Chapter 12 The Capital Budgeting Decision

1. Capital budgeting decisions involve a minimum time horizo of five years.

True False

2. A good capital budgeting program requires that a number of steps be taken in the decision making
process. The first step is the explanation of data.

True False

3. Possibly the most overlooked part of the capital budgeting process is the search for new opportunities
through innovation and creative thinking.

True False

4. In most capital budgeting decisions the emphasis should be on reported earnings rather than cash flows.

True False

5. Even though one project may have superior cash flows, top management may sometimes choose a project
that inflates earnings instead of cash flow.

True False

6. The first administrative consideration in any capital budgeting process is collection of data.

True False

7. It is not unusual for a corporate president, who deals with security analysts, to be as sensitive to after-tax
income as to cash flow.

True False

1
8. Capital budgeting is only a concern of finance and accounting personnel.

True False

9. We add depreciation to net income to arrive at a true earnings picture.

True False

10 The payback method is Basic to understand and places a heavy emphasis on liquidity.
.
True False

11 The payback method is not really a theoretically correct approach.

.
True False

12 A rapid payback may be important to firms having rapid technological development.

.
True False

13 The payback method considers all cash inflows.

.
True False

14 Using the payback method can be appropriate when the time value of money is very low.
.
True False

15 Depreciation is important in calculating projected cash flows because it generates a tax deduction.
.
True False

16 To find the exact internal rate of return for projects with uneven cash flows, we can interpolate between
. two present value annuity factors from Appendix D.

True False

2
17 With non-mutually exclusive events and no capital rationing, we will usually arrive at the same
. conclusions using either the net present value or internal rate of return methods.

True False

18 The internal rate of return is the interest rate that equates the cash outflows of an investment with the
. subsequent inflows.

True False

19 The net present value profile's primary advantage over the internal rate of return method is that it does not
. require the time consuming trial and error calculations of the IRR.

True False

20 Non-mutually exclusive alternatives can be accepted at the same time.

.
True False

21 The selection of a mutually exclusive project means that all other projects with a positive net present
. value may also be selected.

True False

22 The profitability index is calculated by dividing the project's net present value by the present value of the
. projected cash outflows.

True False

23 It is the difference in the reinvestment assumptions that can be significant in determining when to use the
. net present value or internal rate of return methods.

True False

3
24 Under the net present value method, cash flows are assumed to be reinvested at the firm's weighted
. average cost of capital.

True False

25 For high-IRR investments, it is perfectly acceptable to assume that reinvestment will occur at an equally
. high, if not higher, rate.

True False

26 The modified internal rate of return assumes that inflows are reinvested at 80 percent of the internal rate
. of return.

True False

27 Under capital rationing, a firm will maximize profitability.

.
True False

28 The net present value profile allows a firm to examine the project's net present value over time.
.
True False

29 The net present value profile examines the relationship of the discount rate to the net present value.
.
True False

30 The net present value profile's weakness is that it does not provide a decision for mutually exclusive
. investments.

True False

31 When using accelerated depreciation, the present value of future cash flows increases.
.
True False

4
32 Under the modified accelerated-cost-recovery system of depreciation, cash flow tends to decline with the
. passage of time.

True False

33 Although firms can elect to use straight-line depreciation, the MACRS depreciation schedules have
. superseded other depreciation methods for tax purposes.

True False

34 In most cases, asset lives are shorter under MACRS depreciation than they would be with straight-line
. depreciation.

True False

35 Most real estate property is depreciated over a 10 year period.

.
True False

36 For a small business, it is possible for the purchase price of an asset to be expensed rather than
. depreciated.

True False

37 The base for depreciation expense calculations is equal to the cost of a new asset.
.
True False

38 Under MACRS depreciation, taxes paid in the first year of an asset's life are subtracted from the base used
. to calculate depreciation expense.

True False

39 Under MACRS depreciation, there are no tax credits for the purpose of calculating the base for
. depreciation expenses.

True False

5
40 Under MACRS depreciation, the tax life of an asset and its economically useful life are assumed to be the
. same.

True False

41 If an asset is sold for a price above its book value, the difference is considered taxable income to the
. firm.

True False

42 A tax loss on the sale of a depreciable asset used in business or trade may be written off against income.
.
True False

43 In a replacement decision, a book loss on an old asset can be a valuable feature.

.
True False

44 The dollar amount of losses incurred when an old asset is sold below book value is added to the purchase
. price of a new asset in calculating the base for depreciation.

True False

45 Cash flow is used for a net present value analysis and earnings are used for an IRR and payback analysis.
.
True False

46 When NPV and IRR analysis provide inconsistent rankings of projects, the financial manager should
. generally select the project with the highest IRR.

True False

47 Investors discount the later years of a long-term project at a lower rate because they are generally less
. precise.

True False

6
48 It is more likely for financial managers to focus on cash flow and corporate executives to focus on
. earnings of the company.

True False

49 Capital rationing is generally a positive action for a firm because it prevents rapid growth which can drive
. up the cost of capital.

True False

50 The reinvestment assumption is a downside of the IRR method of analysis because it assumes that cash
. flows are reinvested at the cost of capital.

True False

51 Cash flow can be said to equal

.

A. operating income less taxes plus depreciation.

B. operating income less taxes.
C. operating income before depreciation and taxes plus depreciation.
D. operating income after taxes minus depreciation.

52 The reason cash flow is used in capital budgeting is because

.

A. cash rather than income is used to purchase new machines.

B. cash outlays need to be evaluated in terms of the present value of the resultant cash inflows.
C. to ignore the tax shield provided from depreciation ignores the cash flow provided by the machine
which should be reinvested to replace old worn out machines.
D. all of these.

7
53 The first step in the capital budgeting process is
.

A. collection of data.
B. idea development.
C. assign probabilities.
D. determine cashflow.

54 Capital budgeting is primarily concerned with

.

A. capital formation in the economy.

B. planning future financing needs.
C. evaluating investment alternatives.
D. minimizing the cost of capital.

55 An appropriate capital budgeting process requires that the following steps are taken in which order?
.

A. Collection of data
B. Reevaluation and adjustment
C. Evaluation and decision making
D. Search for and discovery of investment opportunities
E. d, a, c, b
F. d, a, b, c
G. d, b, a, c
H. b, d, a, c

8
56 Assume a corporation has earnings before depreciation and taxes of $82,000, depreciation of $45,000,
. and that it has a 30 percent tax bracket. What are the after-tax cash flows for the company?

A. $70,900
B. $82,000
C. $42,000
D. None of these

57 Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and that
. the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project?

