1 (true or false) Whenever the IRR on a project equals that project’s required rate of return, the NPV equals zero.
2 If the NPV of a project is positive, then the project’s IRR ____________ the required rate of return.
a. must be less than
b. must be greater than
c. could be greater or less than
d. cannot be determined without actual cash flows
3 Which of the following capital-budgeting techniques assume the same reinvestment rate of cash flows?
d. Both a & b
e. All of the above
4 Payback period:
a. ignores the time value of money.
b. deals with cash flows rather than accounting profits.
c. measures how quickly the project will return its original investment.
d. does all of the above.
5 As the cost of capital is increased, the:
6 Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%.
a. NPV = -$30,000 + $20,000(1.10)1 + $20,000(1.10)2 + $20,000(1.10)3
b. NPV = -$30,000 + $20,000(1.10)-1 + $20,000(1.10)-2 + $20,000(1.10)-3
c. NPV = -$30,000 + $20,000/(1.01).10 + $20,000/(1.02).10 + $20,000/(1.03).10
d. NPV = -$30,000 + $20,000/(1.1).10+ $20,000(1.2).10 + $20,000(1.3).10
7 Why does the NPV method of evaluating an investment proposal require that the cash inflows of a project be discounted to the present?
a. It is the only way to arrive at the correct amount to divide into the cost in order to determine the rate of return.
b. The IRS requires it.
c. This enables the analyst to determine the amount of the investment outlay.
d. It provides a measurement of the value of an investment proposal in terms of today’s dollars.
8 Kannan Enterprise has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. The terminal cash flow of the project is $10,000. Assuming a discount rate of 10%, which of the following is the correct equation to solve for the IRR of the project?
a. $40,000 = $35,000(1.12)1 + $35,000(1.12)2 + $45,000(1.12)3
b. $40,000 = $35,000(1 + IRR)1 + $35,000(1+IRR)2 + $45,000(1+IRR)3
c. $40,000 = $35,000/(1.12)IRR + $35,000/(1.12)IRR + $45,000/(1.12)IRR
d. $40,000 = $35,000(1+IRR)-1 + $35,000(1.IRR)-2 + $45,000(1+IRR)-3
9 Mayhem Mines, Inc. is analyzing a project that requires an initial investment of $50,000, followed by cash inflows of $15,000 in Year 1, $60,000 in Year 2, and $75,000 in Year 3. The cost of capital is 10%. Calculate the profitability index of the project.
10 Mayhem Mines, Inc. is analyzing a project that has a profitability index of 2.5. Given the following cash flows for the project, calculate the present value of inflows for the project.
Year Cash Flow
11 So long as money has a time value, the discounted payback will always be greater than the:
12 (true or false) The capital rationing problem can be correctly solved by ranking projects according to the profitability index.
13 (true or false) Working capital for a project includes investment in fixed assets.
14 (true or false) If the firm decides to impose a capital constraint on investment projects, the appropriate decision criterion is to select the set of projects that has the highest net present value subject to the capital constraint.
15 (true or false) Sales captured from the firm’s competitors can be relevant to the capital-budgeting decision.
16 (true or false) NPV and IRR can provide ranking inconsistencies when projects have unequal lives.
Use the following information to answer questions 17-19. Delta Inc. is considering the purchase of a new machine which is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually. Due to the sales increase, Delta expects its working capital to increase $1,000 during the life of the project. Delta will depreciate the machine using the straight-line method over the project’s four year life to a salvage value of zero. The machine’s purchase price is $20,000, and installation fee is $1,000. The firm has a marginal tax rate of 34 percent, and its required rate of return is 12 percent.
17 The machine’s initial cash outflow is:
18 The machine’s incremental after-tax cash inflow is:
19 The machine’s after-tax incremental cash flow in year four is:
20 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.
e. none of the above.
21 When determining the initial cash outlay of an asset that is being replaced, which of the following should be included?
a. Interest expense that is directly related to the financing of a project
b. The pre-tax sales proceeds of the asset being sold
c. Market study expenses that were incurred in order to decide if the firm should accept a project
d. Principal payments that are directly related to the financing of a project
e. The sales proceeds of the asset being sold, net of any income taxes related to the sale
22 Which of the following should be considered in the estimation of termination cash flows?
a. Cash generated from the sale of a project
b. Recovery of net working capital
c. Income taxes associated with the sale of a project
d. All of the above
23 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. Land and building expenses
c. Changes in net working capital requirements
d. Shipping and installation costs
e. All of the above should be included.
24 (true or false) No adjustment is made in the cost of preferred stock for taxes since preferred stock dividends are not tax-deductible.
25 The investor’s required rate of return differs from the firm’s cost of capital due to the:
a. firm’s beta.
b. tax deductibility of interest.
d. time value of money.
26 Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. Bender will have to pay $33 per bond in flotation costs. What is the after tax cost of debt if the firm is in the 34% tax bracket?
27 The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of retained earnings if the long-term growth in dividends is projected to be 8%?
28 (true or false) As the tax rate increases, the weighted average cost of capital decreases.
29 (true or false) Using a firm’s overall cost of capital to evaluate divisional projects can lead to the rejection of good investments in low-risk divisions and the acceptance of poor projects in high-risk divisions.
30 (true or false) The data a firm used to calculate its cost of capital is appropriate for varying levels of debt and equity in the firm’s capital structure.
31 (true or false) The cost of capital for common stock is higher than that for bond and preferred stock.
32 Which of the following is considered a problem in using the dividend-growth model to estimate the cost of equity?
a. Estimating the expected growth rate of future dividends
b. Determining the expectations of the minds of the investors
e. All of the above are correct
Use the following information to answer questions 33-35. Sigma Corp. has a target financing mix of 30% debt and 70% common equity. The before-tax cost of Sigma’s debt is 10%. Sigma estimates its cost of internal equity at 14% and its cost of new common equity at 17%. Sigma’s marginal tax rate is 34%, and it expects to have $2,100,000 of profit available for reinvestment in the firm.
33 If Sigma can meet all of its financing needs with debt and internally generated equity, then Sigma’s weighted cost of capital is:
34 What is the total dollar amount of new investment that Sigma can support without issuing new common equity?
35 If Sigma cannot meet all of its financing needs with debt and internally generated equity, then Sigma’s weighted cost of capital is: