Student

12
Student: _______________________________________________________________________________________
1. Especially for projects with long lives, estimation of revenues (or benefits), costs, and cash flows of a capital investment project is a
difficult task principally because of:
A. The lack of good data.

B. Uncertainty about future events.
C. The large dollar amounts involved.
D. Income tax effects.
E. Lack of available forecasting tools.
2. Which of the following is NOT one of the more common strategic benefits provided by capital investment projects?
A. Being able to deliver a product that competitors cannot (i.e., product differentiation).
B. Improving product quality.
C. Reducing manufacturing cycle time.
D. Reducing the number of short-term (i.e., operational) decisions that management must make.
E. Providing significant cost reductions, in terms of production and/or marketing costs.
3. Which of the following methods is potentially useful for helping an organization align its capital expenditures with its strategy?
A. Multiproduct cost-volume-profit analysis.

B. Analytic hierarchy process (AHP).
C. Multiple regression and correlation analysis.
D. Linear optimization (e.g., linear programming models).
E. Strategic cost management.
4. Which of the following statements regarding capital investment analysis is false?
A. A long-term planning horizon is assumed.

B. Benefits of potential investment projects are conceptually expressed in terms of accounting income (or reduction in costs).
C. Project acceptance decisions are based on models that explicitly incorporate the time value of money.
D. Need to incorporate income-tax effects in the analysis, for both revenues (gains) as well as expenses (losses).
E. Discounted cash flow (DCF) decision models are used by a majority of large organizations.
5. For a typical capital investment project, the bulk of the investment-related cash outflow occurs:
A. During the initiation stage of the project.

B. During the operation stage of the project.
C. Either during the initiation stage or the operation stage.
D. During neither the initiation stage nor the operation stage.
E. Evenly during all three stages: initiation, operation, and final disposal.
6. Accounting makes all of the following contributions to the capital budgeting process except:
A. The theoretical development of appropriate decision models.

B. Linkage of capital investment projects to the organization's Balanced Scorecard (BSC).
C. Conducting post-audits of capital investment decisions.
D. Generation of relevant data for investment-analysis purposes.
E. Performing sensitivity or "what-if" analysis of proposed capital investments.
7. The Analytic Hierarchy Process (AHP) is:
A. A single-criterion decision technique that can combine qualitative and quantitative factors in the overall evaluation of decision
alternatives.
B. A multi-criteria decision technique that can combine qualitative and quantitative factors in the overall evaluation of decision alternatives.
C. A technique that does not use qualitative factors in the evaluation of decision alternatives.
D. A technique that only uses qualitative factors in the evaluation of decision alternatives.
E. Not useful in choosing between two mutually exclusive capital budgeting projects.
8. In making capital budgeting decisions, the principal focus is on:
A. Cash flows only.

B. Timing of the cash flows only.
C. Cash flows and the timing of the cash flows.
D. Accounting-based measures of revenues and expenses.
E. Nonfinancial performance indicators.
9. The process of identifying, evaluating, selecting, and controlling capital investments is referred to as:
A. Investment discounting.
B. Capital rationing.
C. Capital investing.
D. Capital budgeting.
E. Post-audit analysis.
10. The tax impact of a capital investment project (such as the replacement of a major piece of machinery) is present during:
A. The initiation stage and final disposal stage only.

B. All stages: initiation, operation, and final disposal.
C. The initiation stage and the operation stage only.
D. The operation stage only.
E. The disposal stage only.
11. Which of the following is not a characteristic of capital budgeting post-audits?
A. They provide feedback to managers regarding the soundness of their decision-making.

B. They encourage managers to build slack into capital investment proposals.
C. They are sometimes difficult to implement in practice.
D. They may be cost-prohibitive to accomplish.
E. They help keep actual projects on target (e.g., by limiting project managers from diverting project funds, without authorization, to other
uses).
12. Which of the following can a final disposal of a capital asset not produce?
A. A net cash outflow.

B. A net cash inflow.
C. An income tax consequence.
D. An operating gain or loss.
13. Which of the following is not a characteristic of the payback method for making capital budgeting decisions?
A. It is easy to calculate and comprehend.

B. It focuses primarily on liquidity, rather than profitability of an investment project.
C. It can be considered a rough measure of risk.
D. It considers returns over the entire life of the project.
E. It requires estimates of after-tax cash inflows and after-tax cash outflows.
14. The capital budgeting method(s) that is (are) most likely to provide consistency between data for capital budgeting and data for
subsequent performance evaluation is (are) the:
A. Payback period.
B. Discounted cash flow (DCF) methods.
C. Book (i.e., accounting) rate of return method.
D. Discounted payback period.
E. Cash-flow proxy method.
15. The time value of money is explicitly considered in which of the following capital budgeting method(s)?
A. Payback method.
B. Net present value (NPV) method.
C. Operating cash-flow method.
D. Book (accounting) rate of return method.
E. Residual income method.
16. Results from the net present value (NPV) method and the internal rate of return (IRR) method may differ between projects if they differ in
all of the following except:
A. Required initial investment.

B. Cash-flow pattern.
C. Cost of capital (i.e., discount rate).
D. Length of useful life of the two projects.
E. Book (accounting) rate of return on the two projects.
17. Which of the following statements regarding cost of capital is not true?
A. It reflects the perceived level of risk that investors (owners and lenders) in the company require.
B. It is another term for "required rate of return."
C. It is typically defined as a weighted-average of all sources of capital for the company.
D. It is used to calculate the present value of anticipated cash flows for a project.
E. It is used when calculating the internal rate of return (IRR) of a proposed investment.
18. Given the same total cash flow returns (CFRs), the internal rate of return (IRR) method of capital budgeting would favor a proposal
having yearly CFRs that were:
A. Even.
B. Uneven.
C. Heavier towards the end of a proposal's life.
D. Heavier towards the beginning of a proposal's life.
E. Heavier towards the middle of a proposal's life.
19. The internal rate of return (IRR) method favors investment proposals with:
A. Short useful lives.

B. Long useful lives.
C. Moderate cash flow returns.
D. Large residual values.
E. Large initial investment.
20. Which of the following is not true regarding the appropriate discount rate to be used in conjunction with discounted cash flow (DCF)
decision models?
A. For projects of "above average" risk, the appropriate discount rate is the weighted-average cost of capital (WACC).
B. It includes an estimate of the after-tax cost of debt.
C. It can differ across investment projects, according to perceived risk.
D. It is also sometimes referred to as the "hurdle rate" for capital budgeting purposes.
E. It is also sometimes referred to as the "minimum required rate of return."
21. Research has shown that in framing capital investment decisions, sunk costs tend to:
A. Have no discernable impact on decisions by managers.

B. Have a slight impact on the decision-making process.
C. Have an impact only when capital funds are limited.
D. Escalate commitment in making capital budgeting decisions.
E. Have a significant impact, but only when dealing with mutually exclusive investment projects.
22. Intolerance of uncertainty often leads managers to:
A. Invest heavily in strategic-related investments.

B. Choose projects with short payback periods.
C. Invest in a few large, sequential investments.
D. Invest in projects with relatively long payback periods.
E. Favor projects that are mutually exclusive.
23. Which one of the following capital budgeting decision models consists of dividing the total initial investment outlay by annual after-tax
cash inflows (when such inflows are assumed equal over time)?
A. Profitability index.
B. Payback period.
C. Book (accounting) rate of return.
D. Internal rate of return.
E. Adjusted payback period.
24. Which one of the following is calculated by dividing average annual net operating income by the average investment associated with a
capital project?
B. Payback period.
D. Internal rate of return (IRR).
E. Net present value (NPV).
25. The internal rate of return (IRR) for an investment:
A. Frequently results in positive net present values on attractive projects.

B. Generally is greater than the company's desired rate of return.
C. Ignores the time value of money.
D. May produce different results than the net present value method (NPV) in evaluating projects with different useful lives.
E. Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes.
26. Which one of the following is the estimated rate (i.e., percentage) that makes the discounted present value of future cash flows equal to
the initial investment?
A. Weighted-average cost of capital (WACC).

B. Modified internal rate of return (MIRR).
E. Accounting rate of return (ARR), after tax.
27. Which one of the following is an advantage of the payback method?
A. It provides a (rough) measure of risk.

B. It is linearly related to the net present value (NPV) of a proposed project.
C. It considers all possible future cash flows.
D. It applies conventional discounting procedures to anticipated future cash flows.
E. It allows managers to choose between competing projects with different useful lives.
28. Which one of the following is an advantage of the book (accounting) rate of return method for analyzing capital investment proposals?
A. It is not affected by different accounting methods.

B. It is precise and objective.
C. Data for calculating the return are typically readily available.
D. The method explicitly adjusts for the time value of money.
E. The accounting rate of return is generally approximately equal to a project's internal rate of return (IRR).
29. A composite of the cost of various sources of funds comprising a firm's capital structure is its:
A. Internal rate of return.

B. Weighted-average cost of capital.
C. Book rate of return.
D. Modified internal rate of return (MIRR).
E. Accounting rate of return, after tax.
30. The excess of the present value of future cash flows over the initial investment outlay for a project is the:
A. Internal rate of return (IRR) of the project.
B. Modified internal rate of return (MIRR) on the project.
C. Book (accounting) rate of return for the project.
D. Net present value (NPV) of the project.
E. Modified internal rate of return (MIRR) of the project.
31. A capital budgeting model that accounts for an assumed rate of return on interim-period cash inflows from an investment is the:
A. Internal rate of return (IRR) model.

B. Present-value payback period model.
C. Net present value (NPV) model.
D. Accounting rate of return (ARR) model.
E. Modified internal rate of return (MIRR) model.
32. Under conditions of capital rationing (i.e., limited capital funds are available), the optimal allocation of funds occurs when management
uses which of the following decision models?
A. Discounted payback.
B. Profitability index (PI).
C. Modified internal rate of return (MIRR).
E. Discounted accounting rate of return.
33. Which one of the following methods assumes that all interim cash inflows generated by an investment earn a return equal to the internal
rate of return (IRR) of the investment?
A. Modified internal rate of return (MIRR).

B. Payback.
C. Net present value (NPV).
D. Present value index (PI).
E. Internal rate of return method (IRR).
34. For a capital investment project, a net present value (NPV) of $500 indicates that the:
A. Project's rate of return exceeds the hurdle (discount) rate.

B. Project's internal rate of return is unacceptable.
C. Present value of cash outflows exceeds the present value of cash inflows.
D. Total cash outflows for the project are expected to be $500.
E. Internal rate of return (IRR) exceeds the accounting rate of return on the project.
35. A 15% internal rate of return (IRR) on a proposed capital investment indicates all of the following except:
A. The actual (economic) rate of return on the project is 15%.

B. Use of a 15% discount rate would result in an estimated project NPV of zero.
C. An acceptable capital project if the cost of capital is 16 percent or higher.
D. A positive net present value (NPV) if the cost of capital is less than 15%.
E. An acceptable project, in a present value sense, if the discount rate is less than 15%.
36. Which one of the following is true for the IRR method?
A. It assumes cash proceeds can be reinvested to earn the same rate of return as the cost of capital or desired rate of return on that particular
project.
B. Unlike the NPV method, it assumes only a single discount rate.
C. IRRs of multiple projects are additive (that is, can be added together).
D. It can be used to make optimal decisions regarding mutually exclusive investment projects.
E. It makes it easy to incorporate multiple costs of capital.
37. Which one of the following statements concerning capital budgeting is not true?
A. A basic objective underlying capital budgeting is to select assets that will earn a satisfactory return.
B. Capital budgeting is the process of planning asset investments.
C. Capital budgeting is based on precise estimates of future events.
D. Capital budgeting involves estimating the revenues and costs of each proposed project, evaluating their merits, and choosing those worthy
of investment.
E. Capital budgeting uses after-tax cash flows in the analysis of proposed investments.
38. Which of the following methods can be used to deal formally with uncertainty in the capital-budgeting process?
A. Real options analysis.

B. Net present value (NPV) analysis.
C. Capital rationing analysis.
D. Linear programming optimization.
E. Equivalent annual annuity (EAA) analysis.
39. Two investments have the same total cash inflows and the same payback period. Therefore:
A. These two investments are equally desirable.

B. These two investments must be identical in terms of the present value of the cash inflows.
C. The payback period method can help decision makers choose between these two investments.
D. One pattern of cash inflows may be preferable to the other investment's pattern of cash inflows.
E. Most likely, these two investments required approximately the same initial investment.
40. In a discounted cash flow (DCF) analysis, a required incremental investment in net working capital:
A. Should be amortized over the useful life of the equipment.

B. Can be disregarded because the same amount of cash will be recovered at the end of the project's life.
C. Should be treated as a recurring cash outflow over the life of the project.
D. Should be treated as a reduction in the required cash outflow in period 0.
E. Should be treated as an immediate cash outflow that is later recovered when it is no longer needed.
41. Which of the following is always true with regard to the NPV decision model?
A. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal rate of return (IRR)
approach.
B. The NPV and the IRR approaches will always rank projects in the same order.
C. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the payback approach.
D. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the book (accounting) rate of return
approach.
E. If a project is rejected under the NPV approach, it would also be rejected under the payback approach.
42. If a company is in the situation of having unlimited capital funds, the best decision rule, considering only financial factors, is for it to
invest in all projects in which:
A. The payback period is short.

B. The book (accounting) rate of return is greater than its current return on invested capital (ROI).
C. The net present value (NPV) is greater than the cost of capital.
D. The internal rate of return (IRR) is greater than zero.
E. The NPV is greater than zero.
43. When the net present value (NPV) of a project is calculated based on the assumption that the cash flows occurred at the end of the year
when they actually occurred uniformly throughout each year, the NPV will:
A. Not be in error.
B. Be slightly overstated.
C. Be unusable for actual decision-making.
D. Be slightly understated but probably usable.
E. Produce an error the direction of which is undeterminable.
44. Without knowing its required rate of return (i.e., hurdle rate) for use in the evaluation of capital investment projects, a company will be
prohibited from calculating a project's:
A. A
B. B
C. C
D. D
E. E
45. When the internal rate of return (IRR) method and the net present value (NPV) method do not yield the same recommendation for the
same investment project, the technique normally selected is:
A. IRR, because all reinvestment of funds occurs at the rate of the cost of capital and because it takes into consideration the relative size of
the initial investment.
B. NPV, because it takes into consideration the relative size of the initial investment.
C. IRR, because all reinvestment of funds occurs at the discount rate that will make the NPV of the project equal to zero.
D. NPV, because all reinvestment of funds occurs at the discount rate that will make the NPV of the project equal to zero.
E. IRR, because all reinvestment of funds occurs at the rate the project generates and because it takes into consideration the relative size of
46. If an existing asset is sold at a gain, and the gain is taxable, then the after-tax proceeds from this transaction would be equal to:
A. Net proceeds from the sale plus the after-tax gain on the sale.
B. Net proceeds from the sale less the after-tax gain on the sale.
C. Net proceeds from the sale plus the taxes paid on the gain.
D. Net proceeds from the sale less the taxes paid on the gain.
E. The pre-tax proceeds plus taxes on the gain.
47. For a given income tax rate, t, after-tax cash operating receipts are calculated as follows:
A. Taxable cash receipt times (1 - t).

B. Taxable case receipt times t.
C. Taxable cash receipt times (1 + t).
D. Taxable cash receipt divided by (1 - t).
E. Taxable cash receipt divided by t.
48. Which of the following statements regarding the determination of the weighted-average cost of capital is not true:
A. The capital asset pricing model (CAPM) cannot be used to estimate the cost of debt for a company.
B. The capital asset pricing model (CAPM) can be used to estimate the cost of equity for a non-public company.
C. In estimating the cost of debt, the analyst typically estimates the current yield-to-maturity of the debt instruments in the company's capital
structure.
D. Market, not book, values of the components of capital are preferable in terms of determining weights for the weighted-average calculation.
49. Which of the following is not used to deal with uncertainty in the capital budgeting process?
A. What-if analysis.
B. Sensitivity analysis.
C. Monte Carlo simulation.
D. Real options analysis.
E. Linear programming analysis.
50. The term "breakeven after-tax cash flow" represents:
A. A pessimistic estimate in a typical scenario analysis.

B. An optimistic estimate in a typical scenario analysis.
C. The amount of after-tax cash flow needed to generate a return equal to a project's IRR.
D. The cash flow needed to generate an IRR of zero.
E. An estimate that can be arrived at using Goal Seek in Excel.
51. Tyson Company has a pre-tax net cash inflow of $1,200,000. The company can claim depreciation expense of $500,000 this year. The
company is subject to a combined income tax rate of 26%. What is the after-tax cash flow for the year?
A. $700,000.
B. $1,018,000.
C. $182,000.
D. $370,000.
E. $1,200,000.
52. What is the present value of $1 received five years from now (rounded to two decimal places) if the discount rate is 12%?
A. $1.76.
B. $0.57.
C. $1.00.
D. $1.60.
53. Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine will generate a constant after-tax income of
$100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual
value.
What is the payback period for the new machine, under the assumption that cash inflows occur evenly throughout the year?
A. 4 years.
B. 5 years.
C. 6 years.
D. 10 years.
E. 15 years.
value.
What is the annual accounting (book) rate of return (rounded) on the initial investment?
A. 6.67%.
B. 10.00%.
C. 13.33%.
D. 16.67%.
E. 23.33%.
55. All of the following capital budgeting decision models, except for this one, use cash flows as the primary basis for the calculation.
A. Net present value (NPV)

B. Internal rate of return (IRR)
C. Payback period
D. Discounted payback period
E. Accounting rate of return (ARR)
56. Madson Company is analyzing several proposed investment projects. The firm has resources only for one project.
The company uses the payback period method for capital investment decisions. On the basis of this decision model, which project should
be selected? (Ignore taxes.)
A. Project P.
B. Project Q.
C. Project R.
D. Project S.
E. Project T.
57. Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000
each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding
depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's
tax rate is 40%. Management requires a minimum 10% rate of return on all investments.
What is the net after-tax cash inflow in Year 1 from the investment?
A. $72,000.
B. $96,000.
C. $108,000.
D. $112,000.
E. $120,000.
What is the amount of net income (after taxes) in Year 2 of the investment?
A. $24,000.
B. $36,000.
C. $48,000.
D. $72,000.
E. $120,000.
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the payback period for the new machine
(rounded to nearest one-tenth of a year)? (Assume that the cash inflows occur evenly throughout the year.)
A. 2.5 years.
B. 2.7 years.
C. 3.1 years.
D. 3.6 years.
E. 4.2 years.
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the annual book (accounting) rate of
return based on the initial investment?
A. 12%.
B. 20%.
C. 32%.
D. 36%.
E. 40%.
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the net present value (NPV) of the
investment? (The PV annuity factor for 5 years, 10% is 3.791.) Assume that the cash inflows occur at year-end.
A. ($270,480).
B. $63,936.
C. $109,428.
D. $154,920.
E. None of the above.
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the approximate internal rate of return
(IRR) of the investment? (NOTE: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.)
A. Less than 12%.