A. $18,000
B. $19,000
C. A loss of $21,000
D. None of these

58 Which of the following is not a time-adjusted method for ranking investment proposals?
.

A. Net present value method

B. Payback method
C. Internal rate of return method
D. All of these are time-adjusted methods

59 Which of the following statements about the "payback method" is true?

.

A. The payback method considers cash flows after the payback has been reached.
B. The payback method does not consider the time value of money.
C. The payback method uses discounted cash-flow techniques.
D. The payback method generally leads to the same decision as other investment selection methods.

9
60 There are several disadvantages to the payback method, among them:
.

A. payback ignores the time value of money.

B. payback emphasizes receiving money back as fast as possible for reinvestment.
C. payback is Basic to use and to understand.
D. payback can be used in conjunction with time adjusted methods of evaluation.

61 The payback method has several disadvantages, among them:

.

A. payback fails to choose the optimum or most economic solution to a capital budgeting problem.
B. payback ignores cash inflows after the payback period.
C. a and b.
D. none of these.

62 Assume a $6,500 investment and the following cash flows for two alternatives.
.

Under the payback method, which of the following would be concluded?

A. Investment X should be selected

B. Investment Y should be selected
C. Investment X and Y provide the same payback period
D. Neither investment is acceptable under the payback method

10
63 The Dammon Corp. has the following investment opportunities:
.

Under the payback method and assuming these machines are mutually exclusive, which machine(s)
would Dammon Corp. choose?

A. Machine A
B. Machine B
C. Machine C
D. Machine A and B

64 Suppose that interest rates (and, therefore, the firm's Weighted Average Cost of Capital) increase. This
. WOULD NOT CHANGE the capital budgeting choices a firm would make if it

A. uses payback period analysis.

B. uses net present value analysis.
C. uses internal rate of return analysis.
D. uses profitability indexes.

65 You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000 per year for 10
. years. What is the internal rate of return?

A. 5%
B. 6%
C. 7%
D. More than 7%

11
66 You require an IRR of 14% to accept a project. If the project will yield $10,000 per year for 10 years,
. what is the maximum amount that you would be willing to invest in the project?

A. Less than $50,000

B. More than $50,000 and less than $60,000
C. More than $60,000 and less than $70,000
D. More than $70,000

67 The longer the life of an investment

.

A. the more significant the discount rate.

B. the less significant the discount rate.
C. Makes no difference.
D. None of these.

68 Stone Inc. is evaluating a project with an initial cost of $9,500. Cash inflows are expected to be $1,500,
. $1,500 and $10,000 in the three years over which the project will produce cash flows. If the discount rate
is 9%, what is the net present value of the project?

A. Less than $0
B. Between $0 and $400
C. Between $400 and $800
D. More than $800

12
69 Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are not
. mutually exclusive, the firm should accept all investment proposals

A. for which it can obtain financing.

B. that have a positive net present value.
C. that have positive cash flows.
D. that provide returns greater than the after-tax cost of debt.

70 If projects are mutually exclusive

.

A. they can only be accepted under capital rationing.

B. the selection of one alternative precludes the selection of other alternatives.
C. the payback method should be used.
D. the net present-value should be used.

71 The internal rate of return and net present value methods:

.

A. always give the same investment decision answer.

B. never give the same investment decision answer.
C. usually give the same investment decision answer.
D. always give answers different from the payback method.

72 A characteristic of capital budgeting is

.

A. a large amount of money is always involved.

B. the internal rate of return must be less than the cost of capital.
C. the internal rate of return must be greater than the cost of capital.
D. the time horizon is at least five years.

13
73 A project requires an investment of $2,500 and has a net present value of $430. If the IRR is 10%, what is
. the profitability index for the project?

A. 0.25
B. 2.33
C. 0.70
D. 1.17

74 With non-mutually exclusive projects.

.

A. the payback method will select the best project.

B. the net present value is not acceptable.
C. the internal rate of return method will always select the best project.
D. the net present value and the internal rate of return methods will accept or reject the same project.

75 The Net Present Value Method is a more conservative technique for selecting investment projects than the
. Internal Rate of Return method because the NPV method

A. assumes that cash flows are reinvested at the project's internal rate of return.
B. concentrates on the liquidity aspects of investment projects.
C. assumes that cash flows are reinvested at the firm's weighted average cost of capital.
D. none of these.

76 The _________ assumes returns are reinvested at the cost of capital.

.

A. payback method
B. internal rate of return
C. net present value
D. capital rationing

14
77 In using the internal rate of return method, it is assumed that cash flows can be reinvested at
.

A. the cost of equity.

B. the cost of capital.
C. the internal rate of return.
D. the prevailing interest rate.

78 For acceptable investments, the reinvestment assumption under the internal rate of return is generally
.

A. higher than under the net present-value method.

B. lower than under the net present-value method.
C. at the cost of capital.
D. below the cost of capital.

79 The internal rate of return assumes that funds are reinvested at the:
.

A. cost of capital.
B. yield on the investment.
C. minimal acceptable rate to the corporation.
D. yield to maturity.

80 If an investment project has a positive net present value, then the internal rate of return is
.

A. less than the cost of capital.

B. greater than the cost of capital.
C. equal to the cost of capital.
D. indeterminate; it depends on the length of the project.

15
81 As the cost of capital increases
.

A. fewer projects are accepted.

B. more projects are accepted.
C. project selection remains unchanged.
D. None of these.

82 The net present value method is a better method of evaluation than the internal rate of return method
. because the NPV method

A. assumes cash flows are reinvested at the internal rate of return.

B. is a more liberal method of analysis.
C. assumes that cash flows can be reinvested at the firm's more conservative cost of capital.
D. None of these.

83 The modified internal rate of return assumes:

.

A. inflows are invested at the traditional interest rate of return.

B. inflows are reinvested at the cost of capital.
C. outflows must be funded with debt.
D. outflows must be funded with equity.

84 Capital rationing
.

A. is a way of preserving the assets of the firm over the long term.
B. is a less than optimal way to arrive at capital budgeting decisions.
C. assures stockholder wealth maximization.
D. assures maximum potential profitability.

16
85 If a firm is experiencing no capital rationing, it should accept all investment proposals
.

A. as long as it has available funds.

B. that return an amount equal to or greater than the cost of capital.
C. that return an amount greater than the cost of equity.
D. that are available, regardless of return.

86 A firm may adopt capital rationing because

.

A. it is hesitant to use external sources of financing.

B. it wishes to maximize profits.
C. it is fearful of too much growth.
D. a and c.

87 Capital rationing assumes:

.

A. A limited amount of capital is available.

B. A limited amount of investments are available.
C. Maximum profitability will be obtained.
D. B and C.

88 The net present value profile

.

