ch12 capital budgeting decisions
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Which of the following is not an example of a common activity in an AIS? A) buy and pay for goods and
services B) sell goods and services and collect cash C) summarize and report results to interested parties
D) recording of sales calls for marketing purposesAnswer: D
Firm X is considering the replacement of an old machine with one that has a
purchase price of $70,000. The current market value of the old machine is
$25,000 but the book value is $32,000. What is the net cash outflow for the new
machine with consideration for the sale of the old machine?
A. $70,000B
.
B.
$45,000
C
. $38,000
D. $32,000
The Wet Corp. has an investment project that will reduce expenses by $15,000
per year for 3 years. The
project's cost is $20,000, with a 20% CCA rate. Using a
40% tax rate, calculate the net operating cash flow at the end of year 1?
A. $-15,000
B. $+11,000
C. $+9,000
D. $+9,800
+15000
Investment or cost=20,000,
cost saving=15000
CCA=20%
tax=40%
CCA=20,000*.20*1/2=2000
Taxable income=Income or saving - CCA= 15,000 – 2000=13,000
Income after tax=13,000*(1-.40)=7,800
Cashflow after tax= 7,800+2000=
9,800
Taxable income=Investment-CCA(5000) on year 1=20000-1000=19000
After tax income=19000*(1-.40=11400
Cash flow after tax= 11400+1000=12400
An asset just purchased, qualifies for a 20% CCA rate and qualifies for a 5% ITC. If
the asset cost $60,000 what is the amortization base (UCC) in the second year
before CCA is taken?
A. $54,000
B. $51,000
C. $56,000
D. $48,000
60,000*(1->05)=57,000
CCa year 1=57,000*.20*1/2=5700
UCC end of
year 1=57000-5700=51300
Assume a corporation has earnings before depreciation and taxes of $82,000,
depreciation of $45,000, and that it has a 30 percent tax bracket. What are the
after-tax cash flows for the company?
A. $70,900
B. $82,000
C. $42,000
D. $37,000
Before tax income=82,000-45,000=37000
after tax income=37000(1-.30)=25900
cash flows=25900+45000=70900
Assume a project has earnings before depreciation and taxes of $15,000,
depreciation of $25,000, and that the firm has a 30 percent tax bracket. What are
the after-tax cash flows for the project?
A. $18,000
B. $19,000
C. A loss of $21,000
D. $25,000
Before tax income=15,000-25,000=-10000
Tax savings from loss=-10000(30)=3000
cash flows=15000+3000=18000
With a higher CCA rate, the present value of tax savings increases. TRUE
It is not unusual for a
corporate president, who
deals with security
analysts, to be as
sensitive to after tax
income as cash flow.
It is not unusual for a corporate president, who deals with security analysts, to be
as sensitive to after tax income as cash flow. True
With non-mutually exclusive events and no capital rationing, we will usually arrive
at the same conclusions using either the net present value or internal rate of
return methods. TRUE
It is the difference in the discount rate assumptions that can be significant in
determining when to use the present value or internal rate of return methods.
TRUE
Even though one project may have superior cash flow, management may choose
a project that inflates earnings instead of cash flow. TRUE
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To find the exact internal rate of return for projects with uneven cash flows, we
can interpolate between two present value annuity factors. FALSE
The net present value
profile examines the
relationship of the
discount rate to the net
present value.
TRUE
The net present value profile examines the relationship of the discount rate to the
net present value. TRUE
CCA standards have decreased the life span over which an asset may be
amortized. FALSE
Under CCA amortization you must first subtract out salvage value to determine
the amortization base (UCC). TRUE
If an asset is sold for a price above its book value, and it is the last asset in a pool,
the difference is considered taxable income to the firm. TRUE
The internal rate of return is the interest rate that equates the cash outflows of an
investment with the subsequent inflows. TRUE
Under the net present value method, cash flows are assumed to be reinvested at
the firm'sweighted average cost of capital. TRUE
With non-mutually exclusive projects:
A. the payback period will select the best project.
B. the net present value method will always select the best project.
C. the internal rate of return method will always select the best project.
D. the net present value and the internal rate of return methods will always
accept or reject the same project
If an old asset sells below
book value (UCC) and the
asset pool ends, from a
tax
standpoint:
A.
there is a decrease in
cash flow.
