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Exam 10: Capital-Budgeting Techniques and Practice

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Question 1

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All of the following are criticisms of the payback period criterion EXCEPT

A) time value of money is not accounted for.
B) cash flows occurring after the payback are ignored.
C) it deals with accounting profits as opposed to cash flows.
D) None of the above; they are all criticisms of the payback period criteria.

E) None of the above
F) A) and D)

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C

Question 2

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Many financial managers believe the payback period is of limited usefulness because it ignores the time value of money; hence,it is referred to as the discounted payback period.

A) True
B) False

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Question 3

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Any project deemed acceptable using the discounted payback period will also be acceptable if using the traditional payback period.

The modified internal rate of return represents the project's internal rate of return assuming that intermediate cash flows from the project can be reinvested at the project's required return.

The discounted payback period takes the time value of money into account in that it uses discounted free cash flows rather than actual undiscounted free cash flows in calculating the payback period.

The advantages of NPV are all of the following EXCEPT

Raindrip Corp.can purchase a new machine for $1,875,000 that will provide an annual net cash flow of $650,000 per year for five years.The machine will be sold for $120,000 after taxes at the end of year five.What is the net present value of the machine if the required rate of return is 13.5%.

We compute the profitability index of a capital budgeting proposal by

A project's IRR is analogous to the concept of the yield to maturity for bonds.

The required rate of return reflects the costs of funds needed to finance a project.

DYI Construction Co.is considering a new inventory system that will cost $750,000.The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,$325,000 in year two,$150,000 in year three,and $180,000 in year four.DYI's required rate of return is 8%.What is the modified internal rate of return of this project?

Which of the following statements is MOST correct?

I301 Motors has several investment projects under consideration,all with positive net present values.However,due to a shortage of trained personnel,a limit of $1,250,000 has been placed on the capital budget for this year.Which of the projects listed below should be included in this year's capital budget? Explain your answer.

Lithium,Inc.is considering two mutually exclusive projects,A and B.Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.Project B costs $120,000 and is expected to generate $64,000 in year one,$67,000 in year two,$56,000 in year three,and $45,000 in year four.Lithium,Inc.'s required rate of return for these projects is 10%.The profitability index for Project B is

Lithium,Inc.is considering two mutually exclusive projects,A and B.Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.Project B costs $120,000 and is expected to generate $64,000 in year one,$67,000 in year two,$56,000 in year three,and $45,000 in year four.Lithium,Inc.'s required rate of return for these projects is 10%.The modified internal rate of return for Project B is

Capital rationing generally leads to higher stock prices as management is doing the best job it can in selecting only the best capital budgeting projects.

Company K is considering two mutually exclusive projects.The cash flows of the projects are as follows: a.Compute the NPV and IRR for the above two projects,assuming a 13% required rate of return. b.Discuss the ranking conflict. c.What decision should be made regarding these two projects?

The capital budgeting decision-making process involves measuring the incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the project's cost.

A project with a payback period of four years is acceptable as long as the company's target payback period is greater than or equal to four years.

The capital budgeting manager for XYZ Corporation,a very profitable high technology company,completed her analysis of Project A assuming 5-year depreciation.Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation.This change will