Chapter 10 Finance Test 3

34) ________ is the process of evaluating and selecting long-term investments that are consistent with a firm’s goal of maximizing owners’ wealth.A) Recapitalizing assetsB) Capital budgetingC) Ratio analysisD) Securitization B
35) A $60,000 outlay for a new machine with a usable life of 15 years is called ________.A) capital expenditureB) financing expenditureC) replacement expenditureD) operating expenditure A
36) Fixed assets that provide the basis for a firm’s earning and value are often called ________.A) tangible assetsB) noncurrent assetsC) earning assetsD) book assets C
37) Which of the following is true of a capital expenditure?A) It is an outlay made to replace current assets.B) It is an outlay expected to produce benefits within one year.C) It is commonly used for current asset expansion.D) It is commonly used to expand the level of operations. D
38) The basic motive for capital expenditure is to ________.A) expand operationsB) replace current assetsC) renew current assetsD) improve leverage A
39) One of the primary motives for adding fixed assets to a firm is ________.A) expansionB) replacementC) renewalD) transformation A
40) The final step in the capital budgeting process is ________.A) implementationB) follow-upC) review and analysisD) decision making B
41) The first step in the capital budgeting process is ________.A) review and analysisB) implementationC) decision makingD) proposal generation D
42) Which of the following steps in the capital budgeting process follows the decision making step?A) proposal generationB) review and analysisC) transformationD) implementation D
43) ________ projects do not compete with each other: the acceptance of one ________ the others from consideration.A) Capital: eliminatesB) Independent: does not eliminateC) Mutually exclusive: eliminatesD) Replacement: eliminates B
44) ________ projects have the same function: the acceptance of one ________ the others from consideration.A) Capital: eliminatesB) Independent: does not eliminateC) Mutually exclusive: eliminatesD) Replacement: eliminates C
45) A firm with limited dollars available for capital expenditures is subject to ________.A) capital dependencyB) capital gainsC) working capital constraintsD) capital rationing D
46) Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called ________.A) independent projectsB) mutually exclusive projectsC) replacement projectsD) capital projects B
47) Which of the following is true of the accept-reject approach?A) It involves ranking projects on the basis of some predetermined measure, such as the rate of return.B) It cannot be used when the firm has limited funds.C) It can be used for making capital budgeting decisions when there is capital rationing.D) It can be used only for evaluating mutually exclusive projects. C
48) A conventional cash flow pattern associated with capital investment projects consists of an initial ________.A) outflow followed by a broken cash seriesB) inflow followed by a broken series of outlayC) outflow followed by a series of inflowsD) outflow followed by a series of outflows C
49) A nonconventional cash flow pattern associated with capital investment projects consists of an initial ________.A) outflow followed by a series of both cash inflows and outflowsB) inflow followed by a series of both cash inflows and outflowsC) outflow followed by a series of inflowsD) inflow followed by a series of outflows A
50) Which of the following is an example of a nonconventional pattern of cash flows?A) Year 0 1 2 3 4cash flow -200 150 310 265 200B) Year 0 1 2 3 4cash flow 200 100 -100 200 -300C) Year 0 1 2 3 4cash flow -200 100 100 200 300D) Year 0 1 2 3 4cash flow -200 150 150 150 150
18) Which of the following is an unsophisticated capital budgeting technique?A) internal rate of returnB) payback periodC) profitability indexD) net present value B
19) Which of the following capital budgeting techniques ignores the time value of money?A) payback period approachB) net present valueC) internal rate of returnD) profitability index A
20) The ________ measures the amount of time it takes a firm to recover its initial investment.A) profitability indexB) internal rate of returnC) net present valueD) payback period D
21) An annuity is ________.A) a mix of cash flows in conventional and nonconventionalB) a stream of perpetual cash flows C) a series of constantly growing cash flowsD) a series of equal annual cash flows D
22) Which pattern of cash flow stream is the most difficult to use when evaluating projects?A) mixed streamB) conventional flowC) nonconventional flowD) annuity C
25) Payback is considered an unsophisticated capital budgeting because it ________.A) gives explicit consideration to the timing of cash flows and therefore the time value of moneyB) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rateC) does not gives explicit consideration on the recovery of initial investment and possibility of a calamityD) it does not explicitly consider the time value of money D
26) A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is ________.A) 1 yearB) 2 yearsC) between 1 and 2 yearsD) between 2 and 3 years D
27) A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. The payback period of the project is ________.A) 1.5 yearsB) 2 yearsC) 3.3 yearsD) 4 years C
28) Which of the following statements is true of payback period?A) If the payback period is less than the maximum acceptable payback period, management should be indifferent.B) If the payback period is greater than the maximum acceptable payback period, accept the project.C) If the payback period is less than the maximum acceptable payback period, accept the project.D) If the payback period is greater than the maximum acceptable payback period, management should be indifferent. C
29) What is the payback period for Tangshan Mining company’s new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?A) 4.33 yearsB) 3.33 yearsC) 2.33 yearsD) 1.33 years B
