Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
63. Calculate the profitability index for a project that has a net present value equal to –$10,000. The project’s net
investment is $20,000, and the firm has a 40 percent marginal tax rate.
a.
–0.5
b.
0
c.
0.8
d.
None of these are correct
d
64. A project requires a net investment of $100,000. At the firm’s cost of capital of 10%, the project’s profitability index is
1.15. Determine the net present value of the project.
a.
$15,000
b.
$215,000
c.
$115,000
d.
Cannot be determined
a
65. What is the NPV of a project that required a net investment of $500,000 and produced net cash flows of $150,000 per
year for 5 years and $110,000 for the next 5 years? Assume the cost of capital is 14%.
a.
$211,080
b.
$392,580
c.
$588,710
d.
$160,920
a
66. Kinetics is considering a project that has a NINV of $874,000 and generates net cash flows of $170,000 per year for
12 years. What is the NPV of this project if Kinetics cost of capital is 14%?
a.
$252,760
b.
$110,840
c.
$88,200
d.
$47,570
c
67. Using the profitability index, which of the following projects should be accepted?
Project M:
NPV = $60,000
NINV = $200,000
Project N:
NPV = $10,000
NINV = $30,000
Project O:
NPV = $2,000
NINV = $5,000
a.
Project M
b.
Project N
c.
Project O
d.
All projects should be accepted
d
68. ZPS Models is considering a project that has a NINV of $564,000 and generates net cash flows of $105,000 per year
for 10 years. What is the NPV of this project if ZPS has a cost of capital of 12.45%?
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
a.
$47,625
b.
$18,503
c.
$17,490
d.
None of these are correct
69. Decode Genetics purchased lab equipment for $600,000 that will generate net cash flows of $130,000 per year for 10
years. What is the IRR for this project?
a.
16.76%
b.
17.26%
c.
18.13%
d.
17.76%
70. What is the net present value of a project that has a net investment of $148,000 and net cash flows of $25,000 in the
first year, $45,000 in years 2-7, and a negative net cash flow of $27,000 in year 8? Assume the cost of capital is 11%.
a.
$34,302
b.
$74,847
c.
$57,738
d.
–$2,238
a
71. What is the internal rate of return for a project that has a net investment of $169,165 and net cash flows of $25,000 in
the first year and 40,000 in years 2-7?
a.
12.5%
b.
13%
c.
12%
d.
13.5%
c
72. What is the internal rate of return for a project that has a net investment of $60,000 and the following net cash flows:
Year 1 = $15,000; Year 2 = $20,000; Year 3 = $25,000; Year 4 = $30,000?
a.
17.3%
b.
16.7%
c.
15.7%
d.
16.3%
73. Road Hawk Inc. is adding a new production line that will cost $720,000. The line will be depreciated on a straight-line
basis over a 7-year period and will generate net cash flows of $160,000 in each of the 7 years. At the end of the project, it
is expected the line can be sold as scrap for $10,000. If the firm’s marginal tax rate is 40% and its required rate of return is
14%, what is the net present value of this project?
a.
$70,091
b.
–$27,920
c.
$64,091
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
d.
–$31,520
d
74. Consider a capital expenditure project that has forecasted revenues equal to $32,000 per year; cash expenses are
estimated to be $29,000 per year. The cost of the project equipment is $23,000, and the equipment’s estimated salvage
value at the end of the project is $9,000. The equipment’s $23,000 cost will be depreciated on a straight-line basis to $0
over a 10-year estimated economic life. Assume that the project requires an initial $7,000 working capital investment. The
company’s marginal tax rate is 30%. Calculate the project’s net present value using a 12% discount rate.
a.
about –$10,610
b.
about –$12,530
c.
about –$9,954
d.
about +$9,462
c
75. Calculate the net present value for an investment project with the following cash flows using a 12% cost of capital:
Year
0
1
2
3
Net Cash Flow
–$100,000
$80,000
$80,000
-$30,000
a.
$56,560
b.
$30,000
c.
$13,840
d.
Cannot be determined with information given
c
76. Ecogen is considering the purchase of some new equipment that will cost $340,000 installed. The equipment will
produce a product that must be FDA approved and this will require at least a year. Net cash flow in Year 1 will be a
negative $110,000 but is expected to be a positive $50,000 in Year 2. Net cash flows will be $150,000, $240,000, and
$330,000 in the next 3 years. At the end of 5 years the equipment and the product will be obsolete. If the firm’s marginal
tax rate is 40% and their costs of capital is 15%, should they invest in the new equipment?
a.
Yes, NPV = $2,090
b.
Yes, NPV = $12,390
c.
No, NPV = –$63,210
d.
No, NPV = –$12,210
a
77. G-III Apparel is considering increasing the size of a warehouse. The cost of the expansion is $825,000, and the
increase in inventories and accounts payable will be $410,000 and $360,000, respectively. G-III expects that the
expansion will increase net cash flows by $150,000 a year for the next 5 years and $200,000 a year for years 6-12. G-III
has a 14% cost of capital and a marginal tax rate of 35%. What is the NPV of the warehouse expansion?
a.
