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Week 7

The document contains 12 multiple choice questions that assess capital budgeting concepts. Specifically, it tests understanding of: 1) incremental cash flows are easiest to identify for projects that do not affect current operations or fixed assets; 2) depreciation is incorporated in cash flows because it reduces tax liability; 3) relevant cash flows for capital budgeting include incremental cash flows, tax shields, and changes in net working capital and fixed assets. The questions provide scenarios to calculate project cash flows under different conditions in order to evaluate capital budgeting proposals.

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164 views

Week 7

The document contains 12 multiple choice questions that assess capital budgeting concepts. Specifically, it tests understanding of: 1) incremental cash flows are easiest to identify for projects that do not affect current operations or fixed assets; 2) depreciation is incorporated in cash flows because it reduces tax liability; 3) relevant cash flows for capital budgeting include incremental cash flows, tax shields, and changes in net working capital and fixed assets. The questions provide scenarios to calculate project cash flows under different conditions in order to evaluate capital budgeting proposals.

Uploaded by

yogeshgharpure
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Q1.

In a proper capital budgeting analysis, we calculate incremental:

A. Accounting income
B. Operating profit
C. Earnings
D. Cash flow

Q.2. Depreciation is incorporated in cash flows because it:

A. is unavoidable cost
B. is a cash flow
C. reduces tax liability
D. involves an outflow

Q.3. The incremental cash flows related to a capital investment project are easiest to identify when:

A. sunk costs exist


B. opportunity costs are significant
C. a proposed project has no effect on the current operations
D. the project has no impact on total fixed assets

Q.4. Which of the following describes relevant cash flows for the purpose of performing capital
budgeting analysis?

I. incremental cash flow

II. tax shield

III. changes in net working capital

IV. changes in fixed assets

A. I and III only


B. I, II, and III only
C. II, III, and IV only
D. I, II, III, and IV

Q.5. Given the following end-of-year cash flows, what is the present value of the second cash flow if
the discount rate is 6 percent?

Year Cash Flow (Rs.)

1 500

2 750

3 1,000

A. Rs. 471.70
B. Rs. 667.50
C. Rs. 707.55
D. Rs. 750.00
Q.6. In estimating "after tax incremental operating cash flows" for a project, you should include all of
the following except:

A. Changes in working capital resulting from the project, net of spontaneous changes in current
liabilities.
B. Effects of inflation.
C. Opportunity costs.
D. Sunk costs.

Q.7. Which of the following does not affect cash flows proposal?

A. Salvage value
B. Depreciation amount
C. Tax rate change
D. Method of project financing

Q.8. Evaluation of capital budgeting proposals is based on cash flows because:

A. Cash flows are easy to calculate


B. Cash flows are suggested by SEBI
C. Cash is more important than profit
D. None of the above.

Q.9. XYZ Pharmaceutical Company is considering the purchase of a DNA-testing equipment costing
Rs. 60,000. This equipment is expected to reduce labor costs of the clinical staff by Rs. 20,000
annually. The equipment has a useful life of five years but falls in the three-year property class for
cost recovery (depreciation) purposes. No salvage value is expected at the end. The corporate tax
rate for is 38 percent, and its required rate of return is 15 percent. (If profits after taxes on the
project are negative in any year, the firm will offset the loss against other firm income for that year.)
On the basis of this information, what are the relevant cash flows for the fourth and fifth years?

A. Rs. 14,089 and Rs. 12,400 respectively


B. Rs. 22,535 and Rs. 15,777 respectively
C. Rs. 17,065 and Rs. 15, 554 respectively
D. Rs. 19,999 and Rs. 12, 600 respectively

Q.10. Suppose, in the above question, 6 percent inflation in savings from labor costs is expected over
the last four years, so that savings in the first year are Rs. 20,000, savings in the second year are Rs.
21,200, and so forth. On the basis of this information, what are the relevant cash flows for the fourth
and fifth years?

A. Rs. 19,999 and Rs. 23,279 respectively


B. Rs. 16,458 and Rs. 15,655 respectively
C. Rs. 17,309 and Rs. 23,279 respectively
D. Rs. 16,236 and Rs. 18, 569 respectively
Q.11. In question 10, if working capital of Rs. 10,000 were required in addition to the cost of the
equipment and this additional investment were needed over the life of the project, what would be
the terminal cash flow, all other things remaining the same?

A. Rs. 23,000
B. Rs. 20,000
C. Rs. 25,000
D. Rs. 23279

Q.12. The managers of Insomniac, Inc. plan to manufacture engine blocks for classic cars from the
1960s. They expect to sell 250 blocks annually for the next 5 years. The necessary foundry and
machining equipment will cost a total of Rs. 800,000 and will be depreciated on a straight-line basis
to zero over the project's life. The firm expects to be able to sell the equipment for Rs. 150,000 at
the end of 5 years. Labor and materials costs total Rs. 500 per engine block, fixed costs are Rs.
125,000 per year. Assume a 35 percent tax rate and a 12 percent discount rate. What is the expected
after-tax cash flow to the firm when the equipment is sold in year five?

A. Rs. 65,000
B. Rs. 97,500
C. Rs. 100,000
D. Rs. 115,000

ANSWERS

Q.1 Q.2 Q.3 Q.4 Q.5 Q.6 Q.7 Q.8 Q.9 Q.10 Q.11 Q.12
D C C D B B D C A B C B

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