investment opportunity curve, ascending
b. marginal cost of capital curve, ascending
c. investment opportunity curve, descending
d. marginal cost of capital curve, descending
5. Which of the following would not be classified as a capital expenditure for decision-making purposes?
a. purchase of a building
b. investment in a management training program
c. purchase of 90-day Treasury Bills
d. development of a major advertising campaign
Chapter 9: Capital Budgeting and Cash Flow Analysis
6. A firm’s cost of capital is:
a. an important financial ratio
b. equal to 10 percent
c. rarely used in practice
d. an important input in the capital budgeting process
7. The decision by the Municipal Transportation Authority to either refurbish existing buses, to buy new large
buses, or to supplement the existing fleet with mini-buses is an example of:
a. independent projects
b. mutually exclusive projects
c. contingent projects
d. separable projects
8. Which of the following is not a major difficulty in implementing the basic capital budgeting model?
a. determining the schedule of available projects before a decision on any one project can be made
b. accounting for the risk of individual projects.
c. projecting the cost of funds over the investment decision horizon
d. choosing an appropriate criterion for selecting among various investment alternatives
9. Which of the following is not a major step in the capital budgeting process?
a. generating investment project proposals
b. estimating cash flows
c. analyzing the effect of a project on the firm’s financial ratios
d. performing a project post-audit and review
10. Which of the following is a basic principle when estimating a project’s cash flows?
a. cash flows should be measured on a pretax basis
b. cash flows should ignore depreciation because it is a non-cash charge
c. only direct effects of a project should be included in cash flow calculations
d. cash flows should be measured on an incremental basis
Chapter 9: Capital Budgeting and Cash Flow Analysis
11. Which of the following items is not considered as a part of the net investment calculation?
a. the first year’s net cash flow
b. increase in net working capital
c. salvage of an old piece of equipment that is being replaced
d. installation and shipping charges
12. The effect of a one dollar increase in depreciation expenses is to the typical firm’s net cash flows by
one dollar.
a. increase, less than
b. increase, exactly
c. decrease, more than
d. increase, more than
13. The dollar amount of interest charges is:
a. always considered in the net cash flow calculation
b. normally not considered in the net cash flow calculation
c. always considered as a part of the net investment
d. never a consideration
14. Raider Productions has to decide whether to build its warehouse in Dallas or Houston. This decision falls into
the class of:
a. independent projects
b. mutually exclusive projects
c. contingent projects
d. marginal projects
15. The determination of net cash flows (NCF) should never include
a. changes in depreciation
b. changes in operating costs
c. interest charges
d. indirect effects
Chapter 9: Capital Budgeting and Cash Flow Analysis
16. Which of the following are (is) generally considered problems associated with cash flow estimation?
a. uncertainty about the future cash flows
b. the introduction of bias into the estimation of cash flows
c. uncertainty about the magnitude of fixed cost financing charges
d. uncertainty about the future cash flows and the introduction of bias into the estimation of cash flows
17. Most firms choose accelerated depreciation methods because
a. reported net income is higher
b. tax payments are made sooner, resulting in a lower deferred tax liability
c. operating expenses are correspondingly reduced
d. income taxes are deferred
18. Cash flows for all investment projects should be projected over the of the project.
a. MACRS recovery period
b. depreciable life
c. economic life
d. smaller of depreciable or economic lives
19. When a firm sells an asset for , it realizes a capital gain and must pay income taxes on it.
a. book value
b. less than book value
c. more than book value but less than original cost
d. more than its original cost
20. is the term used when the initial cost of all acceptable capital budgeting projects is greater than the total
funds the firm has available.
