Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5 respectively. The firm uses straight-line depreciation with no residual value at the end of five years. The hurdle rate for accepting new capital investment projects is 4%, after-tax. The estimated book (accounting) rate of return on this project (rounded to two decimal points), based on the initial investment is:
If a company must choose between two mutually exclusive investment projects, the best general method to employ for decision-making purposes is:
a) Cash-flow bailout
b) Cash-flow break-even
c) Net present value (NPV)
d) Discounted payback
e) Accounting (book) rate of return, based on average investment over the life of each project
Amster Corporation has not yet decided on its discount rate for use in the evaluation of capital budgeting proposals. This lack of information will prohibit the company from calculating a proposed investment’s:
Accounting rate of return
Net present value
Internal Rate of return
Which of the following is not one of the four general classes of real options?
a) Expansion option.
b) Exercise option.
c) Abandonment option.
d) Investment-timing option (e.g., delay)
Which of the following characteristics is not true of the modified internal rate of return (MIRR)?
a) Unlike IRR, MIRR does not consider the time value of money.
b) It focuses on after-tax cash flows, rather than accounting income amounts.
c) It cannot be used reliably to choose between mutually exclusive projects.
d) Its use may not lead to an optimum capital budget.
e) It is complex to compute, if done manually.
The decision technique that measures the estimated performance of a capital investment by dividing the project’s annual after-tax income by the average investment cost is called the:
a) Break-even point for the project.
b) Internal rate of return on the proposed investment.
c) Accounting (book) rate of return on the investment.
d) Capital asset pricing model.
e) Profitability index (PI) for the investment.
Which of the following is not an important advantage of the net present value (NPV) method over the internal rate of return (IRR) method in evaluating capital investment proposals?
a) NPV facilitates comparisons of mutually exclusive projects requiring different amounts of initial investments.
b) NPV facilitates comparisons among mutually exclusive projects that have the same useful life but different initial outlays.
c) NPV can be used to determine an optimum capital budget under conditions of capital rationing, while IRR cannot.
d) NPV is relatively intuitive.
e) IRR relies on discounted cash-flow analysis, while NPV does not.
In addition to a one million dollar acquisition cost, an investment requires $200,000 working capital during its useful years. This investment in working capital should be:
a) Added to the cash outflow each year during the useful life of the investment.
b) Disregarded in the capital budgeting decision because the working capital is not an expense.
c) Treated as an immediate cash outflow that is recovered at the end of the investment’s useful life.
d) Treated as an immediate expense and a gain at the end of the investment’s useful life.
e) Added to the initial investment.
A profitable company pays $100,000 wages and has depreciation expense of $100,000. The company’s income tax rate is 40%. The after-tax effects on cash flow are a net cash outflow of:
a) $40,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
b) $40,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
c) $60,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
d) $60,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
e) $40,000 for wages and a net cash inflow of $100,000 for depreciation expenses.
In capital budgeting, the accounting rate of return (ARR) decision model:
a) Considers the time value of money.
b) Ignores cash outflows after the initial investment.
c) Incorporates the timing of cash flows.
d) Ignores accounting income generated after the break-even point.
e) Does not provide an unambiguous decision criterion regarding the acceptance of capital investment projects.
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