B. Somewhere between 12% and 14%.
C. Somewhere between 15% and 20%.
D. Somewhere between 20% and 25%.
E. Over 25%.
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the present value payback period,
rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683;
year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
A. 2.5 years.
B. 3.0 years.
C. 3.3 years.
D. 3.6 years.
E. 4.0 years.
64. Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000
depreciation) totaling $80,000 per year. The firm uses the straight-line depreciation and expects the machine to have a residual value of
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the net after-tax cash inflow
in Year 1 from the investment?
A. $72,000.
B. $92,000.
C. $96,000.
D. $102,000.
E. $120,000.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the net income (after tax) in
Year 3?
A. $28,000.
B. $36,000.
C. $42,000.
D. $70,000.
E. $72,000.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the payback period for the
new machine (rounded to the nearest one-tenth of a year)? Assume that the cash inflows occur evenly throughout the year.
A. 2.7 years.
B. 3.0 years.
C. 3.3 years.
D. 3.6 years.
E. 4.2 years.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the annual book (accounting)
rate of return based on the initial investment?
A. 12%.
B. 14%.
C. 17%.
D. 20%.
E. 24%.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the estimated book
(accounting) rate of return based on average investment?
A. 12%.
B. 14%.
C. 17%.
D. 24%.
E. 34%.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the investment's net present
value (NPV) of the proposed investment (rounded to the nearest hundred)? (The PV annuity factor for 10%, 5 years, is 3.791 and for 4
years it is 3.17. The present value factor for 10%, 5 years, is 0.621.) Assume that cash inflows occur at year-end.
A. $48,800.
B. $79,800.
C. $99,000.
D. $112,000.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the approximate internal rate
of return (IRR) of the proposed investment? (Note: To answer this question, students must have access to Table 2 from Appendix C,
Chapter 12.)
A. Less than 12%.
E. Over 20%.
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the present value payback
period, rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 =
0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
A. 2.5 years.
B. 3.0 years.
C. 3.6 years.
D. 4.1 years.
E. 4.8 years.
72. Marc Corporation wants to purchase a new machine for $400,000. Management predicts that the machine can produce sales of $275,000
depreciation) totaling $80,000 per year. The company uses MACRS for depreciation. The machine is considered as a 3-year property and
is not expected to have any significant residual at the end of its useful years. Marc's income tax rate is 40%. Management requires a
minimum of 10% return on all investments. A partial MACRS depreciation table is reproduced below.
What is the after-tax cash inflow in Year 1 from the investment (rounded to the nearest thousand)?
A. $62,000.
B. $114,000.
C. $170,000.
D. $240,000.
E. $37,000.
73. If the net present value (NPV) of an investment proposal is positive, it would indicate that the:
A. PV of cash outflows exceeds the PV of cash inflows

B. Payback period is less than one-half the life of the project
C. Internal rate of return (IRR) is equal to the discount percentage used in the NPV calculation
D. PV index would be less than 100%
E. Rate of return for this project is greater than the discount rate used in the NPV computation
74. When evaluating capital budgeting decision models, the payback period emphasizes:
A. Liquidity
B. Profitability
C. Cost of capital
D. Average net income divided by average investment
E. Average cash flow divided by average investment
75. Which of the following would not be considered a benefit of conducting post-implementation audits of capital investment projects?
A. Such audits ensure the realization of future after-tax cash flows.

B. Such audits facilitate learning from estimation errors.
C. Knowledge that investments are subject to post-implementation audit can counter tendencies to inflate estimates of net cash benefits
associated with projects.
D. The use of such audits allows top management to identify and reward good project planners.
E. Such audits reduce the tendency of managers to overstate benefits or understate costs associated with proposed capital investments.
76. Income tax effects are associated with all of the following except:
A. Disposition (i.e., sale) of an existing asset.

B. Required increase in net working capital associated with an investment project.
C. Sale of an investment asset at the end of the asset's useful life.
D. Effect of depreciation expense associated with an investment project.
E. Annual net benefits associated with a proposed investment.
77. XYZ Corporation is contemplating the replacement of an existing asset used in the operation of its business. The original cost of this asset
was $28,000; since date of acquisition, the company has taken a total of $20,000 of depreciation expense on this asset. The current
disposal (market) value of this asset is estimated as $18,000. XYZ is subject to an income tax rate of 34%. What is the projected after-tax
cash flow associated with the sale of the existing asset?
A. $18,000
B. $10,000
C. $14,600
D. $8,000
E. $11,400
78. Carmino Company is considering an investment in equipment that will generate an after-tax income of $6,000 for each year of its four-
year life. The asset has no salvage value. The firm is in the 40% tax bracket. The book values of the investment at the beginning of each
year are as follows:
This asset's book (accounting) rate of return on average investment, which is defined as a simple average of the average book value for
each of the four years. The final answer should be rounded to the nearest whole %.
A. 15%.
B. 27%.
C. 36%.
D. 43%.
E. 58%.
The amount of after-tax cash inflow from the asset in Year 3 is:
A. $6,600.
B. $7,500.
C. $8,100.
D. $9,000.
E. $9,750.
80. Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket.
Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5
respectively. The firm uses straight-line depreciation with no residual value at the end of five years. The payback period in years (rounded
to the nearest 10th of a year) for this proposed investment is (assume that the cash inflows occur evenly throughout the year):
A. 2.5 years.
B. 3.0 years.
C. 3.5 years.
D. 4.3 years.
E. 4.5 years.
respectively. The firm uses straight-line depreciation with no residual value at the end of five years. The hurdle rate for accepting new
capital investment projects is 4%, after-tax. The estimated book (accounting) rate of return on this project (rounded to two decimal
points), based on the initial investment is:
A. 2.67%.
B. 3.33%.
C. 6.67%.
D. 10.00%.
E. 12.00%.
capital investment projects is 4%, after-tax. (Note: the following PV factors for 4%: for 1 year = 0.962, for year 2 = 0.925, for year 3 =
0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
At a discount rate of 4%, the net present value is (rounded to the nearest hundred):
A. ($15,000).
B. ($12,300).
C. ($9,300).
D. ($6,000).
E. $1,800.
capital investment projects is 4%, after-tax. (Note: PV factors for 4%: for 1 year = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4
= 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
At a discount rate of 4%, the PV payback period, in years (rounded to two decimal places) is:
A. 2.89 years.
B. 3.50 years.
C. 3.89 years.
D. 4.27 years.
E. More than 5 years.
capital investment projects is 4%, after-tax. (Note: To answer this question, students will have to be provided with the Tables provided in
Appendix C, Chapter 12. Alternatively, the instructor can provide students with the following PV factors for 4%: for 1 year = 0.962, for
year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
The estimated internal rate of return (IRR) on this investment is:
A. Less than 4%.

B. 4%.
C. Slightly above 4%.
D. Greater than 6%.
E. Undeterminable with only the given information.
85. Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen
can sell all that it could manufacture for the next ten years. The government exempts taxes on profits from new investments in order to
encourage capital investments. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to
have ten years of useful life with no salvage value. The firm uses straight-line depreciation. The net cash inflow is expected to be
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. Assume that cash inflows occur evenly
throughout the year. The estimated payback period for this proposed investment, in years, is (rounded to two decimal places):
A. 4.17 years.
B. 5.05 years.
C. 5.43 years.
D. 5.67 years.
E. 7.14 years.
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The book (accounting) rate of return based on
initial investment is:
A. 12.73%.
B. 14.00%.
C. 24.00%.
D. 28.00%.
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The accounting (book) rate of return based on
average investment (rounded to two decimal places) is:
A. 12.73%.
B. 14.00%.
C. 25.45%.
D. 28.00%.
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The estimated net present value of this
proposed investment (rounded to the nearest thousand) is:
Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145.
A. ($105,000).
B. ($84,000).
C. $181,000.
D. $248,000.
E. $285,000.
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The estimated internal rate of return (IRR) on
this proposed investment is:
(Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145):
A. Less than 10%.

B. 10%.
C. 12%.
D. Greater than 12%.
E. Indeterminable.
90. If a company is faced with limited capital funds for investment (i.e., the company faces capital rationing), the best general method to
employ to assess individual project profitability is:
A. Cash-flow bailout
B. Net present value (NPV)
C. Payback
D. Discounted payback
E. Present value index (PI)
91. If a company must choose between two mutually exclusive investment projects, the best general method to employ for decision-making
purposes is:
B. Cash-flow break-even
C. Net present value (NPV)
E. Accounting (book) rate of return, based on average investment over the life of each project
92. A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate
of the financial consequences of possible prediction errors is:
A. Expected value analysis

B. Learning curve analysis
C. Capital budgeting analysis
D. Sensitivity analysis
E. Exponential distribution analysis
93. Flex Corporation is studying a capital investment proposal in which newly acquired assets will be depreciated using the straight-line (SL)
method. Which one of the following statements about the proposal would be incorrect if, instead of SL, the Modified Accelerated Cost
Recovery System (MACRS) is used for determining depreciation for income tax purposes?
A. The estimated net present value (NPV) of the project would increase.
B. The internal rate of return (IRR) of the project would likely increase.
C. The payback period for the investment would be shortened.
D. The total after-tax income from this project, over its life, would normally increase.
E. Total tax payments over the life of the project would be unaffected.
94. Jasper Company has a payback goal of three years on acquisitions of new equipment. A new piece of equipment that costs $450,000 and a
five-year life is being considered. Straight-line (SL) depreciation will be used, with zero salvage value. Jasper is subject to a 40% income
tax rate. To meet the company's payback goal, the equipment must generate reductions in annual cash operating costs of:
A. $60,000.
B. $114,000.
C. $150,000.
D. $190,000.
E. $285,000.
95. Amster Corporation has not yet decided on its discount rate for use in the evaluation of capital budgeting proposals. This lack of
information will prohibit the company from calculating a proposed investment's:
A. A
B. B
C. C
D. D
E. E
96. For dealing with uncertainty in the capital budgeting process, all of the following techniques can be used except which one?
B. Monte Carlo simulation.
C. Scenario analysis.
D. Linear programming.
97. Which of the following statements regarding real options is not true:
A. Similar to financial options, real options are traded on an open exchange.

B. Their consideration in capital budgeting analysis is designed to complement conventional DCF models.
C. They refer to options on real assets (i.e., tangible and intangible property).
D. They can never reduce NPV of a proposed investment, only increase its NPV.
E. They represent one way of handling risk and uncertainty in the capital budgeting process.
98. Which of the following is not one of the four general classes of real options?
A. Expansion option.
B. Exercise option.
C. Abandonment option.
D. Investment-timing option (e.g., delay)
99. Which of the following statements regarding real options is true:
A. The farther away the expiration date, the less valuable the option is.
B. They can be incorporated into the capital budgeting decision process through the use of decision trees.
C. They allow decision makers to react to unfavorable, but not favorable, future information/news.
D. Conventional DCF decision models cannot incorporate the effects of real options.
E. Capital budgeting models cannot handle multiple options embedded in an investment project.
100. The estimated value of a real option:
A. Is affected by essentially the same set of factors that affect the value of financial options.
B. Cannot be incorporated into a conventional DCF analysis of an investment project.
C. Is affected by the length of the expiration date of the option.
D. Decreases as the underlying risk of a project increases.
E. Is inversely related to estimated volatility of returns for a proposed project.
101. If the present value payback period is less than the life of the project, one may conclude that:
A. The project's IRR is less than the discount (hurdle) rate.

B. The project's accounting (book) rate of return exceeds the discount (hurdle) rate.
C. The project is not desirable in a present-value sense.
D. The project's net present value is positive.
102. Which of the following characteristics is not true of the modified internal rate of return (MIRR)?
A. Unlike IRR, MIRR does not consider the time value of money.
B. It focuses on after-tax cash flows, rather than accounting income amounts.
C. It cannot be used reliably to choose between mutually exclusive projects.
D. Its use may not lead to an optimum capital budget.
E. It is complex to compute, if done manually.
103. GuSont Inc. was considering an investment in the following project:
Assume that cash inflows occur evenly throughout the year. The estimated payback period in years (rounded to one decimal place) is:
A. 3.7 years.
B. 4.6 years.
C. 5.8 years.
D. 6.0 years.
E. 7.9 years.
The internal rate of return (IRR) is (note: to solve this problem students will need access either to Appendix C, Table 2 (Chapter 12) or
Excel):
A. Less than 10%.

E. Greater than 15%.
105. LaVar, Inc. has obtained probability estimates from its production and sales departments regarding the costs and selling prices it can
anticipate for a new product line. The company is uncertain as to which combination of costs and selling prices will occur. The best
method for determining the expected outcome of the investment, based on an assumed probability distribution for both sales and costs,
is:
A. Monte Carlo simulation.

B. The analytic hierarch process (AHP).
C. Correlation analysis.
D. Multiple regression analysis.
E. Linear programming.
106. The decision technique that measures the estimated performance of a capital investment by dividing the project's annual after-tax income
by the average investment cost is called the:
A. Break-even point for the project.

B. Internal rate of return on the proposed investment.
C. Accounting (book) rate of return on the investment.
D. Capital asset pricing model.
E. Profitability index (PI) for the investment.
107. The internal rate of return for an investment:
A. Frequently results in positive net present value on attractive projects.

B. Generally coincides with the company's discount rate.
C. Disregards discounted cash flows.
D. On mutually exclusive projects may produce different project rankings than the net present value (NPV) method.
E. Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes rather than the straight-line (SL)
method.
108. The net present value (NPV) method and the internal rate of return (IRR) method are used to analyze proposed capital expenditures. The
IRR method, as contrasted with the NPV method:
A. Is considered inferior because it fails to calculate compounded rates of return.

B. Incorporates the time value of money, while the NPV method does not.
C. Almost always gives a different decision that the NPV method as to the acceptability ("go" versus "no go") of a given proposed
investment.
D. Assumes that the rate of return on the reinvestment of the cash proceeds is at the indicated rate of return of the project analyzed rather than
at the discount rate used.
E. Is preferred in practice because it is able to handle multiple desired rates of return, which is impossible to do with the NPV method.
109. Generally speaking, when ranking two mutually exclusive investments with different initial amounts, management should give first
priority to the project:
A. That generates cash flows for the longer period of time.

B. Whose net after-tax cash flows equal the initial investment outlay.
C. That has the greater accounting rate of return (ARR).
D. Whose cash flows vary the least.
E. That has the greater profitability index (PI).
110. Which of the following is not an important advantage of the net present value (NPV) method over the internal rate of return (IRR)
method in evaluating capital investment proposals?
A. NPV facilitates comparisons of mutually exclusive projects requiring different amounts of initial investments.
B. NPV facilitates comparisons among mutually exclusive projects that have the same useful life but different initial outlays.
C. NPV can be used to determine an optimum capital budget under conditions of capital rationing, while IRR cannot.
D. NPV is relatively intuitive.
E. IRR relies on discounted cash-flow analysis, while NPV does not.
111. In situations where a firm specifies to different required rates of return (i.e., discount rates) over the years, it is advantageous to use:
A. The payback method.

B. The book rate of return method.
C. The net present value (NPV) method.
D. The internal rate of return (IRR) method.
E. Sensitivity analysis.
112. Which of the following is an example of a sunk cost in a capital budgeting decision regarding the purchase of new equipment for a
profitable business that pays taxes?
A. The disposal of the equipment to be replaced.

B. The purchase price of the equipment to be replaced.
C. The additional working capital requirement.
D. The operating cost of the new equipment.
113. Which of the following items has no after-tax consequences in the analysis of a capital investment proposal?
A. Cash flow from operations.

B. Salvage of the old investment.
C. Employee severance compensation.
D. Reduction of working capital.
E. Gain or loss on the disposal of the investment.
114. When we assume in our calculations for capital budgeting decisions that all cash flows occur at the end of individual years during the life
of an investment project when, in fact, they flow more or less continuously during those years, which of the following statements is
true?
A. The internal rate of return (IRR) of the project will be overstated.

B. The net present value (NPV) of the project will be overstated.
C. Inconsistent errors will exist in either NPV or IRR.
D. The net present value (NPV) of the project will be understated.
E. The use of DCF models in practice will not provide valid results.
115. In addition to a one million dollar acquisition cost, an investment requires $200,000 working capital during its useful years. This
investment in working capital should be:
A. Added to the cash outflow each year during the useful life of the investment.
B. Disregarded in the capital budgeting decision because the working capital is not an expense.
C. Treated as an immediate cash outflow that is recovered at the end of the investment's useful life.
D. Treated as an immediate expense and a gain at the end of the investment's useful life.
E. Added to the initial investment.
116. Within the context of capital budgeting, a primary goal-congruency problem exists when DCF models are used for decision-making
purposes but accrual-based earnings figures are used for subsequent performance evaluation purposes. Which of the following items is
not likely useful for addressing this goal-congruency problem?

B. Use of EVA→ as the financial-performance metric.
C. Separating incentive compensation (i.e., "reward") from budgeted performance.
D. Conducting post-audits of capital investment decisions.
117. The profitability index (PI) is calculated as:
A. Net present value (NPV) divided by average investment.

B. Net present value (NPV) divided by initial investment.
C. Average investment divided by net present value (NPV).
D. Initial investment divided by net present value (NPV).
118. Western Electronics (WE) is reviewing the following data relating to a new equipment proposal:
WE expects the net after-tax savings in cash outflows from the investment to be equal in each of the 5 years. What is the minimum
amount of after-tax annual savings (including depreciation effects) needed to make the investment yield a 12% return (rounded to the
nearest whole dollar)?
A. $8,189.
B. $11,111.
C. $12,297.
D. $13,889.
E. $15,678.
119. A profitable company pays $100,000 wages and has depreciation expense of $100,000. The company's income tax rate is 40%. The
after-tax effects on cash flow are a net cash outflow of:
A. $40,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
B. $40,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
C. $60,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
D. $60,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
E. $40,000 for wages and a net cash inflow of $100,000 for depreciation expenses.
120. Conceptually, a firm's capital structure is its:
A. Mix of debt and equity capital, expressed in book-value terms.

B. Mix of debt and equity capital, expressed in market-value terms.
C. Equity capital only, expressed in book-value terms.
D. Equity capital only, expressed in market-value terms.
121. Consider two projects, A and B. The present value (PV) of cash inflows for project A is $55,000, while the present value of cash
outflows for this project is $50,000. Project B, on the other hand, has the following characteristics: PV of cash inflows = $24,000; PV of
cash outflows = $20,000. Assume that these two projects are mutually exclusive. Assume that the company has adequate capital to fund
either investment option. All of the following statements are true except:
A. The NPV of Project A is $5,000.

B. The IRR of Project A is greater than the cost of capital (discount rate).
C. The profitability index (PI) for Project A is 1:1.
D. Project A is preferable to Project B (all else held constant).
122. XYZ Corporation's capital structure consists of 60% debt with a pretax cost of 10%, and the balance by common equity, with a cost of
15%. The company's marginal tax rate (federal and state combined) is 50%. XYZ's weighted-average cost of capital (WACC) is:
A. 9.0%
B. 10.0%
C. 12.0%
D. 12.5%
123. In capital budgeting, the accounting rate of return (ARR) decision model:
A. Considers the time value of money.

B. Ignores cash outflows after the initial investment.
C. Incorporates the timing of cash flows.
D. Ignores accounting income generated after the break-even point.
E. Does not provide an unambiguous decision criterion regarding the acceptance of capital investment projects.
124. All of the following capital budgeting models incorporate the time value of money except:

B. The modified internal rate of return (MIRR) method.
C. The profitability index (PI) method.
D. The discounted payback method.
E. The internal rate of return (IRR) method.
125. ______________ is the recommended method for determining the optimal capital budget under conditions of capital rationing.
A. The net present value (NPV) method.

