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Chapter 15 TB - Lauderbach 1
Chapter 15 TB - Lauderbach 1
Multiple Choice
a 4. If the present value of the future cash flows for an investment equals
the required investment, the IRR is
a. equal to the cutoff rate.
b. equal to the cost of borrowed capital.
c. equal to zero.
d. lower than the company's cutoff rate of return.
c 6. Which of the following events is most likely to reduce the expected NPV
of an investment?
a. The major competitor for the product to be manufactured with the
machinery being considered for purchase has been rated
"unsatisfactory" by a consumer group.
b. The interest rate on long-term debt declines.
c. The income tax rate is raised by the Congress.
d. Congress approves the use of faster depreciation than was previously
available.
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a 7. If an investment has a positive NPV,
a. its IRR is greater than the company's cost of capital.
b. cost of capital exceeds the cutoff rate of return.
c. its IRR is less than the company's cutoff rate of return.
d. the cutoff rate of return exceeds cost of capital.
c 8. Which of the following describes the annual returns that are discounted
in determining the NPV of an investment?
a. Net incomes expected to be earned by the project.
b. Pre-tax cash flows expected from the project.
c. After-tax cash flows expected from the project.
d. After-tax cash flows adjusted for the time value of money.
b 9. Which of the following capital budgeting methods does NOT consider the
time value of money?
a. IRR.
b. Book rate of return.
c. Time-adjusted rate of return.
d. NPV.
d 11. Which of the following is a basic difference between the IRR and the
book rate of return (BRR) criteria for evaluating investments?
a. IRR emphasizes expenses and BRR emphasizes expenditures.
b. IRR emphasizes revenues and BRR emphasizes receipts.
c. IRR is used for internal investments and BRR is used for external
investments.
d. IRR concentrates on receipts and expenditures and BRR concentrates
on revenues and expenses.
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c. cannot be used if the company plans to finance the project with
funds already available internally.
d. require forecasts of cash flows expected from the project.
c 17. Which of the following events will increase the NPV of an investment
involving a new product?
a. An increase in the income tax rate.
b. An increase in the expected per-unit variable cost of the product.
c. An increase in the expected annual unit volume of the product.
d. A decrease in the expected salvage value of equipment.
b 18. An investment has a positive NPV discounting the cash flows at a 14%
cost of capital. Which statement is true?
a. The IRR is lower than 14%.
b. The IRR is higher than 14%.
c. The payback period is less than 14 years.
d. The book rate of return is 14%.
a 22. Two new products, X and Y, are alike in every way except that the sales
of X will start low and rise throughout its life, while those of Y will
be the same each year. Total volumes over their five-year lives will
be the same, as will selling prices, unit variable costs, cash fixed
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costs, and investment. The NPV of product X
a. will be less than that of product Y.
b. will be the same as that of product Y.
c. will be greater than that of product Y.
d. none of the above.
d 23. Which of the following events is most likely to increase the number of
investments that meet a company's acceptance criteria?
a. Top management raises the target rate of return.
b. The interest rate on long-term debt rises.
c. The income tax rate rises.
d. The IRS allows companies to expense purchases of fixed assets,
instead of depreciating them over their lives.
d 24. Investment A has a payback period of 5.4 years, investment B one of 6.7
years. From this information we can conclude
a. that investment A has a higher NPV than B.
b. that investment A has a higher IRR than B.
c. that investment A's book rate of return is higher than B's.
d. none of the above.
d 25. Investment A has a book rate of return of 26%, investment B one of 18%.
From this information we can conclude
a. that investment A has a higher NPV than B.
b. that investment A has a higher IRR than B.
c. that investment A has a shorter payback period than B.
d. none of the above.
c 26. A dollar now is worth more than a dollar to be received in the future
because of
a. inflation.
b. uncertainty.
c. the opportunity cost of waiting.
d. none of the above.
a 27. In contrast to the payback and book rate of return methods, the NPV and
IRR methods
a. consider the time value of money.
b. ignore depreciation.
c. use after-tax cash flows.
d. all of the above.
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b 30. As the discount rate increases
a. present value factors increase.
b. present value factors decrease.
c. present value factors remain constant.
d. it is impossible to tell what happens to the factors.
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a 31. As the length of an annuity increases
a. present value factors increase.
b. present value factors decrease.
c. present value factors remain constant.
d. it is impossible to tell what happens to present value factors.
a 32. The only future costs that are relevant to deciding whether to accept
an investment are those that will
a. be different if the project is accepted rather than rejected.
b. be saved if the project is accepted rather than rejected.
c. be deductible for tax purposes.
d. affect net income in the period that they are incurred.
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d. greater than the current book rate of return.
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a 39. Which of the following is NOT relevant in calculating net cash flows
for Project N?
a. Interest payments on funds that would be borrowed to finance Project
N.
b. Depreciation on assets purchased for Project N.
c. The contribution margin the company would lose if sales of the
product introduced by Project N will reduce sales of other products.
d. The income tax rate applicable to the entity.
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b 46. An investment opportunity costing $150,000 is expected to yield net
cash flows of $45,000 annually for five years. The cost of capital is
10%. The book rate of return would be
a. 10%.
b. 20%.
c. 30%.
d. 33.3%.
True-False
F 4. The higher the cost of capital, the higher the present value of future
cash inflows.
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F 5. If the IRR on a capital project is positive, its NPV will be positive.
F 7. IRR can be computed for even cash flows, but not for uneven cash flows.
T 8. If IRR is less than the cost of capital, the NPV will be negative.
T 10. Payback emphasizes the return of the investment and ignores the return
on the investment.
Problems
SOLUTION:
Cost $100,000
Useful life 10 years
Annual straight-line depreciation $ 10,000
Expected annual savings in cash
operation costs $ 18,000
SOLUTION:
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a. Annual net cash flows: $14,800 [$18,000 pretax - 40% x ($18,000 -
$10,000 depreciation)]
Cost $150,000
Estimated useful life 10 years
Expected annual cash cost savings $35,000
Marquette's tax rate is 40%, its cost of capital is 12%, and it will use
straight-line depreciation for the new machine.
SOLUTION:
a. Find the increase in annual after-tax cash flows for this opportunity.
SOLUTION:
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Net cash flow $1,700,000
==========
SOLUTION:
SOLUTION:
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Average income $50,000
c. NPV: $130,530
Cash Factor PV
------ ------ ------
1 75,000 .909 68,175
2 90,000 .826 74,340
3 115,000 .751 86,365
4 130,000 .683 88,790
5 100,000 .621 62,100
6 90,000 .564 50,760
-------
430,530
Investment 300,000
-------
NPV 130,530
======
Cost $160,000
Useful life 10 years
Annual straight-line depreciation $ ???
Expected annual savings in cash
operation costs $ 33,000
SOLUTION:
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Year One $ 30,000
Year Two $ 60,000
Year Three $ 90,000
Year Four $ 60,000
Year Five $ 30,000
SOLUTION:
c. NPV: $6,930
Cash Factor PV
------ ------ ------
1 30,000 .893 26,790
2 60,000 .797 47,820
3 90,000 .712 64,080
4 60,000 .636 38,160
5 30,000 .567 17,010
-------
193,860
Investment 180,000
-------
NPV 13,860
======
Cost $160,000
Estimated useful life 5 years
Expected annual cash cost savings $56,000
Expected salvage value none
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Reno's tax rate is 40%, its cost of capital is 12%, and it will use
straight-line depreciation for the new machine.
SOLUTION:
10. Whitehall Co. has the opportunity to introduce a new product. Whitehall
expects the project to sell for $40 and to have per-unit variable costs of
$27 and annual cash fixed costs of $1,500,000. Expected annual sales
volume is 200,000 units. The equipment needed to bring out the new
product costs $3,500,000, has a four-year life and no salvage value, and
would be depreciated on a straight-line basis. Whitehall's cutoff rate is
10% and its income tax rate is 40%.
a. Find the increase in annual after-tax cash flows for this opportunity.
SOLUTION:
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