1)

1

________ is the process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization.

2

1)

3

_______ A)

4

Ratio analysis

5

B)

6

Restructuring debt C)

7

Capital budgeting

8

D)

9

Recapitalizing assets

2)

10

Fixed assets that provide the basis for the firm's profit and value are often called

11

2)

12

_______ A)

13

book assets.

14

B)

15

tangible assets. C)

16

earning assets.

17

D)

18

non-current assets.

3)

19

The final step in the capital budgeting process is

20

3)

21

_______ A)

22

implementation.

23

B)

24

re-evaluation. C)

25

follow-up.

26

D)

27

education.

4)

28

A firm with limited dollars available for capital expenditures is subject to

29

4)

30

_______ A)

31

capital rationing.

32

B)

33

mutually exclusive projects. C)

34

working capital constraints.

35

D)

36

capital dependency.

5)

37

A non-conventional cash flow pattern associated with capital investment projects consists of an initial

38

5)

39

_______ A)

40

outflow followed by a series of both cash inflows and outflows. B)

41

inflow followed by a series of outflows. C)

42

outflow followed by a series of inflows. D)

43

inflow followed by a series of both cash inflows and outflows.

6)

44

The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criteria is called

45

6)

46

_______ A)

47

the accept-reject approach.

48

B)

49

the ranking approach. C)

50

an independent investment.

51

D)

52

a mutually exclusive investment.

Table 10.1

7)

53

The cash flow pattern depicted is associated with a capital investment and may be characterized as ________. (See Table 10.1)

54

7)

55

_______ A)

56

an annuity and non-conventional cash flow B)

57

a mixed stream and conventional cash flow C)

58

an annuity and conventional cash flow D)

59

a mixed stream and non-conventional cash flow

8)

60

Which of the following capital budgeting techniques ignores the time value of money?

61

8)

62

_______ A)

63

Internal rate of return.

64

B)

65

Payback. C)

66

Net present value.

67

D)

68

Two of the above.

9)

69

The ________ measures the amount of time it takes the firm to recover its initial investment.

70

9)

71

_______ A)

72

average rate of return

73

B)

74

payback period C)

75

internal rate of return

76

D)

77

net present value

10)

78

All of the following are weaknesses of the payback period EXCEPT

79

10)

80

______ A)

81

a disregard for cash flows after the payback period. B)

82

it uses cash flows, not accounting profits. C)

83

the difficulty of specifying the appropriate payback period. D)

84

only an implicit consideration of the timing of cash flows.

11)

85

Many firms use the payback method as a guideline in capital investment decisions. Reasons they do so include all of the following EXCEPT

86

11)

87

______ A)

88

it is easy to calculate. B)

89

it is a measure of risk exposure. C)

90

it gives an implicit consideration to the timing of cash flows. D)

91

it recognizes cash flows which occur after the payback period.

12)

92

Payback is considered an unsophisticated capital budgeting because it

93

12)

94

______ A)

95

gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate. B)

96

gives explicit consideration to the timing of cash flows and therefore the time value of money. C)

97

gives explicit consideration to the timing of cash flows and therefore the time value of money. D)

98

none of the above.

13)

99

Which of the following statements is false?

100

13)

101

______ A)

102

If the payback period is less than the maximum acceptable payback period, reject the project B)

103

If the payback period is less than the maximum acceptable payback period, accept the project. C)

104

If the payback period is greater than the maximum acceptable payback period, reject the project. D)

105

Two of the above.

14)

106

Evaluate the following projects using the payback method assuming a rule of 3 years for payback.

Year Project A Project B0 -10,000 -10,0001 4,000 4,0002 4,000 3,0003 4,000 2,0004 0 1,000,000

107

14)

108

______ A)

109

Project A can be accepted because the payback period is 2.5 years but Project B can not be accepted because it's payback period is longer than 3 years.

B)

110

Both projects can be accepted because the payback is less than 3 years. C)

111

Project B should be accepted because even thought the payback period is 2.5 years for project A and 3.001 project B, there is a $1,000,000 payoff in the 4th year in Project B.

D)

112

Project B should be accepted because you get more money paid back in the long run.

15)

113

A firm is evaluating three capital projects. The net present values for the projects are as follows:

The firm should

114

15)

115

______ A)

116

accept Project 1 and reject Projects 2 and 3. B)

117

reject all projects. C)

118

accept Projects 1 and 2 and reject Project 3. D)

119

accept Projects 1 and 3 and reject Project 2.

16)

120

What is the NPV for the following project if its cost of capital is 12 percent and its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and ($1,300,000) in year 4?

121

16)

122

______ A)

123

$158,011

124

B)

125

$(1,494,336) C)

126

$1,494,336

127

D)

128

Two of the above

17)

129

Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project B also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?

130

17)

131

______ A)

132

Project Y.

133

B)

134

Project X. C)

135

Neither.

136

D)

137

Not enough information to tell.

