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# test8 - Chapter 8Capital Budgeting Process and Techniques...

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Chapter 8—Capital Budgeting Process and Techniques MULTIPLE CHOICE 1. The capital budgeting process involves a. identifying potential investments b. analyzing the set of investment opportunities, and identifying those that will create share- holder value c. implementing and monitoring the selected investment projects d. all of the above ANS: D DIF: E REF: Introduction 2. The preferred technique for evaluating most capital investments is NARRBEGIN: Gamma Electronics Gamma Electronics Gamma Electronics is considering the purchase of testing equipment that will cost \$500,000 to replace old equipment. Assume the new machine will generate after-tax savings of \$250,000 per year over the next four years. NARREND 3. Refer to Gamma Electronics. What’s the payback period for the investment? DIF: E REF: 8.3 Payback Methods NAR: Gamma Electronics 4. Refer to Gamma Electronics. If the firm has a 15% cost of capital, what’s the discount payback period of the investment? By the end of year 3, the project produces a cumulative cash flow that’s greater than \$500,000. Thus the project earns back the initial \$500,000 at some point during the third year.

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(500,000 - 217,391 - 189,036)/164,379 = 93,573/164,379 = 0.569 The discount payback period is 2.6 years. DIF: M REF: 8.3 Payback Methods NAR: Gamma Electronics 5. If Gamma Electronics has a 15% cost of capital, what’s the NPV of the investment? a. \$213,745 b. \$185,865 c. \$713,745 d. \$500,000 ANS: A NPV = -500,000 + 250,000/1.15 + 250,000/1.15 2 + 250,000/1.15 3 + 250,000/1.15 4 = 213,745 DIF: E REF: 8.4 Net Present Value NAR: Gamma Electronics 6. If Gamma Electronics has a 15% cost of capital, what’s the IRR of the investment? -500,000 + 250,000/(1+r) + 250,000/(1+r) 2 + 250,000/(1+r) 3 + 250,000/(1+r) 4 = 0 r = 34.9% DIF: E REF: 8.5 Internal Rate of Return NAR: Gamma Electronics 7. If Gamma Electronics has a 15% cost of capital, what’s the profitability index of the investment? DIF: E REF: 8.6 Profitability IndexNAR: Gamma Electronics NARRBEGIN: Exhibit 8-1 Invst Csh Prj Exhibit 8-1 The cash flows associated with an investment project are as follows: Cash Flows Initial Outflow -\$70,000 Year 1 \$20,000 Year 2 \$30,000 Year 3 \$30,000 Year 4 \$30,000 NARREND

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