Question 1

Financing an investment with debt increases the net present value of the investment.

Accepted Answer

Financing an investment with debt can increase the net present value of the investment because the cost of borrowing is typically lower than the expected return on the investment. However, using too much debt can increase the risk and potential for financial distress, which can ultimately decrease the net present value.

Question 2

Super Haulers is a hauling company and delivers large and heavy materials to construction job sites. Super Haulers is considering purchasing a new dump truck that costs $185,000 and the managers of Super Haulers have estimated that the new dump truck will generate $50,000 a year in future operating profit for the next four years. At the end of four years, Super Haulers can sell the dump truck at a salvage price of $20,000. If the discount rate is 5 percent, which of the following is true if the managers of Super Haulers are profit- maximizing?
A)The manager should make the investment because the net present value is negative.
B)The manager should not make the investment because the net present value is negative.
C)The manager should make the investment because the net present value is positive.
D)The manager should not make the investment because the net present value is positive.

Accepted Answer

To determine whether the investment is worthwhile or not, the net present value (NPV) of the investment should be calculated. Using a discount rate of 5 percent, the NPV of the investment can be calculated as follows:

NPV = (-$185,000) + ($50,000 / (1 + 0.05)^1) + ($50,000 / (1 + 0.05)^2) + ($50,000 / (1 + 0.05)^3) + ($50,000 / (1 + 0.05)^4) + ($20,000 / (1 + 0.05)^4)
NPV = -$185,000 + $47,619.05 + $45,351.47 + $43,192.35 + $41,132.25 + $14,621.82
NPV = $6,613.94

Since the NPV is positive, the investment is expected to generate a return that exceeds the discount rate, and managers of Super Haulers should make the investment. Therefore, the correct answer is C: The manager should make the investment because the net present value is positive.

Question 3

When the maximum amount of interest is paid on a loan, the present value of the cost of the investment exceeds the initial cost of the investment.

Accepted Answer

The present value of the cost of the investment, including interest, represents the current worth of all future payments made for the investment. If the maximum amount of interest is paid, it increases the total cost over time, but the present value is a way to compare the total cost to the initial cost at a single point in time, typically not exceeding the initial cost when considering the time value of money.

Question 4

When a firm uses its own funds to self- finance an investment, the operating profit exceeds the taxable profit.

Accepted Answer

When a firm uses its own funds to self-finance an investment, the operating profit and taxable profit are not directly affected by the source of financing. Operating profit is determined by the firm's core business operations, while taxable profit is calculated after accounting for allowable deductions and expenses. The decision to self-finance does not inherently cause operating profit to exceed taxable profit.

Question 5

Accountants consider depreciation allowance as profit before calculating the tax._______and _______it from the firm's operating
A)profit; add
B)a cost; subtract
C)profit; subtract
D)a cost; add

Accepted Answer

Depreciation is considered a cost and is subtracted from the firm's operating profit before calculating tax, as it reduces the taxable income.

Question 6

In a sensitivity analysis, managers should change ________ variable(s)at a time to determine how sensitive the_______ _ value of the investment is to the different variables used in the calculations.
A)all; future
B)one; present
C)one; future
D)all; present

Accepted Answer

In a sensitivity analysis, managers should change only one variable at a time to determine how sensitive the present value of the investment is to the different variables used in the calculations. This allows them to isolate the impact of each individual variable on the investment's value. Changing all variables at once would make it difficult to determine which variable is having the most significant impact on the investment's value. Changing only future variables would not provide a clear indication of the impact of current variables on the investment's value.

Question 7

Salvage values are strictly positive.

Accepted Answer

Salage values can be zero or positive, depending on the residual value of the asset at the end of its useful life.

Question 8

A firm is considering using its own funds to finance an investment, but needs an estimate of the discount rate. Currently the firm is earning 4 percent on funds held in a bank account and 6 percent on funds held in stocks. If the firm has 20 percent of its funds in the bank account and the remaining 80 percent in stocks, what is the firm's weighted average cost of capital?
A)5.6 percent
B)5.8 percent
C)4.4 percent
D)4.2 percent

Accepted Answer

The firm's weighted average cost of capital (WACC) is calculated by taking the weighted average of the returns on the different types of investments it holds, which in this case are the bank account and stocks. The calculation is as follows: (0.20 * 4%) + (0.80 * 6%) = 0.8% + 4.8% = 5.6%.

Question 9

Depreciation allowance _________ the profit subject to taxation, which_______ the amount of tax the firm pays.
A)decreases; decreases
B)increases; increases
C)increases; decreases
D)decreases; increases

Accepted Answer

Depreciation allowance decreases the profit subject to taxation because it is deducted from the revenue before calculating taxable income, which in turn decreases the amount of tax the firm pays because the tax is calculated on a lower profit.