B. there is an increase in
cash flow.
C.
there is no effect on
cash flow.
D.
there is a decrease in
net present value
If an old asset sells below book value (UCC) and the asset pool ends, from a tax
standpoint:
A. there is a decrease in cash flow.
B. there is an increase in cash flow.
C. there is no effect on cash flow.
D. there is a decrease in net present value
At higher tax rates, CCA
amortization is:
A. more beneficial.
B.
less beneficial.
C.
decreased.
D.
unaffected.
At higher tax rates, CCA amortization is:
A. more beneficial.
B. less beneficial.
C. decreased.
D. unaffected.
The reason cash flow is used in capital budgeting is because:
A. income rather than cash is used to purchase new machines.
B. cash outlays need not be evaluated in terms of the present value of the
resultant cash inflows.
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C. the tax shield provided from amortization ignores the cash flow provided by
the machine which should be
reinvested to replace old worn out machines.
D. cash flow includes accounting accruals
The reason cash flow is used in capital budgeting is because:
A. income is used to purchase new machines.
B. cash outlays need to be evaluated in terms of the present value of the
resultant cash inflows.
C. to include the tax shield provided from amortization ignores the cash flow
provided by the machine which should be reinvested to replace old worn out
machines.
D. cash includes all accounting accruals
The net present value
method is a better
method of evaluation
than the internal rate of
return method because:
A.
the NPV method
discounts cash flows at
the internal rate of
return.
B.
the NPV method is a
more liberal method of
analysis.
C. the NPV method
discounts cash flows at
the firm's more
conservative cost of
capital.
D.
the NPV method
includes accruals and
other accounting
discounts.
Project A has a $5,000 net present value at a zero discount rate and an internal
rate of return of 12%. Project B has an $8,000 net present value at a 0% discount
rate and an IRR of return of 10%. If the projects are mutually exclusive, which one
should be chosen?
A. Project A because it has a higher internal rate of return.
B. Project B if the cost of capital is less than the crossover point.
C. Both projects if the net present value is positive.
D. Neither project meets the investment criteria.
The net present value method is a better method of evaluation than the internal
rate of return method because: A. the NPV method discounts cash flows at the
internal rate of return.
B. the NPV method is a more liberal method of analysis.
C. the NPV method discounts cash flows at the firm's more conservative cost of
capital.
D. the NPV method includes accruals and other accounting discounts.
Under the capital cost allowance system:
A. the life span over which an asset may be amortized is fixed at five years.
B. all assets are amortized down to their salvage value.
C. recovery periods for different types of assets are broken down into categories.
D. the tax effect of accounting depreciation is included.
The Net Present Value Method is a more conservative technique for selecting
investment projects than the Internal Rate of Return method because the NPV
method:
A. discounts cash flows at the project's internal rate of return.
B. concentrates on the liquidity aspects of investment projects.
C. discounts cash flows at the firm's weighted average cost of capital.
D. ignores cash flows after the payback period.
If the capital budgeting decision includes a replacement analysis, then:
A. a gain from the sale of the old asset will represent a tax savings inflow.
B. only incremental cash flows should be considered.
C. the sale price and tax savings will increase the cash inflows throughout the
asset's life.
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D. only initial cash in-flow should be considered.
The longer the life of an investment:
A.
the more significant the discount rate
B.
.B. the less significant the discount rate
C.
.C. Makes no difference.
D.
D. the easier it is to determine the discount rate.
A firm is selling an old asset below book value in a replacement decision. As the firm's taxrate is raised,
the net cash outflow (purchase price less proceeds from the sale of the old asset plus CCA effects)
would:
A. go up.
C.
go down
D.
.C. remain the same.
E.
D. More information required
The _________ assumes returns are reinvested at the cost of capital.
A. payback periodB. internal rate of return
C. net present value
D. capital rationing
Using higher discount rates,:
A. accelerated amortization is more valuable than straight line amortization.
B. straight-line amortization is more valuable than accelerated amortization.C. amortization policy makes
no difference.D. later year amortization has a higher net present value
For acceptable investments, the discount rate assumption under the internal rate of return is generally:
A. higher than under the net present-value method.
B. lower than under the net present-value method.
C. at the cost of capital.
D. below the cost of capital
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