Unit 5: Investment Decisions - Practice Quiz

1 What is a capital budgeting decision primarily concerned with?

2 Which proposal is most likely to require a capital budgeting decision?

3 What does an independent project mean in capital budgeting?

4 Why are capital budgeting decisions important to a company?

5 What is a common financial objective of capital budgeting?

6 Why should future cash flows be estimated before accepting a capital project?

7 Which technique does not explicitly consider the time value of money?

8 Which pair consists of non-discounting capital budgeting techniques?

9 What is a major advantage of non-discounting techniques?

10 What does the payback period measure?

11 A project costs $60,000 and generates equal annual cash inflows of $20,000. What is its payback period?

12 Under the payback method, when is a project generally accepted?

13 What is a limitation of the traditional payback period?

14 Which formula represents the profitability index?

15 A project has cash inflows with a present value of $120,000 and an initial investment of $100,000. What is its profitability index?

16 Using the profitability index rule, which project is normally acceptable?

17 What does the accounting rate of return primarily use?

18 When average investment is used as the denominator, which formula calculates ARR?

19 A project earns an average annual accounting profit of $10,000 on an average investment of $50,000. What is its ARR?

20 Under the ARR method, when is a project generally accepted?

21 A company is considering replacing an existing machine. Which cash flows should be included in the capital budgeting analysis?

22 A new machine costs $500,000, installation costs $20,000, and additional working capital of $40,000 is required. An old machine with a book value of $20,000 can be sold for $30,000. If the tax rate is $25\%$, what is the initial net investment?

23 Why does an incorrect capital budgeting decision often have a greater effect than an incorrect short-term inventory decision?

24 A project reports high accounting income but generates cash receipts mainly in its final years. Why should management still evaluate the timing of its cash flows?

25 Which limitation is shared by the traditional payback period and the accounting rate of return?

26 A cash-constrained company emphasizes how quickly a project recovers its initial cost. Which non-discounting technique best addresses this concern?

27 A project requires an initial investment of $240,000 and generates equal annual cash inflows of $60,000. What is its payback period?

28 A project costs $300,000 and is expected to generate cash inflows of $80,000, $100,000, $90,000, and $70,000 in Years 1–4. Assuming cash flows occur evenly during each year, what is the payback period?

29 A company requires projects to pay back within 3 years. Project X has a payback of 2.8 years, while Project Y has a payback of 3.2 years. What decision follows from this rule?

30 Projects A and B each cost $200,000 and both pay back in 3 years. After Year 3, Project A generates an additional $100,000, while Project B generates no additional cash. What does the traditional payback method conclude?

31 A project requires $220,000 initially, including $20,000 of working capital. It generates $60,000 annually for four years, and the working capital is recovered at the end of Year 4. Assuming Year 4 cash flows occur evenly, what is the payback period?

32 A project requires an initial investment of $480,000 and has a present value of future cash inflows of $540,000. What is its profitability index?

33 An independent project has a profitability index of . Based only on this measure, what should the company do?

34 A company has a $300,000 capital budget. Project A costs $180,000 and has inflows with a present value of $225,000. Project B costs $120,000 and has inflows with a present value of $156,000. Project C costs $300,000 and has inflows with a present value of $375,000. The projects are indivisible. Which selection creates the most value?

35 Two mutually exclusive projects have the following results: Project A has an initial cost of $100,000 and present-value inflows of $140,000; Project B has an initial cost of $500,000 and present-value inflows of $650,000. If the goal is to maximize shareholder wealth and funding is available, which project should be selected?

36 A project's profitability index increases from to while its initial investment remains unchanged. What must have occurred, assuming the same cash-flow estimates?

37 A project costs $240,000, has no salvage value, and earns an average annual accounting profit of $36,000. Using average investment as the denominator, what is its accounting rate of return?

38 A machine costs $200,000, has a $20,000 salvage value, and lasts 5 years. It produces average annual cash inflows of $62,000 and has no other operating expenses. Using straight-line depreciation and average investment, what is its ARR?

39 Equipment costs $300,000, will have a salvage value of $40,000, and requires permanent working capital of $20,000. If average annual accounting profit is $38,000, what is the ARR using average investment?

40 A company requires a minimum ARR of . Project M has an ARR of , and Project N has an ARR of . If the projects are independent, what decision follows from the ARR rule?

41 A company is considering replacing an old machine with a new one. The new machine costs USD 500,000, requires USD 20,000 of installation, and increases net working capital by USD 40,000. The old machine has a book value of USD 60,000 and can be sold immediately for USD 90,000. If the tax rate is , what is the replacement project's initial net outlay?

