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Chapter 12 - The Capital Budgeting Decision
1. Capital budgeting decisions involve a minimum time horizon of five years.
2. A good capital budgeting program requires that a number of steps be taken in the decision
Chapter 12 - The Capital Budgeting Decision
3. Possibly the most overlooked part of the capital budgeting process is the search for new
opportunities through innovation and creative thinking.
4. In most capital budgeting decisions the emphasis should be on reported earnings rather than
cash flows.
5. Even though one project may have superior cash flows, top management may sometimes
choose a project that inflates earnings instead of cash flow.
Chapter 12 - The Capital Budgeting Decision
7. It is not unusual for a corporate president, who deals with security analysts, to be as
sensitive to after-tax income as to cash flow.
8. Capital budgeting is only a concern of finance and accounting personnel.
9. We add depreciation to net income to arrive at a true earnings picture.
10. The payback method is Basic to understand and places a heavy emphasis on liquidity.
11. The payback method is not really a theoretically correct approach.
Chapter 12 - The Capital Budgeting Decision
12. A rapid payback may be important to firms having rapid technological development.
13. The payback method considers all cash inflows.
14. Using the payback method can be appropriate when the time value of money is very low.
15. Depreciation is important in calculating projected cash flows because it generates a tax
deduction.
16. To find the exact internal rate of return for projects with uneven cash flows, we can
interpolate between two present value annuity factors from Appendix D.
Chapter 12 - The Capital Budgeting Decision
17. With non-mutually exclusive events and no capital rationing, we will usually arrive at the
same conclusions using either the net present value or internal rate of return methods.
18. The internal rate of return is the interest rate that equates the cash outflows of an
investment with the subsequent inflows.
19. The net present value profile's primary advantage over the internal rate of return method is
that it does not require the time consuming trial and error calculations of the IRR.
20. Non-mutually exclusive alternatives can be accepted at the same time.
Chapter 12 - The Capital Budgeting Decision
21. The selection of a mutually exclusive project means that all other projects with a positive
net present value may also be selected.
22. The profitability index is calculated by dividing the project's net present value by the
present value of the projected cash outflows.
23. It is the difference in the reinvestment assumptions that can be significant in determining
when to use the net present value or internal rate of return methods.
24. Under the net present value method, cash flows are assumed to be reinvested at the firm's
weighted average cost of capital.
Chapter 12 - The Capital Budgeting Decision
25. For high-IRR investments, it is perfectly acceptable to assume that reinvestment will
occur at an equally high, if not higher, rate.
26. The modified internal rate of return assumes that inflows are reinvested at 80 percent of
the internal rate of return.
27. Under capital rationing, a firm will maximize profitability.
28. The net present value profile allows a firm to examine the project's net present value over
time.
Chapter 12 - The Capital Budgeting Decision
29. The net present value profile examines the relationship of the discount rate to the net
present value.
30. The net present value profile's weakness is that it does not provide a decision for mutually
exclusive investments.
31. When using accelerated depreciation, the present value of future cash flows increases.
32. Under the modified accelerated-cost-recovery system of depreciation, cash flow tends to
decline with the passage of time.
Chapter 12 - The Capital Budgeting Decision
33. Although firms can elect to use straight-line depreciation, the MACRS depreciation
schedules have superseded other depreciation methods for tax purposes.
34. In most cases, asset lives are shorter under MACRS depreciation than they would be with
straight-line depreciation.
35. Most real estate property is depreciated over a 10 year period.
36. For a small business, it is possible for the purchase price of an asset to be expensed rather
than depreciated.
37. The base for depreciation expense calculations is equal to the cost of a new asset.
Chapter 12 - The Capital Budgeting Decision
38. Under MACRS depreciation, taxes paid in the first year of an asset's life are subtracted
from the base used to calculate depreciation expense.
39. Under MACRS depreciation, there are no tax credits for the purpose of calculating the
base for depreciation expenses.
40. Under MACRS depreciation, the tax life of an asset and its economically useful life are
assumed to be the same.
41. If an asset is sold for a price above its book value, the difference is considered taxable
income to the firm.
Chapter 12 - The Capital Budgeting Decision
42. A tax loss on the sale of a depreciable asset used in business or trade may be written off
against income.
43. In a replacement decision, a book loss on an old asset can be a valuable feature.
44. The dollar amount of losses incurred when an old asset is sold below book value is added
to the purchase price of a new asset in calculating the base for depreciation.
45. Cash flow is used for a net present value analysis and earnings are used for an IRR and
payback analysis.
Chapter 12 - The Capital Budgeting Decision
46. When NPV and IRR analysis provide inconsistent rankings of projects, the financial
manager should generally select the project with the highest IRR.
47. Investors discount the later years of a long-term project at a lower rate because they are
generally less precise.
48. It is more likely for financial managers to focus on cash flow and corporate executives to
focus on earnings of the company.
49. Capital rationing is generally a positive action for a firm because it prevents rapid growth
which can drive up the cost of capital.
Chapter 12 - The Capital Budgeting Decision
50. The reinvestment assumption is a downside of the IRR method of analysis because it
assumes that cash flows are reinvested at the cost of capital.
51. Cash flow can be said to equal
52. The reason cash flow is used in capital budgeting is because
Chapter 12 - The Capital Budgeting Decision
53. The first step in the capital budgeting process is
54. Capital budgeting is primarily concerned with
55. An appropriate capital budgeting process requires that the following steps are taken in
which order?
Chapter 12 - The Capital Budgeting Decision
56. Assume a corporation has earnings before depreciation and taxes of $82,000, depreciation
of $45,000, and that it has a 30 percent tax bracket. What are the after-tax cash flows for the
company?
57. Assume a project has earnings before depreciation and taxes of $15,000, depreciation of
$25,000, and that the firm has a 30 percent tax bracket. What are the after-tax cash flows for
the project?
Chapter 12 - The Capital Budgeting Decision
58. Which of the following is not a time-adjusted method for ranking investment proposals?
59. Which of the following statements about the "payback method" is true?
60. There are several disadvantages to the payback method, among them:
Chapter 12 - The Capital Budgeting Decision
61. The payback method has several disadvantages, among them:
62. Assume a $6,500 investment and the following cash flows for two alternatives.
Under the payback method, which of the following would be concluded?
Chapter 12 - The Capital Budgeting Decision
63. The Dammon Corp. has the following investment opportunities:
Under the payback method and assuming these machines are mutually exclusive, which
machine(s) would Dammon Corp. choose?
64. Suppose that interest rates (and, therefore, the firm's Weighted Average Cost of Capital)
increase. This WOULD NOT CHANGE the capital budgeting choices a firm would make if
it
Chapter 12 - The Capital Budgeting Decision
65. You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000
per year for 10 years. What is the internal rate of return?
66. You require an IRR of 14% to accept a project. If the project will yield $10,000 per year
for 10 years, what is the maximum amount that you would be willing to invest in the project?
Chapter 12 - The Capital Budgeting Decision
67. The longer the life of an investment
68. Stone Inc. is evaluating a project with an initial cost of $9,500. Cash inflows are expected
to be $1,500, $1,500 and $10,000 in the three years over which the project will produce cash
flows. If the discount rate is 9%, what is the net present value of the project?