A. doesn't work if projects have a negative net present value.

B. is a substitute for the IRR.
C. graphically portrays the relationship between the discount rate and the net present value.
D. two of the above.

17
89 Which of the following is not a step in creating the net present value profile?
.

A. Determining the net present value at a zero discount rate.

B. Determining the net present value at a normal discount rate.
C. Determining the project's internal rate of return.
D. Determining the payback for the project.

90 Using higher discount rates,

.

A. accelerated cost recovery depreciation is more valuable than straight line.

B. straight-line depreciation is more valuable than the accelerated cost recovery system of
depreciation.
C. depreciation policy makes no difference.
D. later year depreciation has a higher net present value.

91 Which statement, or statements, are true about depreciation?

.

A. Depreciation is a non-cash expense that provides tax shield benefits.

B. The greater the depreciation expenses in earlier years, the higher the present value of the project.
C. The MACRS depreciation schedules supersede the old methods of sum-of-the-years' digits, double
declining balance, etc.
D. All these are true.

18
92 The Wet Corp. has an investment project that will reduce expenses by $25,000 per year for 3 years. The
. project's cost is $55,000. If the asset is part of the 3-year MACRS category (33% first year depreciation)
and the company's tax rate is 34%, what is the cash flow from the project in year 1?

A. $16,800
B. $15,100
C. $22,671
D. $16,667

93 An asset fitting into the 7-year MACRS category was purchased 2 years ago for $72,000. The book value
. of this asset is now

A. $44,064
B. $31,200
C. $48,317
D. $60,052

94 For MACRS depreciation, automobiles and light trucks fit into the
.

A. 3-year MACRS category.

B. 5-year MACRS category.
C. 7-year MACRS category.
D. 10-year MACRS category.

19
95 With the exception of real estate investments, MACRS depreciation is beneficial to corporations because
. it

A. increases total depreciation.

B. lengthens the lives of assets for depreciation purposes.
C. shortens the lives of assets for depreciation purposes.
D. classifies assets into specific, well-understood groups for depreciation purposes.

96 A firm purchases an asset falling into the 3-year MACRS category for $48,000. The second year's
. depreciation expense for this asset would be

A. $34,710.
B. $21,360.
C. $16,000.
D. cannot be determined without knowing second-year earnings before depreciation and taxes.

97 Which of the following does MACRS depreciation provide to corporations?

.

A. Increases total depreciation.

B. Lengthens the lives of assets for depreciation purposes.
C. Shortens the lives of assets for depreciation purposes.
D. Full-year vs. half-year convention.

98 Elective expensing has the following characteristic:

.

A. it is primarily beneficial to large businesses.

B. it is exclusively used for financial reporting.
C. it allows a more rapid write-off than MACRS depreciation.
D. a and c.

20
99 At higher tax rates, depreciation is
.

A. more beneficial.
B. less beneficial.
C. unaffected.
D. none of these.

10 If the capital budgeting decision includes a replacement analysis, then

0.

A. a gain from the sale of the old asset will represent a tax savings inflow.
B. only incremental cash flows should be looked at.
C. the sale price and tax savings will increase the cash inflows throughout the asset's life.
D. two of the above.

10 An equipment replacement decision, under incremental analysis, requires

1.

A. calculating the present value of all cash flows associated with the new equipment minus the
salvage value of the old asset.
B. calculating the present value of all changes in cash flows from the old equipment to the new
equipment.
C. subtracting the purchase price of the old equipment from the purchase price of the new equipment.
D. two of the above.

10 In a replacement decision, if an old asset sells below book value, from a tax standpoint
2.

A. there is a decrease in cash flow.

B. there is an increase in cash flow.
C. there is no effect on cash flow.
D. there is a decrease in net present value.

21
10 Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000.
3. The current market value of the old machine is $18,000 but the book value is $32,000. The firm's tax rate
for ordinary income is 30%. What is the net cash outflow for the new machine after considering the sale
of the old machine?

A. $47,800
B. $38,000
C. $45,000
D. $40,100

10 A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised,
4. the net cash outflow (purchase price less proceeds from the sale of the old asset) would:

A. go up.
B. go down.
C. remain the same.
D. more information required.

10 Project X has a cost of $100,000 and provides the following annual earnings: year 1 $35,000; year 2
5. $25,000; year 3 $175,000; and year 4 $10,000. Under the payback method, in which year is the
investment recouped?

A. Year 2
B. Year 3
C. Year 4
D. Not enough information to determine

22
10 All of the following is information required to create a net present value profile except:
6.

A. NPV at a 0 discount rate

B. NPV at the risk-free rate
C. NPV at the cost of capital
D. IRR of investment

10 A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the
7. following 2 projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000;
year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows:
year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 12% cost of capital, which decision
should the financial manager make?

A. Select project A
B. Select project B
C. Do not select either project
D. Select both projects

10 Technology Corp. is considering a $200,000 investment in a new marketing campaign which they
8. anticipate will provide annual cash flows of $52,000 for the next 5 years. The firm has a 10% cost of
capital. What should the analysis indicate to the firm's managers?

A. IRR between 9% and 10% - accept the project

B. IRR between 9% and 10% - reject the project
C. IRR between 10% and 11% - accept the project
D. Not enough information to determine

23
10 Match the following with the items below:
9.

1. capital rationing Concerns the rate of return that can be earned on the cash flow generated by
capital budgeting projects. ____
2. payback period Occurs when a corporation has more dollars of capital budgeting projects with
positive net present values than it has money allocated to invest in them. ____
3. modified accelerated cost recovery system depreciation (MACRS) Has defined asset lives of 3
to 39 years for different categories of assets. ____
4. reinvestment assumption Equals cash inflows minus cash expenses. ____
5. normal recovery period A discounted cash flow method for evaluating capital budgeting projects
where the present value of the cash inflows are equal to the present value of the cash outflows. ____
6. planning horizon The time it takes to depreciate an asset under the accelerated cost recovery
system. ____
7. net present value profile The length of time it takes to conceive, develop, and complete a project
and to recover the cost of the project on a discounted cash flow basis. ____
8. cash flow Indicates the length of time required to recoup an initial investment. ____
9. internal rate of return (IRR) A graphical presentation of the potential net present values of a
project at different discount rates. ____

11 Match the following with the questions below:

0.