42 A new product will generate annual sales of USD 1,200,000 and variable costs of USD 720,000. It is allocated USD 180,000 of existing fixed overhead, but only USD 60,000 is incremental. The product will reduce the annual contribution from another product by USD 90,000. Annual depreciation is USD 100,000, and the tax rate is . What is the project's annual operating cash flow?

43 An analyst forecasts a project's revenues and costs in nominal terms, explicitly incorporating expected inflation. Which discounting approach is internally consistent?

44 When a project's required return is estimated using the weighted average cost of capital, why is interest expense normally excluded from the project's operating cash flows?

45 A project generates annual earnings before depreciation and tax of USD 70,000. Tax depreciation is USD 120,000, the tax rate is , and the firm can immediately use project tax losses against other income. What is annual operating cash flow?

46 Projects P and Q each cost USD 100,000, last three years, have zero salvage value, and use straight-line depreciation. Their annual net cash inflows are P: USD 60,000, USD 40,000, USD 30,000; and Q: USD 50,000 each year. Using average investment for ARR, which comparison is correct?

47 Two projects each cost USD 100,000, last three years, and have zero salvage value. Project A produces cash inflows of USD 90,000, USD 10,000, and USD 10,000; Project B produces USD 40,000 annually. Assuming straight-line depreciation and average investment for ARR, how do the methods rank them?

48 A project costs USD 480,000 and generates year-end cash inflows of USD 100,000, USD 140,000, USD 180,000, and USD 160,000. Assuming cash flows occur uniformly within each year, what is its payback period?

49 A project requires USD 500,000 and generates USD 150,000 at each year-end. If abandoned at the end of year 3, it also produces USD 80,000 of after-tax disposal proceeds. What is the earliest end-of-year point at which the initial investment is recovered under this abandonment policy?

50 A project has cash flows of USD initially, USD in year 1, and USD in year 2 for mandatory remediation. What is the most accurate interpretation of its conventional payback period?

51 A project requires an immediate investment of USD 400,000. The present value of its future operating inflows is USD 468,000, and the present value of a mandatory future decommissioning outflow is USD 28,000. If PI uses net post-investment cash flows in the numerator, what is the profitability index?

52 Two mutually exclusive projects have equal risk. Project X costs USD 100,000 and has future inflows with a present value of USD 130,000. Project Y costs USD 500,000 and has future inflows with a present value of USD 620,000. With no capital constraint, which decision is value-maximizing?

53 A firm has a USD 500,000 capital budget and can accept divisible projects. Project A costs USD 250,000 and has NPV USD 75,000; B costs USD 300,000 and has NPV USD 105,000; C costs USD 200,000 and has NPV USD 50,000; D costs USD 100,000 and has NPV USD 20,000. What is the maximum total NPV?

54 A project requires USD 250,000 immediately. Its future positive cash flows have a present value of USD 330,000, while a contractual cleanup payment has a present value of USD 40,000. Under a PI definition that nets all post-investment cash flows in the numerator, what are the PI and NPV?

55 Equipment costs USD 600,000, has a five-year life and USD 100,000 salvage value, and requires USD 50,000 of working capital throughout the project. Annual net cash income before depreciation is USD 190,000. Using straight-line depreciation and average total investment, what is ARR?

56 A four-year project costs USD 800,000, has no salvage value, and generates annual cash income before depreciation and tax of USD 300,000. The tax rate is . If ARR uses average investment and after-tax accounting profit, what is the ARR?

57 Project A costs USD 400,000, has zero salvage value, and earns average annual accounting profit of USD 60,000. Project B costs USD 300,000, has USD 100,000 salvage value, and earns USD 50,000 annually. Which ranking result is correct?

58 A replacement project releases USD 30,000 of working capital at the end of year 4. The new machine will then be sold for USD 70,000, while the old machine could have been sold for USD 20,000 if retained. Both machines will have zero tax book value, and the tax rate is . What is the replacement project's incremental terminal cash flow?

59 A company owns land with a book and tax basis of USD 120,000. It can sell the land for USD 500,000, incur USD 20,000 of selling costs, and pay tax on the stated taxable gain of USD 380,000. If the land is used for a new project, what opportunity cost should be included in the initial investment?

60 Four projects each cost USD 300,000, last four years, have zero salvage value, and use straight-line depreciation. Their annual cash inflows are M: USD 140,000, 100,000, 60,000, 40,000; N: USD 100,000, 100,000, 50,000, 200,000; O: USD 160,000, 100,000, 40,000, 20,000; and P: USD 80,000, 100,000, 140,000, 100,000. Which project satisfies both a maximum three-year payback and a minimum ARR based on average investment?