B. The use of Monte Carlo simulation.
C. The modified rate of return (MIRR) method.
D. The profitability index (PI) method.
E. Discounted payback method.
126. Jason Company provides weather and climate forecasts to almost 100 firms in the northwestern states of Washington, Oregon, and
Idaho. New technology is available that should improve forecast accuracy anywhere from ten to fifteen percentage points.
Required:
1. What information is likely to be most difficult to estimate in conjunction with this investment decision?
2. Which capital budgeting decision model is the most appropriate for making this decision?
127. Acorn Corporation designs and installs fire-suppression systems in commercial buildings. Over 90 percent of Acorn's business is in new
construction, with the remainder in upgrade installations in remodeled buildings. For planning and control purposes, Acorn's controller
(Jane Reid) is considering purchasing cost and financial accounting software from Constructor Solutions. Costs for the software modules
are shown below:
Required:
1. Jane uses value-chain analysis in evaluation of capital investments. She asks you which method, internal rate of return (IRR) or net
present value (NPV), would be best in selecting individual software modules, and your reason(s) for the choice of method.
2. Jane says, "If we buy the entire set of six modules, we will get the equivalent of Module 6 free." Why might this savings of almost
$1,500 be illusory?
3. The present value of the cost savings generated by the set of six modules, based on a five-year life and discount rate of 18 percent, is
estimated as $13,844.50. Should the set be purchased? Explain. How would your decision be affected if Acorn's minimum rate of return
were 24 percent? (No calculations are necessary to answer this question.)
128. Jason Kirby is the leader of the capital budget group charged with reviewing capital investment options for Archer Construction
Corporation. Jason is an advocate of a short payback period requirement, since "Cash flow is the bottom line in this company."
Required: Do you agree or not? Why?
129. Paulsen Inc. purchased a $700,000 machine to manufacture a specialty tap for electrical equipment. The tap was in high demand and
Paulsen could sell all that it could manufacture for the next five years. The government exempted taxes on profits from new investments
in order to encourage capital investments. This legislation was not expected to be altered in the foreseeable future. The equipment was
expected to have five years of useful life with no salvage value. The company employed straight-line depreciation. The net cash inflow
was expected to be $180,000 each year for five years. Olsen uses a rate of 9% in evaluating its capital investments.
Required: Round all answers to 2 decimal places (e.g., 12.34%).
1. Calculate the payback period for this proposed investment. (Assume that cash inflows occur evenly throughout the year.)
2. Calculate the project's accounting rate of return (ARR) based on the initial investment.
3. Calculate the accounting rate of return (ARR) based on average investment, where the latter is defined as a simple average of
beginning-of-project net book value and end-of-project net book value
4. Calculate the internal rate of return (IRR) of this proposed investment. (Note: To answer this question, students need access either to
Appendix C, Table 2 or to Excel.)
130.
Harris Corporation provides the following data on a proposed capital project:

Harris uses straight-line depreciation method with no salvage value.
Required: Compute for this investment project:
1. NPV (the PV annuity factor for 12%, 4 years is 3.037)
2. IRR (to the nearest tenth of a percent). Note: PV annuity factors for 4 years: @ 8% = 3.312; @ 9% = 3.240; @ 10% = 3.170; @ 11% =
3.102; @ 12% = 3.037; and, @ 13% = 2.974)
3. Payback period (assume that cash inflows occur evenly throughout the year).
4. Accounting rate of return (ARR) on the net initial investment.
5. Discounted payback period (assume that the cash inflows occur evenly throughout the year; round to 2 decimal places). The
appropriate PV factors for 12% are as follows: year 1 = 0.893; year 2 = 0.797; year 3 = 0.712; year 4 = 0.636.
131. The Zone Company is evaluating a capital expenditure proposal that requires an initial investment of $1,040,000. The machine will
improve productivity and thereby increases net after-tax cash inflows by $250,000 per year for 7 years. It will have no salvage value. The
company requires a minimum rate of return of 12 percent on this type of capital investment.
Required:
(A) Determine the net present value (NPV) of the investment proposal. (The PV annuity factor for 12%, 7 years is 4.564.)
(B) Determine the proposal's internal rate of return, rounded to the nearest tenth of a percent. (Note: PV annuity factors for 7 years: @
10% = 4.868; @ 11% = 4.712; @ 12% = 4.564; @ 13% = 4.423; @ 14% = 4.288; @ 15% = 4.160; and, @ 20% = 3.605.)
(C) What is the estimated payback period for the proposed investment, under the assumption that cash inflows occur evenly throughout
the year? Round your answer to 2 decimal places.
(D) What is the present value payback period for the proposed investment? Round your answer to 2 decimal places.
(E) What is the estimated accounting rate of return (on initial investment) for the proposed project?
Round your answer to 1 decimal place, e.g., 12.2%.
132. Said Company is considering the purchase of a new piece of equipment for $45,000. The projected after-tax net income associated with
this investment is $3,000 for each of the next three years. The company uses straight-line depreciation. The machine has a useful life of 3
years and no salvage value. Management of the company considers a 12% return on investment to be satisfactory. (Note: You will be
required to calculate, as part of your answer, the appropriate discount rate for a three-year annuity, at 12%.)
Required:
1. What is the discounted payback period for this investment? (The appropriate discount factors for 12% are as follows: Year 1 = 0.893;
Year 2 = 0.797, and Year 3 = 0.712.)
2. What is the net present value (NPV) of this proposed investment?
133. George's Garage is considering purchasing a machine for $75,000. The machine is expected to generate a net after-tax income of
$11,250 per year. This machine is to be depreciated over a 10-year period with no residual value.
Required: What is the payback period, in years, for this machine? (Assume that the cash inflows from this investment occur evenly
throughout the year.)
134. National Rodeo Association, a not-for-profit organization, is considering purchasing a new enterprise software system for $90,000. This
investment is projected to have an eight-year useful life, and a salvage value of $8,800. Its anticipated eight-year life is projected to save
the organization approximately $18,000 each year in operating costs. In addition, the association needs an increase of $5,000 in net
working capital (other than cash) in the first year, which will not be released until the end of eight years.
Required:
(A) What is the payback period for this proposed investment? (Assume that the cash flows, other than salvage value, occur evenly
throughout the year. Round your answer to 2 decimal places.)
(B) If the Association has a required rate of return of 10 percent, what is the net present value (NPV) of this investment? Round your
calculation results to whole numbers. (The PV annuity factor for 10%, 8 years is 5.335, while the PV factor for 10%, 8 years is 0.467.)
(C) What is the internal rate of return (to the nearest whole percent)? (Note: The following present value factors are taken from the
present value tables in Appendix C of Chapter 12, for an 8-year period. This information is needed to answer the question.)
135. Megan Inc. has a policy of not accepting any investment proposal that requires more than three years to payback. The company is
considering the purchase of new drafting equipment for $630,000. The equipment has an estimated useful life of seven years. Megan will
use straight-line depreciation for this asset, with no salvage value. Megan's income tax rate is approximately 25%.
Required: Determine the required before-tax savings for the drafting equipment to meet the company's payback requirement.
136. Durable Inc. is considering replacing an old drilling machine that cost $200,000 six years ago with a new one that costs $450,000.
Shipping and installation cost an additional $60,000. The old machine has been depreciated using straight-line method with no salvage
value over an estimated 8-year useful life. The old machine can be sold for $40,000 now or $10,000 in two years. Management expects
increases in inventories of $10,000, accounts receivable of $32,000, and accounts payable of $12,000 if the new machine is acquired.
Durable's income tax rate is expected to be 30 percent over the years affected by the investment.
Required: What is Durable's net initial investment (i.e., its after-tax initial cash outlay for the machine)?
137. Fieldgard Inc. invested $800,000 in a project nine years ago. This project has generated $320,000 cash revenues per year and incurred
$250,000 cash operating costs each year. The project qualified as 7-year property under MACRS. Salvage value of this project (at the
end of the tenth, and final, year of the project's life) is expected to be $200,000. The project required $80,000 net additional working
capital at its inception and another $60,000 at the end of year 5. The increased working capital commitment is expected to be fully
recoverable when the project terminates. The company has a 40% tax rate.
Required: What is the expected total after-tax cash flow expected from this project next year (i.e., during the 10th and final year of the
project's life)?
138. Six years ago, Nebrow Inc. purchased a polishing machine for $600,000. The company expected to use the machine for 10 years with no
residual value at the end of the tenth year. The machine has been generating annual cash revenue of $460,000 and incurring annual cash
operating costs of $210,000. Nebrow is considering the purchase of a new digital polishing machine for $800,000, which will have
annual cash revenues of $690,000 and annual cash operating costs of $180,000. The new machine is expected to have a useful life of
four years. The company uses the straight-line depreciation method with no salvage value to depreciate all of its assets. Assume, for
purposes of analysis, that Nemrow is subject to a combined 40% tax rate.
Required: What is the annual incremental after-tax cash flow from the new polishing machine?
139. Solich Company is evaluating a new tractor that costs $1,350,000 to replace the tractor purchased years earlier, which currently has no
salvage value; the new tractor has an estimated useful life of five years with no disposal value or anticipated cost of disposal. The
company uses straight-line depreciation with no residual value on all equipment. Solich is subject to a 40% income tax rate. The
company uses a 12% hurdle rate for evaluating capital investment projects. The PV of an annuity of $1 at 12% for 5 years is 3.605, and
the PV of $1 at 12% in 5 years is 0.567.
Required:
1. Compute the amount of before-tax savings that must be generated by the new tractor to have a payback period of no more than 3
years.
2. Compute the amount of before-tax savings that must be generated by the new tractor to have a NPV of at least $500,000 at a desired
rate of return of 12%. (Round your answer to the nearest whole dollar amount.)
3. Compute the amount of before-tax savings that must be generated by the new tractor to have an IRR of 12%.
140.
Grey Inc. is considering purchasing a machine for $50,000, which is expected to generate an annual after-tax income of $10,000 and is to
be depreciated over 5 years with no residual value.
Required:
1. Under the assumption that cash inflows occur evenly throughout the year, what is the payback period for this machine?
2. Based on the initial investment outlay, what is the anticipated accounting rate of return (ARR) on this investment?
3. What is the anticipated internal rate of return (IRR) on this investment? (Note: To answer this question, you will need to have access
to Excel or the present value tables presented as Appendix C to Chapter 12.)
4. Assume a discount rate (i.e., cost of capital) of 15%:
(a)What is the modified rate of return (MIRR) on this investment, under the assumption that the interim cash inflows can be reinvested at
an estimated rate of 15%?
(b)What is the MIRR of the project under the assumption that the interim cash flows can be reinvested at a rate of 28.65%? (Note: To
answer this question, you will need access to Excel.)
141. Green Leaf Inc. is considering the purchase of a new piece of equipment for $30,000. The projected after-tax net income per year on this
investment is estimated to be $5,000. The firm uses straight-line depreciation. This asset is expected to have a useful life of 5 years and
no salvage value at the end of its useful life. Management of the company considers a 10% return on investment to be satisfactory. The
present value factor for 10%, 5 years = 0.621, while the present value annuity factor for 5 years at 10% is 3.791.
Required:
1. What is the estimated net present value (NPV) of the machine?
2. What is the profitability index (or, present value index), PI, for this proposed investment?
3. For what purpose is the profitability index (PI) useful, in a capital budgeting context?
4. Use the built-in function in Excel to estimate this project's internal rate of return (IRR).
5. Use the built-in function in Excel to estimate the project's modified internal rate of return (MIRR) under the assumption that the
interim cash flows from the investment generate a rate of return of: (a) 10%, and (b) 20%.
6. How does the MIRR measure differ from the conventional IRR calculation?
142. HHR Construction, Inc. is currently considering developing, on a piece of land currently held by the company, a new courtyard motel.
This project would provide a single payoff from a buyer in one year (after construction was completed). The concept of a courtyard
motel is relatively new, so there is a certain amount of risk associated with this project. The company's management feels that new
information regarding potential consumer demand would be revealed, that is, whether in the chosen geographic location a courtyard
motel would be popular ("good news") or unpopular ("bad news"). In the former case, you anticipate a selling price of $13 million, while
in the latter case only $9 million. At the present, these two outcomes are considered equally likely. For projects of this sort, the company
uses a WACC (discount rate) of 10% after tax. The company estimates that total construction costs for this project would, in today's
dollars, be approximately $9.7 million.
Required:
1. Based on the given probabilities for the two possible outcomes (states of nature), what is the expected NPV of the proposed
investment?
2. What is the primary deficiency of the traditional DCF analysis you conducted above in (1)?
3. Suppose now that management has an option to wait a year before deciding whether to construct the motel in question. The question
the company is grappling with is whether it should delay the investment decision for one year. Given the information above, what do you
recommend, and why? (For simplicity, assume that one year from now the investment cost would be $9.7 million and that the return one
year later would be $13 million.)
4. Define the term "real option." Compare real options with financial options.
5. This problem deals with what is called an investment-timing option, one of four general classes of real options. What other types of
real options can be embedded in a capital investment proposal? How do these classes relate to put options and call options?
143. Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine will generate a constant after-tax income
of $100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual
value. Note: the PV factor for 5 years, 10% is 0.386; the PV annuity factor for 10%, 10 years is 6.145; and, the PV annuity factor for
10%, 5 years is 3.791.
Required: Using the desired rate of return of 10%, what is the estimated net present value (NPV) of the investment project (rounded to
the nearest thousand)? Assume that the cash flows occur at year-end.
Required:
1. What is the payback period for the new machine (rounded to the nearest tenth of a year)? Assume for purposes of this calculation that
the cash inflows occur evenly throughout the year.
2. What is the book (accounting) rate of return (rounded to the nearest whole percent) based on the initial investment and on average
after-tax income over the five-year period?
3. What is the book (accounting) rate of return, rounded to the nearest whole percent, based on the average investment, where the latter is
determined as a simple average of beginning-of-project and end-of-project book value of the asset?
Required:
1. What is the estimated net present value of the investment (rounded to the nearest hundred dollars)? (Note: PV factors for 10% are as
follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
Assume that all estimated cash flows occur at year-end.
2. What is the present value payback period (rounded to two decimal points)?
146. Nelson Inc. is considering the purchase of a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high
demand and Nelson can sell all that it could manufacture for the next ten years, the government exempts taxes on profits from new
investments. This legislation will most likely remain in effect in the foreseeable future. The equipment is expected to have ten years of
useful life with no salvage value. The firm uses the double-declining-balance depreciation method and switches to the straight-line
depreciation method in the last four years of the asset's 10-year life. Nelson uses a rate of 10% in evaluating its capital investments. The
net cash inflows are expected to be as follows:
Required:
1. Under the assumption that cash inflows occur evenly throughout the year, what is the estimated payback period for this investment is
(round your answer to two decimal points)?
What is the estimated book (accounting) rate of return based on initial investment (rounded)?
What is the estimated book (accounting) rate of return based on average investment, where "average investment" is defined as a simple
average of the beginning-of-project book value and the end-of-project book value of the asset?
147.
Nelson Inc. is considering the purchase of a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high
Note: PV factors, at 10%: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; year 6 = 0.564; year 7 = 0.513;
year 8 = 0.467; year 9 = 0.424; year 10 = 0.386. The PV annuity factor for 10 years, 10% = 6.145.
Required:
1. What is the estimated net present value (NPV) of this proposed investment, rounded to the nearest thousand?
2. What is the estimated internal rate of return (IRR) on this project, rounded to the nearest %? (Note: Students would have to have
access to Excel in order to answer this question?
3. What is the present value payback period for this proposed investment, in years (rounded to two decimal points)?
148. Fritz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash operating
costs (before taxes) by $80,000 for each of the next five years. The company has a minimum rate of return of 8% on all capital
investments. The machine will be depreciated using straight-line method over a five-year life with no salvage value at the end of five
years. Fritz is subject to a combined 40% income tax rate.
Required:
1. What is the machine's payback period, in years (rounded to two decimal places), under the assumption that cash flows occur evenly
throughout the year?
2. What is the book (accounting) rate of return (ARR), based on the initial investment amount (rounded to one decimal point, that is,
nearest one-tenth of a percent)?
149. Kravitz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash
operating costs (before taxes) by $80,000 for each of the next five years. The company has a minimum rate of return of 8% on all capital
Note: at 8%, the PV annuity factor for five years is 3.993; at 8%, the PV factor for year 1 = 0.926, the PV factor for year 2 = 0.857, the
PV factor for year 3 = 0.794, the PV factor for year 4 = 0.735, and the PV factor for year 5 = 0.681.
Required:
1. What is the net present value (rounded to the nearest hundred dollars) of the proposed investment?
What is the present value payback period, in years (rounded to one decimal place, that is, to tenth of a year)?
What is the estimated internal rate of return (IRR) on the proposed investment? Round your answer to one decimal place (i.e., tenth of a
percent). (Note: to answer this question, you will need access to the tables presented in Chapter 12, Appendix C or to Excel.)
150. Slumber Company is considering two mutually exclusive investment alternatives. Its estimated weighted-average cost of capital, used as
the discount rate for capital budgeting purposes, is 10%. Following is information regarding each of the two projects:
Required:
1. Compute the estimated net present value of each project and determine which alternative, based on NPV, is more desirable. (The PV
annuity factor for 10%, 5 years, is 3.7908.)
2. Compute the profitability index (PI) for each alternative and state which alternative, based on PI, is more desirable.
3. Why do the project rankings differ under the two methods of analysis? Which alternative would you recommend, and why?
12 KEY
1. Especially for projects with long lives, estimation of revenues (or benefits), costs, and cash flows of a capital investment project is a
difficult task principally because of:
A. The lack of good data.

B. Uncertainty about future events.
C. The large dollar amounts involved.
D. Income tax effects.
E. Lack of available forecasting tools.
Blocher - Chapter 12 #1
Difficulty: Medium
Learning Objective: 12-5
2. Which of the following is NOT one of the more common strategic benefits provided by capital investment projects?
A. Being able to deliver a product that competitors cannot (i.e., product differentiation).
B. Improving product quality.
C. Reducing manufacturing cycle time.
D. Reducing the number of short-term (i.e., operational) decisions that management must make.
E. Providing significant cost reductions, in terms of production and/or marketing costs.
AACSB: Analytic
Difficulty: Easy
Emerging Issues: Strategy
3. Which of the following methods is potentially useful for helping an organization align its capital expenditures with its strategy?
A. Multiproduct cost-volume-profit analysis.

B. Analytic hierarchy process (AHP).
C. Multiple regression and correlation analysis.
D. Linear optimization (e.g., linear programming models).
E. Strategic cost management.
AACSB: Analytic
Difficulty: Medium
Emerging Issues: Strategy
4. Which of the following statements regarding capital investment analysis is false?
A. A long-term planning horizon is assumed.

B. Benefits of potential investment projects are conceptually expressed in terms of accounting income (or reduction in costs).
C. Project acceptance decisions are based on models that explicitly incorporate the time value of money.
D. Need to incorporate income-tax effects in the analysis, for both revenues (gains) as well as expenses (losses).
E. Discounted cash flow (DCF) decision models are used by a majority of large organizations.
Difficulty: Medium
5. For a typical capital investment project, the bulk of the investment-related cash outflow occurs:
A. During the initiation stage of the project.