1. incremental depreciation Equals the present value of the cash inflows minus the present value of
the cash outflows when the cost of capital is used as a discount rate. ____
2. asset depreciation range (ADR) Is calculated by taking the depreciable cost of an asset and
dividing it by the useful life of the asset. ____
3. mutually exclusive The selection of one choice precludes the selection of any other competitive
choice. ____
4. straight-line depreciation This value is multiplied by the tax rate to determine the company's tax
shield benefit. ____
5. elective expensing The capital budgeting decision on whether or not to replace an old asset with a
new one. ____
6. replacement decision The expected physical life of an asset or class of assets. ____
7. net present value (NPV) Writing off an asset in the year of purchase for tax purposes rather than
depreciating it over its valued life. ____

24
11 The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business
1. computer system. The initial investment will be $50,000. The computer is in the 5-year MACRS category,
and the firm's tax rate is 34%. The computer system is expected to provide additional revenue of $32,000
per year for the next six years, and to reduce expenses by $7,000 per year for the same period.
a) Calculate the net after-tax cash flows from this investment.
b) Calculate the net present value of the system, given that the law firm's weighted average cost of capital
is 12%.
c) Should they buy the computer system?

11 Tabletop Ranches, Inc. is considering the purchase of a new helicopter for $400,000. The firm's old
2. helicopter has a book value of $90,000, but can only be sold for $60,000. It was being depreciated at the
rate of $13,500 per year for four more years under an old depreciation method.
The new helicopter will be depreciated using the 5-year MACRS schedule. It is expected to save $75,000
after taxes through reduced fuel and maintenance expenses. Tabletop Ranch is in the 34% tax bracket and
has a 12% cost of capital. Assume a 6 year time horizon.
a) Calculate the cash inflows from selling the old helicopter.
b) Calculate the net cost of the new helicopter.
c) Calculate the incremental depreciation for the new helicopter.
d) Calculate the net cash flows for the purchase.
e) Calculate the net present value of the helicopter purchase and of the helicopter purchase and state
whether or not the firm should buy it.

25
11 The Taylor Corporation is using a machine that originally cost $88,000. The machine is being depreciated
3. by the straight-line method over 8 years ($11,000 per year) and has 4 years of depreciation remaining.
The machine has a book value of $44,000 and a current market value of $40,000.
Jacqueline Elliott, the Chief Financial Officer of Taylor, is considering replacing this machine with a
newer model costing $75,000. The new machine will save $5,000 in after-tax earnings each year for the
next six years. The new machine is in the 5-year MACRS category. Taylor Corporation is in the 34% tax
bracket and has a 10 percent cost of capital.
a) Calculate the cash inflows from the sale of the old machine.
b) Calculate the net cost of the new machine.
c) Calculate the incremental depreciation on the new versus the old machine.
d) Determine the net present value of the new machine. Should they purchase the new machine?

11 A&B Enterprises is trying to select the best investment from among four alternatives. Each alternative
4. involves an initial outlay of $100,000. Their cash flows follow:

26
12 Key

1. Capital budgeting decisions involve a minimum time horizon of five years.

FALSE

27
Block - Chapter 12 #1
Blooms: Understand
Difficulty: Basic
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

2. A good capital budgeting program requires that a number of steps be taken in the decision making
process. The first step is the explanation of data.

FALSE

Block - Chapter 12 #2
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

3. Possibly the most overlooked part of the capital budgeting process is the search for new opportunities
through innovation and creative thinking.

TRUE

Block - Chapter 12 #3
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

4. In most capital budgeting decisions the emphasis should be on reported earnings rather than cash
flows.

FALSE

AACSB: Ethics (ethical understanding and reasoning) Abilities

Block - Chapter 12 #4
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

5. Even though one project may have superior cash flows, top management may sometimes choose a
project that inflates earnings instead of cash flow.

TRUE
28
AACSB: Ethics (ethical understanding and reasoning) Abilities
Block - Chapter 12 #5
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

6. The first administrative consideration in any capital budgeting process is collection of data.

FALSE

Block - Chapter 12 #6
Blooms: Understand
Difficulty: Basic
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

7. It is not unusual for a corporate president, who deals with security analysts, to be as sensitive to after-
tax income as to cash flow.

TRUE

AACSB: Ethics (ethical understanding and reasoning) Abilities

Block - Chapter 12 #7
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

8. Capital budgeting is only a concern of finance and accounting personnel.

FALSE

Block - Chapter 12 #8
Blooms: Remember
Difficulty: Basic
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

9. We add depreciation to net income to arrive at a true earnings picture.

FALSE

29
Block - Chapter 12 #9
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

10. The payback method is Basic to understand and places a heavy emphasis on liquidity.

TRUE

Block - Chapter 12 #10

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

11. The payback method is not really a theoretically correct approach.

TRUE

Block - Chapter 12 #11

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

12. A rapid payback may be important to firms having rapid technological development.

TRUE

Block - Chapter 12 #12

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

13. The payback method considers all cash inflows.

FALSE

Block - Chapter 12 #13

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

30
14. Using the payback method can be appropriate when the time value of money is very low.

FALSE

Block - Chapter 12 #14

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

15. Depreciation is important in calculating projected cash flows because it generates a tax deduction.

TRUE

Block - Chapter 12 #15

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

16. To find the exact internal rate of return for projects with uneven cash flows, we can interpolate
between two present value annuity factors from Appendix D.

FALSE

Block - Chapter 12 #16

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

17. With non-mutually exclusive events and no capital rationing, we will usually arrive at the same
conclusions using either the net present value or internal rate of return methods.

TRUE

Block - Chapter 12 #17

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

31
18. The internal rate of return is the interest rate that equates the cash outflows of an investment with the
subsequent inflows.

TRUE

Block - Chapter 12 #18

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

19. The net present value profile's primary advantage over the internal rate of return method is that it does
not require the time consuming trial and error calculations of the IRR.

FALSE

Block - Chapter 12 #19

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

20. Non-mutually exclusive alternatives can be accepted at the same time.

TRUE

Block - Chapter 12 #20

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

21. The selection of a mutually exclusive project means that all other projects with a positive net present
value may also be selected.

FALSE

32
Block - Chapter 12 #21
Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

22. The profitability index is calculated by dividing the project's net present value by the present value of
the projected cash outflows.

FALSE

Block - Chapter 12 #22

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

23. It is the difference in the reinvestment assumptions that can be significant in determining when to use
the net present value or internal rate of return methods.

TRUE

Block - Chapter 12 #23

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

24. Under the net present value method, cash flows are assumed to be reinvested at the firm's weighted
average cost of capital.

TRUE

Block - Chapter 12 #24

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

33
25. For high-IRR investments, it is perfectly acceptable to assume that reinvestment will occur at an
equally high, if not higher, rate.

FALSE

Block - Chapter 12 #25

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

26. The modified internal rate of return assumes that inflows are reinvested at 80 percent of the internal
rate of return.