Question 10

If a project involves risk, managers can account for the risk by_______ the discount rate, which _______the present value of the future profits.
A)decreasing; increases
B)increasing; decreases
C)increasing; increases
D)decreasing; decreases

Accepted Answer

When a project involves risk, its future cash flows become uncertain. Therefore, managers can increase the discount rate to account for the risk, which decreases the present value of the future profits. This means that the project's profitability would be lower than what was initially estimated due to higher uncertainty, and a higher level of compensation would be required to justify the investment. Thus, increasing the discount rate is the correct way to account for risk, and option B is the correct answer.

Question 11

Economists consider economic depreciation to be the_______ in market value from the use of the capital and measure this use in terms of _______cost.
A)decrease; opportunity
B)decrease; marginal
C)increase; opportunity
D)increase; marginal

Accepted Answer

Economic depreciation refers to the decrease in market value of capital due to usage. This loss is measured in terms of opportunity cost, as the capital could have been used for alternative purposes instead of depreciating in value.

Question 12

A manager is considering investing in a new piece of equipment. The equipment cost $50,000 and the manager will finance the full amount of the cost over three years at an interest rate of 4 percent. In the third year, the manager will repay the entire principal of the loan plus the year's annual interest, after making interest- only payments for the first two years. The equipment will generate $30,000 in future operating profit each of the three years and has a salvage value of zero at the end of the three years. The tax rate on the firm's profit is 8 percent each year. What is the net present value of the investment?
A)$32,598
B)$27,036
C)$20,589
D)$35,852

Accepted Answer

The net present value (NPV) of the investment is calculated by discounting the net cash flows from the investment back to their present value and subtracting the initial investment. The net cash flows are the operating profits minus taxes and interest payments, adjusted for the repayment of the principal in the third year. Given the information, the calculation would involve finding the present value of the net cash flows for each of the three years and subtracting the initial investment of $50,000. The correct answer reflects the NPV calculation taking into account the 4% interest rate for financing, the 8% tax rate on profits, and the repayment structure of the loan.

Question 13

Financing an investment with debt _______the net present value of the investment because interest payments_______ tax deductible and the full amount of the principal is due in .
A)increases; are; present time
B)increases; are; the future
C)decreases; are; the present time
D)increases; are not; the future

Accepted Answer

Financing an investment with debt increases the net present value because interest payments are tax deductible, which reduces the taxable income and thus taxes paid, and the full amount of the principal is typically due in the future, allowing the use of funds at a lower cost in the present.

Question 14

Operating profits omit interest payments.

Accepted Answer

Operating profits are a measure of a company's earnings excluding interest expenses and taxes.

Question 15

All of the following are tax shields except which one?
A)depreciation allowances
B)straight- line depreciation
C)an interest- only payment of a loan
D)a principal payment on a loan

Accepted Answer

A principal payment on a loan is not a tax shield because it is not deductible for tax purposes. Depreciation allowances, straight-line depreciation, and an interest-only payment of a loan are all tax shields because they reduce taxable income and therefore reduce the amount of taxes owed.

Question 16

A make- or- buy decision examines whether a manager should incur - period costs in order to produce _______in the ________ period(s).
A)future; inputs; present
B)present; inputs; future
C)present; outputs; future
D)future; outputs; present

Accepted Answer

A make-or-buy decision considers whether a company should incur period costs in order to produce outputs in future periods, or whether it would be more cost-effective to purchase inputs from an external supplier. Therefore, the correct answer is "present; inputs; future", which corresponds to choice B.

Question 17

Suppose a manager of a firm is considering investing in a piece of equipment that will generate $20,000 in future operating profit each year for the next three years. The discount rate is 5 percent and the salvage value of zero. The equipment's current cost is $50,000 and this cost will be financed by the firm. If the tax rate on the firm's profit is 4 percent each year, what is the net present value of the equipment?
A)- $2,581
B)$2,286
C)$3,569
D)$4,464

Accepted Answer

To find the net present value (NPV), we need to calculate the present value of each year's operating profit and then subtract the initial cost of the equipment.

First, let's calculate the present value factor using the discount rate and number of years:
PVF = 1 / (1+r)^n
PVF = 1 / (1+0.05)^1 = 0.9524
PVF = 1 / (1+0.05)^2 = 0.9070
PVF = 1 / (1+0.05)^3 = 0.8638

Next, we can calculate the present value of each year's operating profit:
Year 1: $20,000 x 0.96 / (1+0.05)^1 = $19,047
Year 2: $20,000 x 0.96 / (1+0.05)^2 = $17,750
Year 3: $20,000 x 0.96 / (1+0.05)^3 = $16,423

Now, we can calculate the NPV by subtracting the initial cost from the sum of the present values:
NPV = -$50,000 + $19,047 + $17,750 + $16,423
NPV = -$50,000 + $53,220
NPV = $3,220

Since the NPV is positive, the investment is expected to generate a return greater than the required rate of return (5%), so it would be a good investment. Choice B is the correct answer.