a. Profit maximization
b. Funds constraint
c. Mutually exclusive
d. Contingent
Chapter 9: Capital Budgeting and Cash Flow Analysis
21. In estimating the net investment, an outlay that has already been made is known as a (n) .
a. sunk cost
b. cash outflow
c. opportunity cost
d. expansion cost
22. Depreciation is based on the asset cost plus all of the following except
a. shipping costs
b. increase in inventory
c. installation
d. cost of attached equipment acquired at the same time
23. Depreciation reported profits and it taxes paid by a firm.
a. increases, reduces
b. reduces, reduces
c. reduces, increases
d. increases, increases
24. If a firm sells an asset for less than its book value,
a. there are no tax consequences
b. the loss is treated as lost depreciation
c. the loss reduces depreciation expenses
d. the loss may be used to offset operating income
25. The the amount of depreciation charged in a period, the will be the firm’s taxable income.
a. greater, lower
b. lower, lower
c. lower, greater
d. greater, higher
26. In terms of the capital budgeting process, net cash flows are
a. the net cash outlays required to place a project in service.
b. the funds invested in additional assets.
c. incremental changes in a firm’s cash flow.
d. the outlays that have already been made.
Chapter 9: Capital Budgeting and Cash Flow Analysis
27. A recent survey of Fortune 500 firms regarding their cash flow estimation procedures indicated that
a. few firms prepared formal cash flow estimates
b. the majority produced detailed cash flow projections
c. a majority estimated cash flows for a range of estimates
d. about 50 percent made comparisons between actual and projected cash flows.
28. Depreciation
a. does not affect cash flows.
b. does not affect profits.
c. is not a cash outflow.
d. is a cash inflow.
29. The capital budgeting process is very important to the firm because it:
a. highlights the impacts of a project on net income
b. essentially plots the company’s future direction
c. is used in working capital analysis
d. indicates the net cash flows available for employee education
30. A (n) is a cash outlay that is expected to generate a flow of future cash benefits lasting longer than 1 year.
a. depreciation charge
b. operating expenditure
c. capital expenditure
d. capital gain
31. The set of investment projects arranged in descending order according to their expected rates of return is
known as the ____.
a. marginal cost of capital schedule
b. schedule of mutually exclusive projects
c. schedule of contingent projects
d. simplified capital budgeting model
Chapter 9: Capital Budgeting and Cash Flow Analysis
32. A(n) project is one whose acceptance is dependent on the adoption of one or more other projects.
a. contingent
b. mutually exclusive
c. independent
d. perfectly correlated
33. The net cash flows for any year during the life of capital expenditure project are equal to the change in
plus the change in .
a. earnings before interest and taxes; depreciation
b. earnings before taxes; depreciation
c. earnings after taxes; depreciation
d. revenues; costs
34. The net investment calculation for an project normally includes .
a. asset expansion; pretax proceeds from the sale of the old asset
b. asset replacement; pretax proceeds from the sale of the old asset
c. asset expansion; after-tax proceeds from the sale of the old asset
d. asset replacement; after-tax proceeds from the sale of the old asset
35. There is a capital gain on the sale of an asset for .
a. more than its original cost
b. more than its book value but less than its original cost
c. its depreciation value
d. its net present value
36. The net investment calculation for an asset replacement decision normally includes any .
a. after-tax salvage value of the old asset
b. increase in net working capital
c. after-tax salvage value of the old asset and increase in net working capital
d. cannot be computed
Chapter 9: Capital Budgeting and Cash Flow Analysis
37. When calculating the net cash flow in a project’s expected final year,
a. recovery of any working capital invested is disregarded
b. the after-tax salvage value of any project equipment is considered
c. the remaining principal on any borrowed funds is considered
d. the sales proceeds from any land associated with the project is disregarded
38. When managers knowingly bias estimates of cash flows from investment projects in order to serve their
personal objectives, they are .
a. performing management by exception
b. increasing their total compensation
c. departing from the shareholder wealth maximization goal
d. increasing their confidence level
39. Capital expenditure projects may be classified in all the following types except:
a. growth opportunities
b. required to meet legal requirements
c. cost reduction opportunities
d. capital rationing
40. have cash flow patterns with more than one sign change.
a. conventional projects
b. non-normal projects
c. normal projects
d. contingent projects
41. A drill press costs $30,000 and is expected to have a 10 year life. The drill press will be depreciated on a
straight-line basis over 10 years to a zero estimated salvage value. This machine is expected to reduce the
firm’s cash operating costs by $4,500 per year. If the firm is in the 40 percent marginal tax bracket, determine
the annual net cash flows generated by the drill press.
a. $4,500
b. $900
c. $5,700
d. $3,900
Chapter 9: Capital Budgeting and Cash Flow Analysis
42. An investment project is expected to generate earnings before taxes (EBT) of $60,000 per year. Annual
depreciation from the project is $30,000 and the firm’s tax rate is 40 percent. Determine the project’s annual
net cash flows.
a. $48,000
b. $66,000
c. $36,000
d. $52,000
43. Ten years ago J-Bar Company purchased a lathe for $250,000. It was being depreciated on a straight-line basis
to an estimated $25,000 salvage value over a 15 year period. The firm is considering selling the old lathe and
purchasing a new one. The new lathe would cost $500,000. The firm’s marginal tax rate 40 percent. Determine
the net investment required to purchase the new lathe, if the old lathe is sold for $100,000.
a. $380,000
b. $397,500
c. $400,000
d. $418,000
44. Little Giant is building a manufacturing plant that will require a cash outlay of $300,000 for the initial purchase
of a building, $450,000 for remodeling the first year, and $710,00 for new equipment in the second year. If the
firm’s cost of capital is 12 percent, what is the present value of the net investment at time 0?
a. $1,460,000
b. $1,132,070
c. $1,267,720
d. $300,000
Chapter 9: Capital Budgeting and Cash Flow Analysis
45. In Step Video is considering expanding its video rental library to 8,000 tapes. The purchase price of the
additional videos will be $80,000 and the shipping cost is another $4,000. To house the tapes, the owner will
have to spend another $10,000 for display shelves, increase net working capital by $5,000, and interest
expenses will add another $8,000 to the operating cost. What is the net investment to In Step Video for this
project?
a. $95,000
b. $99,000
c. $84,000
d. $107,000
46. What is the net investment for an extruder that costs $42,000, if shipping costs are $1,500 and installation is
$4,800? Assume this efficient machine is replacing an older extruder with a book and market value of zero.
The replacement investment will reduce operating costs by $6,600 a year.
a. $48,300
b. $54,900
c. $43,500
d. $51,000
47. Shunt Technology will spend $800,000 on a piece of equipment that will manufacture fine wire for the
electronics industries. The shipping and installation charges will be $240,000 and net working capital will
increase $48,000.The equipment will replace an existing machine that has a salvage value of $75,000 and a
book value of $125,000. If Shunt has a current marginal tax rate of 34 percent, what is the net investment?
a. $1,030,000
b. $1,163,000
c. $1,033,000
d. $996,000
48. Capital Foods purchased an oven 5 years ago for $45,000. The oven is being depreciated over its estimated
10-year life using the straight line method to a salvage value of $5,000. Capital is planning to replace the
oven with a more automated one that will cost $150,000 installed. If the old oven can be sold for $30,000,
what is the tax liability? Assume a marginal tax rate of 40 percent.
a. $900
b. $2,000
c. $127,000
d. $25,000
Chapter 9: Capital Budgeting and Cash Flow Analysis
49. The management of Jasper Equipment Company is planning to purchase a new milling machine that will cost
$160,000 installed. The old milling machine has been fully depreciated but can be sold for $15,000. The new
machine will be depreciated on a straight line basis over its 10 year economic life to an estimated salvage value
of $10,000. If this milling machine will save Jasper $20,000 a year in production expenses, what are the annual
net cash flows associated with the purchase of this machine? Assume a marginal tax rate of 40 percent.
a. $15,000
b. $18,000
c. $27,000
d. $21,000
50. Jim Bo’s currently has annual cash revenues of $240,000 and annual operating expenses of $185,000 including
$35,000 in depreciation. The firm’s marginal tax rate is 40 percent. A new cutting machine can be purchased
for $120,000 will increase revenues by $50,000 per year while operating expenses would increase to $205,000,
including $42,000 in depreciation. Compute Jim Bo’s annual incremental after-tax net cash flows.
a. $25,000
b. $20,800
c. $93,000
d. $19,000
51. Moon Pie Company is considering automated baking equipment that costs $500,000 installed and would
replace the present hand-made production method. The present equipment has a zero book and salvage value.