18)

138

A firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows:

The firm should

139

18)

140

______ A)

141

accept Project 1 and reject Projects 2 and 3. B)

142

accept Project 2 and reject Projects 1 and 3. C)

143

accept Project 3 and reject Projects 1 and 2. D)

144

accept Projects 2 and 3 and reject Project 1.

Table 10.4

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent.

19)

145

Using the internal rate of return approach to ranking projects, which projects should the firm accept? (See Table 10.4)

146

19)

147

______ A)

148

1, 2, 3, and 5

149

B)

150

2, 3, 4, and 6

151

C)

152

1, 2, 3, 4, and 5

153

D)

154

1, 3, 4, and 6

20)

155

In comparing the internal rate of return and net present value methods of evaluation,

156

20)

157

______ A)

158

net present value is theoretically superior, but financial managers prefer to use internal rate of return. B)

159

financial managers prefer net present value, because it is presented as a rate of return. C)

160

internal rate of return is theoretically superior, but financial managers prefer net present value. D)

161

financial managers prefer net present value, because it measures benefits relative to the amount invested.

21)

162

Unlike the net present value criteria, the internal rate of return approach assumes an interest rate equal to

163

21)

164

______ A)

165

the project's opportunity cost.

166

B)

167

the relevant cost of capital. C)

168

the market's interest rate.

169

D)

170

the project's internal rate of return.

22)

171

When evaluating projects using internal rate of return,

172

22)

173

______ A)

174

projects having higher early-year cash flows tend to be preferred at lower discount rates. B)

175

projects having lower early-year cash flows tend to be preferred at higher discount rates. C)

176

projects having higher early-year cash flows tend to be preferred at higher discount rates. D)

177

the discount rate and magnitude of cash flows do not affect internal rate of return.

23)

178

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as

179

23)

180

______ A)

181

necessary cash flows.

182

B)

183

ordinary cash flows. C)

184

consistent cash flows.

185

D)

186

relevant cash flows.

24)

187

Relevant cash flows for a project are best described as

188

24)

189

______ A)

190

incidental cash flows.

191

B)

192

incremental cash flows. C)

193

accounting cash flows.

194

D)

195

sunk cash flows.

25)

196

Cash flows that could be realized from the best alternative use of an owned asset are called

197

25)

198

______ A)

199

opportunity costs.

200

B)

201

incremental costs. C)

202

sunk costs.

203

D)

204

lost resale opportunities.

26)

205

The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT

206

26)

207

______ A)

208

cost of the new asset. B)

209

taxes on the sale of an existing asset. C)

210

proceeds from the sale of the existing asset. D)

211

incremental annual savings produced by the new asset.

27)

212

A corporation is considering expanding operations to meet growing demand. With the capital expansion the current accounts are expected to change. Management expects cash to increase by $10,000, accounts receivable by $20,000, and inventories by $30,000. At the same time accounts payable will increase by $40,000, accruals by $30,000, and long-term debt by $80,000. The change in net working capital is

213

27)

214

______ A)

215

a decrease of $90,000.

216

B)

217

an increase of $80,000. C)

218

an increase of $10,000.

219

D)

220

a decrease of $10,000.

28)

221

A corporation is selling an existing asset for $1,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period, and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is

222

28)

223

______ A)

224

$0 tax liability.

225

B)

226

$280 tax benefit. C)

227

$3,600 tax liability.

228

D)

229

$1,100 tax liability.

29)

230

The portion of an asset's sale price that is below its book value and below its initial purchase price is called

231

29)

232

______ A)

233

recaptured depreciation.

234

B)

235

a capital loss. C)

236

book value.

237

D)

238

a capital gain.

Table 11.3

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.

30)

239

The cash flow pattern for the capital investment proposal is ________. (See Table 11.3)

240

30)

241

______ A)

242

a mixed stream and conventional

243

B)

244

an annuity and non-conventional C)

245

an annuity and conventional

246

D)

247

a mixed stream and non-conventional

31)

248

The tax effect on the sale of the existing asset results in ________. (See Table 11.3)

249

31)

250

______ A) B)

251

$6,000 tax liability $1,000 tax liability

252

C)

253

$1,100 tax liability D) $800 tax benefit

32)

254

A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $2,000. The machine has an original purchase price of $80,000, installation cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is

255

32)

256

______ A)

257

$5,800.

258

B)

259

$6,200.

260

C)

261

$8,200.

262

D)

263

$7,800.

33)

264

In a capital budgeting context, risk refers to

265

33)

266

______ A)

267

the chance that a project will prove unacceptable. B)

268

the degree of variability of cash flows. C)

269

neither A nor B is correct. D)

270

both A and B are correct.

34)

271

Behavioral approaches for dealing with project risk

272

34)

273

______ A)

274

are used both to get a feel for project risk and also explicitly recognize project risk. B)

275

are used to get a feel for project risk. C)

276

explicitly recognize project risk. D)

277

none of the above.

35)

278

One type of simulation program made popular by the widespread use of personal computers is called

279

35)

280

______ A)

281

Monte Carlo Simulation.

282

B)

283

Monaco Simulation. C)

284

Cannes Simulation.