–$3,450
b.
$60,050
c.
$10,050
d.
–$338,570
c
78. What is the internal rate of return for a project that has a net investment of $370,000 and net cash flows of $60,000 in
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
year 1, $75,000 in year 2, and $85,000 in years 3 through 8?
a.
15.5%
b.
13.6%
c.
17.4%
d.
None of these are correct
79. Rollerblade, a manufacturer of skating gear, plans to expand its operation in Brighton, England. The expansion will
cost $18.5 million and is expected to generate annual net cash flows of 2.2 million pounds for a period of 15 years and
nothing thereafter. The cost of capital for the project is 16%. Using the spot exchange rate of $1.60 per British pound,
compute the net present value of the expansion project.
a.
–$6.235 million
b.
$2.458 million
c.
$1.124 million
d.
–$10.83 million
c
80. Zimmer, a manufacturer of modular rooms, plans to expand its operation in Landshut, Germany. The expansion will
cost $14.5 million and is expected to generate annual net cash flows of DM4.5 million for a period of 12 years and then
the operation will be sold for DM2 million. The cost of capital for the project is 14%. Using the spot exchange rate of
$0.60 per DM, compute the NPV of this expansion project.
a.
$0.78 million
b.
$1.03 million
c.
$2.58 million
d.
$11.39 million
81. A digital assembly system that costs $160,000 is expected to operate for 8 years. The estimated salvage value at the
end of 8 years is $12,000. The system is expected to save the company $38,000 in labor costs before taxes and
depreciation. The company will depreciate this system on a 5-year MACRS schedule. If the firm’s cost of capital is 12%
and its marginal tax rate is 35%, compute the NPV for the project. (Note: Requires MACRS tables.)
a.
$4,045
b.
$7,196
c.
$20,873
d.
$167,196
82. TexMex is considering replacing its tortilla machine with a new model that sells for $46,000 including the cost of
installation. The old machine has been fully depreciated and has a $0 salvage value. The new machine will be depreciated
as a 3-year MACRS asset. Revenues are expected to increase $18,000 per year over the 5-year life of the new machine. At
the end of 5 years the new machine is expected to have no salvage value. What is the IRR for this project if TexMex has a
required rate of return of 14% and a marginal tax rate of 40%? Operating costs are not expected to increase from the
current level of $8,000 per year.
a.
21.0%
b.
14.0%
c.
19.3%
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
d.
5.7%
c
83. Colex wishes to bid on a contract that is expected to yield after-tax net cash flows of $25,000 in year 1, $30,000 in
year 2, and $35,000 per year in years 3–8. To obtain the contract, Colex will need to invest $110,000 to reconfigure a
packaging system, $20,000 (after-tax) to retrain current employees, and $15,000 (after-tax) on an environmental impact
study that is required to be completed on acceptance of the contract. What is the project’s internal rate of return?
a.
16.7%
b.
14.1%
c.
16.2%
d.
14.9%
d
84. Which of the following statements about comparing capital budget techniques is (are) correct?
I. The payback period is easy to understand and helps the firm identify how long it will be unable to use the initial
investment for other projects.
II. Mutually exclusive projects allow a firm to do other like projects (mutually exclusive) simultaneously as long as the
budget constraints are met.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
a
85. Which of the following statements about comparing the techniques of net present value (NPV) and internal rate of
return (IRR) is (are) correct?
I. The net present value assumes that all cash flows are reinvested at the cost of capital and is therefore realistic.
II. The internal rate of return is stated as a percent and is therefore easy to communicate to decision-makers who may not
understand the fine points of finance.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
c
86. What is the net present value of the following project if the required rate of return is 15%? The initial investment is
$150,000.
Years
Cash Flows
1
$30,000
2
$80,000
3
$100,000
4
$200,000
a.
$203,690
b.
$180,665
c.
$150,000
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
d.
$116,681
d
87. Should the following project be accepted if the cost of capital is 12%?
Initial Investment is $50,000.
Years
Cash Flows
1
$25,000
2
$35,000
3
$55,000
a.
Yes, because the internal rate of return is 10.5%, which is less than 12%.
b.
Yes, because the internal rate of return is 35%, which is more than 12%.
c.
No, because the internal rate of return is 8.7%, which is less than 12%.
d.
Yes, because the internal rate of return is 48%, which is more than 12%.
d
88. In comparing the techniques of net present value and internal rate of return:
I. The NPV and IRR techniques will generate the same accept-reject decision provided the projects have conventional
cash flows.
II. The differences between the underlying assumptions of NPV and IRR can cause them to rank projects differently.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
c
89. In considering the payback period, ____.
a.
the maximum period allowed by a firm is a specific time period based on objective criteria
b.
it considers the time value of money in determining the maximum allowable time period
c.
it gives some indication of a project’s desirability from a liquidity viewpoint
d.
it is based on cash flows both during and after the payback period
c
90. In considering the payback method, ____.
a.
it is a method of determining the financial exposure of a firm for a project
b.
it is a complicated but accurate capital budgeting method
c.
it is generally superior to the net present value method
d.