The new equipment will not increase revenues but will reduce operating costs from a current level of $600,000
to $300,000 per year. The depreciation of the new equipment will be $73,000 per year. What are the annual
incremental net cash flows? Assume a marginal tax rate of 40 percent.
a. $296,800
b. $136,200
c. $192,200
d. $209,200
52. LISP Inc. is planning to purchase a new mixer/dubber for $50,000. The new equipment will replace an older
mixer that has been fully depreciated but has a salvage value of $5,000. Compute the net investment required
for this project. Assume a marginal tax rate of 40 percent.
a. $47,000
b. $45,000
c. $48,000
d. $55,000
Chapter 9: Capital Budgeting and Cash Flow Analysis
53. LISP Inc. is planning to purchase a new mixer for $50,000 that will qualify as MACRS 3-year property (first
year depreciation rate = 33.33%). The new mixer should increase revenues by $20,000 per year with no
increase in operating cost. If LISP’s marginal tax rate is 40 percent, what is the net cash flow in the first year?
a. $22,665
b. $19,000
c. $18,666
d. $21,500
54. Outback is purchasing a new machine that will cost $98,000. The machine will qualify as MACRS 5-year
property but has an economic life of 8 years. The new machine is expected to increase revenues by $35,000 per
year and operating costs are expected to increase by $15,000 per year. If the firm’s marginal tax rate is 34
percent and the first year’s depreciation rate is 20 percent, what is the net cash flow in the first year.
a. $264
b. $7,984
c. $19,864
d. $26,034
55. What is the net investment required for a pitting machine that will cost $35,000 including installation? The
machine replaces a machine that cost $5,000 when purchased five years ago. The old machine has been fully
depreciated but has a market value of $6,000. Assume the marginal tax rate is 40 percent.
a. $29,000
b. $31,400
c. $32,600
d. $34,505
56. Allen Company is considering an investment project that is expected to generate $100,000 in annual earnings
before taxes. Annual depreciation will be $50,000. Allen’s marginal tax rate is 40%. Determine the project’s
annual net cash flows.
a. $150,000
b. $110,000
c. $90,000
d. $60,000
Chapter 9: Capital Budgeting and Cash Flow Analysis
57. Baker Company is considering an investment in a new metal lathe. If the new lathe is purchased, revenues will
increase by $5,000 per year and cash operating costs will decline by $10,000 per year. The lathe will cost
$60,000 and will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value.
Baker’s marginal tax rate is 40%. Determine the annual net cash flows generated by the lathe.
a. $11,400
b. $9,000
c. $600
d. $5,400
58. Basin Manufacturing (40% marginal tax rate) is considering a plant expansion project. The equipment will cost
$100,000 and will require an additional $10,000 for delivery and installation. The expansion also will require
Basin to increase immediately its net working capital by $25,000. The expansion is expected to generate
revenues of $150,000 per year. Calculate the project’s net investment.
a. $81,000
b. $125,000
c. $131,000
d. $135,000
59. Maritech purchased a pellet mill 4 years ago for $60,000. The mill is being depreciated over 7 years using
MACRS. Maritech is planning to replace the mill with a higher volume unit that will cost $110,000 installed. If
the old mill can be sold for $25,000, what is the tax liability? Assume a marginal tax rate of 40%. Use the
rounded MACRS schedule listed below.
(7-Year Depreciation Schedule: 14%, 25%, 18%, 12%, 9%, 9%, 9%, 4%)
a. $3,754
b. $7,498
c. $2,560
d. $16,502