FALSE

Block - Chapter 12 #26

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

27. Under capital rationing, a firm will maximize profitability.

FALSE

Block - Chapter 12 #27

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

28. The net present value profile allows a firm to examine the project's net present value over time.

FALSE

Block - Chapter 12 #28

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

34
29. The net present value profile examines the relationship of the discount rate to the net present value.

TRUE

Block - Chapter 12 #29

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. The net present value
and internal rate of return are generally the preferred methods of capital budgeting analysis.

30. The net present value profile's weakness is that it does not provide a decision for mutually exclusive
investments.

FALSE

Block - Chapter 12 #30

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

31. When using accelerated depreciation, the present value of future cash flows increases.

TRUE

Block - Chapter 12 #31

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

32. Under the modified accelerated-cost-recovery system of depreciation, cash flow tends to decline with
the passage of time.

TRUE

Block - Chapter 12 #32

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

35
33. Although firms can elect to use straight-line depreciation, the MACRS depreciation schedules have
superseded other depreciation methods for tax purposes.

TRUE

Block - Chapter 12 #33

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

34. In most cases, asset lives are shorter under MACRS depreciation than they would be with straight-line
depreciation.

FALSE

Block - Chapter 12 #34

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

35. Most real estate property is depreciated over a 10 year period.

FALSE

Block - Chapter 12 #35

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

36. For a small business, it is possible for the purchase price of an asset to be expensed rather than
depreciated.

TRUE

Block - Chapter 12 #36

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

36
37. The base for depreciation expense calculations is equal to the cost of a new asset.

TRUE

Block - Chapter 12 #37

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

38. Under MACRS depreciation, taxes paid in the first year of an asset's life are subtracted from the base
used to calculate depreciation expense.

FALSE

Block - Chapter 12 #38

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

39. Under MACRS depreciation, there are no tax credits for the purpose of calculating the base for
depreciation expenses.

TRUE

Block - Chapter 12 #39

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

40. Under MACRS depreciation, the tax life of an asset and its economically useful life are assumed to be
the same.

FALSE

Block - Chapter 12 #40

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

37
41. If an asset is sold for a price above its book value, the difference is considered taxable income to the
firm.

TRUE

Block - Chapter 12 #41

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

42. A tax loss on the sale of a depreciable asset used in business or trade may be written off against
income.

TRUE

Block - Chapter 12 #42

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

43. In a replacement decision, a book loss on an old asset can be a valuable feature.

TRUE

Block - Chapter 12 #43

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

44. The dollar amount of losses incurred when an old asset is sold below book value is added to the
purchase price of a new asset in calculating the base for depreciation.

FALSE

Block - Chapter 12 #44

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

38
45. Cash flow is used for a net present value analysis and earnings are used for an IRR and payback
analysis.

FALSE

Block - Chapter 12 #45

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

46. When NPV and IRR analysis provide inconsistent rankings of projects, the financial manager should
generally select the project with the highest IRR.

FALSE

Block - Chapter 12 #46

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

47. Investors discount the later years of a long-term project at a lower rate because they are generally less
precise.

FALSE

AACSB: Analytic
Block - Chapter 12 #47
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

48. It is more likely for financial managers to focus on cash flow and corporate executives to focus on
earnings of the company.

TRUE

39
AACSB: Analytic
Block - Chapter 12 #48
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

49. Capital rationing is generally a positive action for a firm because it prevents rapid growth which can
drive up the cost of capital.

FALSE

Block - Chapter 12 #49

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

50. The reinvestment assumption is a downside of the IRR method of analysis because it assumes that
cash flows are reinvested at the cost of capital.

FALSE

Block - Chapter 12 #50

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

51. Cash flow can be said to equal

A. operating income less taxes plus depreciation.

B. operating income less taxes.
C. operating income before depreciation and taxes plus depreciation.
D. operating income after taxes minus depreciation.

Block - Chapter 12 #51

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

40
52. The reason cash flow is used in capital budgeting is because

A. cash rather than income is used to purchase new machines.

B. cash outlays need to be evaluated in terms of the present value of the resultant cash inflows.
C. to ignore the tax shield provided from depreciation ignores the cash flow provided by the
machine which should be reinvested to replace old worn out machines.
D. all of these.

Block - Chapter 12 #52

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

53. The first step in the capital budgeting process is

A. collection of data.
B. idea development.
C. assign probabilities.
D. determine cashflow.

Block - Chapter 12 #53

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

54. Capital budgeting is primarily concerned with

A. capital formation in the economy.

B. planning future financing needs.
C. evaluating investment alternatives.
D. minimizing the cost of capital.

41
Block - Chapter 12 #54
Blooms: Understand
Difficulty: Basic
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

55. An appropriate capital budgeting process requires that the following steps are taken in which order?

A. Collection of data
B. Reevaluation and adjustment
C. Evaluation and decision making
D. Search for and discovery of investment opportunities
E. d, a, c, b
F. d, a, b, c
G. d, b, a, c
H. b, d, a, c

Block - Chapter 12 #55

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

56. Assume a corporation has earnings before depreciation and taxes of $82,000, depreciation of $45,000,
and that it has a 30 percent tax bracket. What are the after-tax cash flows for the company?

A. $70,900
B. $82,000
C. $42,000
D. None of these

42
AACSB: Analytic
Block - Chapter 12 #56
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

57. Assume a project has earnings before depreciation and taxes of $15,000, depreciation of $25,000, and
that the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project?

A. $18,000
B. $19,000
C. A loss of $21,000
D. None of these

AACSB: Analytic
Block - Chapter 12 #57
Blooms: Apply
Difficulty: Challenge
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

58. Which of the following is not a time-adjusted method for ranking investment proposals?

A. Net present value method

B. Payback method
C. Internal rate of return method
D. All of these are time-adjusted methods

Block - Chapter 12 #58

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

43
 Which of the following statements about the "payback method" is true?
..‫ح‬

A. The payback method considers cash flows after the payback has been reached.
B. The payback method does not consider the time value of money.
C. The payback method uses discounted cash-flow techniques.
D. The payback method generally leads to the same decision as other investment selection
methods.

Block - Chapter 12 #59

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

60. There are several disadvantages to the payback method, among them:

A. payback ignores the time value of money.

B. payback emphasizes receiving money back as fast as possible for reinvestment.
C. payback is Basic to use and to understand.
D. payback can be used in conjunction with time adjusted methods of evaluation.

Block - Chapter 12 #60

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

61. The payback method has several disadvantages, among them:

A. payback fails to choose the optimum or most economic solution to a capital budgeting
problem.
B. payback ignores cash inflows after the payback period.
C. a and b.
D. none of these.