30) Should Tangshan Mining company accept a new project if its maximum payback is 3.5 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?A) Yes, since the payback period of the project is less than the maximum acceptable payback period.B) No, since the payback period of the project is more than the maximum acceptable payback period.C) Yes, since the risk exposure of the project is less than the maximum acceptable risk exposure.D) No, since the risk exposure of the project is more than the maximum acceptable risk exposure. A
31) Should Tangshan Mining company accept a new project if its maximum payback is 3.25 years and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3, and $1,800,000 in year 4?A) Yes, since the payback period of the project is less than the maximum acceptable payback period.B) No, since the payback period of the project is more than the maximum acceptable payback period.C) Yes, since the risk exposure of the project is less than the maximum acceptable risk exposure.D) No, since the risk exposure of the project is more than the maximum acceptable risk exposure. B
32) 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 1,000,000A) Project A can be accepted because the payback period is 2.5 years but Project B cannot be accepted because it’s payback period is longer than 3 years.B) Project B should be accepted because even though the payback period is 2.5 years for Project A and 3.001 for project B, there is a $1,000,000 payoff in the 4th year in Project B.C) Project B should be accepted because you get more money paid back in the long run.D) Both projects can be accepted because the payback is less than 3 years. A
33) Which of the following is a disadvantage of payback period approach?A) It does not examine the size of the initial outlay.B) It does not use net profits as a measure of return.C) It does not explicitly consider the time value of money.D) It does not take into account an unconventional cash flow pattern. C
34) Which of the following is a strength of payback period?A) a disregard for cash flows after the payback periodB) only an implicit consideration of the timing of cash flowsC) merely a subjectively determined numberD) a measure of risk exposure D
35) Which of the following is a reason for firms not using the payback method as a guideline in capital investment decisions?A) It gives an explicit consideration to the timing of cash flows.B) It cannot be specified in light of the wealth maximization goal.C) It is a measure of risk exposure and projects the possibility of a calamity.D) It is easy to calculate and has intuitive appeal. B
36) Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because ________.A) it explicitly considers the time value of moneyB) it can be viewed as a measure of risk exposure due to its focus on liquidityC) the determination of the required payback period is an objectively determined criteriaD) it considers the timing of cash flows and therefore the time value of money B
15) Which of the following is an advantage of NPV?A) It measures the risk exposure.B) It takes into account the time value of investors’ money.C) It is highly sensitive to the discount rates.D) It measures how quickly a firm can breakeven. B
16) The minimum return that must be earned on a project in order to leave the firm’s value unchanged is ________.A) the internal rate of returnB) the interest rateC) the cost of capitalD) the compound rate C
17) A firm can accept a project with a net present value of zero because ________.A) the project would maintain the wealth of the firm’s ownersB) the project would enhance the wealth of the firm’s ownersC) the project would maintain the earnings of the firmD) the project would enhance the earnings of the firm A
18) A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000. The net present value of the investment is ________.A) -$1,000B) $9,000C) $4,000D) -$4,000 A
19) What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is $5,000,000 and is expected to provide after-tax operating cash inflows 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?A) $1,700,000B) $371,764C) -$137,053D) -$4,862,947 C
20) What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows 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?A) $1,700,000B) $371,764C) $137,053D) $6,700,000 A
21) What is the NPV for a 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?A) -$1,494,336B) $158,011C) -$158,011D) $3,505,664 A
22) A firm is evaluating three capital projects. The net present values for the projects are as follows:Proj. NPV1 100 2 103 -100 The firm should ________.A) accept Projects 1 and 2, and reject Project 3B) accept Projects 1 and 3, and reject Project 2C) accept Project 3, and reject Projects 1 and 2D) accept all projects A
23) What is the profitability index of a project that has an initial cash outflow of $600, an inflow of $250 for the next 3 years and a cost of capital of 10 percent?A) 0.667B) 2.036C) 1.036D) 2.739 C
Table 10.1Operating Cash inflows$1000 $1000 $1000 $1000 $1000——————————————-$2500Initial Outlay24) Given the information in Table 10.1 and 15 percent cost of capital,(a) compute the net present value.(b) should the project be accepted? (a) NPV = (1,000 / 0.15) x [1 – 1 / (1.15)5] – 2,500 = 1,000 × (3.352) – 2,500 = $852(b) Since NPV > 0, the project should be accepted. Table 10.2$25000 $10000 $50000 $10000 $10000 $60000———————————————————-$100000Initial Outlay25) Given the information in Table 10.2 and 15 percent cost of capital,(a) compute the net present value.(b) should the project be accepted?Answer: (a)Year (t) CF (1+.15)^-t PV1 25000 .870 217502 10000 .756 75603 50000 .658 329004 10000 .572 57205 10000 .497 49706 60000 .432 25920 98820NPV = $98,820 – $100,000 = -$1,180 < 0(b) Since NPV < 0, the project should be rejected.
