The calculation of differential cash flows over a project's life should include which of the following?

The calculation of differential cash flows over a project's life should include which of the following?

A) Labor and material savings

B) Additional revenues attributable to the project

C) Investment in net working capital

D) All of the above

Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal?

A) Increase in accounts receivable

B) The cost of shipping new equipment

C) The cost of issuing new bonds if the project is financed by a new bond issue

D) The cost of installing new equipment

Which of the following expenses should be included when estimating cash flows for investment projects?

A) Interest expense related to financing a project

B) Sunk costs

C) Required principal payments related to financing a project

D) Opportunity costs

When evaluating Capital Budgeting decisions, which of the following items should NOT be included in the construction of cash flow projections for purposes of analysis?

A) Net salvage value

B) Changes in net working capital requirements

C) Shipping and installation costs

D) All of the above should be included.

Holding all other variables constant, which of the following would INCREASE net working capital for given year on a project?

A) Allowing customers less time to pay for purchases

B) Taking longer to pay suppliers

C) Increasing inventory levels

D) Both A and C

If an investment project would make use of land which the firm currently owns, the project should be charged with

A) a sunk cost.

B) an opportunity cost.

C) amortization.

D) interest.

Which of the following best describe why cash flows are utilized rather than accounting profits

Which of the following best describe why cash flows are utilized rather than accounting profits when evaluating capital projects?

A) Deducting interest expense from income and also including it in the discount rate would result in double counting.

B) Cash flows reflect the timing of benefits and costs more accurately than accounting profits.

C) Cash flows are more stable than accounting profits.

D) Both A and B.

Which of the following is the best example of an incremental cash inflow/outflow?

A) Cash flows that are achieved by diverting sales from other projects of the firm

B) Cash flows that are associated with the financing of a project

C) Cash flows that occur a little at a time

D) What the total cash flows will be to the company if the project is undertaken as opposed to what they would have been if the project had not been undertaken

Which of the following is an example of a sunk cost?

A) Overhead costs that are associated with a project

B) Interest expense associated with a project

C) Market study expenses incurred in order to decide if a firm should accept a project

D) Depreciation expenses associated with a project

Which of the following cash flows should be included as incremental costs when evaluating capital projects?

A) A new security system will reduce shoplifting losses by $50,000 per year.

B) New equipment associated with the project will increase depreciation expense by $300,000 per year.

C) Interest on construction loans will increase interest expense by $225,000 per year.

D) The new project will occupy about 5% of the Chief Operating Officer’s time, so 5% of her salary should be included.

Which of the following would be considered a termination cash flow?

A) The expected salvage value of the asset

B) Any tax payments or refunds associated with the salvage value of the asset

C) Recapture of any investment in working capital that was included as an incremental cash outlay

D) All of the above

How is interest expense that is associated with a project treated in the capital budgeting process?

A) It is treated as a cash outflow when estimating the incremental cash flows associated with a project.

B) It is built into the discount rate.

C) It is considered a synergistic incremental cash flow.

D) Interest expense is not relevant to any capital budgeting decisions.

Which of the following is NOT one of the categories for a project's relevant after-tax cash flows?

Incremental cash flows from a project =

A) Firm cash flows without the project plus or minus changes in net income.

B) Firm cash flows with the project plus firm cash flows without the project.

C) Firm cash flows with the project minus firm cash flows without the project.

D) Firm cash flows without the project plus or minus changes in revenue with the project.

Which of the following is NOT one of the categories for a project's relevant after-tax cash flows?

A) Financing flows

B) Initial cash outflow

C) Differential flows over the project's life

D) Terminal cash flow

Which of the following is NOT part of a project's initial cash outflow?

A) The asset's purchase price

B) Funds committed to support increased inventory levels due to expected increased sales if the firm adopts the project

C) A marketing survey completed last year to determine the project's feasibility

D) Expenses incurred to install the asset

Relevant incremental cash flows include

A) sales captured from the firm's competitors.

B) retained sales that would have been lost to new competing products.

C) incremental sales brought to the firm as a whole.

D) all of the above.

Which of the following is NOT considered in the calculation of incremental cash flows?

A) Depreciation tax shield

B) Sunk costs

C) Opportunity costs

D) Both A and B

Which of the following cash flows should be included as incremental costs when evaluating capital projects?

A) Investment in working capital that is directly related to a project

B) Expenses that are incurred in order to modify a firm's production facility in order to invest in a project

C) Opportunity costs that are directly related to a project

D) All of the above

Depreciation expenses affect tax-related cash flows by

A) increasing taxable income, thus increasing taxes.

B) decreasing taxable income, thus reducing taxes.

C) decreasing taxable income, but not altering cash flows since depreciation is not a cash expense.

D) all of the above.

Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which order

Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which order?

A) IRR, NPV, Payback, Discounted Payback, Profitability Index

B) Payback, Discounted Payback, Profitability Index, IRR, NPV

C) NPV, IRR, Profitability Index, Discounted Payback, Payback

D)  NPV, IRR, Payback, Discounted Payback, Profitability Index

Which of the following best explains the continuing popularity of the payback method?

A) Mathematical simplicity and some insight into the riskiness of cash flows.

B) Uses all cash flows and takes into account the time value of money.

C) Reliably selects the projects that add most value to the firm.

D) It provides objective selection criteria and is taught as the primary method in most business schools.

With respect to the capital budgeting practices of large U. S. corporations

A) the profitability index has been gaining in popularity.

B) IRR and NPV have been gaining in popularity.

C) payback and discounted payback have been gaining in popularity.

D) IRR and NPV have declined in popularity.

Which of the following techniques will always produce a single rate of return estimate?

A) IRR

B) MIRR

C) PI

D) Discounted payback

Which of the following techniques might be useful in situations where the economic life of a project is highly uncertain?

A) IRR

B) MIRR

C) PI

D) Discounted payback

Which of the following techniques might be useful in situations where mutually exclusive projects have unequal lives?

A) IRR

B) Equivalent annual cost (EAC).

C) PI

D) Discounted payback

When various capital budgeting techniques rank mutually exclusive projects differently, which of the following is theoretically most reliable?

A) IRR

B) Equivalent annual cost (EAC).

C) NPV

D) Discounted payback

Many firms today continue to use the payback method but employ the NPV or IRR methods as secondary decision methods of control for risk.

Answer:  FALSE

Currently, most firms use NPV and IRR as their primary capital-budgeting technique.

Answer:  TRUE

Most firms use the payback period as a secondary capital-budgeting technique, which in a sense allows them to control for risk.

Answer:  TRUE

Although discounted cash flow decision techniques have become widely accepted, their use depends to some degree on the size of the project and where within the firm the decision is being made.

Answer:  TRUE

Briefly describe the actual capital budgeting methods of large U.S. corporations.

Answer:  According to recent surveys of CFOs, the most common methods are IRR and NPV used by more than 70% of large corporations. The payback method remains popular and is used as a primary or secondary method by almost 60% of those surveyed, perhaps because of its simplicity and for a quick calculation of risk.

Tinker Tools, Inc. is considering a project with the following cash flows. Calculate the MIRR of the project

Tinker Tools, Inc. is considering a project with the following cash flows. Calculate the MIRR of the project assuming a reinvestment rate of 8%.

   Year                Cash Flows

       0                      ($70,000)

       1                      ($55,000)

       2                       $40,000

       3                       $60,000

       4                      $100,000

Answer: 

PV Cash Outflows

                Year 0 = -$70,000

                Year 1: Calculator Steps' → N=1, i=8, FV=-55,000, solve for PV = -$50,926

                PV Outflows = -$70,000 - $50,926 = -$120,926

FV of Cash Inflows

                N=2, i=8, PV=40000, PMT =0, solve for FV = $46,656

                N=1, i=8, PV=60000, PMT =0, solve for FV = $64,800

                FV of Inflows = $46,656 +$64,800 + $100,000 = $211,456

MIRR:  N=4, PV=-$120,926,FV= $211,456 solve for i=15%

Determine the IRR on the following projects:

a.     Initial outlay of $35,000 with an after-tax cash flow at the end of the year of $5,836 for seven years

b.     Initial outlay of $350,000 with an after-tax cash flow at the end of the year of $70,000 for seven years

c.     Initial outlay of $3,500 with an after-tax cash flow at the end of the year of $1,500 for three years

Answer: 

Using a financial calculator

a.     N=7, PV=-35,000, PMT=5,836, FV= 0, solve for i=4.02%

b.     N=7, PV=-350,000, PMT=70,000, solve for i=9.2%

c.     N=7, PV=-3,500, PMT=1,500, FV= 0, solve for i=13.7%

Discuss the merits and shortcomings of using the payback period for capital budgeting decisions.

Answer:  The payback period is intuitive and easily understood even by those with no training in finance. It also provides a quick assessment of a project's risk because cash flow forecasts are likely to be more accurate for the near-term.

On the other hand, there is no clear-cut decision rule associated with this method; it does not specifically take the time value of money into account, and it ignores cash flows that occur after the payback period.