B. During the operation stage of the project.
C. Either during the initiation stage or the operation stage.
D. During neither the initiation stage nor the operation stage.
E. Evenly during all three stages: initiation, operation, and final disposal.
Difficulty: Easy
6. Accounting makes all of the following contributions to the capital budgeting process except:
A. The theoretical development of appropriate decision models.

B. Linkage of capital investment projects to the organization's Balanced Scorecard (BSC).
C. Conducting post-audits of capital investment decisions.
D. Generation of relevant data for investment-analysis purposes.
E. Performing sensitivity or "what-if" analysis of proposed capital investments.
Difficulty: Easy
7. The Analytic Hierarchy Process (AHP) is:
A. A single-criterion decision technique that can combine qualitative and quantitative factors in the overall evaluation of decision
alternatives.
B. A multi-criteria decision technique that can combine qualitative and quantitative factors in the overall evaluation of decision alternatives.
C. A technique that does not use qualitative factors in the evaluation of decision alternatives.
D. A technique that only uses qualitative factors in the evaluation of decision alternatives.
E. Not useful in choosing between two mutually exclusive capital budgeting projects.
Difficulty: Medium
8. In making capital budgeting decisions, the principal focus is on:

A. Cash flows only.
B. Timing of the cash flows only.
C. Cash flows and the timing of the cash flows.
D. Accounting-based measures of revenues and expenses.
E. Nonfinancial performance indicators.
Difficulty: Easy
9. The process of identifying, evaluating, selecting, and controlling capital investments is referred to as:
A. Investment discounting.
B. Capital rationing.
C. Capital investing.
D. Capital budgeting.
E. Post-audit analysis.
Difficulty: Easy
10. The tax impact of a capital investment project (such as the replacement of a major piece of machinery) is present during:
A. The initiation stage and final disposal stage only.

B. All stages: initiation, operation, and final disposal.
C. The initiation stage and the operation stage only.
D. The operation stage only.
E. The disposal stage only.
Difficulty: Medium
11. Which of the following is not a characteristic of capital budgeting post-audits?
A. They provide feedback to managers regarding the soundness of their decision-making.

B. They encourage managers to build slack into capital investment proposals.
C. They are sometimes difficult to implement in practice.
D. They may be cost-prohibitive to accomplish.
E. They help keep actual projects on target (e.g., by limiting project managers from diverting project funds, without authorization, to other
uses).
Difficulty: Easy
12. Which of the following can a final disposal of a capital asset not produce?
A. A net cash outflow.

B. A net cash inflow.
C. An income tax consequence.
D. An operating gain or loss.
Difficulty: Medium
13. Which of the following is not a characteristic of the payback method for making capital budgeting decisions?
A. It is easy to calculate and comprehend.

B. It focuses primarily on liquidity, rather than profitability of an investment project.
C. It can be considered a rough measure of risk.
D. It considers returns over the entire life of the project.
E. It requires estimates of after-tax cash inflows and after-tax cash outflows.
Difficulty: Medium
14. The capital budgeting method(s) that is (are) most likely to provide consistency between data for capital budgeting and data for
subsequent performance evaluation is (are) the:
A. Payback period.
B. Discounted cash flow (DCF) methods.
C. Book (i.e., accounting) rate of return method.
D. Discounted payback period.
E. Cash-flow proxy method.
Difficulty: Medium
15. The time value of money is explicitly considered in which of the following capital budgeting method(s)?
A. Payback method.
B. Net present value (NPV) method.
C. Operating cash-flow method.
D. Book (accounting) rate of return method.
E. Residual income method.

Difficulty: Easy
16. Results from the net present value (NPV) method and the internal rate of return (IRR) method may differ between projects if they differ in
all of the following except:
A. Required initial investment.

B. Cash-flow pattern.
C. Cost of capital (i.e., discount rate).
D. Length of useful life of the two projects.
E. Book (accounting) rate of return on the two projects.
Difficulty: Medium
Learning Objective: Appendix B
17. Which of the following statements regarding cost of capital is not true?
A. It reflects the perceived level of risk that investors (owners and lenders) in the company require.
B. It is another term for "required rate of return."
C. It is typically defined as a weighted-average of all sources of capital for the company.
D. It is used to calculate the present value of anticipated cash flows for a project.
E. It is used when calculating the internal rate of return (IRR) of a proposed investment.
Difficulty: Medium
18. Given the same total cash flow returns (CFRs), the internal rate of return (IRR) method of capital budgeting would favor a proposal
having yearly CFRs that were:
A. Even.
B. Uneven.
C. Heavier towards the end of a proposal's life.
D. Heavier towards the beginning of a proposal's life.
E. Heavier towards the middle of a proposal's life.
Difficulty: Hard
19. The internal rate of return (IRR) method favors investment proposals with:
A. Short useful lives.

B. Long useful lives.
C. Moderate cash flow returns.
D. Large residual values.
E. Large initial investment.
Difficulty: Hard
20. Which of the following is not true regarding the appropriate discount rate to be used in conjunction with discounted cash flow (DCF)
decision models?
A. For projects of "above average" risk, the appropriate discount rate is the weighted-average cost of capital (WACC).
B. It includes an estimate of the after-tax cost of debt.
C. It can differ across investment projects, according to perceived risk.
D. It is also sometimes referred to as the "hurdle rate" for capital budgeting purposes.
E. It is also sometimes referred to as the "minimum required rate of return."
Difficulty: Medium
21. Research has shown that in framing capital investment decisions, sunk costs tend to:
A. Have no discernable impact on decisions by managers.

B. Have a slight impact on the decision-making process.
C. Have an impact only when capital funds are limited.
D. Escalate commitment in making capital budgeting decisions.
E. Have a significant impact, but only when dealing with mutually exclusive investment projects.
Difficulty: Medium
22. Intolerance of uncertainty often leads managers to:
A. Invest heavily in strategic-related investments.

B. Choose projects with short payback periods.
C. Invest in a few large, sequential investments.
D. Invest in projects with relatively long payback periods.
E. Favor projects that are mutually exclusive.
Difficulty: Easy
23. Which one of the following capital budgeting decision models consists of dividing the total initial investment outlay by annual after-tax
cash inflows (when such inflows are assumed equal over time)?
B. Payback period.
D. Internal rate of return.
E. Adjusted payback period.
Difficulty: Easy
24. Which one of the following is calculated by dividing average annual net operating income by the average investment associated with a
capital project?
B. Payback period.
E. Net present value (NPV).
Difficulty: Easy
25. The internal rate of return (IRR) for an investment:
A. Frequently results in positive net present values on attractive projects.

B. Generally is greater than the company's desired rate of return.
C. Ignores the time value of money.
D. May produce different results than the net present value method (NPV) in evaluating projects with different useful lives.
E. Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes.
Difficulty: Medium
26. Which one of the following is the estimated rate (i.e., percentage) that makes the discounted present value of future cash flows equal to
the initial investment?
A. Weighted-average cost of capital (WACC).

B. Modified internal rate of return (MIRR).
E. Accounting rate of return (ARR), after tax.
Difficulty: Easy
27. Which one of the following is an advantage of the payback method?
A. It provides a (rough) measure of risk.

B. It is linearly related to the net present value (NPV) of a proposed project.
C. It considers all possible future cash flows.
D. It applies conventional discounting procedures to anticipated future cash flows.
E. It allows managers to choose between competing projects with different useful lives.
Difficulty: Medium
28. Which one of the following is an advantage of the book (accounting) rate of return method for analyzing capital investment proposals?
A. It is not affected by different accounting methods.

B. It is precise and objective.
C. Data for calculating the return are typically readily available.
D. The method explicitly adjusts for the time value of money.
E. The accounting rate of return is generally approximately equal to a project's internal rate of return (IRR).
Difficulty: Medium
29. A composite of the cost of various sources of funds comprising a firm's capital structure is its:
A. Internal rate of return.

B. Weighted-average cost of capital.
C. Book rate of return.
D. Modified internal rate of return (MIRR).
E. Accounting rate of return, after tax.
Difficulty: Easy
30. The excess of the present value of future cash flows over the initial investment outlay for a project is the:
A. Internal rate of return (IRR) of the project.

B. Modified internal rate of return (MIRR) on the project.
C. Book (accounting) rate of return for the project.
D. Net present value (NPV) of the project.
E. Modified internal rate of return (MIRR) of the project.

Difficulty: Easy
31. A capital budgeting model that accounts for an assumed rate of return on interim-period cash inflows from an investment is the:
A. Internal rate of return (IRR) model.

B. Present-value payback period model.
C. Net present value (NPV) model.
D. Accounting rate of return (ARR) model.
E. Modified internal rate of return (MIRR) model.
Difficulty: Medium
32. Under conditions of capital rationing (i.e., limited capital funds are available), the optimal allocation of funds occurs when management
uses which of the following decision models?
A. Discounted payback.
B. Profitability index (PI).
C. Modified internal rate of return (MIRR).
E. Discounted accounting rate of return.
Difficulty: Easy
33. Which one of the following methods assumes that all interim cash inflows generated by an investment earn a return equal to the internal
rate of return (IRR) of the investment?
A. Modified internal rate of return (MIRR).

B. Payback.
C. Net present value (NPV).
D. Present value index (PI).
E. Internal rate of return method (IRR).
Difficulty: Medium
34. For a capital investment project, a net present value (NPV) of $500 indicates that the:
A. Project's rate of return exceeds the hurdle (discount) rate.

B. Project's internal rate of return is unacceptable.
C. Present value of cash outflows exceeds the present value of cash inflows.
D. Total cash outflows for the project are expected to be $500.
E. Internal rate of return (IRR) exceeds the accounting rate of return on the project.
Difficulty: Easy
35. A 15% internal rate of return (IRR) on a proposed capital investment indicates all of the following except:
A. The actual (economic) rate of return on the project is 15%.

B. Use of a 15% discount rate would result in an estimated project NPV of zero.
C. An acceptable capital project if the cost of capital is 16 percent or higher.
D. A positive net present value (NPV) if the cost of capital is less than 15%.
E. An acceptable project, in a present value sense, if the discount rate is less than 15%.
Difficulty: Medium
36. Which one of the following is true for the IRR method?
A. It assumes cash proceeds can be reinvested to earn the same rate of return as the cost of capital or desired rate of return on that particular
project.
B. Unlike the NPV method, it assumes only a single discount rate.
C. IRRs of multiple projects are additive (that is, can be added together).
D. It can be used to make optimal decisions regarding mutually exclusive investment projects.
E. It makes it easy to incorporate multiple costs of capital.
Difficulty: Medium
37. Which one of the following statements concerning capital budgeting is not true?
A. A basic objective underlying capital budgeting is to select assets that will earn a satisfactory return.
B. Capital budgeting is the process of planning asset investments.
C. Capital budgeting is based on precise estimates of future events.
D. Capital budgeting involves estimating the revenues and costs of each proposed project, evaluating their merits, and choosing those worthy
of investment.
E. Capital budgeting uses after-tax cash flows in the analysis of proposed investments.
Difficulty: Easy
38. Which of the following methods can be used to deal formally with uncertainty in the capital-budgeting process?
A. Real options analysis.

B. Net present value (NPV) analysis.
C. Capital rationing analysis.
D. Linear programming optimization.
E. Equivalent annual annuity (EAA) analysis.
Difficulty: Easy
39. Two investments have the same total cash inflows and the same payback period. Therefore:
A. These two investments are equally desirable.

B. These two investments must be identical in terms of the present value of the cash inflows.
C. The payback period method can help decision makers choose between these two investments.
D. One pattern of cash inflows may be preferable to the other investment's pattern of cash inflows.
E. Most likely, these two investments required approximately the same initial investment.
Difficulty: Medium
40. In a discounted cash flow (DCF) analysis, a required incremental investment in net working capital:
A. Should be amortized over the useful life of the equipment.

B. Can be disregarded because the same amount of cash will be recovered at the end of the project's life.
C. Should be treated as a recurring cash outflow over the life of the project.
D. Should be treated as a reduction in the required cash outflow in period 0.
E. Should be treated as an immediate cash outflow that is later recovered when it is no longer needed.
Difficulty: Medium
41. Which of the following is always true with regard to the NPV decision model?
A. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal rate of return (IRR)
approach.
B. The NPV and the IRR approaches will always rank projects in the same order.
C. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the payback approach.
D. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the book (accounting) rate of return
approach.
E. If a project is rejected under the NPV approach, it would also be rejected under the payback approach.
Difficulty: Easy
42. If a company is in the situation of having unlimited capital funds, the best decision rule, considering only financial factors, is for it to
invest in all projects in which:
A. The payback period is short.

B. The book (accounting) rate of return is greater than its current return on invested capital (ROI).
C. The net present value (NPV) is greater than the cost of capital.
D. The internal rate of return (IRR) is greater than zero.
E. The NPV is greater than zero.
Difficulty: Easy
43. When the net present value (NPV) of a project is calculated based on the assumption that the cash flows occurred at the end of the year
when they actually occurred uniformly throughout each year, the NPV will:
A. Not be in error.
B. Be slightly overstated.
C. Be unusable for actual decision-making.
D. Be slightly understated but probably usable.
E. Produce an error the direction of which is undeterminable.
Difficulty: Hard
44. Without knowing its required rate of return (i.e., hurdle rate) for use in the evaluation of capital investment projects, a company will be
prohibited from calculating a project's:
A. A
B. B
C. C
D. D
E. E

Difficulty: Medium
45. When the internal rate of return (IRR) method and the net present value (NPV) method do not yield the same recommendation for the
same investment project, the technique normally selected is:
A. IRR, because all reinvestment of funds occurs at the rate of the cost of capital and because it takes into consideration the relative size of
B. NPV, because it takes into consideration the relative size of the initial investment.
C. IRR, because all reinvestment of funds occurs at the discount rate that will make the NPV of the project equal to zero.
D. NPV, because all reinvestment of funds occurs at the discount rate that will make the NPV of the project equal to zero.
E. IRR, because all reinvestment of funds occurs at the rate the project generates and because it takes into consideration the relative size of
Difficulty: Hard
46. If an existing asset is sold at a gain, and the gain is taxable, then the after-tax proceeds from this transaction would be equal to:
A. Net proceeds from the sale plus the after-tax gain on the sale.
B. Net proceeds from the sale less the after-tax gain on the sale.
C. Net proceeds from the sale plus the taxes paid on the gain.
D. Net proceeds from the sale less the taxes paid on the gain.
E. The pre-tax proceeds plus taxes on the gain.
Difficulty: Medium
47. For a given income tax rate, t, after-tax cash operating receipts are calculated as follows:
A. Taxable cash receipt times (1 - t).

B. Taxable case receipt times t.
C. Taxable cash receipt times (1 + t).
D. Taxable cash receipt divided by (1 - t).
E. Taxable cash receipt divided by t.
Difficulty: Easy
48. Which of the following statements regarding the determination of the weighted-average cost of capital is not true:
A. The capital asset pricing model (CAPM) cannot be used to estimate the cost of debt for a company.
B. The capital asset pricing model (CAPM) can be used to estimate the cost of equity for a non-public company.
C. In estimating the cost of debt, the analyst typically estimates the current yield-to-maturity of the debt instruments in the company's capital
structure.
D. Market, not book, values of the components of capital are preferable in terms of determining weights for the weighted-average calculation.
Difficulty: Medium
49. Which of the following is not used to deal with uncertainty in the capital budgeting process?
B. Sensitivity analysis.
C. Monte Carlo simulation.
D. Real options analysis.
E. Linear programming analysis.
Difficulty: Easy
50. The term "breakeven after-tax cash flow" represents:
A. A pessimistic estimate in a typical scenario analysis.

B. An optimistic estimate in a typical scenario analysis.
C. The amount of after-tax cash flow needed to generate a return equal to a project's IRR.
D. The cash flow needed to generate an IRR of zero.
E. An estimate that can be arrived at using Goal Seek in Excel.
Difficulty: Easy
51. Tyson Company has a pre-tax net cash inflow of $1,200,000. The company can claim depreciation expense of $500,000 this year. The
company is subject to a combined income tax rate of 26%. What is the after-tax cash flow for the year?
A. $700,000.
B. $1,018,000.
C. $182,000.
D. $370,000.
E. $1,200,000.
1. Taxable income = Net cash inflow - Depreciation expense = $1,200,000 - $500,000 = $700,000
2. Tax liability = Taxable income x t, where t = income tax rate
3. Tax liability = $700,000 x 0.26 = $182,000
4. After-tax cash flow = pre-tax cash flow - tax liability = $1,200,000 - $182,000 = $1,018,000

Difficulty: Easy
52. What is the present value of $1 received five years from now (rounded to two decimal places) if the discount rate is 12%?
A. $1.76.
B. $0.57.
C. $1.00.
D. $1.60.
1. The appropriate discount factor, if the tables are not available, can be determined as follows: 1/(1 + r)n, where r = the discount rate (per
period) and n = the number of periods.
2. In the present case, we have 1/(1 + 0.12)5 = 1/1.762341683.
3. Thus, PV of $1 to be received five years from now when the discount rate is 12% per year = $0.567427, or $0.57 if rounded to two decimal
places.
Difficulty: Easy
value.
What is the payback period for the new machine, under the assumption that cash inflows occur evenly throughout the year?
A. 4 years.
B. 5 years.
C. 6 years.
D. 10 years.
E. 15 years.
1. Annual depreciation expense = ($1,500,000 - $0)/10 years = $150,000

2. After-tax cash flow = after-tax income + non-cash expenses (depreciation)
3. After-tax cash flow = $100,000 + $150,000 = $250,000
4. Payback (in years) = $1,500,000/$250,000 = 6 years
Difficulty: Medium
value.
What is the annual accounting (book) rate of return (rounded) on the initial investment?
A. 6.67%.
B. 10.00%.
C. 13.33%.
D. 16.67%.
E. 23.33%.
1. Annual book (accounting) rate of return = annual accounting income/initial investment

2. ARR = $100,000/$1,500,000 = 6.67%
Difficulty: Easy
55. All of the following capital budgeting decision models, except for this one, use cash flows as the primary basis for the calculation.
A. Net present value (NPV)

B. Internal rate of return (IRR)
C. Payback period
D. Discounted payback period
E. Accounting rate of return (ARR)
Difficulty: Easy
56. Madson Company is analyzing several proposed investment projects. The firm has resources only for one project.
The company uses the payback period method for capital investment decisions. On the basis of this decision model, which project should
be selected? (Ignore taxes.)
A. Project P.
B. Project Q.
C. Project R.
D. Project S.
E. Project T.
1. Project P: Payback = 2 years + ($6,000/$12,000) year = 2.5 years
2. Project Q: Payback = 3 years + ($5,000/$18,000) year = 3.28 years
3. Project R: Payback = 3 years + ($14,000/$30,000) year = 3.47 years
4. Project S: Payback = N/A (cumulative cash inflows < original investment outlay)
5. Project T: Payback = 3 years + ($5,000/$10,000) = 3.5 years
Difficulty: Easy
What is the net after-tax cash inflow in Year 1 from the investment?
A. $72,000.
B. $96,000.
C. $108,000.
D. $112,000.
E. $120,000.
1. SL depreciation expense per year = ($300,000 - $0)/5 years = $60,000

2. Pre-tax income per year = Sales - depreciation - cash expenses = $200,000 - $60,000 - $80,000 = $60,000
3. Tax expense per year = $60,000 x 0.40 = $24,000
4. After-tax income = Pre-tax income - income taxes = $36,000
5. After-tax cash flow = $36,000 + depreciation expense = $36,000 + $60,000 = $96,000
Difficulty: Easy
What is the amount of net income (after taxes) in Year 2 of the investment?
A. $24,000.
B. $36,000.
C. $48,000.
D. $72,000.
E. $120,000.
1. Pre-tax income = Sales - depreciation expense - cash expenses = $200,000 - $60,000 - $80,000 = $60,000
2. After-tax income = (1 - 0.40) x $60,000 = $36,000
Difficulty: Easy
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the payback period for the new machine
(rounded to nearest one-tenth of a year)? (Assume that the cash inflows occur evenly throughout the year.)
A. 2.5 years.
B. 2.7 years.
C. 3.1 years.
D. 3.6 years.
E. 4.2 years.
Payback (in years) = original investment cost/annual after-tax cash flow = $300,000/$96,000 = 3.125 years = 3.1 years, rounded
Difficulty: Easy
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the annual book (accounting) rate of
return based on the initial investment?
A. 12%.
B. 20%.
C. 32%.
D. 36%.
E. 40%.
ARR = annual after-tax earnings/initial investment outlay = $36,000/$300,000 = 0.12

Difficulty: Easy
61.
Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the net present value (NPV) of the
investment? (The PV annuity factor for 5 years, 10% is 3.791.) Assume that the cash inflows occur at year-end.
A. ($270,480).
B. $63,936.
C. $109,428.
D. $154,920.
E. None of the above.
1. PV of future after-tax cash inflows = $96,000 x 3.791 = $363,936

2. Original investment outlay = $300,000
3. NPV = PV of future after-cash inflows - Original investment outlay = $363,936 - $300,000 = $63,936
Difficulty: Easy
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the approximate internal rate of return
(IRR) of the investment? (NOTE: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.)
A. Less than 12%.