Question 18

A manager is considering investing in a new piece of equipment. The equipment cost $50,000 and the manager will finance the full amount of the cost over three years at an interest rate of 4 percent. In the third year, the manager will repay the entire principal of the loan plus the year's annual interest, after making interest- only payments for the first two years. The equipment will generate $30,000 in future operating profit each of the three years and has a salvage value of zero at the end of the three years. The tax rate on the firm's profit is 8 percent each year. What is the firm's interest- only payment in each of the three years?
A)$2,400
B)$4,000
C)$1,200
D)$2,000

Accepted Answer

The interest-only payment each year is calculated as the principal amount ($50,000) multiplied by the interest rate (4%), which equals $2,000.

Question 19

If the life span of a piece of equipment is 10 years and its current cost is $400,000, what is the straight- line depreciation allowance each year?
A)$40,000
B)$400
C)$4,000
D)$400,000

Accepted Answer

The straight-line depreciation method divides the cost of the asset by its lifespan to find the annual depreciation expense. Here, $400,000 / 10 years = $40,000 per year.

Question 20

The lower the tax rate, the _______the after- tax profits and the ________ the after- tax net present value of an investment.
A)lower; higher
B)higher; higher
C)lower; lower
D)higher; lower

Accepted Answer

Lower tax rates increase after-tax profits because businesses get to keep a larger portion of their earnings. Similarly, the after-tax net present value (NPV) of an investment increases as the tax rate decreases, because the future cash flows from the investment are less reduced by taxes, making the investment more valuable.

Quiz 16: Using Present Value to Make Multi-Period Managerial Decisions

Financing an investment with debt increases the net present value of the investment.

When the maximum amount of interest is paid on a loan, the present value of the cost of the investment exceeds the initial cost of the investment.

When a firm uses its own funds to self- finance an investment, the operating profit exceeds the taxable profit.

Accountants consider depreciation allowance as profit before calculating the tax._and _it from the firm's operating

In a sensitivity analysis, managers should change __ variable(s) at a time to determine how sensitive the_ _ value of the investment is to the different variables used in the calculations.

Salvage values are strictly positive.

Depreciation allowance ___ the profit subject to taxation, which_ the amount of tax the firm pays.

If a project involves risk, managers can account for the risk by_ the discount rate, which _the present value of the future profits.

Economists consider economic depreciation to be the_ in market value from the use of the capital and measure this use in terms of _cost.

Financing an investment with debt _the net present value of the investment because interest payments_ tax deductible and the full amount of the principal is due in .

Operating profits omit interest payments.

All of the following are tax shields except which one?

A make- or- buy decision examines whether a manager should incur - period costs in order to produce _in the __ period(s) .

If the life span of a piece of equipment is 10 years and its current cost is $400,000, what is the straight- line depreciation allowance each year?

The lower the tax rate, the _the after- tax profits and the __ the after- tax net present value of an investment.

Quiz 16: Using Present Value to Make Multi-Period Managerial Decisions

Financing an investment with debt increases the net present value of the investment.

When the maximum amount of interest is paid on a loan, the present value of the cost of the investment exceeds the initial cost of the investment.

When a firm uses its own funds to self- finance an investment, the operating profit exceeds the taxable profit.

Accountants consider depreciation allowance as profit before calculating the tax._______and _______it from the firm's operating

In a sensitivity analysis, managers should change ________ variable(s) at a time to determine how sensitive the_______ _ value of the investment is to the different variables used in the calculations.

Salvage values are strictly positive.

Depreciation allowance _________ the profit subject to taxation, which_______ the amount of tax the firm pays.

If a project involves risk, managers can account for the risk by_______ the discount rate, which _______the present value of the future profits.

Economists consider economic depreciation to be the_______ in market value from the use of the capital and measure this use in terms of _______cost.

Financing an investment with debt _______the net present value of the investment because interest payments_______ tax deductible and the full amount of the principal is due in .

Operating profits omit interest payments.

All of the following are tax shields except which one?

A make- or- buy decision examines whether a manager should incur - period costs in order to produce _______in the ________ period(s) .

If the life span of a piece of equipment is 10 years and its current cost is $400,000, what is the straight- line depreciation allowance each year?

The lower the tax rate, the _______the after- tax profits and the ________ the after- tax net present value of an investment.

Accountants consider depreciation allowance as profit before calculating the tax._and _it from the firm's operating

In a sensitivity analysis, managers should change __ variable(s) at a time to determine how sensitive the_ _ value of the investment is to the different variables used in the calculations.

Depreciation allowance ___ the profit subject to taxation, which_ the amount of tax the firm pays.

If a project involves risk, managers can account for the risk by_ the discount rate, which _the present value of the future profits.

Economists consider economic depreciation to be the_ in market value from the use of the capital and measure this use in terms of _cost.

Financing an investment with debt _the net present value of the investment because interest payments_ tax deductible and the full amount of the principal is due in .

A make- or- buy decision examines whether a manager should incur - period costs in order to produce _in the __ period(s) .

The lower the tax rate, the _the after- tax profits and the __ the after- tax net present value of an investment.