44
Block - Chapter 12 #61
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

62. Assume a $6,500 investment and the following cash flows for two alternatives.

Under the payback method, which of the following would be concluded?

A. Investment X should be selected

B. Investment Y should be selected
C. Investment X and Y provide the same payback period
D. Neither investment is acceptable under the payback method

AACSB: Analytic
Block - Chapter 12 #62
Blooms: Apply
Difficulty: Basic
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

45
63. The Dammon Corp. has the following investment opportunities:

Under the payback method and assuming these machines are mutually exclusive, which machine(s)
would Dammon Corp. choose?

A. Machine A
B. Machine B
C. Machine C
D. Machine A and B

AACSB: Analytic
Block - Chapter 12 #63
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

64. Suppose that interest rates (and, therefore, the firm's Weighted Average Cost of Capital) increase. This
WOULD NOT CHANGE the capital budgeting choices a firm would make if it

A. uses payback period analysis.

B. uses net present value analysis.
C. uses internal rate of return analysis.
D. uses profitability indexes.

46
AACSB: Analytic
Block - Chapter 12 #64
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

65. You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000 per year for 20
years. What is the internal rate of return?

A. 5%
B. 6%
C. 7%
D. More than 7%

Appendix D

AACSB: Analytic
Block - Chapter 12 #65
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

66. You require an IRR of 14% to accept a project. If the project will yield $10,000 per year for 10 years,
what is the maximum amount that you would be willing to invest in the project?

A. Less than $50,000

B. More than $50,000 and less than $60,000
C. More than $60,000 and less than $70,000
D. More than $70,000

47
AACSB: Analytic
Block - Chapter 12 #66
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

67. The longer the life of an investment

A. the more significant the discount rate.

B. the less significant the discount rate.
C. Makes no difference.
D. None of these.

Block - Chapter 12 #67

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital. The discount or cutoff rate is normally the cost of capital.

68. Stone Inc. is evaluating a project with an initial cost of $9,500. Cash inflows are expected to be
$1,500, $1,500 and $10,000 in the three years over which the project will produce cash flows. If the
discount rate is 9%, what is the net present value of the project?

A. Less than $0
B. Between $0 and $400
C. Between $400 and $800
D. More than $800

48
AACSB: Analytic
Block - Chapter 12 #68
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

69. Assuming that a firm has no capital rationing constraint and that a firm's investment alternatives are
not mutually exclusive, the firm should accept all investment proposals

A. for which it can obtain financing.

B. that have a positive net present value.
C. that have positive cash flows.
D. that provide returns greater than the after-tax cost of debt.

Block - Chapter 12 #69

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

70. If projects are mutually exclusive

A. they can only be accepted under capital rationing.

B. the selection of one alternative precludes the selection of other alternatives.
C. the payback method should be used.
D. the net present-value should be used.

Block - Chapter 12 #70

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

49
71. The internal rate of return and net present value methods:

A. always give the same investment decision answer.

B. never give the same investment decision answer.
C. usually give the same investment decision answer.
D. always give answers different from the payback method.

Block - Chapter 12 #71

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

72. A characteristic of capital budgeting is

A. a large amount of money is always involved.

B. the internal rate of return must be less than the cost of capital.
C. the internal rate of return must be greater than the cost of capital.
D. the time horizon is at least five years.

Block - Chapter 12 #72

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

50
73. A project requires an investment of $2,500 and has a net present value of $430. If the IRR is 10%,
what is the profitability index for the project?

A. 0.25
B. 2.33
C. 0.70
D. 1.17

Net present value = Present value of inflows - Present value of outflows

$430 = Present value of inflows - $2,500
Present value of inflows = $2,930

AACSB: Analytic
Block - Chapter 12 #73
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

74. With non-mutually exclusive projects.

A. the payback method will select the best project.

B. the net present value is not acceptable.
C. the internal rate of return method will always select the best project.
D. the net present value and the internal rate of return methods will accept or reject the same
project.

Block - Chapter 12 #74

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

51
75. The Net Present Value Method is a more conservative technique for selecting investment projects than
the Internal Rate of Return method because the NPV method

A. assumes that cash flows are reinvested at the project's internal rate of return.
B. concentrates on the liquidity aspects of investment projects.
C. assumes that cash flows are reinvested at the firm's weighted average cost of capital.
D. none of these.

Block - Chapter 12 #75

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

76. The _________ assumes returns are reinvested at the cost of capital.

A. payback method
B. internal rate of return
C. net present value
D. capital rationing

Block - Chapter 12 #76

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

77. In using the internal rate of return method, it is assumed that cash flows can be reinvested at

A. the cost of equity.

B. the cost of capital.
C. the internal rate of return.
D. the prevailing interest rate.

52
Block - Chapter 12 #77
Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

78. For acceptable investments, the reinvestment assumption under the internal rate of return is generally

A. higher than under the net present-value method.

B. lower than under the net present-value method.
C. at the cost of capital.
D. below the cost of capital.

Block - Chapter 12 #78

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

79. The internal rate of return assumes that funds are reinvested at the:

A. cost of capital.
B. yield on the investment.
C. minimal acceptable rate to the corporation.
D. yield to maturity.

Block - Chapter 12 #79

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

53
80. If an investment project has a positive net present value, then the internal rate of return is

A. less than the cost of capital.

B. greater than the cost of capital.
C. equal to the cost of capital.
D. indeterminate; it depends on the length of the project.

Block - Chapter 12 #80

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

81. As the cost of capital increases

A. fewer projects are accepted.

B. more projects are accepted.
C. project selection remains unchanged.
D. None of these.

Block - Chapter 12 #81

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

82. The net present value method is a better method of evaluation than the internal rate of return method
because the NPV method

A. assumes cash flows are reinvested at the internal rate of return.

B. is a more liberal method of analysis.
C. assumes that cash flows can be reinvested at the firm's more conservative cost of capital.
D. None of these.

54
Block - Chapter 12 #82
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

83. The modified internal rate of return assumes:

A. inflows are invested at the traditional interest rate of return.

B. inflows are reinvested at the cost of capital.
C. outflows must be funded with debt.
D. outflows must be funded with equity.

Block - Chapter 12 #83

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

84. Capital rationing

A. is a way of preserving the assets of the firm over the long term.
B. is a less than optimal way to arrive at capital budgeting decisions.
C. assures stockholder wealth maximization.
D. assures maximum potential profitability.

Block - Chapter 12 #84

Blooms: Remember
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

55
85. If a firm is experiencing no capital rationing, it should accept all investment proposals

A. as long as it has available funds.

B. that return an amount equal to or greater than the cost of capital.
C. that return an amount greater than the cost of equity.
D. that are available, regardless of return.

