Deck 10: Capital Budgeting Techniques

Question 1

In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value of money, risk and return considerations, and valuation concepts to select capital expenditures that are consistent with the firm's goal of maximizing owners' wealth.

Answer 1

False

Question 2

Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

Answer 2

False

Question 3

Capital budgeting is the process of evaluating and selecting short-term investments that are consistent with the firm's goal of maximizing owners' wealth.

Answer 3

False

Question 4

An outlay for advertising and management consulting is considered to be a fixed asset expenditure.

Question 5

The capital budgeting process consists of five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up.

Question 6

If a firm has unlimited funds to invest in capital assets, all independent projects that meet its minimum investment criteria should be implemented.

Question 7

The basic motives for capital expenditures are to expand operations, to replace or renew fixed assets, or to obtain some other, less tangible benefit over a long period.

Question 8

Capital budgeting techniques are used to evaluate a firm's fixed asset investments which provide the basis for the firm's earning power and value.

Question 9

If a firm has limited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria should be implemented.

Question 10

In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value procedures, risk and return considerations, and valuation concepts.

Question 11

Independent projects are projects that compete with one another for a firm's resources, so that the acceptance of one eliminates the others from further consideration.

Question 12

Capital expenditure proposals are reviewed to assess their appropriateness in light of a firm's overall objectives and plans, and to evaluate their economic validity.

Question 13

A capital expenditure is an outlay of funds invested only in fixed assets that is expected to produce benefits over a period of time less than one year.

Question 14

A nonconventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows.

Question 15

A $60,000 outlay for a new machine with a usable life of 15 years is an operating expenditure that would appear as a current asset on a firm's balance sheet.

Question 16

The capital budgeting process consists of four distinct but interrelated steps: proposal generation, review and analysis, decision making, and termination.

Question 17

The purchase of additional physical facilities, such as additional property or a new factory, is an example of a capital expenditure.

Question 18

Research and development is considered to be a motive for making capital expenditures.

Question 19

Time value of money should be ignored in capital budgeting techniques to make accurate decisions.

Question 20

The primary motive for capital expenditures is to refurbish fixed assets.

Question 21

A nonconventional cash flow pattern is one in which an initial inflow is followed by a series of inflows and outflows.

Question 22

A conventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows.

Question 23

Fixed assets that provide the basis for a firm's earning and value are often called ________.

A) tangible assets
B) noncurrent assets
C) earning assets
D) book assets

Question 24

If a firm is subject to capital rationing, it has only a fixed number of dollars available for capital expenditures and numerous projects compete for these dollars.

Question 25

If a firm is subject to capital rationing, it is able to accept all independent projects that provide an acceptable return.

Question 26

Independent projects are those whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

Question 27

Mutually exclusive projects are those whose cash flows compete with one another; the acceptance of one eliminates the others from further consideration.

Question 28

One of the primary motives for adding fixed assets to a firm is ________.

A) expansion
B) replacement
C) renewal
D) transformation

Question 29

Large firms evaluate the merits of individual capital budgeting projects to ensure that the selected projects have the best chance of increasing the firm value.

Question 30

A $60,000 outlay for a new machine with a usable life of 15 years is called ________.

A) capital expenditure
B) financing expenditure
C) replacement expenditure
D) operating expenditure

Question 31

Mutually exclusive projects are those whose cash flows are constant over a specified period of time and more than one project needs to be accepted in order to implement capital budgeting decisions.

Question 32

The availability of funds for capital expenditures does not affect a firm's capital budgeting decisions.

Question 33

If a firm has unlimited funds, it is able to accept all independent projects that provide an acceptable return.

Question 34

The final step in the capital budgeting process is ________.

A) implementation
B) follow-up
C) review and analysis
D) decision making

Question 35

Which of the following is true of a capital expenditure?

A) It is an outlay made to replace current assets.
B) It is an outlay expected to produce benefits within one year.
C) It is commonly used for current asset expansion.
D) It is commonly used to expand the level of operations.

Question 36

The basic motive for capital expenditure is to ________.

A) expand operations
B) replace current assets
C) renew current assets
D) improve leverage

Question 37

The ranking approach involves the ranking of capital expenditure projects on the basis of some predetermined measure such as the rate of return.

Question 38

Independent projects are those whose cash flows compete with one another and therefore more than one project needs to be accepted in order to implement the capital budgeting decision.

Question 39

________ is the process of evaluating and selecting long-term investments that are consistent with a firm's goal of maximizing owners' wealth.

A) Recapitalizing assets
B) Capital budgeting
C) Ratio analysis
D) Securitization

Question 40

The accept-reject approach involves the ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return.

Question 41

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $2,000 each year for the next three years is 0.5 years.

Question 42

The first step in the capital budgeting process is ________.

A) review and analysis
B) implementation
C) decision making
D) proposal generation

Question 43

Which of the following is true of the accept-reject approach?

A) It involves ranking projects on the basis of some predetermined measure, such as the rate of return.
B) It cannot be used when the firm has limited funds.
C) It can be used for making capital budgeting decisions when there is capital rationing.
D) It can be used only for evaluating mutually exclusive projects.

Question 44

The payback period is the amount of time required for a firm to dispose a replaced asset.

