Question 1

Which of the statements below is TRUE of the payback period method?

Accepted Answer

The payback period method only considers the time it takes to recover the initial investment and does not incorporate any cash flows beyond that. It does not consider time-value-of-money principles either. Therefore, option A is the correct statement. Option B is incorrect because the payback period method does not discriminate against projects with early-term payouts.

Question 2

Capital budgeting decisions are typically long-term decisions.

Accepted Answer

Capital budgeting decisions involve large investments in projects with long-term implications, often spanning multiple years. These decisions involve analyzing future cash flows and assessing the potential risks and benefits of each investment option. As a result, they require significant planning, analysis, and evaluation before a decision can be made.

Question 3

Cranium,Inc.is considering a four-year project that has an initial outlay or cost of $100,000.The respective future cash inflows from its project for years 1,2,3 and 4 are: $50,000,$40,000,$30,000 and $20,000.Will it accept the project if it's payback period is 26 months?

Accepted Answer

Payback period is the time required to recover the initial investment or outlay.

To calculate the payback period, we need to add up the cash inflows until they equal the initial outlay.

In this case, the payback period would be:

Year 1 cash inflow = $50,000
Year 2 cash inflow = $40,000
Total cash inflow = $90,000

Initial outlay = $100,000

Remaining cash required to recover = $10,000

Year 3 cash inflow = $30,000
Remaining cash required to recover = $10,000 - $30,000 = -$20,000

The project pays back in 28 months or 2 years and 4 months.

Since the payback period exceeds the given limit of 26 months, the project should not be accepted, and the answer is B.

Question 4

Consider the following four-year project.The initial outlay or cost is $210,000.The respective cash inflows for years 1,2,3 and 4 are: $100,000,$80,000,$80,000 and $20,000.What is the discounted payback period if the discount rate is 11%?

Accepted Answer

The discounted cash flows for each year are calculated using the formula: Cash Flow / (1 + discount rate)^year. The cumulative discounted cash flows are then summed until they equal or exceed the initial outlay. The discounted payback period is the time it takes for these cumulative discounted cash flows to equal the initial investment. In this case, it is about 2.94 years.

Question 5

We can separate short-term and long-term decisions into three dimensions.Which of the below is NOT one of these?

Accepted Answer

The three dimensions of short-term and long-term decisions are degree of information gathering prior to the decision, cost, and length of effect. Personality of the CEO making the decisions is not one of these dimensions.

Question 6

The ________ model is usually considered the best of the capital budgeting decision-making models.

Accepted Answer

The net present value (NPV) model is typically considered the best capital budgeting decision-making model because it takes into account the time value of money, provides a dollar amount to compare to the initial investment, and considers all cash flows over the life of the project. The other models mentioned (IRR, PI, and discounted payback period) have their own advantages and disadvantages, but NPV is generally preferred.

Question 7

The ________ model answers one basic question: How soon will I recover my initial investment?

Accepted Answer

The payback period model specifically focuses on calculating the duration it will take for an investment to return its initial cost, answering the question of how soon the initial investment will be recovered.

Question 8

Which of the statements below is FALSE?

Accepted Answer

The statement that firms rarely use the payback period for small-dollar decisions is false. In reality, many companies prefer using the payback period for small-dollar decisions because it simplifies the analysis and reduces the need for detailed long-term cash flow forecasts.

Question 9

Which of the statements below is FALSE?

Accepted Answer

The Payback Period method calculates the time it takes to recover the initial investment, not the dollar amount.

Question 10

Consider the following ten-year project.The initial after-tax outlay or after-tax cost is $1,500,000.The future after-tax cash inflows each year for years 1 through 10 are $400,000 per year.What is the payback period without discounting cash flows?

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual cash inflow. So, $1,500,000 / $400,000 = 3.75 years.

Question 11

The ________ model determines at what point in time cash outflow is recovered by the corresponding future cash inflow.

Accepted Answer

The payback period model is used to determine the time it takes to recover the initial investment, i.e., when the future cash inflow equals the initial cash outflow. It is a simple measure of investment risk and liquidity and does not consider the time value of money.

Question 12

Which of the statements below is FALSE?

Accepted Answer

The Discounted Payback Period method is the time it takes to recover the initial investment in discounted dollars, not future dollars. Therefore, statement B is false. A, C, and D are true statements.

Question 13

The initial outlay or cost is $1,500,000 for a four-year project.The respective future cash inflows for years 1,2,3 and 4 are: $400,000,$500,000,$600,000 and $200,000.What is the payback period without discounting cash flows?

Accepted Answer

The cumulative cash inflows reach $1,500,000 at the end of year 3, so the payback period is 3 years.

Question 14

Consider the following three-year project.The initial after-tax outlay or after-tax cost is $1,500,000.The future after-tax cash inflows for years 1,2,3 and 4 are: $800,000,$800,000,$300,000 and $100,000,respectively.What is the payback period without discounting cash flows?