E. Over 25%.
1. Ratio of original investment outlay to annual after-tax cash inflow = $300,000/$96,000 = 3.125
2. The discount rate (given) is 10%.
3. From Table 2, Appendix C, 5 years, an annuity factor of 3.125 corresponds to a rate of return between 15 and 20%
Difficulty: Easy
tax rate is 40%. Management requires a minimum 10% rate of return on all investments. What is the present value payback period,
rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683;
year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
A. 2.5 years.
B. 3.0 years.
C. 3.3 years.
D. 3.6 years.
E. 4.0 years.
1. PV of cash inflow, year 1 = $96,000 x 0.909 = $87,264

2. PV of cash inflow, year 2 = 0.826 x $96,000 = $79,296
6. Cumulative PV of cash inflows, after year 3 = $238,656
8. Since original investment outlay = $300,000, the PV payback period = approximately 4.0 years
Difficulty: Medium
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the net after-tax cash inflow
in Year 1 from the investment?
A. $72,000.
B. $92,000.
C. $96,000.
D. $102,000.
E. $120,000.
1. SL depreciation expense per year = ($300,000 - $50,000)/5 years = $50,000

2. Pre-tax income per year = Sales - depreciation - cash expenses = $200,000 - $50,000 - $80,000 = $70,000
3. Tax expense per year = $70,000 x 0.40 = $28,000
4. After-tax income = Pre-tax income - income taxes = $42,000
5. After-tax cash flow = after-tax income + depreciation expense = $42,000 + $50,000 = $92,000
Difficulty: Easy
65.
Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the net income (after tax) in
Year 3?
A. $28,000.
B. $36,000.
C. $42,000.
D. $70,000.
E. $72,000.
1. Pre-tax income = Sales - depreciation expense - cash expenses = $200,000 - $50,000 - $80,000 = $70,000
2. After-tax income = (1 - 0.40) x $70,000 = $42,000
Difficulty: Easy
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the payback period for the
new machine (rounded to the nearest one-tenth of a year)? Assume that the cash inflows occur evenly throughout the year.
A. 2.7 years.
B. 3.0 years.
C. 3.3 years.
D. 3.6 years.
E. 4.2 years.
Payback (in years) = original investment cost/annual after-tax cash flow = $300,000/$92,000 = 3.261years = 3.3 years, rounded
Difficulty: Easy
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the annual book (accounting)
rate of return based on the initial investment?
A. 12%.
B. 14%.
C. 17%.
D. 20%.
E. 24%.
ARR = annual after-tax earnings/initial investment outlay = $42,000/$300,000 = 0.14

Difficulty: Easy
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the estimated book
(accounting) rate of return based on average investment?
A. 12%.
B. 14%.
C. 17%.
D. 24%.
E. 34%.
1. ARR = Average annual accounting income after-tax/average investment

2. Average annual accounting income after-tax = $42,000
3. Average investment = ($300,000 + $50,000)/2 = $175,000
4. ARR = $42,000/$175,000 = 24%
Difficulty: Medium
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the investment's net present
value (NPV) of the proposed investment (rounded to the nearest hundred)? (The PV annuity factor for 10%, 5 years, is 3.791 and for 4
years it is 3.17. The present value factor for 10%, 5 years, is 0.621.) Assume that cash inflows occur at year-end.
A. $48,800.
B. $79,800.
C. $99,000.
D. $112,000.
1. PV of future after-tax cash inflows = $92,000 x 3.791 = $348,772

PV of future after-tax cash inflow, residual in year 5 = $50,000 x.621 = $31,050
Total PV for 5 years = $379,822.
Alternatively, PV of future after-tax cash inflows, 4 years = $92,000 x 3.17 = $291,640
PV of future after-tax cash inflow, year 5 = $142,000 x.621 = $88,182
Total PV for 5 years = $379,822.
2. NPV = $379,822 - $300,000 = $79,822 ($79,800 rounded)
Difficulty: Easy
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the approximate internal rate
of return (IRR) of the proposed investment? (Note: To answer this question, students must have access to Table 2 from Appendix C,
Chapter 12.)
A. Less than 12%.

E. Over 20%.
1. Ratio of original investment outlay to annual after-tax cash inflow = $300,000/$92,000 = 3.261
2. The discount rate (given) is 10%.
3. From Table 2, Appendix C, 5 years, an annuity factor of 3.261 corresponds to a rate of return between 15 and 20%
Difficulty: Easy
$50,000. Quip's tax rate is 40%. Management requires a minimum of 10% return on all investments. What is the present value payback
period, rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 =
0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
A. 2.5 years.
B. 3.0 years.
C. 3.6 years.
D. 4.1 years.
E. 4.8 years.

8. Since original investment outlay = $300,000, the PV payback period = approximately 4.1 years ($300,000 - $291,548 = $8,452; $8,452/
$57,132 = 0.1479, or 0.1 rounded) (Note that this is an approximation because it assumes that CFs occur evenly throughout each year, while
the PV calculations above assumed end-of-period CFs.)
Difficulty: Medium
What is the after-tax cash inflow in Year 1 from the investment (rounded to the nearest thousand)?
A. $62,000.
B. $114,000.
C. $170,000.
D. $240,000.
E. $37,000.
1. MACRS depreciation, Year 1 = 0.3333 x $400,000 = $133,320

2. Pre-tax income, Year 1 = Sales - depreciation - cash operating expenses = $275,000 - $133,320 - $80,000 = $61,680
3. After-tax income, Year 1 = $61,680 x (1 - 0.40) = $37,008
4. After-tax cash flow, Year 1 = $37,008 + $133,320 = $170,328 ($170,000 rounded)

Difficulty: Medium
73. If the net present value (NPV) of an investment proposal is positive, it would indicate that the:
A. PV of cash outflows exceeds the PV of cash inflows

B. Payback period is less than one-half the life of the project
C. Internal rate of return (IRR) is equal to the discount percentage used in the NPV calculation
D. PV index would be less than 100%
E. Rate of return for this project is greater than the discount rate used in the NPV computation
If the NPV > 0, it must be true that the IRR on the investment > discount rate (cost of capital).
Difficulty: Easy
74. When evaluating capital budgeting decision models, the payback period emphasizes:
A. Liquidity
B. Profitability
C. Cost of capital
D. Average net income divided by average investment
E. Average cash flow divided by average investment
Payback focuses on the amount of time it takes to return, in the form of after-tax cash inflows, the original investment outlay for a project. In
this sense, it focuses on liquidity rather than the profitability of the proposed investment.
Difficulty: Easy
75. Which of the following would not be considered a benefit of conducting post-implementation audits of capital investment projects?
A. Such audits ensure the realization of future after-tax cash flows.

B. Such audits facilitate learning from estimation errors.
C. Knowledge that investments are subject to post-implementation audit can counter tendencies to inflate estimates of net cash benefits
associated with projects.
D. The use of such audits allows top management to identify and reward good project planners.
E. Such audits reduce the tendency of managers to overstate benefits or understate costs associated with proposed capital investments.
Difficulty: Easy
76. Income tax effects are associated with all of the following except:
A. Disposition (i.e., sale) of an existing asset.

B. Required increase in net working capital associated with an investment project.
C. Sale of an investment asset at the end of the asset's useful life.
D. Effect of depreciation expense associated with an investment project.
E. Annual net benefits associated with a proposed investment.
Both the increase in net working capital and the ultimate release of working capital are non-taxable events.
Difficulty: Easy
77. XYZ Corporation is contemplating the replacement of an existing asset used in the operation of its business. The original cost of this asset
was $28,000; since date of acquisition, the company has taken a total of $20,000 of depreciation expense on this asset. The current
disposal (market) value of this asset is estimated as $18,000. XYZ is subject to an income tax rate of 34%. What is the projected after-tax
cash flow associated with the sale of the existing asset?
A. $18,000
B. $10,000
C. $14,600
D. $8,000
E. $11,400

Difficulty: Easy
78.
Carmino Company is considering an investment in equipment that will generate an after-tax income of $6,000 for each year of its four-
This asset's book (accounting) rate of return on average investment, which is defined as a simple average of the average book value for
each of the four years. The final answer should be rounded to the nearest whole %.
A. 15%.
B. 27%.
C. 36%.
D. 43%.
E. 58%.
1. Average annual after-tax income (given) = $6,000

2. Average book values, year by year:
a. Average book value, Year 1 = ($30,000 + $15,000)/2 = $22,500
b. Average book value, Year 2 = ($15,000 + $7,500)/2 = $11,250
c. Average book value, Year 3 = ($7,500 + $3,750)/2 = $5,625
d. Average book value, Year 4 = ($3,750 + $0)/2 = $1,875
3. Average investment = ($22,500 + $11,250 + $5,625 + $1,875)/4 = $10,313
4. Book (accounting) rate of return = $6,000/$10,313 = 58%
Difficulty: Medium
The amount of after-tax cash inflow from the asset in Year 3 is:
A. $6,600.
B. $7,500.
C. $8,100.
D. $9,000.
E. $9,750.
1. After-tax income, Year 3 (given) = $6,000

2. Non-cash charges (depreciation), Year 3 = book value of asset, beginning of Year 3 - book value of asset, end of Year 3 = $7,500 - $3,750
= $3,750
3. After-tax cash inflow, Year 3 = After-tax income + non-cash charges (depreciation) = $6,000 + $3,750 = $9,750
Difficulty: Easy
respectively. The firm uses straight-line depreciation with no residual value at the end of five years. The payback period in years (rounded
to the nearest 10th of a year) for this proposed investment is (assume that the cash inflows occur evenly throughout the year):
A. 2.5 years.
B. 3.0 years.
C. 3.5 years.
D. 4.3 years.
E. 4.5 years.
1. Cum. After-tax CF, Period 0 = ($45,000).

2. Cum. After-tax CF, Period 1 = ($45,000) + $18,000 = ($27,000)
5. Cum. After-tax CF, Period 4 = ($3,000) + $6,000 = $3,000
6. Cum. After-tax CF, Period 5 = $3,000 + $3,000 = $6,000
7. Therefore Payback = 3 + ($3,000/$6,000) = 3.5 years
Difficulty: Easy
capital investment projects is 4%, after-tax. The estimated book (accounting) rate of return on this project (rounded to two decimal
points), based on the initial investment is:
A. 2.67%.
B. 3.33%.
C. 6.67%.
D. 10.00%.
E. 12.00%.
1. Total after-tax cash inflows, 5 years = $18,000 + $15,000 + $9,000 + $6,000 + $3,000 = $51,000.
2. On average, after-tax cash flow per year = $51,000/5 years = $10,200.
3. The average depreciation charge per year = ($45,000 - $0)/5 years = $9,000.
4. Therefore, the average after-tax income per year = $10,200 - $9,000 = $1,200
5. ARR = $1,200/$45,000 = 2.67%
Difficulty: Medium
capital investment projects is 4%, after-tax. (Note: the following PV factors for 4%: for 1 year = 0.962, for year 2 = 0.925, for year 3 =
0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
At a discount rate of 4%, the net present value is (rounded to the nearest hundred):
A. ($15,000).
B. ($12,300).
C. ($9,300).
D. ($6,000).
E. $1,800.
1. PV of CF, Year 0 = ($45,000) x 1.00 = ($45,000)

2. PV of CF, Year 1 = $18,000 x 0.962 = $17,316
3. PV of CF, Year 2 = $15,000 x 0.925 = $13,875
4. PV of CF, Year 3 = $9,000 x 0.889 = $8,001
5. PV of CF, Year 4 = $6,000 x 0.855 = $5,130
6. PV of CF, Year 5 = $3,000 x 0.822 = $2,466
7. NPV = ($45,000) + $17,316 + $13,875 + $8,001 + $5,130 + $2,466 = $1,788 ($1,800 rounded)
Difficulty: Medium
capital investment projects is 4%, after-tax. (Note: PV factors for 4%: for 1 year = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4
= 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
At a discount rate of 4%, the PV payback period, in years (rounded to two decimal places) is:
A. 2.89 years.
B. 3.50 years.
C. 3.89 years.
D. 4.27 years.
E. More than 5 years.
1. PV of CF, Year 0 = ($45,000) x 1.00 = ($45,000); PV of CF, Year 1 = $18,000 x 0.962 = $17,316; PV of CF, Year 2 = $15,000 x 0.925 =
$13,875; PV of CF, Year 3 = $9,000 x 0.889 = $8,001; PV of CF, Year 4 = $6,000 x 0.855 = $5,130; PV of CF, Year 5 = $3,000 x 0.822 =
$2,466
2. Cum. PV of after-tax cash flow, end of period 0 = ($45,000)
Cum. PV of after-tax cash flow, end of period 1 = ($45,000) + $17, 316 = ($27,684)
Cum. PV of after-tax cash flow, end of period 2 = ($27,684) + $13,875 = ($13,908)
Cum. PV of after-tax cash flow, end of period 3 = ($13,908) + $8,001 = ($5,808)
Cum. PV of after-tax cash flow, end of period 4 = ($5,808) + $5,130 = ($678)
Cum. PV of after-tax cash flow, end of period 5 = ($678) + $2,466 = $1,788
3. Therefore, the PV payback period = 4 + ($678/$2,466) = 4.27 years (Note that this is an approximation because it assumes that CFs occur
evenly throughout each year, while the PV calculations above assumed end-of-period CFs.)
Difficulty: Medium
capital investment projects is 4%, after-tax. (Note: To answer this question, students will have to be provided with the Tables provided in
Appendix C, Chapter 12. Alternatively, the instructor can provide students with the following PV factors for 4%: for 1 year = 0.962, for
year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.)
The estimated internal rate of return (IRR) on this investment is:
A. Less than 4%.

B. 4%.
C. Slightly above 4%.
D. Greater than 6%.
E. Undeterminable with only the given information.
Because the PV payback is close to the life of the project (see answer to Question #83), we know that the IRR is close to the required rate of
return (i.e., the discount rate), 4% in the current example. When the PV payback period is less than the life of the project, it implies that the
IRR of the project > required rate of return; alternatively, it implies that the NPV is positive. Note from Question #82 that the estimated NPV
of this project, at 4%, is approximately $1,800. Thus, for both reasons we can conclude that the estimated IRR of this project is slightly above
4%.
Difficulty: Medium
85.
Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. Assume that cash inflows occur evenly
throughout the year. The estimated payback period for this proposed investment, in years, is (rounded to two decimal places):
A. 4.17 years.
B. 5.05 years.
C. 5.43 years.
D. 5.67 years.
E. 7.14 years.
Payback period (in years) = Original investment outlay/annual after-tax cash flow = $600,000/$144,000 = 4.17 years (under the assumption
that the cash inflows occur evenly throughout the year)
Difficulty: Easy
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The book (accounting) rate of return based on
initial investment is:
A. 12.73%.
B. 14.00%.
C. 24.00%.
D. 28.00%.
1. Average annual after-tax profit = Avg. after-tax cash flow - Avg. depreciation expense
2. Average after-tax cash flow (given) = $144,000
3. Average annual depreciation expense = ($600,000 - $0)/10 years = $60,000
4. Average annual after-tax profit = $144,000 - $60,000 = $84,000
5. ARR = average annual after-tax profit/initial investment = $84,000/$600,000 = 0.14
Difficulty: Easy
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The accounting (book) rate of return based on
average investment (rounded to two decimal places) is:
A. 12.73%.
B. 14.00%.
C. 25.45%.
D. 28.00%.
1. Average annual after-tax profit = Avg. after-tax cash flow - Avg. depreciation expense
2. Average after-tax cash flow (given) = $144,000
3. Average annual depreciation expense = ($600,000 - $0)/10 years = $60,000
4. Average annual after-tax profit = $144,000 - $60,000 = $84,000
5. Average investment = (Book value, beginning of year 1 + Book value, end of year 10)/2 = ($600,000 + $0)/2 = $300,000
6. ARR = $84,000/$300,000 = 28.00%
Difficulty: Easy
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The estimated net present value of this
proposed investment (rounded to the nearest thousand) is:
Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145.
A. ($105,000).
B. ($84,000).
C. $181,000.
D. $248,000.
E. $285,000.
1. Initial investment outlay = $600,000

2. PV of stream of future after-tax cash inflows = $144,000 (given) x 6.145 = $884,880
3. NPV @ 10% = $884,880 - $600,000 = $284,880 ($285,000, rounded)
Difficulty: Easy
89.
Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen
$144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. The estimated internal rate of return (IRR) on
this proposed investment is:
(Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145):
A. Less than 10%.