285

D)

286

Lemans Simulation.

36)

287

In international capital budgeting decisions, political risks can be minimized using all of the following strategies EXCEPT

288

36)

289

______ A)

290

structuring the financing of such investments as equity rather than as debt. B)

291

structuring the financing of such investments as debt rather than as equity. C)

292

structuring the investment as a joint venture and selecting well-connected local partner. D)

293

none of the above.

37)

294

The amount by which the required discount rate exceeds the risk-free rate is called

295

37)

296

______ A)

297

the opportunity cost.

298

B)

299

the excess risk. C)

300

the risk equivalent.

301

D)

302

the risk premium.

38)

303

The ________ reflects the return that must be earned on the given project to compensate the firm's owners adequately according to the project's variability of cash flows.

304

38)

305

______ A)

306

cost of capital

307

B)

308

internal rate of return C)

309

risk-adjusted discount rate

310

D)

311

average rate of return

Table 12.2

A firm is considering investment in a capital project which is described below. The firm's cost of capital is 18 percent and the risk-free rate is 6 percent. The project has a risk index of 1.5. The firm uses the following equation to determine the risk adjusted discount rate, RADR, for each project: RADR = Rf + Risk Index (Cost of capital - Rf)

39)

312

The discount rate that should be used in the net present value calculation to compensate for risk is ________. (See Table 12.2)

313

39)

314

______ A)

315

18 percent

316

B)

317

15 percent

318

C)

319

24 percent

320

D)

321

6 percent

40)

322

It has been found that the value of the stock of corporations whose shares are traded publicly in an efficient marketplace is

323

40)

324

______ A)

325

generally negatively affected by diversification, because of the increase in risk. B)

326

generally positively affected by diversification, because of the reduction in risk. C)

327

generally negatively affected by diversification, because of the increase in the required rate of return. D)

328

generally not affected by diversification, unless greater returns are expected.

41)

329

The ________ approach is used to convert the net present value of unequal-lived projects into an equivalent annual amount (in net present value terms).

330

41)

331

______ A)

332

investment opportunities schedule

333

B)

334

annualized net present value C)

335

internal rate of return

336

D)

337

risk-adjusted discount rate

Table 12.6Yong Importers, an Asian import company, is evaluating two mutually exclusive projects, A and B. The relevant cash flows for each project are given in the table below. The cost of capital for use in evaluating each of these equally risky projects is 10 percent.

42)

338

The Annualized NPV of project B is ________. (See Table 12.6)

339

42)

340

______ A)

341

$12,947

342

B)

343

$21,828

344

C)

345

$11,673

346

D)

347

$38,227

43)

348

Which project should be chosen using the Annualized NPV approach? (See Table 12.6)

349

43)

350

______ A)

351

Project A

352

B)

353

Project B

354

C)

355

neither

356

D)

357

both

44)

358

Major types of real options include all of the following EXCEPT the

359

44)

360

______ A)

361

conversion option.

362

B)

363

timing option. C)

364

abandonment option.

365

D)

366

growth option.

45)

367

If a firm's fixed operating costs decrease, the firm's operating breakeven point will

368

45)

369

______ A)

370

change in an undetermined direction.

371

B)

372

increase. C)

373

decrease.

374

D)

375

remain unchanged.

46)

376

If a firm's variable costs per unit increase, the firm's operating breakeven point will

377

46)

378

______ A)

379

remain unchanged.

380

B)

381

change in an undetermined direction. C)

382

increase.

383

D)

384

decrease.

47)

385

A major assumption of breakeven analysis and one which causes severe limitations in its use is that

386

47)

387

______ A)

388

fixed costs really are fixed.

389

B)

390

revenues and operating costs are linear. C)

391

total revenue is nonlinear.

392

D)

393

all costs are really semi-variable.

48)

394

Mark must buy four new tires for his car. He is considering buying tires that are $25 a piece more than his regular brand, because the higher priced tires are supposed to increase his miles per gallon by 20%. If the tires are good for 48,000 miles and Mark drives an average of 1000 miles per month, gas costs $2.50 per gallon over the next 4 years, and Mark's car gets 30 miles to the gallon now (on the old tires), should Mark purchase the more expensive tires?

395

48)

396

______ A)

397

Yes, because Mark will save about $660 dollars in gas over the four years but the new tires will only be $100 more.

B)

398

There is not enough information given in the problem to make the decision. C)

399

No, because Mark will only save about $60 dollars in gas over the four years but the new tires will only be $100 more.

D)

400

Yes, because Mark will save about $560 dollars in gas over the four years but the new tires will only be $100 more.

401

49)

402

The payment of cash dividends to corporate stockholders is decided by the

403

49)

404

______ A)

405

stockholders.

406

B)

407

management. C)

408

board of directors.

409

D)

410

SEC.

50)

411

The purpose of a reverse stock split is to

412

50)

413

______ A)

414

reduce trading activity.

415

B)

416

issue additional shares. C)

417

increase the price of stock.

418

D)

419

increase the dividend.

420

421