1) The first step in the capital budgeting process is
b. proposal generation.
d. review and analysis.
2) All of the following are steps in the capital budgeting process EXCEPT
3) Cash flows that could be realized from the best alternative use of an owned asset are
a. opportunity costs.
b. incremental costs.
c. lost resale opportunities.
d. sunk costs.
4) An important cash inflow in the analysis of initial cash flows for a replacement project
a. installation cost.
b. the cost of the new asset.
c. the sale value of the old asset.
5) A corporation is considering expanding operations to meet growing demand. With
the capital expansion, the current accounts are expected to change. Management
expects cash to increase by $20,000, accounts receivable by $40,000, and inventories
by $60,000. At the same time accounts payable will increase by $50,000, accruals
by $10,000, and long-term debt by $100,000. The change in net working
a. a decrease of $40,000.
b. a decrease of $120,000.
c. an increase of $120,000.
d. an increase of $60,000.
6) A loss on the sale of an asset that is depreciable and used in business is ________; a
loss on the sale of a non-depreciable asset is ________.
a. not deductible; deductible only against capital gains
b. deductible from ordinary income; deductible only against capital gains
c. a credit against the tax liability; not deductible
d. deductible from capital gains income; deductible from ordinary income
7) A corporation has decided to replace an existing asset with a newer model. Two years
ago, the existing asset originally cost $30,000 and was being depreciated under
MACRS using a five-year recovery period. The existing asset can be sold for $25,000.
The new asset will cost $75,000 and will also be depreciated under MACRS using a
five-year recovery period. If the assumed tax rate is 40 percent on ordinary income
and capital gains, the initial investment is ________.
8) A corporation is evaluating the relevant cash flows for a capital budgeting decision
and must estimate the terminal cash flow. The proposed machine will be disposed
of at the end of its usable life of five years at an estimated sale price of $15,000.
The machine has an original purchase price of $80,000, installation cost of
$20,000, and will be depreciated under the five-year MACRS. Net working capital is
expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income
and long-term capital gain. The terminal cash flow is
9) All of the following are weaknesses of the payback period EXCEPT
a. only an implicit consideration of the timing of cash flows.
b. the difficulty of specifying the appropriate payback period.
c. a disregard for cash flows after the payback period.
d. it uses cash flows, not accounting profits.
10) Payback is considered an unsophisticated capital budgeting because it
a. gives explicit consideration to risk exposure due to the use of the cost of capital as a
b. gives explicit consideration to the timing of cash flows and therefore the time value of
c. gives consideration to cash flows that occur before the payback period.
d. none of the above
11) What is the payback period for Tangshan Mining company’s new project if its initial
after tax cost is $5,000,000 and it is expected to provide after-tax operating cash
inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3 and
$1,800,000 in year 4?
a. 3.33 years.
b. 4.33 years.
c. 2.33 years.
d. None of the above
12) Should Tangshan Mining company accept a new project if its maximum payback is
3.5 years and its initial after tax cost is $5,000,000 and it is expected to provide after-
tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2,
$700,000 in year 3 and $1,800,000 in year 4?
c. It depends.
13) What is the NPV for the following project if its cost of capital is 0 percent and its
initial after tax cost is $5,000,000 and it is expected to provide after-tax operating
cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3
and $1,300,000 in year 4?
14) What is the IRR for the following project if its initial after tax cost is $5,000,000
and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1,
$2,900,000 in year 2, $2,700,000 in year 3 and $2,300,000 in year 4?
15) Consider the following projects, X and Y where the firm can only choose one. Project
X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also
costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively.
Which investment should the firm choose if the cost of capital is 25 percent?
a. Project Y.
b. Project X.
d. Not enough information to tell.
16) The ________ is the compound annual rate of return that the firm will earn if it invests
in the project and receives the given cash inflows.
a. discount rate
b. opportunity cost
c. cost of capital
d. internal rate of return
17) In comparing the internal rate of return and net present value methods of evaluation,
a. net present value is theoretically superior, but financial managers prefer to use internal
rate of return.
b. financial managers prefer net present value, because it measures benefits relative to
the amount invested.
c. financial managers prefer net present value, because it is presented as a rate of return.
d. internal rate of return is theoretically superior, but financial managers prefer net present
18) In the context of capital budgeting, risk generally refers to
a. the chance that the net present value will be greater than zero.
b. the degree of variability of the initial investment.
c. the chance that the internal rate of return will exceed the cost of capital.
d. the degree of variability of the cash inflows.
19) Two approaches for dealing with project risk to capture the variability of cash inflows
and NPVs are
a. scenario analysis and simulation.
b. sensitivity analysis and scenario analysis.
c. sensitivity analysis and simulation.
d. none of the above.
20) A behavioral approach for dealing with project risk that uses several possible values
for a given variable such as cash inflows to assess that variable’s impact on NPV is
a. sensitivity analysis.
b. simulation analysis.
c. scenario analysis
21) The ________ reflects the return that must be earned on the given project to compensate
the firm’s owners adequately according to the project’s variability of cash flows.
a. cost of capital
b. internal rate of return
c. risk-adjusted discount rate
d. average rate of return
22) The theoretical basis from which the concept of risk-adjusted discount rates is derived
a. simulation theory.
b. the Gordon model.
c. the capital asset pricing model.
d. the basic cost of money.
23) The ________ approach is used to convert the net present value of unequal-lived projects
into an equivalent annual amount (in net present value terms).
a. investment opportunities schedule
b. annualized net present value
c. internal rate of return
d. risk-adjusted discount rate
24) Major types of real options include all of the following except the
a. growth option.
b. conversion option.
c. timing option.
d. abandonment option.
25) The ________ is the rate of return a fi rm must earn on its investments in projects in
order to maintain the market value of its stock.
c. gross profit margin
d. net present value