Question 45

Which of the following is an example of a nonconventional pattern of cash flows?

A)
B)
C)
D)

Question 46

Which of the following steps in the capital budgeting process follows the decision making step?

A) proposal generation
B) review and analysis
C) transformation
D) implementation

Question 47

________ projects have the same function; the acceptance of one ________ the others from consideration.

A) Capital; eliminates
B) Independent; does not eliminate
C) Mutually exclusive; eliminates
D) Replacement; eliminates

Question 48

Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration are called ________.

A) independent projects
B) mutually exclusive projects
C) replacement projects
D) capital projects

Question 49

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 each year for the next three years is 0.333 years.

Question 50

For calculating payback period for an annuity, all cash flows must be adjusted for time value of money.

Question 51

A nonconventional cash flow pattern associated with capital investment projects consists of an initial ________.

A) outflow followed by a series of both cash inflows and outflows
B) inflow followed by a series of both cash inflows and outflows
C) outflow followed by a series of inflows
D) inflow followed by a series of outflows

Question 52

A firm with limited dollars available for capital expenditures is subject to ________.

A) capital dependency
B) capital gains
C) working capital constraints
D) capital rationing

Question 53

If a project's payback period is greater than the maximum acceptable payback period, we would accept it.

Question 54

A conventional cash flow pattern associated with capital investment projects consists of an initial ________.

A) outflow followed by a broken cash series
B) inflow followed by a broken series of outlay
C) outflow followed by a series of inflows
D) outflow followed by a series of outflows

Question 55

In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

Question 56

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $3,000 each year for the next three years is 0.333 years.

Question 57

If a project's payback period is greater than the maximum acceptable payback period, we would reject it.

Question 58

If a project's payback period is less than the maximum acceptable payback period, we would accept it.

Question 59

________ projects do not compete with each other; the acceptance of one ________ the others from consideration.

A) Capital; eliminates
B) Independent; does not eliminate
C) Mutually exclusive; eliminates
D) Replacement; eliminates

Question 60

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 for the next three years is 3.33 years.

Question 61

Which of the following statements is true of payback period?

A) If the payback period is less than the maximum acceptable payback period, management should be indifferent.
B) If the payback period is greater than the maximum acceptable payback period, accept the project.
C) If the payback period is less than the maximum acceptable payback period, accept the project.
D) If the payback period is greater than the maximum acceptable payback period, management should be indifferent.

Question 62

Table 10.2
The cash flow pattern depicted is associated with a capital investment and may be characterized as ________. (See Table 10.2)

A) an annuity and a conventional cash flow
B) a mixed stream and a nonconventional cash flow
C) an annuity and a nonconventional cash flow
D) a mixed stream and a conventional cash flow

Question 63

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?

A) Yes, since the payback period of the project is less than the maximum acceptable payback period.
B) No, since the payback period of the project is more than the maximum acceptable payback period.
C) Yes, since the risk exposure of the project is less than the maximum acceptable risk exposure.
D) No, since the risk exposure of the project is more than the maximum acceptable risk exposure.

Question 64

One strength of payback period is that it fully accounts for the time value of money.

Question 65

By measuring how quickly a firm recovers its initial investment, the payback period gives implicit consideration to the time value of money and ignores the timing of cash flows.

Question 66

A project must be rejected if its payback period is less than the maximum acceptable payback period.

Question 67

A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years. The payback period of the project is ________.

A) 1.5 years
B) 2 years
C) 3.3 years
D) 4 years

Question 68

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) 4.33 years
B) 3.33 years
C) 2.33 years
D) 1.33 years

Question 69

The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.

Question 70

Which of the following capital budgeting techniques ignores the time value of money?

A) payback period approach
B) net present value
C) internal rate of return
D) profitability index

Question 71

The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.

Question 72

An annuity is ________.

A) a mix of cash flows in conventional and nonconventional
B) a stream of perpetual cash flows
C) a series of constantly growing cash flows
D) a series of equal annual cash flows

Question 73

Table 10.1
The cash flow pattern depicted is associated with a capital investment and may be characterized as ________. (See Table 10.1)

A) an annuity and a conventional cash flow
B) a mixed stream and a nonconventional cash flow
C) an annuity and a nonconventional cash flow
D) a mixed stream and a conventional cash flow

Question 74

Payback is considered an unsophisticated capital budgeting because it ________.

A) gives explicit consideration to the timing of cash flows and therefore the time value of money.
B) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate.
C) does not gives explicit consideration on the recovery of initial investment and possibility of a calamity.
D) it does not explicitly consider the time value of money.

Question 75

One weakness of payback period approach is its failure to recognize cash flows that occur after the payback period.

Question 76

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a supplement to other decision techniques.

Question 77

Which of the following is an unsophisticated capital budgeting technique?

A) internal rate of return
B) payback period
C) profitability index
D) net present value

Question 78

Which pattern of cash flow stream is the most difficult to use when evaluating projects?

A) mixed stream
B) conventional flow
C) nonconventional flow
D) annuity

Question 79

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is ________.

A) 1 year
B) 2 years
C) between 1 and 2 years
D) between 2 and 3 years

Question 80

The ________ measures the amount of time it takes a firm to recover its initial investment.

A) profitability index
B) internal rate of return
C) net present value
D) payback period