Accepted Answer

The payback period is the time it takes for the project to recover its initial investment. Here, in the first year, the project recovers $800,000, and in the second year, another $800,000, totaling $1,600,000, which exceeds the initial investment of $1,500,000. To find the exact payback period, we calculate the fraction of the year needed to recover the remaining $700,000 after the first year. Since the project fully recovers its initial investment by the end of the second year, the payback period is 1 year plus the fraction of the second year needed to recover the remaining $700,000. However, the calculation provided was incorrect in determining the exact fraction of the year needed; the correct calculation should consider the cash inflows and the point at which the initial investment is fully recovered. Given the inflows, the project recovers its initial cost between the first and second years, specifically, it takes less than 2 years, making the closest correct answer 1.875 years based on the options provided.

Question 15

A company usually establishes a short,arbitrary cutoff date for handling the initial screening of many small-dollar opportunities.

Accepted Answer

This statement is true. Many companies establish cutoff dates for handling the initial screening of small-dollar opportunities in order to streamline their processes and focus their resources on larger opportunities.

Question 16

The initial outlay or cost for a four-year project is $1,100,000.The respective cash inflows for years 1,2,3 and 4 are: $500,000,$300,000,$300,000 and $300,000.What is the discounted payback period if the discount rate is 10%?

Accepted Answer

The discounted cash flows for each year are calculated using the formula: Cash Flow / (1 + discount rate)^year. The cumulative discounted cash flows are then summed until they equal or exceed the initial outlay. The discounted payback period is the time it takes for these cumulative discounted cash flows to equal the initial investment. In this case, it is about 3.84 years.

Question 17

Because money is often limited,companies must be careful to choose projects that are feasible and profitable.

Accepted Answer

This statement is true as companies need to prioritize and invest in projects that have a high chance of success and generate profits to ensure their financial sustainability.

Question 18

________ is at the heart of corporate finance,because it is concerned with making the best choices about project selection.

Accepted Answer

The answer of ________ is at the heart of corporate...

Question 19

Name and describe three key observations that we can make about the capital budgeting decision.

Accepted Answer

The answer of Name and describe three key observations that...

Question 20

Acme,Inc.is considering a four-year project that has initial outlay or cost of $100,000.The respective cash inflows for years 1,2,3 and 4 are: $50,000,$40,000,$30,000 and $20,000.Acme uses the discounted payback period method,and has a discount rate of 11.50%.Will Acme accept the project if it's payback period is 38 months?

Accepted Answer

The answer of Acme,Inc.is considering a four-year project that has...

Quiz 9: Capital Budgeting Decision Models

Which of the statements below is TRUE of the payback period method?

Capital budgeting decisions are typically long-term decisions.

Cranium,Inc.is considering a four-year project that has an initial outlay or cost of $100,000.The respective future cash inflows from its project for years 1,2,3 and 4 are: $50,000,$40,000,$30,000 and $20,000.Will it accept the project if it's payback period is 26 months?

Consider the following four-year project.The initial outlay or cost is $210,000.The respective cash inflows for years 1,2,3 and 4 are: $100,000,$80,000,$80,000 and $20,000.What is the discounted payback period if the discount rate is 11%?

We can separate short-term and long-term decisions into three dimensions.Which of the below is NOT one of these?

The ________ model is usually considered the best of the capital budgeting decision-making models.

The ________ model answers one basic question: How soon will I recover my initial investment?

Which of the statements below is FALSE?

Which of the statements below is FALSE?

Consider the following ten-year project.The initial after-tax outlay or after-tax cost is $1,500,000.The future after-tax cash inflows each year for years 1 through 10 are $400,000 per year.What is the payback period without discounting cash flows?

The ________ model determines at what point in time cash outflow is recovered by the corresponding future cash inflow.

Which of the statements below is FALSE?

The initial outlay or cost is $1,500,000 for a four-year project.The respective future cash inflows for years 1,2,3 and 4 are: $400,000,$500,000,$600,000 and $200,000.What is the payback period without discounting cash flows?

Consider the following three-year project.The initial after-tax outlay or after-tax cost is $1,500,000.The future after-tax cash inflows for years 1,2,3 and 4 are: $800,000,$800,000,$300,000 and $100,000,respectively.What is the payback period without discounting cash flows?

A company usually establishes a short,arbitrary cutoff date for handling the initial screening of many small-dollar opportunities.

The initial outlay or cost for a four-year project is $1,100,000.The respective cash inflows for years 1,2,3 and 4 are: $500,000,$300,000,$300,000 and $300,000.What is the discounted payback period if the discount rate is 10%?

Because money is often limited,companies must be careful to choose projects that are feasible and profitable.

________ is at the heart of corporate finance,because it is concerned with making the best choices about project selection.

Name and describe three key observations that we can make about the capital budgeting decision.