B. 10%.
C. 12%.
D. Greater than 12%.
E. Indeterminable.
1. Initial investment outlay = $600,000

2. PV of stream of future after-tax cash inflows = $144,000 (given) x 6.145 = $884,880
3. NPV @ 10% = $884,880 - $600,000 = $284,880 ($285,000, rounded)
4. The NPV of this project is rather large (viz., $285,000). Because the NPV > $0, we can conclude that the IRR > 10%. Because of the
absolute size of the estimated NPV, we can conclude that it is likely greater than 12%.
Difficulty: Medium
90. If a company is faced with limited capital funds for investment (i.e., the company faces capital rationing), the best general method to
employ to assess individual project profitability is:
B. Net present value (NPV)
C. Payback
E. Present value index (PI)
Difficulty: Easy
91. If a company must choose between two mutually exclusive investment projects, the best general method to employ for decision-making
purposes is:
B. Cash-flow break-even
C. Net present value (NPV)
E. Accounting (book) rate of return, based on average investment over the life of each project
Difficulty: Easy
92. A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate
of the financial consequences of possible prediction errors is:
A. Expected value analysis

B. Learning curve analysis
C. Capital budgeting analysis
D. Sensitivity analysis
E. Exponential distribution analysis
Difficulty: Easy
93. Flex Corporation is studying a capital investment proposal in which newly acquired assets will be depreciated using the straight-line (SL)
method. Which one of the following statements about the proposal would be incorrect if, instead of SL, the Modified Accelerated Cost
Recovery System (MACRS) is used for determining depreciation for income tax purposes?
A. The estimated net present value (NPV) of the project would increase.
B. The internal rate of return (IRR) of the project would likely increase.
C. The payback period for the investment would be shortened.
D. The total after-tax income from this project, over its life, would normally increase.
E. Total tax payments over the life of the project would be unaffected.
Total after-tax income over the life of the project should be unaffected by the choice of depreciation method, just as total tax payments over
the life of the project would normally be unaffected.
Difficulty: Medium
94. Jasper Company has a payback goal of three years on acquisitions of new equipment. A new piece of equipment that costs $450,000 and a
five-year life is being considered. Straight-line (SL) depreciation will be used, with zero salvage value. Jasper is subject to a 40% income
tax rate. To meet the company's payback goal, the equipment must generate reductions in annual cash operating costs of:
A. $60,000.
B. $114,000.
C. $150,000.
D. $190,000.
E. $285,000.
1. $450,000/3 years = $150,000 per year.

2. Depreciation/year (SL) = $450,000/5 years = $90,000/year.
3. Income tax savings/year based on depreciation deduction = $90,000 x 0.40 = $36,000.
4. After-tax cash operating cost savings needed per year = $150,000 - $36,000 = $114,000.
5. Therefore, pre-tax operating cost savings needed per year = $114,000/(1 - 0.40) = $190,000.
Difficulty: Medium
95. Amster Corporation has not yet decided on its discount rate for use in the evaluation of capital budgeting proposals. This lack of
information will prohibit the company from calculating a proposed investment's:
A. A
B. B
C. C
D. D
E. E
Both the net present value (NPV) and the internal rate of return (IRR) decision models require a discount rate, which is applied to estimated
future cash flows associated with the investment project. On the other hand, the ARR model uses undiscounted accounting income (and
investment) data. As such, ARR can be estimated in the absence of information regarding the discount rate.
Difficulty: Easy
96. For dealing with uncertainty in the capital budgeting process, all of the following techniques can be used except which one?
B. Monte Carlo simulation.
C. Scenario analysis.
D. Linear programming.
Difficulty: Easy
97. Which of the following statements regarding real options is not true:
A. Similar to financial options, real options are traded on an open exchange.

B. Their consideration in capital budgeting analysis is designed to complement conventional DCF models.
C. They refer to options on real assets (i.e., tangible and intangible property).
D. They can never reduce NPV of a proposed investment, only increase its NPV.
E. They represent one way of handling risk and uncertainty in the capital budgeting process.
Difficulty: Hard
98. Which of the following is not one of the four general classes of real options?
A. Expansion option.
B. Exercise option.
C. Abandonment option.
D. Investment-timing option (e.g., delay)
Difficulty: Easy
99. Which of the following statements regarding real options is true:
A. The farther away the expiration date, the less valuable the option is.
B. They can be incorporated into the capital budgeting decision process through the use of decision trees.
C. They allow decision makers to react to unfavorable, but not favorable, future information/news.
D. Conventional DCF decision models cannot incorporate the effects of real options.
E. Capital budgeting models cannot handle multiple options embedded in an investment project.
Difficulty: Medium
100. The estimated value of a real option:
A. Is affected by essentially the same set of factors that affect the value of financial options.
B. Cannot be incorporated into a conventional DCF analysis of an investment project.
C. Is affected by the length of the expiration date of the option.
D. Decreases as the underlying risk of a project increases.
E. Is inversely related to estimated volatility of returns for a proposed project.
Difficulty: Medium
101. If the present value payback period is less than the life of the project, one may conclude that:
A. The project's IRR is less than the discount (hurdle) rate.

B. The project's accounting (book) rate of return exceeds the discount (hurdle) rate.
C. The project is not desirable in a present-value sense.
D. The project's net present value is positive.
Difficulty: Medium
102. Which of the following characteristics is not true of the modified internal rate of return (MIRR)?
A. Unlike IRR, MIRR does not consider the time value of money.
B. It focuses on after-tax cash flows, rather than accounting income amounts.
C. It cannot be used reliably to choose between mutually exclusive projects.
D. Its use may not lead to an optimum capital budget.
E. It is complex to compute, if done manually.
Difficulty: Medium
Assume that cash inflows occur evenly throughout the year. The estimated payback period in years (rounded to one decimal place) is:
A. 3.7 years.
B. 4.6 years.
C. 5.8 years.
D. 6.0 years.
E. 7.9 years.
1. Annual cash inflow (given) = $165,000

2. Original investment outlay (given) = $990,000
3. Payback period = $990,000/$165,000 = 6 years
Difficulty: Easy
The internal rate of return (IRR) is (note: to solve this problem students will need access either to Appendix C, Table 2 (Chapter 12) or
Excel):
A. Less than 10%.

E. Greater than 15%.
1. If the tables are available to students, then we are looking in Table 2 for a PV annuity factor equal to the ratio of the original investment
outlay ($990,000) to the annual net cash inflow from the investment ($165,000), or 6.00. We look in the row corresponding to 15 periods and
find that the associated interest rate (IRR) is between 14 and 15 percent.
2. If using the built-in IRR function in Excel, we estimate the IRR directly as 14.47%, as follows:
= IRR({-990000;165000;165000;165000;165000;165000; 165000;165000;165000;165000;165000;
165000;165000;165000;165000;165000}). Note: data in the above formula are entered in as an array.
Difficulty: Medium
105. LaVar, Inc. has obtained probability estimates from its production and sales departments regarding the costs and selling prices it can
anticipate for a new product line. The company is uncertain as to which combination of costs and selling prices will occur. The best
method for determining the expected outcome of the investment, based on an assumed probability distribution for both sales and costs,
is:

B. The analytic hierarch process (AHP).
C. Correlation analysis.
D. Multiple regression analysis.
E. Linear programming.
Difficulty: Easy
106. The decision technique that measures the estimated performance of a capital investment by dividing the project's annual after-tax income
by the average investment cost is called the:
A. Break-even point for the project.
B. Internal rate of return on the proposed investment.
C. Accounting (book) rate of return on the investment.
D. Capital asset pricing model.
E. Profitability index (PI) for the investment.
Difficulty: Easy
107. The internal rate of return for an investment:
A. Frequently results in positive net present value on attractive projects.

B. Generally coincides with the company's discount rate.
C. Disregards discounted cash flows.
D. On mutually exclusive projects may produce different project rankings than the net present value (NPV) method.
E. Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes rather than the straight-line (SL)
method.
Difficulty: Easy
108. The net present value (NPV) method and the internal rate of return (IRR) method are used to analyze proposed capital expenditures. The
IRR method, as contrasted with the NPV method:
A. Is considered inferior because it fails to calculate compounded rates of return.

B. Incorporates the time value of money, while the NPV method does not.
C. Almost always gives a different decision that the NPV method as to the acceptability ("go" versus "no go") of a given proposed
investment.
D. Assumes that the rate of return on the reinvestment of the cash proceeds is at the indicated rate of return of the project analyzed rather than
at the discount rate used.
E. Is preferred in practice because it is able to handle multiple desired rates of return, which is impossible to do with the NPV method.
Difficulty: Medium
109. Generally speaking, when ranking two mutually exclusive investments with different initial amounts, management should give first
priority to the project:
A. That generates cash flows for the longer period of time.

B. Whose net after-tax cash flows equal the initial investment outlay.
C. That has the greater accounting rate of return (ARR).
D. Whose cash flows vary the least.
E. That has the greater profitability index (PI).
Difficulty: Medium
110. Which of the following is not an important advantage of the net present value (NPV) method over the internal rate of return (IRR)
method in evaluating capital investment proposals?
A. NPV facilitates comparisons of mutually exclusive projects requiring different amounts of initial investments.
B. NPV facilitates comparisons among mutually exclusive projects that have the same useful life but different initial outlays.
C. NPV can be used to determine an optimum capital budget under conditions of capital rationing, while IRR cannot.
D. NPV is relatively intuitive.
E. IRR relies on discounted cash-flow analysis, while NPV does not.
Difficulty: Hard
111. In situations where a firm specifies to different required rates of return (i.e., discount rates) over the years, it is advantageous to use:

B. The book rate of return method.
C. The net present value (NPV) method.
D. The internal rate of return (IRR) method.
E. Sensitivity analysis.
Difficulty: Medium
112. Which of the following is an example of a sunk cost in a capital budgeting decision regarding the purchase of new equipment for a
profitable business that pays taxes?
A. The disposal of the equipment to be replaced.

B. The purchase price of the equipment to be replaced.
C. The additional working capital requirement.
D. The operating cost of the new equipment.
Difficulty: Easy
113. Which of the following items has no after-tax consequences in the analysis of a capital investment proposal?
A. Cash flow from operations.

B. Salvage of the old investment.
C. Employee severance compensation.
D. Reduction of working capital.
E. Gain or loss on the disposal of the investment.
Difficulty: Medium
114. When we assume in our calculations for capital budgeting decisions that all cash flows occur at the end of individual years during the life
of an investment project when, in fact, they flow more or less continuously during those years, which of the following statements is
true?
A. The internal rate of return (IRR) of the project will be overstated.

B. The net present value (NPV) of the project will be overstated.
C. Inconsistent errors will exist in either NPV or IRR.
D. The net present value (NPV) of the project will be understated.
E. The use of DCF models in practice will not provide valid results.
Difficulty: Medium
115. In addition to a one million dollar acquisition cost, an investment requires $200,000 working capital during its useful years. This
investment in working capital should be:
A. Added to the cash outflow each year during the useful life of the investment.
B. Disregarded in the capital budgeting decision because the working capital is not an expense.
C. Treated as an immediate cash outflow that is recovered at the end of the investment's useful life.
D. Treated as an immediate expense and a gain at the end of the investment's useful life.
E. Added to the initial investment.
Difficulty: Medium
116. Within the context of capital budgeting, a primary goal-congruency problem exists when DCF models are used for decision-making
purposes but accrual-based earnings figures are used for subsequent performance evaluation purposes. Which of the following items is
not likely useful for addressing this goal-congruency problem?

B. Use of EVA→ as the financial-performance metric.
C. Separating incentive compensation (i.e., "reward") from budgeted performance.
D. Conducting post-audits of capital investment decisions.
Difficulty: Easy
117. The profitability index (PI) is calculated as:
A. Net present value (NPV) divided by average investment.

B. Net present value (NPV) divided by initial investment.
C. Average investment divided by net present value (NPV).
D. Initial investment divided by net present value (NPV).
Difficulty: Easy
118. Western Electronics (WE) is reviewing the following data relating to a new equipment proposal:
WE expects the net after-tax savings in cash outflows from the investment to be equal in each of the 5 years. What is the minimum
amount of after-tax annual savings (including depreciation effects) needed to make the investment yield a 12% return (rounded to the
nearest whole dollar)?
A. $8,189.
B. $11,111.
C. $12,297.
D. $13,889.
E. $15,678.
1. PV of future salvage value, after tax = $10,000 x 0.567 = $5,670

2. Original investment outlay = $50,000
3. Net amount (in present value terms) to be recovered = $50,000 - $5,670 = $44,330
4. Required annual after-tax savings to generate return of 12% = $44,330/3.605 = $12,297
Difficulty: Medium
119. A profitable company pays $100,000 wages and has depreciation expense of $100,000. The company's income tax rate is 40%. The
after-tax effects on cash flow are a net cash outflow of:
A. $40,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
B. $40,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
C. $60,000 for wages and a net cash inflow of $60,000 for depreciation expenses.
D. $60,000 for wages and a net cash inflow of $40,000 for depreciation expenses.
E. $40,000 for wages and a net cash inflow of $100,000 for depreciation expenses.
Difficulty: Medium
120. Conceptually, a firm's capital structure is its:
A. Mix of debt and equity capital, expressed in book-value terms.

B. Mix of debt and equity capital, expressed in market-value terms.
C. Equity capital only, expressed in book-value terms.
D. Equity capital only, expressed in market-value terms.
Difficulty: Easy
121. Consider two projects, A and B. The present value (PV) of cash inflows for project A is $55,000, while the present value of cash
outflows for this project is $50,000. Project B, on the other hand, has the following characteristics: PV of cash inflows = $24,000; PV of
cash outflows = $20,000. Assume that these two projects are mutually exclusive. Assume that the company has adequate capital to fund
either investment option. All of the following statements are true except:
A. The NPV of Project A is $5,000.

B. The IRR of Project A is greater than the cost of capital (discount rate).
C. The profitability index (PI) for Project A is 1:1.
D. Project A is preferable to Project B (all else held constant).
Difficulty: Medium
122. XYZ Corporation's capital structure consists of 60% debt with a pretax cost of 10%, and the balance by common equity, with a cost of
15%. The company's marginal tax rate (federal and state combined) is 50%. XYZ's weighted-average cost of capital (WACC) is:
A. 9.0%
B. 10.0%
C. 12.0%
D. 12.5%
1. After-tax cost of debt = pretax cost x (1 - tax rate) = 0.10 x (1 - 0.50) = 5.0%
2. After-tax cost of equity = pretax cost of equity = 15%
3. Weighted-average cost of capital (WACC) = (0.60 x 5%) + (0.40 x 0.15) = 0.03 + 0.06 = 0.09
Difficulty: Medium
123. In capital budgeting, the accounting rate of return (ARR) decision model:
A. Considers the time value of money.

B. Ignores cash outflows after the initial investment.
C. Incorporates the timing of cash flows.
D. Ignores accounting income generated after the break-even point.
E. Does not provide an unambiguous decision criterion regarding the acceptance of capital investment projects.
Difficulty: Medium
124. All of the following capital budgeting models incorporate the time value of money except:

B. The modified internal rate of return (MIRR) method.
C. The profitability index (PI) method.
D. The discounted payback method.
E. The internal rate of return (IRR) method.
Difficulty: Easy
125. ______________ is the recommended method for determining the optimal capital budget under conditions of capital rationing.
A. The net present value (NPV) method.

B. The use of Monte Carlo simulation.
C. The modified rate of return (MIRR) method.
D. The profitability index (PI) method.
E. Discounted payback method.
Difficulty: Easy
126. Jason Company provides weather and climate forecasts to almost 100 firms in the northwestern states of Washington, Oregon, and
Idaho. New technology is available that should improve forecast accuracy anywhere from ten to fifteen percentage points.
Required:
1. What information is likely to be most difficult to estimate in conjunction with this investment decision?
2. Which capital budgeting decision model is the most appropriate for making this decision?
1. Perhaps the most difficult piece of data to calculate will be the revenue the investment will generate. What dollar impact will increased
accuracy have on current client revenue? Can we raise the rates we charge users of weather forecasts? How attractive is increased accuracy in
generating new clients?
2. Beyond answering the preceding questions, either a net present value (NPV) analysis or internal rate of return (IRR) calculation would be
appropriate. If the technology can be purchased in segments, a value chain analysis could be used to verify the results of a NPV analysis.
Since we need addable figures dealing with multiple projects, NPV would be used for time-valued analysis.
Difficulty: Easy
127. Acorn Corporation designs and installs fire-suppression systems in commercial buildings. Over 90 percent of Acorn's business is in new
construction, with the remainder in upgrade installations in remodeled buildings. For planning and control purposes, Acorn's controller
(Jane Reid) is considering purchasing cost and financial accounting software from Constructor Solutions. Costs for the software modules
are shown below:
Required:
1. Jane uses value-chain analysis in evaluation of capital investments. She asks you which method, internal rate of return (IRR) or net
present value (NPV), would be best in selecting individual software modules, and your reason(s) for the choice of method.
2. Jane says, "If we buy the entire set of six modules, we will get the equivalent of Module 6 free." Why might this savings of almost
$1,500 be illusory?
3. The present value of the cost savings generated by the set of six modules, based on a five-year life and discount rate of 18 percent, is
estimated as $13,844.50. Should the set be purchased? Explain. How would your decision be affected if Acorn's minimum rate of return
were 24 percent? (No calculations are necessary to answer this question.)
1. Jane should use net present value (NPV) analysis since results from NPV analysis of multiple projects are addable; internal rates of return
are not addable. Value-chain analysis goes beyond NPV analysis by considering the financial impact of all activities that add value to the
firm. Many of these activities are not included in conventional capital investment analysis, e.g., downstream costs of warranties and upstream
value added in the experience gained through design of products.
2. True, the cost of the set of six modules is $1,472.50 less than the six modules purchased separately. However, there is no value in
purchasing any module unless it can generate a return, either in cost reduction or revenue increase. Justification of the purchase of any and all
modules should be based on the individual module's merit, whether measured by NPV analysis or value-chain analysis.
3. Yes, the NPV of the set is $502 ($13,844.50 PV less $13,342.50 cost); as long as the NPV is positive, the answer is yes (all other things
being equal). If the firm's minimum rate of return (MRR) were 24 percent, the NPV would be lower, perhaps even negative. As the expected
earning rate rises, the present value of the return decreases while the cost remains constant.
Difficulty: Medium
Emerging Issues: Service
128. Jason Kirby is the leader of the capital budget group charged with reviewing capital investment options for Archer Construction
Corporation. Jason is an advocate of a short payback period requirement, since "Cash flow is the bottom line in this company."
Required: Do you agree or not? Why?
Jason is correct in saying that a quick payback would increase cash flow. Although a short payback period requirement reduces risk, it also
eliminates some desirable investments, especially new product development, new territories, and new manufacturing technologies. These
investments tend to be long-term, higher-risk ventures, but also tend to produce high IRRs.
Difficulty: Easy
129. Paulsen Inc. purchased a $700,000 machine to manufacture a specialty tap for electrical equipment. The tap was in high demand and
Paulsen could sell all that it could manufacture for the next five years. The government exempted taxes on profits from new investments
in order to encourage capital investments. This legislation was not expected to be altered in the foreseeable future. The equipment was
expected to have five years of useful life with no salvage value. The company employed straight-line depreciation. The net cash inflow
was expected to be $180,000 each year for five years. Olsen uses a rate of 9% in evaluating its capital investments.
Required: Round all answers to 2 decimal places (e.g., 12.34%).
1. Calculate the payback period for this proposed investment. (Assume that cash inflows occur evenly throughout the year.)
2. Calculate the project's accounting rate of return (ARR) based on the initial investment.
3. Calculate the accounting rate of return (ARR) based on average investment, where the latter is defined as a simple average of
beginning-of-project net book value and end-of-project net book value
4. Calculate the internal rate of return (IRR) of this proposed investment. (Note: To answer this question, students need access either to
Appendix C, Table 2 or to Excel.)
4. Two approaches for estimating the IRR for the proposed investment:
● The PV annuity factor is equal to the payback period, 3.89. This project has a five-year life. In Table 2, Appendix C, an annuity factor of
3.89 in row 5 corresponds to an interest rate (IRR) of 9%.
● Alternatively, we can use the built-in IRR function in Excel to estimate the investment's IRR, as follows (note: the amounts are entered here
as an array in Excel):
= IRR({-700000;180000;180000;180000;180000;180000})
The above formula, when entered into a cell, returns the value 0.09.
Difficulty: Medium
130. Harris Corporation provides the following data on a proposed capital project:
Harris uses straight-line depreciation method with no salvage value.