None of these are correct
a
91. The payback method has all of the following advantages EXCEPT it ____.
a.
considers the time value of money
b.
determines a firm’s financial exposure
c.
is easy to calculate
d.
determines if the project under consideration will be able to replace the start-up costs.
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
a
92. A weakness of the payback period is that it disregards ____.
a.
projects with shorter payback periods
b.
cash flows during the payback period
c.
start-up costs
d.
the time value of money
d
93. Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be
termed “waiting to invest” is the ____ option.
a.
investment timing
b.
abandonment
c.
shutdown
d.
growth
a
94. Barnacle Bob’s Fish and Tackle Shop is planning an expansion. The initial investment is $480,000, and anticipated
cash inflows are as listed below. The cost of capital is 12.2%. Based on the profitability index, should Barnacle Bob go
ahead with the project?
Years
Cash Inflows
1
$ 90,000
2
105,000
3
105,000
4
195,000
5
195,000
6
195,000
a.
No, the profitability index is 2.
b.
No, the profitability index is 0.95.
c.
Yes, the profitability index is 1.18.
d.
Yes, the profitability index is 0.78.
c
95. Based upon the following cash flows, should Ooey Gooey Candy Makers introduce a new product, Skinny Minnie
Diet Cuisine? The initial investment is $780,000, and the cost of capital is 12.2%.
Years
Cash Flows
1
$ 90,000
2
$105,000
3
$105,000
4
$195,000
5
$195,000
6
$195,000
a.
Yes, the NPV is $288,410.60 and the IRR is 38.2%.
b.
Yes, the NPV is $175,478.98 and the IRR is 20.42%.
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
c.
No, the NPV is –$211,589.40 and the IRR is 3.24%.
d.
No, the NPV is –$75,375.18 and the IRR is 11.75%.
c
96. Based upon the following cash flows, should Chipper Nipper Cookie Company introduce a new product, Rolling In
Dough Pies? The initial investment is $180,000, and the cost of capital is 11.5%.
Years
Cash Flows
1
$ 80,000
2
$ 95,000
3
$ 95,000
4
$110,000
5
$110,000
6
$110,000
a.
Yes, the rounded NPV is $228, 940.00 and the IRR is 46.62%.
b.
Yes, the rounded NPV is $75,428.63 and the IRR is 12.27%.
c.
No, the rounded NPV is –$57,277.32 and the IRR is 8.75%.
d.
No, the rounded NPV is –$221,275.39 and the IRR is 9.97%.
a
97. The choice to accept or reject projects based on the payback period ____.
a.
is an objective decision
b.
is a subjective decision
c.
will always give the same results as when using the net present value method
d.
will always give the same results as when using the internal rate of return method
b
98. The payback period can be considered justified for which of the following reasons?
a.
It can account for the risk of the project.
b.
It can account for the time value of the project.
c.
It can account for the return on investment.
d.
It can account for the objective rationale of the project.
a
99. When considering projects for implementation, management generally has three options. All of the following reflect
possible managerial options EXCEPT that management could ____.
a.
attempt to find another combination of projects that would allow for a more complete utilization of available
funds
b.
accept the current project or projects and hope that the preliminary analysis is correct
c.
choose to reject the projects under consideration and place the available funds in a short term security until the
next period
d.
sell stock to raise sufficient capital to invest in the project if it is required to make it profitable
d
100. A firm’s capital expenditures may be limited due to externally imposed constraints. All but which of the following
are external constraints?
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
a.
The firm’s loan agreements may contain restrictive constraints.
b.
The firm may decide to place an upper limit on the amount of funds allocated to capital investment.
c.
If the firm has a weak financial position, it may be too expensive to float a new bond issue.
d.
There may be market-imposed difficulties such as a tight money policy on the part of the Federal Reserve
System.
Essay
101. List the advantages and disadvantages of the payback method.
1.
It is easy and inexpensive to use.
2.
It provides a crude measure of project risk.
3.
It provides a measure of project liquidity.
The disadvantages of the payback method are:
1.
There is no objective decision criterion.
2.
3.
It ignores cash flows occurring after the payback period.
102. Why is the net present value method of evaluating projects better than the internal rate of return method?
reinvestment rate than the computed internal rate of return.
103. Explain why the internal rate of return method is more popular than the net present value method. What are some
potential problems with relying on the IRR method?
104. How does the profitability index differ from the net present value, and when would each method be preferred?
Name:
Class:
Date:
Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
105. In working with capital budgeting, what does a post-audit do?
106. There are various reasons why companies may have difficulty in earning a positive net present value. These reasons
include barriers to market entry and other factors. List these factors.
107. Explain the three different types of designed–in options.