10) What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows 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?A) 15.57%B) 0.00%C) 13.57%D) 12.25% C
11) What is the IRR for the following project if 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, $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?A) 5.83%B) 9.67%C) 11.44%D) 6.85% A
7) 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 Y 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 10 percent?A) Project X, since it has a higher NPV than Project YB) Project Y, since it has a higher NPV than Project XC) Project X, since it has a lower NPV than Project YD) Project Y, since it has a lower NPV than Project X A
8) 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 Y 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?A) Project X, since it has a higher NPV than Project YB) Project Y, since it has a higher NPV than Project XC) neither, since both the projects have negative NPVD) neither, since both the projects have positive NPV C
9) Which of the following is true of NPV profile?A) It is used for evaluating and comparing independent projects when conflicting ranking exists.B) It is a graph that illustrates a project’s IRR against various values of NPV.C) It shows an inverse relationship between a project’s IRR and NPV.D) It charts the net present value of a project as a function of the cost of capital. D
16) The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.A) payback periodB) net present valueC) cost of capitalD) internal rate of return D
17) The ________ is the compound annual rate of return that a firm will earn if it invests in the project and receives the given cash inflows.A) risk-free rateB) internal rate of returnC) opportunity costD) cost of capital B
18) A firm with a cost of capital of 13 percent is evaluating three capital projects. The internal rates of return are as follows:Project IRR1 12%2 153 13The firm should ________.A) accept Project 1 and 2, and reject Project 3B) accept Project 2, and reject Projects 1 and 3C) accept Project 1, and reject Projects 2 and 3D) accept Project 3, and reject Projects 1 and 2 B
23) When the net present value is negative, the internal rate of return is ________ the cost of capital.A) greater thanB) greater than or equal toC) less thanD) equal to C
24) A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. Project Z has an initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should ________.A) accept both the projects because they have equal IRRB) accept Project Y because its IRR is higher than Project ZC) accept Project Z because its IRR is higher than Project XD) reject both the projects because they have negative IRR B
25) Comparing net present value and internal rate of return ________.A) always results in the same ranking of projectsB) always results in the same accept-reject decisionC) may give different accept-reject decisionsD) is only necessary on independent projects C
26) Unlike the net present value criteria, the internal rate of return approach assumes a reinvestment rate equal to ________.A) the relevant cost of capitalB) the project’s internal rate of returnC) the project’s opportunity costD) the market’s interest rate B
27) When evaluating projects using NPV approach, ________.A) projects having lower early-year cash flows tend to be preferred at higher discount ratesB) projects having higher early-year cash flows tend to be preferred at higher discount ratesC) projects having higher early-year cash flows tend to be preferred at lower discount ratesD) the discount rate and magnitude of cash flows do not affect the ranking by NPV approach B
28) Which capital budgeting method is most useful for evaluating a project that has an initial after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of $1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?A) net present valueB) internal rate of returnC) paybackD) accounting rate of return A
29) The underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is ________.A) the reinvestment rate assumption regarding intermediate cash flowsB) that neither method explicitly considers the time value of moneyC) the assumption made by the IRR method that cash inflows are spread equally throughout the timelineD) that NPV approach favors small projects with high returns A
30) Which of the following is a reason that makes NPV a better approach to capital budgeting on a purely theoretical basis?A) It measures the benefits relative to the relative amount invested.B) The reinvestment rate assumed by this method is reasonable.C) Financial decision makers are inclined to higher rates of return.D) Interest rates are expressed as annual rates of return. B
31) In comparing the internal rate of return and net present value methods of evaluation, ________.A) internal rate of return is theoretically superior, but financial managers prefer net present valueB) net present value is theoretically superior, but financial managers prefer to use internal rate of returnC) financial managers prefer net present value, because it is presented as a rate of returnD) financial managers prefer net present value, because it measures benefits relative to the amount invested B

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