Block - Chapter 12 #85

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

86. A firm may adopt capital rationing because

A. it is hesitant to use external sources of financing.

B. it wishes to maximize profits.
C. it is fearful of too much growth.
D. a and c.

Block - Chapter 12 #86

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

87. Capital rationing assumes:

A. A limited amount of capital is available.

B. A limited amount of investments are available.
C. Maximum profitability will be obtained.
D. B and C.

56
Block - Chapter 12 #87
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.

88. The net present value profile

A. doesn't work if projects have a negative net present value.

B. is a substitute for the IRR.
C. graphically portrays the relationship between the discount rate and the net present value.
D. two of the above.

Block - Chapter 12 #88

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

89. Which of the following is not a step in creating the net present value profile?

A. Determining the net present value at a zero discount rate.

B. Determining the net present value at a normal discount rate.
C. Determining the project's internal rate of return.
D. Determining the payback for the project.

Block - Chapter 12 #89

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

57
90. Using higher discount rates,

A. accelerated cost recovery depreciation is more valuable than straight line.

B. straight-line depreciation is more valuable than the accelerated cost recovery system of
depreciation.
C. depreciation policy makes no difference.
D. later year depreciation has a higher net present value.

Block - Chapter 12 #90

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

91. Which statement, or statements, are true about depreciation?

A. Depreciation is a non-cash expense that provides tax shield benefits.

B. The greater the depreciation expenses in earlier years, the higher the present value of the
project.
C. The MACRS depreciation schedules supersede the old methods of sum-of-the-years' digits,
double declining balance, etc.
D. All these are true.

Block - Chapter 12 #91

Blooms: Remember
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

58
92. The Wet Corp. has an investment project that will reduce expenses by $25,000 per year for 3 years.
The project's cost is $55,000. If the asset is part of the 3-year MACRS category (33% first year
depreciation) and the company's tax rate is 34%, what is the cash flow from the project in year 1?

A. $16,800
B. $15,100
C. $22,671
D. $16,667

AACSB: Analytic
Block - Chapter 12 #92
Blooms: Apply
Difficulty: Challenge
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

93. An asset fitting into the 7-year MACRS category was purchased 2 years ago for $72,000. The book
value of this asset is now

A. $44,064
B. $31,200
C. $48,317
D. $60,052

Book value = $72,000 - ($72,000)(.143) - ($72,000)(.245) = $44,064

AACSB: Analytic
Block - Chapter 12 #93
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

59
94. For MACRS depreciation, automobiles and light trucks fit into the

A. 3-year MACRS category.

B. 5-year MACRS category.
C. 7-year MACRS category.
D. 10-year MACRS category.

AACSB: Analytic
Block - Chapter 12 #94
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

95. With the exception of real estate investments, MACRS depreciation is beneficial to corporations
because it

A. increases total depreciation.

B. lengthens the lives of assets for depreciation purposes.
C. shortens the lives of assets for depreciation purposes.
D. classifies assets into specific, well-understood groups for depreciation purposes.

Block - Chapter 12 #95

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

96. A firm purchases an asset falling into the 3-year MACRS category for $48,000. The second year's
depreciation expense for this asset would be

A. $34,710.
B. $21,360.
C. $16,000.
D. cannot be determined without knowing second-year earnings before depreciation and taxes.

Year 2 depreciation = $48,000 x .445 = $21,360

60
AACSB: Analytic
Block - Chapter 12 #96
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

97. Which of the following does MACRS depreciation provide to corporations?

A. Increases total depreciation.

B. Lengthens the lives of assets for depreciation purposes.
C. Shortens the lives of assets for depreciation purposes.
D. Full-year vs. half-year convention.

Block - Chapter 12 #97

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

98. Elective expensing has the following characteristic:

A. it is primarily beneficial to large businesses.

B. it is exclusively used for financial reporting.
C. it allows a more rapid write-off than MACRS depreciation.
D. a and c.

Block - Chapter 12 #98

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

61
99. At higher tax rates, depreciation is

A. more beneficial.
B. less beneficial.
C. unaffected.
D. none of these.

Block - Chapter 12 #99

Blooms: Understand
Difficulty: Basic
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.

100. If the capital budgeting decision includes a replacement analysis, then

A. a gain from the sale of the old asset will represent a tax savings inflow.
B. only incremental cash flows should be looked at.
C. the sale price and tax savings will increase the cash inflows throughout the asset's life.
D. two of the above.

Block - Chapter 12 #100

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

101. An equipment replacement decision, under incremental analysis, requires

A. calculating the present value of all cash flows associated with the new equipment minus the
salvage value of the old asset.
B. calculating the present value of all changes in cash flows from the old equipment to the new
equipment.
C. subtracting the purchase price of the old equipment from the purchase price of the new
equipment.
D. two of the above.

62
Block - Chapter 12 #101
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

102. In a replacement decision, if an old asset sells below book value, from a tax standpoint

A. there is a decrease in cash flow.

B. there is an increase in cash flow.
C. there is no effect on cash flow.
D. there is a decrease in net present value.

Block - Chapter 12 #102

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

103. Firm X is considering the replacement of an old machine with one that has a purchase price of
$70,000. The current market value of the old machine is $18,000 but the book value is $32,000. The
firm's tax rate for ordinary income is 30%. What is the net cash outflow for the new machine after
considering the sale of the old machine?

A. $47,800
B. $38,000
C. $45,000
D. $40,100

63
AACSB: Analytic
Block - Chapter 12 #103
Blooms: Apply
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

104. A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is
raised, the net cash outflow (purchase price less proceeds from the sale of the old asset) would:

A. go up.
B. go down.
C. remain the same.
D. more information required.

Block - Chapter 12 #104

Blooms: Understand
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

105. Project X has a cost of $100,000 and provides the following annual earnings: year 1 $35,000; year 2
$25,000; year 3 $175,000; and year 4 $10,000. Under the payback method, in which year is the
investment recouped?

A. Year 2
B. Year 3
C. Year 4
D. Not enough information to determine

No data on cash flows.

AACSB: Analytic
Block - Chapter 12 #105
Blooms: Analyze
Difficulty: Challenge
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.

64
106. All of the following is information required to create a net present value profile except:

A. NPV at a 0 discount rate

B. NPV at the risk-free rate
C. NPV at the cost of capital
D. IRR of investment

Block - Chapter 12 #106

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

107.‫ ئ‬A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the
following 2 projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000;
year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows:
year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 12% cost of capital, which decision
should the financial manager make?