Required: Compute for this investment project:
1. NPV (the PV annuity factor for 12%, 4 years is 3.037)
2. IRR (to the nearest tenth of a percent). Note: PV annuity factors for 4 years: @ 8% = 3.312; @ 9% = 3.240; @ 10% = 3.170; @ 11% =
3.102; @ 12% = 3.037; and, @ 13% = 2.974)
3. Payback period (assume that cash inflows occur evenly throughout the year).
4. Accounting rate of return (ARR) on the net initial investment.
5. Discounted payback period (assume that the cash inflows occur evenly throughout the year; round to 2 decimal places). The
appropriate PV factors for 12% are as follows: year 1 = 0.893; year 2 = 0.797; year 3 = 0.712; year 4 = 0.636.
Alternatively, if using the built-in function in Excel, we estimate IRR as 9.20% based on the following entry into a cell: = IRR({-
200000;62000;62000;62000;62000}) (Note: The preceding data were entered into Excel as an array.)
3. Payback period = $200,000 ÷ $62,000/year = 3.23 years
4. Accounting rate of return (ARR):
5. Discounted payback period = undefined (we know this in advance for two reasons: (1) the estimated NPV of the project is less than zero,
and (2) equivalently, the IRR < discount rate). The following table provides a direct calculation (note: the difference in the NPV amount in
the following table and the amount reported above in (A) is due to rounding of the PV factors in part (A)):

Difficulty: Hard
131. The Zone Company is evaluating a capital expenditure proposal that requires an initial investment of $1,040,000. The machine will
improve productivity and thereby increases net after-tax cash inflows by $250,000 per year for 7 years. It will have no salvage value. The
company requires a minimum rate of return of 12 percent on this type of capital investment.
Required:
(A) Determine the net present value (NPV) of the investment proposal. (The PV annuity factor for 12%, 7 years is 4.564.)
(B) Determine the proposal's internal rate of return, rounded to the nearest tenth of a percent. (Note: PV annuity factors for 7 years: @
10% = 4.868; @ 11% = 4.712; @ 12% = 4.564; @ 13% = 4.423; @ 14% = 4.288; @ 15% = 4.160; and, @ 20% = 3.605.)
(C) What is the estimated payback period for the proposed investment, under the assumption that cash inflows occur evenly throughout
the year? Round your answer to 2 decimal places.
(D) What is the present value payback period for the proposed investment? Round your answer to 2 decimal places.
(E) What is the estimated accounting rate of return (on initial investment) for the proposed project?
Round your answer to 1 decimal place, e.g., 12.2%.
Please see Feedback for answers.

Feedback:
(B) Present value annuity factor that makes the present value of cash inflows to be equal to the initial investment is $1,040,000/250,000 =
4.160. In the PV annuity table, line 7, a factor of 4.160 corresponds to an interest rate (IRR) of 15%.
If students do not have access to the PV annuity table, then they can use the PV annuity factors provided in the problem and a trial-and-error
process to arrive at the same IRR figure (15%). Specifically, they can calculate the NPV of the investment under alternative discount rates.
The rate that results in a NPV of zero is, by definition, the IRR of a project.
(C) The estimated payback period for this investment = $1,040,000/$250,000 per year = 4.160 years.
(D) The present value payback period is slightly more than six years, as indicated below:
Present value payback period = 6.11 years: 6 + ($12,000/$113,000) = 6.11 years

(E) As indicated in the accompanying table, the average increase in annual after-tax accounting income is $101,429. Thus, the ARR of the
proposed investment, based on initial investment outlay, is as follows:
ARR = average increase in annual after-tax accounting income/initial investment outlay = $101,429/$1,040,000 = 9.8%
Difficulty: Hard
132. Said Company is considering the purchase of a new piece of equipment for $45,000. The projected after-tax net income associated with
this investment is $3,000 for each of the next three years. The company uses straight-line depreciation. The machine has a useful life of 3
years and no salvage value. Management of the company considers a 12% return on investment to be satisfactory. (Note: You will be
required to calculate, as part of your answer, the appropriate discount rate for a three-year annuity, at 12%.)
Required:
1. What is the discounted payback period for this investment? (The appropriate discount factors for 12% are as follows: Year 1 = 0.893;
Year 2 = 0.797, and Year 3 = 0.712.)
2. What is the net present value (NPV) of this proposed investment?
Feedback: 1. As indicated by the following schedule, the present value payback (at 12%) is undefined (since the cumulative after-tax cash
inflows never fully recover the original investment outlay):
Notes: Depreciation expense per year = $45,000/3 years = $15,000; Net after-tax cash inflow/year = $3,000 + $15,000 = $18,000
2. As indicated in the above schedule, the NPV of this proposed investment, at a 12% discount rate, is ($1,764). This negative NPV is
consistent with the answer to part 1 above (i.e., an undefined present value payback period.)
Difficulty: Medium
133. George's Garage is considering purchasing a machine for $75,000. The machine is expected to generate a net after-tax income of
$11,250 per year. This machine is to be depreciated over a 10-year period with no residual value.
Required: What is the payback period, in years, for this machine? (Assume that the cash inflows from this investment occur evenly
throughout the year.)
Feedback: Depreciation expense/year = $75,000/10 years = $7,500. Annual net after-tax cash inflow = $11,250 (given) + $7,500 = $18,750.
Payback period = $75,000/$18,750 per year = 4 years
Difficulty: Easy
134. National Rodeo Association, a not-for-profit organization, is considering purchasing a new enterprise software system for $90,000. This
investment is projected to have an eight-year useful life, and a salvage value of $8,800. Its anticipated eight-year life is projected to save
the organization approximately $18,000 each year in operating costs. In addition, the association needs an increase of $5,000 in net
working capital (other than cash) in the first year, which will not be released until the end of eight years.
Required:
(A) What is the payback period for this proposed investment? (Assume that the cash flows, other than salvage value, occur evenly
throughout the year. Round your answer to 2 decimal places.)
(B) If the Association has a required rate of return of 10 percent, what is the net present value (NPV) of this investment? Round your
calculation results to whole numbers. (The PV annuity factor for 10%, 8 years is 5.335, while the PV factor for 10%, 8 years is 0.467.)
(C) What is the internal rate of return (to the nearest whole percent)? (Note: The following present value factors are taken from the
present value tables in Appendix C of Chapter 12, for an 8-year period. This information is needed to answer the question.)
Feedback: (A) Total initial investment: $90,000 + $5,000 = $95,000; Payback period: $95,000/$18,000 = 5.28 years

Difficulty: Medium
135. Megan Inc. has a policy of not accepting any investment proposal that requires more than three years to payback. The company is
considering the purchase of new drafting equipment for $630,000. The equipment has an estimated useful life of seven years. Megan will
use straight-line depreciation for this asset, with no salvage value. Megan's income tax rate is approximately 25%.
Required: Determine the required before-tax savings for the drafting equipment to meet the company's payback requirement.

Feedback: Let X = Total savings in annual after-tax cash inflow
Then, payback period is defined as: 3 = $630,000/X, so that X = $210,000

Difficulty: Medium
136. Durable Inc. is considering replacing an old drilling machine that cost $200,000 six years ago with a new one that costs $450,000.
Shipping and installation cost an additional $60,000. The old machine has been depreciated using straight-line method with no salvage
value over an estimated 8-year useful life. The old machine can be sold for $40,000 now or $10,000 in two years. Management expects
increases in inventories of $10,000, accounts receivable of $32,000, and accounts payable of $12,000 if the new machine is acquired.
Durable's income tax rate is expected to be 30 percent over the years affected by the investment.
Required: What is Durable's net initial investment (i.e., its after-tax initial cash outlay for the machine)?
Feedback:
Difficulty: Medium
137. Fieldgard Inc. invested $800,000 in a project nine years ago. This project has generated $320,000 cash revenues per year and incurred
$250,000 cash operating costs each year. The project qualified as 7-year property under MACRS. Salvage value of this project (at the
end of the tenth, and final, year of the project's life) is expected to be $200,000. The project required $80,000 net additional working
capital at its inception and another $60,000 at the end of year 5. The increased working capital commitment is expected to be fully
recoverable when the project terminates. The company has a 40% tax rate.
Required: What is the expected total after-tax cash flow expected from this project next year (i.e., during the 10th and final year of the
project's life)?
Feedback:

Difficulty: Medium
138. Six years ago, Nebrow Inc. purchased a polishing machine for $600,000. The company expected to use the machine for 10 years with no
residual value at the end of the tenth year. The machine has been generating annual cash revenue of $460,000 and incurring annual cash
operating costs of $210,000. Nebrow is considering the purchase of a new digital polishing machine for $800,000, which will have
annual cash revenues of $690,000 and annual cash operating costs of $180,000. The new machine is expected to have a useful life of
four years. The company uses the straight-line depreciation method with no salvage value to depreciate all of its assets. Assume, for
purposes of analysis, that Nemrow is subject to a combined 40% tax rate.
Required: What is the annual incremental after-tax cash flow from the new polishing machine?
Feedback:

Difficulty: Medium
139. Solich Company is evaluating a new tractor that costs $1,350,000 to replace the tractor purchased years earlier, which currently has no
salvage value; the new tractor has an estimated useful life of five years with no disposal value or anticipated cost of disposal. The
company uses straight-line depreciation with no residual value on all equipment. Solich is subject to a 40% income tax rate. The
company uses a 12% hurdle rate for evaluating capital investment projects. The PV of an annuity of $1 at 12% for 5 years is 3.605, and
the PV of $1 at 12% in 5 years is 0.567.
Required:
1. Compute the amount of before-tax savings that must be generated by the new tractor to have a payback period of no more than 3
years.
2. Compute the amount of before-tax savings that must be generated by the new tractor to have a NPV of at least $500,000 at a desired
rate of return of 12%. (Round your answer to the nearest whole dollar amount.)
3. Compute the amount of before-tax savings that must be generated by the new tractor to have an IRR of 12%.
Feedback: 1. Annual depreciation = $1,350,000/5 years = $270,000; Annual tax savings from depreciation = $270,000 x 0.40 = $108,000. Let
X be the annual after-tax savings from the new tractor: 3 = $1,350,000/(X + $108,000). 3X + (3 x $108,000) = $1,350,000. 3X = $1,026,000,
and X = $342,000.
Therefore, the amount of before-tax savings required = $342,000/(1 - 0.40) = $570,000.
2. Let Y be the annual after-tax savings from the new tractor: $500,000 = [(Y + $108,000) x 3.6] - $1,350,000; $500,000 = 3.6Y + $388,800 -
$1,350,000, and Y = $405,889. Therefore, the amount of before-tax savings required = $405,889/(1 - 0.40) = $676,482.
3. Let Z be the annual after-tax savings from the new tractor. 3.6 = $1,350,000/(Z + $108,000); Z = $267,000. Therefore, the amount of
before-tax savings required = $267,000/(1 - 0.40) = $445,000.
Difficulty: Hard
140. Grey Inc. is considering purchasing a machine for $50,000, which is expected to generate an annual after-tax income of $10,000 and is to
be depreciated over 5 years with no residual value.
Required:
1. Under the assumption that cash inflows occur evenly throughout the year, what is the payback period for this machine?
2. Based on the initial investment outlay, what is the anticipated accounting rate of return (ARR) on this investment?
3. What is the anticipated internal rate of return (IRR) on this investment? (Note: To answer this question, you will need to have access
to Excel or the present value tables presented as Appendix C to Chapter 12.)
4. Assume a discount rate (i.e., cost of capital) of 15%:
(a)What is the modified rate of return (MIRR) on this investment, under the assumption that the interim cash inflows can be reinvested at
an estimated rate of 15%?
(b)What is the MIRR of the project under the assumption that the interim cash flows can be reinvested at a rate of 28.65%? (Note: To
answer this question, you will need access to Excel.)
Feedback: 1.
2. Average incremental after-tax accounting income (given) = $10,000; initial investment outlay = $50,000. Therefore, ARR (based on initial
investment outlay) = $10,000/$50,000 = 20%.
3. One approach is to use the built-in IRR function in Excel. When data are entered in an array format, we would have (in any cell):
= IRR({-50000;20000;20000;20000;20000;20000}), which returns a value of 28.65%.
Alternatively, once we know the payback period (in years), we can use Table 2, Appendix C of Chapter 12 to estimate a project's IRR. From
(1) above, we see that the project has a payback period of 2.5000. Given a life of 5 years, Table 2 (row 5) shows a corresponding interest rate
of between 25% and 30%. Using linear interpolation, we have: 25% + [5% * (0.189/0.253)] = 25.00% + [5.0% * 0.747] = 25.00% + 3.74% =
28.74%
4. The appropriate built-in function in Excel is MIRR, as follows:
MIRR(values,finance_rate, reinvest_rate)
Values is an array or a reference to cells that contain numbers. These numbers represent a series of payments (negative values) and income
(positive values) occurring at regular periods. Values must contain at least one positive value and one negative value to calculate the modified
internal rate of return. Otherwise, MIRR returns the #DIV/0! error value. If an array or reference argument contains text, logical values, or
empty cells, those values are ignored; however, cells with the value zero are included.
Finance_rate is the interest rate you pay on the money used in the cash flows.
Reinvest_rate is the interest rate you receive on the cash flows as you reinvest them.
a) When the discount rate is 15% and the assumed rate of return on investment for interim cash flows is also 15%, then the MIRR = 21.95%,
as follows: = MIRR({50000;20000;20000;20000;20000;20000},0.15,0.15)
(Note: the above option consists of entering data as an array.)
b) When the discount rate is 15% and the assumed rate of return on interim cash flows is 28.65% (rounded), then the MIRR = 28.60%, as
follows:
= MIRR({-50000;20000;20000;20000;20000;20000},0.15,0.2856)
Note, too, that within rounding error (i.e., the actual IRR for the proposed investment is 28.64929025%, see below) the preceding calculation
demonstrates the point that the conventional IRR formula inherently assumes that interim project cash flows are reinvested at the rate of
return associated with the current project, 28.65% in the present case. Some commentators therefore feel that the conventional IRR method
provides an overly optimistic estimate of a project's financial return.
= IRR({-50000;20000;20000;20000;20000;20000}) = 28.64929025%
Difficulty: Hard
141. Green Leaf Inc. is considering the purchase of a new piece of equipment for $30,000. The projected after-tax net income per year on this
investment is estimated to be $5,000. The firm uses straight-line depreciation. This asset is expected to have a useful life of 5 years and
no salvage value at the end of its useful life. Management of the company considers a 10% return on investment to be satisfactory. The
present value factor for 10%, 5 years = 0.621, while the present value annuity factor for 5 years at 10% is 3.791.
Required:
1. What is the estimated net present value (NPV) of the machine?
2. What is the profitability index (or, present value index), PI, for this proposed investment?
3. For what purpose is the profitability index (PI) useful, in a capital budgeting context?
4. Use the built-in function in Excel to estimate this project's internal rate of return (IRR).
5. Use the built-in function in Excel to estimate the project's modified internal rate of return (MIRR) under the assumption that the
interim cash flows from the investment generate a rate of return of: (a) 10%, and (b) 20%.
6. How does the MIRR measure differ from the conventional IRR calculation?
Feedback: 1.
* The present value annuity factor of 10% for 5 years can be calculated using the following formula: (1 - (1/1.105))/0.10 ≈ 3.791.
2. The profitability index (PI) for a proposed investment = NPV/Initial investment outlay = $11,701/$30,000 = 0.39
3. The profitability index, PI, of a proposed investment is a rate of return measure for the project. Specifically, it is the ratio of NPV to the
original investment outlay. In this sense, it is a relative (not absolute) measure of project profitability. As such, it is useful for determining an
optimal capital budget when under conditions of capital rationing.
4. The internal rate of return (IRR) on the proposed investment is 24.32%, as follows:
= IRR({-30000;11000;11000;11000; 11000;11000}) Note: in this formula, data were entered as an array.
5. The appropriate built-in function in Excel is MIRR, as follows:

MIRR(values,finance_rate,reinvest_rate)
Valuesis an array or a reference to cells that contain numbers. These numbers represent a series of payments (negative values) and income
(positive values) occurring at regular periods. Values must contain at least one positive value and one negative value to calculate the modified
internal rate of return. Otherwise, MIRR returns the #DIV/0! error value. If an array or reference argument contains text, logical values, or
empty cells, those values are ignored; however, cells with the value zero are included.
Finance_rate is the interest rate you pay on the money used in the cash flows.
Reinvest_rate is the interest rate you receive on the cash flows as you reinvest them.
(a) Given a discount rate of 10% and an assumed reinvestment rate of 10%, the estimated MIRR of this project is 17.5% (rounded), as
follows:
= MIRR({-30000;11000;11000;11000;11000;11000},0.10,0.10) = 17.48781919%
(b) Given a discount rate of 10% and an assumed reinvestment rate of 20%, the estimated MIRR of this project is 22.2% (rounded), as
follows:
= MIRR({-30000;11000;11000;11000;11000;11000},0.1,0.2) = 22.23274096%
6. The MIRR adjusts the conventional IRR figure to incorporate an assumed reinvestment rate on interim cash inflows generated by an
investment project. Proponents of the MIRR model maintain that the conventional IRR method implicitly assumes a reinvestment rate equal
to the project's IRR, which (they maintain) is many times overly optimistic. Therefore, the MIRR provides an appropriate adjustment to
account for an assumed (usually lower) rate of return on interim cash inflows. This can be demonstrated by the two calculations above: at an
assumed reinvestment rate of 10%, the project's MIRR is (rounded) 17.5%, while the MIRR based on an assumed reinvestment rate of 20%
for interim cash inflows is 22.2% (rounded).
Difficulty: Hard
142. HHR Construction, Inc. is currently considering developing, on a piece of land currently held by the company, a new courtyard motel.
This project would provide a single payoff from a buyer in one year (after construction was completed). The concept of a courtyard
motel is relatively new, so there is a certain amount of risk associated with this project. The company's management feels that new
information regarding potential consumer demand would be revealed, that is, whether in the chosen geographic location a courtyard
motel would be popular ("good news") or unpopular ("bad news"). In the former case, you anticipate a selling price of $13 million, while
in the latter case only $9 million. At the present, these two outcomes are considered equally likely. For projects of this sort, the company
uses a WACC (discount rate) of 10% after tax. The company estimates that total construction costs for this project would, in today's
dollars, be approximately $9.7 million.
Required:
1. Based on the given probabilities for the two possible outcomes (states of nature), what is the expected NPV of the proposed
investment?
2. What is the primary deficiency of the traditional DCF analysis you conducted above in (1)?
3. Suppose now that management has an option to wait a year before deciding whether to construct the motel in question. The question
the company is grappling with is whether it should delay the investment decision for one year. Given the information above, what do you
recommend, and why? (For simplicity, assume that one year from now the investment cost would be $9.7 million and that the return one
year later would be $13 million.)
4. Define the term "real option." Compare real options with financial options.
5. This problem deals with what is called an investment-timing option, one of four general classes of real options. What other types of
real options can be embedded in a capital investment proposal? How do these classes relate to put options and call options?
Feedback: 1. Given the indicated probabilities, the expected NPV of this project is approximately $300,000, as follows:
Based on a conventional DCF analysis, this project is acceptable. But, the expected value of the net cash flows is close to zero (in a relative
sense).
2. The above analysis appropriately deals with both the risk and the timing of the cash inflows associated with this investment project.
However, it does not incorporate management's ability to time the investment so as to take maximum advantage of information (regarding the
riskiness of the investment project) that might be revealed over time (e.g., over the course of the coming year). The question is whether, for
capital budgeting purposes, it is possible to incorporate the value of waiting a year before making the investment decision.
3. The advantage of waiting is that, presumably, information regarding consumer demand for the new motel concept would be revealed over
time (i.e., uncertainty as to the level of consumer demand would be reduced). If the concept of a courtyard motel is not received favorably by
consumers, then (in retrospect) it would not make sense to invest $9.7 million today in return for $9 million one year from now. On the other
hand, if the concept is received favorably by consumers, then investing today for a $13 million return one year from now makes sense.
Our approach should be to determine the NPV of the investment after considering the option to delay the investment one year. This second
NPV could then be compared to the conventional NPV calculated above in (1).
The NPV (today) of the decision to wait one year is approximately $962,000, as follows:
On the basis of the above, management should delay the investment decision for one year, at which time information regarding the
approximate level of consumer demand will have been revealed. Management, in this case, can then appropriately react to this information. In
an expected NPV sense, then, management should wait a year to make this investment decision.
Note that the original (i.e., conventional) NPV analysis presented above essentially assumes that management would make the investment
decision today and then "passively" wait for future returns to the project, in the hope they are sufficiently high. By contrast, the real options
analysis presented above assumes that management in the future can react to new information. Of particular interest is the ability to avoid
negative NPV situations in the future as new information is revealed. Note, too, that in this particular example the value of waiting was quite
high—higher even than the NPV of the original analysis! By ignoring the value of the embedded option to wait, management in this case
could have walked away from an opportunity to add value to the organization.
4. As noted in the text, real options represent flexibilities and/or growth opportunities that may be embedded in a capital investment project.
Unlike financial options, real options pertain to investments in real property—both tangible and intangible. While financial options are traded
on an organized exchange (so that there are observed market prices), real options are not. However, as the example above shows, such options
have value. To ignore these options in a capital budgeting analysis essentially assigns a value of $0 to such options.
5. There are four general classes of real options: (a) expansion options, (b) abandonment options, (c) delay options (i.e., investment-timing
options, similar to the present example), and (d) scale-back options (i.e., the ability to reduce the magnitude of an investment project).
Category (a) and (c) options are similar in nature to call options, while those in categories (b) and (d) are similar in nature to put options.
Difficulty: Hard
143. Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine will generate a constant after-tax income
of $100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual
value. Note: the PV factor for 5 years, 10% is 0.386; the PV annuity factor for 10%, 10 years is 6.145; and, the PV annuity factor for
10%, 5 years is 3.791.
Required: Using the desired rate of return of 10%, what is the estimated net present value (NPV) of the investment project (rounded to
the nearest thousand)? Assume that the cash flows occur at year-end.
Feedback: Initial investment outlay (time period 0) = $1,500,000. PV of stream of after-tax cash flows, first 10 years = $250,000 x PV
Annuity factor from Table 2 (at 10%) = $250,000 x 6.145 = $1,536,250. PV of stream of after-tax cash flows, years 11 through 15 =
($100,000 x 3.791)/(1 + 0.10)10 = ($100,000 x 3.791)/(0.386) = $146,333. Total PV of future cash inflows = $1,536,250 + $146,333 =
$1,682,583. Therefore, estimated NPV = $1,682,583 - $1,500,000 = $182,583 or $183,000 (rounded to nearest thousand).
Difficulty: Medium
Required:
1. What is the payback period for the new machine (rounded to the nearest tenth of a year)? Assume for purposes of this calculation that
the cash inflows occur evenly throughout the year.
2. What is the book (accounting) rate of return (rounded to the nearest whole percent) based on the initial investment and on average
after-tax income over the five-year period?
3. What is the book (accounting) rate of return, rounded to the nearest whole percent, based on the average investment, where the latter is
determined as a simple average of beginning-of-project and end-of-project book value of the asset?
Feedback: Question 1:
1. Original investment outlay (year 0) = $400,000
2. Remaining MACRS depreciation charges:
a. Year 2 = 44.45% x $400,000 = $177,800
b. Year 3 = 14.81% x $400,000 = $59,240
c. Year 4 = 7.41% x $400,000 = $29,640
d. Year 5 = $0
3. Pre-tax incomes, Years 2 through 5:
a. Year 2 = $275,000 - $80,000 - $177,800 = $17,200
b. Year 3 = $275,000 - $80,000 - $59,240 = $135,760
c. Year 4 = $275,000 - $80,000 - $29,640 = $165,360
d. Year 5 = $275,000 - $80,000 - $0 = $195,000
4. After-tax incomes, Years 2 through 5:
a. Year 2 = $17,200 x (1 - 0.40) = $10,320
b. Year 3 = $135,760 x (1 - 0.40) = $81,456
c. Year 4 = $165,360 x (1 - 0.40) = $99,216
d. Year 5 = $195,000 x (1 - 0.40) = $117,000
5. After-tax cash flows, Years 2 through 5:
a. Year 2 = $10,320 + $177,800 = $188,120
b. Year 3 = $81,456 + $59,240 = $140,696
c. Year 4 = $99,216 + $29,640 = $128,856
d. Year 5 = $117,000 + $0 = $117,000
6. Cumulative after-tax cash inflows:
a. Year 1 = $170,328
b. Year 2 = $170,328 + $188,120 = $358,448
c. Year 3 = $358,448 + $140,696 = $499,144
7. Therefore, the payback period = 2 years + ($400,000 - $358,448)/$140,696 = 2.3 years
Question 2:
1. Average annual after-tax profit = ($37,008 + $10,320 + $81,456 + $99,216 + $117,000)/5 years = $69,000
2. Initial investment = $400,000
3. ARR = $69,000/$400,000 = 17.25% (17%, rounded)
Question 3:
1. Average after-tax income = ($37,008 + $10,320 + $81,456 + $99,216 + $117,000)/5 years = $69,000
2. Average investment = (Initial outlay + end-of-project book value)/2 = ($400,000 + $0)/2 = $200,000
3. ARR = $69,000/$200,000 = 34.5% (35%, rounded)
Difficulty: Hard
Required:
1. What is the estimated net present value of the investment (rounded to the nearest hundred dollars)? (Note: PV factors for 10% are as
follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)
Assume that all estimated cash flows occur at year-end.
2. What is the present value payback period (rounded to two decimal points)?
Feedback: Question 1:
1. Original investment outlay (year 0) = $400,000
2. MACRS depreciation charges:

a. Year 1 = 0.3333 x $400,000 = $133,320
b. Year 2 = 44.45% x $400,000 = $177,800
c. Year 3 = 14.81% x $400,000 = $59,240
d. Year 4 = 7.41% x $400,000 = $29,640
e. Year 5 = $0
3. Pre-tax incomes:
a. Year 1 = Sales - depreciation - cash operating expenses = $275,000 - $133,320 - $80,000 = $61,680
b. Year 2 = $275,000 - $80,000 - $177,800 = $17,200
c. Year 3 = $275,000 - $80,000 - $59,240 = $135,760
d. Year 4 = $275,000 - $80,000 - $29,640 = $165,360
e. Year 5 = $275,000 - $80,000 - $0 = $195,000
4. After-tax incomes:
a. Year 1 = $61,680 x (1 - 0.40) = $37,008
b. Year 2 = $17,200 x (1 - 0.40) = $10,320
c. Year 3 = $135,760 x (1 - 0.40) = $81,456
d. Year 4 = $165,360 x (1 - 0.40) = $99,216
e. Year 5 = $195,000 x (1 - 0.40) = $117,000
5. After-tax cash flows:

a. Year 1 = $37,008 + $133,320 = $170,328
b. Year 2 = $10,320 + $177,800 = $188,120
c. Year 3 = $81,456 + $59,240 = $140,696
d. Year 4 = $99,216 + $29,640 = $128,856
e. Year 5 = $117,000 + $0 = $117,000
6. PV of future after-tax cash inflows:

a. Year 1: $170,328 x 0.909 = $154,828
b. Year 2: $188,120 x 0.826 = $155,387
c. Year 3: $140,696 x 0.751 = $105,663
d. Year 4; $128,856 x 0.683 = $88,009
e. Year 5: $117,000 x 0.621 = $72,657
7. PV of future cash inflows = $154,828 + $155,387 + $105,663 + $88,009 + $72,657 = $576,544
8. NPV = $576,544 - $400,000 = $176,544, rounded to 176,500
Question 2: See question 1, above, for PV of after-tax cash flows.

1. Cumulative PV of after-tax cash flows:
a. Year 1 = $154,828
b. Year 2 = $154,828 + $155,387 = $310,215
c. Year 3 = $310,215 + $105,663 = $415,878
2. Therefore, the PV payback (in years) = 2 + ($400,000 - $310,215)/$105,663 = 2.85 years (Note that this is an approximation because it
assumes that cash flows occur evenly throughout the year, while the PV calculation assume end-of-year cash flows.)

Difficulty: Hard
Required:
1. Under the assumption that cash inflows occur evenly throughout the year, what is the estimated payback period for this investment is
(round your answer to two decimal points)?
What is the estimated book (accounting) rate of return based on initial investment (rounded)?
What is the estimated book (accounting) rate of return based on average investment, where "average investment" is defined as a simple
average of the beginning-of-project book value and the end-of-project book value of the asset?
Feedback:
1. As can be seen from the accompanying schedule (above), the payback period occurs between years 5 and 6. If we assume that the cash
inflows occur evenly throughout the year, then the estimated payback period = 5 + ($20,000/$250,000) = 5.08 years.
2. As seen in the above schedule, the total net income over the 10-year period = $800,000. Therefore, average net income per year =
$800,000/10 years = $80,000. Initial investment = $600,000. Thus, ARR (based on initial investment) = $80,000/$600,000 = 13.33%
3. From 2 above, the average after-tax income per year = $80,000. Average investment in the project = (Book value, beginning of year 1 +
Book value, end of year 0)/2 = ($600,000 + $0)/2 = $300,000. Thus, ARR = $80,000/$300,000 = 26.67%. Alternatively, given the way
"average investment" is calculated, the answer here is twice the answer for the preceding question.
Difficulty: Medium
Note: PV factors, at 10%: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; year 6 = 0.564; year 7 = 0.513;
year 8 = 0.467; year 9 = 0.424; year 10 = 0.386. The PV annuity factor for 10 years, 10% = 6.145.
Required:
1. What is the estimated net present value (NPV) of this proposed investment, rounded to the nearest thousand?
2. What is the estimated internal rate of return (IRR) on this project, rounded to the nearest %? (Note: Students would have to have
access to Excel in order to answer this question?
3. What is the present value payback period for this proposed investment, in years (rounded to two decimal points)?
Feedback: In the solutions below, the PV factors from the tables in the chapter are used for PV calculations. If Excel is used, there will likely
be minor rounding differences.
1. As indicated in the accompanying schedule (above), the PV (@ 10%) of future cash inflows = $819,820. The original investment outlay =
$600,000. Therefore, NPV = $819,820 - $600,000 = $219,820 (or, $220,000, rounded).
2. Using the built-in IRR function in Excel, we generate an IRR of 16.7% (17%, rounded), as follows: = IRR ({-
600000;40000;70000;100000;170000;200000;250000;230000;200000;100000;40000}) Note that in this formulation data were entered in an
array format.
3. As shown in the above schedule, the PV of cumulative cash inflows surpasses the original investment outlay in year 7. Thus, the present
value payback period = 6 + ($49,410/$117,990) = 6.42. (NOTE: this is an approximation because (a) the PVs are calculated under the
assumption that the cash inflows occur at year-end, and (b) the payback calculation, if expressed in partial years, assumes that the cash flows
occur evenly throughout the year.)
Difficulty: Medium
148. Fritz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash operating
costs (before taxes) by $80,000 for each of the next five years. The company has a minimum rate of return of 8% on all capital
Required:
1. What is the machine's payback period, in years (rounded to two decimal places), under the assumption that cash flows occur evenly
throughout the year?
2. What is the book (accounting) rate of return (ARR), based on the initial investment amount (rounded to one decimal point, that is,
nearest one-tenth of a percent)?
Feedback: 1. As indicated in the accompanying schedule (see below), the payback period occurs somewhere between year 3 and year 4.
Under the assumption that after-tax cash inflows occur evenly throughout the year, a linear interpolation produces an estimate of 3.68 years,
as follows: 3 + ($46,000/$68,000) = 3.68 years. Alternatively, payback period (in years) = original investment outlay/annual after-tax net cash
inflow = $250,000/(increased annual pre-tax cash saving - additional income taxes per year) = $250,000/($80,000 - $12,000) = $250,000/
$68,000 = 3.676 years (3.68, rounded).
2. As shown in the accompanying schedule (see below), average annual increase in after-tax income = $18,000. Original investment outlay =
$250,000. Therefore, ARR = $18,000/$250,000 = 7.2%.

Difficulty: Medium
149. Kravitz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies, thereby reducing annual cash
operating costs (before taxes) by $80,000 for each of the next five years. The company has a minimum rate of return of 8% on all capital
Note: at 8%, the PV annuity factor for five years is 3.993; at 8%, the PV factor for year 1 = 0.926, the PV factor for year 2 = 0.857, the
PV factor for year 3 = 0.794, the PV factor for year 4 = 0.735, and the PV factor for year 5 = 0.681.
Required:
1. What is the net present value (rounded to the nearest hundred dollars) of the proposed investment?
What is the present value payback period, in years (rounded to one decimal place, that is, to tenth of a year)?
What is the estimated internal rate of return (IRR) on the proposed investment? Round your answer to one decimal place (i.e., tenth of a
percent). (Note: to answer this question, you will need access to the tables presented in Chapter 12, Appendix C or to Excel.)
Feedback: 1. As shown in the accompanying table (see below), the NPV of this proposed investment, at 8%, is $21,524 ($21,500, rounded).
Alternatively, we have: Initial investment outlay = $250,000; After-tax cash inflow per year = increase in after-tax income + depreciation
expense = ([$80,000 - $50,000] x [1 - 0.40]) + $50,000 = $18,000 + $50,000 = $68,000; PV of incremental after-tax cash inflows = $68,000 x
3.993 = $271,524; NPV = $271,524 - $250,000 = $21,524 ($21,500, rounded).
2. As indicated in the accompanying table (see below), the PV payback occurs somewhere between years 4 and 5. If we assume that the cash
flows occur evenly throughout the year, then the estimated PV payback period (in years) = 4 + ($24,784/$46,308) = 4.535 years (4.5 years if
rounded to one decimal point). (Note that this answer is an approximation because the process of calculating present values assumes end-of-
period cash flows, when the above interpolation method assumes that cash flows occur evenly throughout the year.)
3. In Table 2, Appendix C, we are looking the interest rate corresponding to an annuity factor of ($250,000/$68,000 = 3.676) in the row
corresponding to the life of this project (5 years). We see from Table 2 that the corresponding interest rate is between 11% and 12%. If we
used Excel to estimate the project's IRR, we'd get 11.2%, as follows: = IRR({-250000;68000;68000;68000;68000;68000}). Note that the data
in the above formula are entered as an array.

Difficulty: Hard
150. Slumber Company is considering two mutually exclusive investment alternatives. Its estimated weighted-average cost of capital, used as
the discount rate for capital budgeting purposes, is 10%. Following is information regarding each of the two projects:
Required:
1. Compute the estimated net present value of each project and determine which alternative, based on NPV, is more desirable. (The PV
annuity factor for 10%, 5 years, is 3.7908.)
2. Compute the profitability index (PI) for each alternative and state which alternative, based on PI, is more desirable.
3. Why do the project rankings differ under the two methods of analysis? Which alternative would you recommend, and why?
Feedback: 1. and 2.
Notes: a = $189,540/$170,000 b = $113,724/$100,000
Therefore, alternative 1 is preferred using the NPV criterion while alternative 2 is preferred under the profitability index (PI) ranking.
3. The net present value method determines the magnitude of the difference between the present value of cash inflows and cash outflows,
while the profitability index, intuitively, calculates the ratio of return (PV of cash inflows) to investment (PV of cash outflows). The net
present value method does not inherently distinguish between projects with different magnitudes of investment, while the profitability index
ranking does. The choice between these two mutually exclusive alternatives for Lebar Company may depend on qualitative factors that
distinguish the two alternatives, as well as other possible uses for available funds if Lebar chooses alternative 2.
Difficulty: Medium
12 Summary
Category # of Questions
AACSB: Analytic 2
Blocher - Chapter 12 150
Difficulty: Easy 69
Difficulty: Hard 15
Difficulty: Medium 66
Emerging Issues: Service 1
Emerging Issues: Strategy 2
Learning Objective: 12-1 4
Learning Objective: Appendix B 16

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12

A. The lack of good data.

A. Multiproduct cost-volume-profit analysis.

4. Which of the following statements regarding capital investment analysis is false?

A. A long-term planning horizon is assumed.

A. During the initiation stage of the project.

A. The theoretical development of appropriate decision models.

7. The Analytic Hierarchy Process (AHP) is:

8. In making capital budgeting decisions, the principal focus is on:

A. Cash flows only.

A. The initiation stage and final disposal stage only.

11. Which of the following is not a characteristic of capital budgeting post-audits?

A. They provide feedback to managers regarding the soundness of their decision-making.

A. A net cash outflow.

A. It is easy to calculate and comprehend.

A. Required initial investment.

A. Short useful lives.

A. Have no discernable impact on decisions by managers.

22. Intolerance of uncertainty often leads managers to:

A. Invest heavily in strategic-related investments.

25. The internal rate of return (IRR) for an investment:

A. Frequently results in positive net present values on attractive projects.

A. Weighted-average cost of capital (WACC).

27. Which one of the following is an advantage of the payback method?

A. It provides a (rough) measure of risk.

A. It is not affected by different accounting methods.

A. Internal rate of return.

A. Internal rate of return (IRR) model.

A. Modified internal rate of return (MIRR).

A. Project's rate of return exceeds the hurdle (discount) rate.

A. The actual (economic) rate of return on the project is 15%.

A. Real options analysis.

A. These two investments are equally desirable.

A. Should be amortized over the useful life of the equipment.

A. The payback period is short.

A. Taxable cash receipt times (1 - t).

50. The term "breakeven after-tax cash flow" represents:

A. A pessimistic estimate in a typical scenario analysis.

A. Net present value (NPV)

A. Less than 12%.

A. PV of cash outflows exceeds the PV of cash inflows

A. Such audits ensure the realization of future after-tax cash flows.

A. Disposition (i.e., sale) of an existing asset.

A. Less than 4%.

A. Less than 10%.

A. Expected value analysis

A. Similar to financial options, real options are traded on an open exchange.

99. Which of the following statements regarding real options is true:

100. The estimated value of a real option:

A. The project's IRR is less than the discount (hurdle) rate.

103. GuSont Inc. was considering an investment in the following project:

104. GuSont Inc. was considering an investment in the following project:

A. Less than 10%.

A. Monte Carlo simulation.

A. Break-even point for the project.

107. The internal rate of return for an investment:

A. Frequently results in positive net present value on attractive projects.

A. Is considered inferior because it fails to calculate compounded rates of return.

A. That generates cash flows for the longer period of time.