Project November requires an initial investment of $500,000. The present value of operating cash flows is $550,000. Project December requires an initial investment of $750,000. The present value of operating cash flows is $810,000.

a. Compute the profitability index for each project.

b. If the projects are mutually exclusive, does the profitability index rank them correctly?

Answer: 

a. The PI for November is 550,000/500,000 = 1.1. The PI for December is 810,000/750,000 = 1.08.

b. The PI criterion would select project November because it has the higher PI. December, however, has the higher NPV ($60,000 v. $50,000) and should be selected, so the method does not rank the projects correctly.

Black Friday Inc. has estimated the following cash flows for a project it is considering:

Period	Cash Flow
0	($150,000)
1	$70,000
2	$80,000
3	($100,0000)

a. What is the payback period for this project?

b. What is the obvious problem with using the payback method in this case?

Answer:  The payback period is exactly 2 years (70,000+80,000) = 150,000. However, the project obviously has a negative NPV at any discount rate. One major problem with the payback method is that it ignores cash flows occurring after the payback period.

You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows

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 MIRR?

A) 12.62%

B) 10.44%

C) 16.73%

D) 19.99%

Dizzyland Enterprises has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. What is the profitability index for this investment?

A) 1.34

B) 0.87

C) 1.85

D) 0.21

We compute the profitability index of a capital-budgeting proposal by

A) multiplying the IRR by the cost of capital.

B) dividing the present value of the annual after-tax cash flows by the cost of capital.

C) dividing the present value of the annual after-tax cash flows by the cost of the project.

D) multiplying the cash inflow by the IRR.

What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?

A) 3 1/2

B) 4 1/2

C) 4 2/3

D) 5

The payback method focuses primarily on the length of time required to recover the cost of the investment rather than estimating the total value the project will add to the firm.

Answer:  TRUE

One advantage of the payback method is that it can be readily understood by people with no special training in finance.

Answer:  TRUE

When several sign reversals in the cash flow stream occur, the IRR equation can have more than one positive IRR.

Answer:  TRUE

If the project's internal rate of return is greater than or equal to zero, the project should always be accepted.

Answer:  FALSE

The profitability index provides the same accept/reject decision result as the net present value (NPV) method but would not necessarily rank mutually exclusive projects the same way.

Answer:  TRUE

The internal rate of return (IRR) will increase as the required rate of return of a project is increased.

Answer:  FALSE

The IRR assumes that cash flows are reinvested at the cost of capital.

Answer:  FALSE

If the NPV of a project is zero, then the profitability index should equal one.

Answer:  TRUE

Unlike the basic IRR method, the MIRR method allows the analyst to specify a reinvestment rate for positive cash flows.

Answer:  TRUE

According to the modified internal rate of return (MIRR) technique, when a project's MIRR is greater than its cost of capital, the project should be accepted.

Answer:  TRUE

The IRR is the discount rate that equates the present value of the project's future net cash flows with the project's initial outlay.

Answer:  TRUE

The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000

The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000; it is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14% and its tax rate is 40%, what is the project's IRR?

A) 8%

B) 14%

C) 18%

D) -5%

The owner of a small construction business has asked you to evaluate the purchase of a new front end loader. You have determined that this investment has a large, positive, NPV, but are afraid that your client will not understand the method. A good alternative method in this circumstance might be

A) the payback method.

B) the profitability index.

C) the internal rate of return.

D) the modified internal rate of return.

Whenever the IRR on a project equals that project's required rate of return

A) the NPV equals 0.

B) The NPV equals the initial investment.

C) The profitability index equals 0.

D) The NPV equals 1.

Aroma Candles, Inc. is evaluating a project with the following cash flows. Calculate the IRR of the project. (Round to the nearest whole percentage.)

Year    Cash Flows

0            ($120,000)

1              $30,000

2              $70,000

3              $90,000

A) 18%

B) 23%

C) 28%

D) 33%

Aroma Candles, Inc. is evaluating a project with the following cash flows. The project involves a new product that will not affect the sales of any other project. Which two methods would always lead to the same accept/reject decision for this project, regardless of the discount rate.

Year    Cash Flows

0            ($120,000)

1              $30,000

2              $70,000

3              $90,000

A) Payback and Discounted Payback

B) NPV and Payback

C) NPV and IRR

D) Discounted Payback and IRR

Which of the following is considered to be a deficiency of the IRR?

A) It fails to properly rank capital projects.

B) It could produce more than one rate of return.

C) It fails to utilize the time value of money.

D) It is not useful in accounting for risk in capital budgeting.