A. Select project A
B. Select project B
C. Do not select either project
D. Select both projects

65
AACSB: Analytic
Block - Chapter 12 #107
Blooms: Apply
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

108. Technology Corp. is considering a $200,000 investment in a new marketing campaign which they
anticipate will provide annual cash flows of $52,000 for the next 5 years. The firm has a 10% cost of
capital. What should the analysis indicate to the firm's managers?

A. IRR between 9% and 10% - accept the project

B. IRR between 9% and 10% - reject the project
C. IRR between 10% and 11% - accept the project
D. Not enough information to determine

AACSB: Analytic
Block - Chapter 12 #108
Blooms: Apply and Analysis
Difficulty: Challenge
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

66
109. Match the following with the items below:

1. capital rationing Concerns the rate of return that can be earned on the cash flow generated by
capital budgeting projects. 4
2. payback period Occurs when a corporation has more dollars of capital budgeting projects
with positive net present values than it has money allocated to invest in them. 1
3. modified accelerated cost recovery system depreciation (MACRS) Has defined asset lives
of 3 to 39 years for different categories of assets. 3
4. reinvestment assumption Equals cash inflows minus cash expenses. 8
5. normal recovery period A discounted cash flow method for evaluating capital budgeting
projects where the present value of the cash inflows are equal to the present value of the cash
outflows. 9
6. planning horizon The time it takes to depreciate an asset under the accelerated cost recovery
system. 5
7. net present value profile The length of time it takes to conceive, develop, and complete a
project and to recover the cost of the project on a discounted cash flow basis. 6
8. cash flow Indicates the length of time required to recoup an initial investment. 2
9. internal rate of return (IRR) A graphical presentation of the potential net present values of
a project at different discount rates. 7

Block - Chapter 12 #109

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

67
110. Match the following with the questions below:

1. incremental depreciation Equals the present value of the cash inflows minus the present value
of the cash outflows when the cost of capital is used as a discount rate. 7
2. asset depreciation range (ADR) Is calculated by taking the depreciable cost of an asset and
dividing it by the useful life of the asset. 4
3. mutually exclusive The selection of one choice precludes the selection of any other competitive
choice. 3
4. straight-line depreciation This value is multiplied by the tax rate to determine the company's
tax shield benefit. 1
5. elective expensing The capital budgeting decision on whether or not to replace an old asset with
a new one. 6
6. replacement decision The expected physical life of an asset or class of assets. 2
7. net present value (NPV) Writing off an asset in the year of purchase for tax purposes rather
than depreciating it over its valued life. 5

Block - Chapter 12 #110

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

68
111. The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business
computer system. The initial investment will be $50,000. The computer is in the 5-year MACRS
category, and the firm's tax rate is 34%. The computer system is expected to provide additional
revenue of $32,000 per year for the next six years, and to reduce expenses by $7,000 per year for the
same period.
a) Calculate the net after-tax cash flows from this investment.
b) Calculate the net present value of the system, given that the law firm's weighted average cost of
capital is 12%.
c) Should they buy the computer system?

AACSB: Analytic
Block - Chapter 12 #111
Blooms: Apply and Evaluation
Difficulty: Intermediate
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

69
112. Tabletop Ranches, Inc. is considering the purchase of a new helicopter for $400,000. The firm's old
helicopter has a book value of $90,000, but can only be sold for $60,000. It was being depreciated at
the rate of $13,500 per year for four more years under an old depreciation method.
The new helicopter will be depreciated using the 5-year MACRS schedule. It is expected to save
$75,000 after taxes through reduced fuel and maintenance expenses. Tabletop Ranch is in the 34% tax
bracket and has a 12% cost of capital. Assume a 6 year time horizon.
a) Calculate the cash inflows from selling the old helicopter.
b) Calculate the net cost of the new helicopter.
c) Calculate the incremental depreciation for the new helicopter.
d) Calculate the net cash flows for the purchase.
e) Calculate the net present value of the helicopter purchase and of the helicopter purchase and state
whether or not the firm should buy it.

a)

b)

c)
d) Net cash flows (incremental benefits)

70
AACSB: Analytic
Block - Chapter 12 #112
Blooms: Apply and Evaluation
Difficulty: Challenge
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

71
113. The Taylor Corporation is using a machine that originally cost $88,000. The machine is being
depreciated by the straight-line method over 8 years ($11,000 per year) and has 4 years of depreciation
remaining. The machine has a book value of $44,000 and a current market value of $40,000.
Jacqueline Elliott, the Chief Financial Officer of Taylor, is considering replacing this machine with a
newer model costing $75,000. The new machine will save $5,000 in after-tax earnings each year for
the next six years. The new machine is in the 5-year MACRS category. Taylor Corporation is in the
34% tax bracket and has a 10 percent cost of capital.
a) Calculate the cash inflows from the sale of the old machine.
b) Calculate the net cost of the new machine.
c) Calculate the incremental depreciation on the new versus the old machine.
d) Determine the net present value of the new machine. Should they purchase the new machine?

a)Cash inflow from sale:

b)Net cost of new machine:

c)Depreciation Schedule on new machine:

d)Incremental Depreciation Schedule

72
AACSB: Analytic
Block - Chapter 12 #113
Blooms: Apply and Evaluation
Difficulty: Challenge
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

73
114. A&B Enterprises is trying to select the best investment from among four alternatives. Each alternative
involves an initial outlay of $100,000. Their cash flows follow:

Evaluate and rank each alternative based on a) payback period, b) net present value (use a 10%
discount rate), and c) internal rate of return.

74
AACSB: Analytic
Block - Chapter 12 #114
Blooms: Apply and Evaluation
Difficulty: Challenge
Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision.
Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision.
Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money.
Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.
Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital.

75
12 Summary

Category # of Q
uestio
ns

AACSB: Analytic 23

AACSB: Ethics (ethical understanding and reasoning) Abilities 3

Block - Chapter 12 114

Blooms: Analyze 1

Blooms: Apply 15

Blooms: Apply and Analysis 1

Blooms: Apply and Evaluation 4

Blooms: Evaluate 3

Blooms: Remember 17

Blooms: Understand 73

Difficulty: Basic 36

Difficulty: Challenge 15

Difficulty: Intermediate 63

Learning Objective: 12-01 A capital budgeting decision represents a long-term investment decision. 17

Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision. 40

Learning Objective: 12-03 The payback method considers the importance of liquidity; but fails to consider the time value of money. 15

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analy 38
sis.

Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analy 14
sis. The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis.

Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital. 7

Learning Objective: 12-05 The discount or cutoff rate is normally the cost of capital. The discount or cutoff rate is normally the cost of c 1
apital.

76