This preview shows pages 1–4. Sign up to view the full content.
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
shareholder 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
a.
payback period
b.
discount payback period
c.
internal rate of return
d.
net present value
ANS: D
DIF:
E
REF:
8.1 Introduction to Capital Budgeting
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 aftertax 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?
a.
1.8 years
b.
2.0 years
c.
2.5 years
d.
2.8 years
ANS: B
The investment requires $500,000. In its first two years, this investment generates $500,000.
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?
a.
1.5 years
b.
2.0 years
c.
2.4 years
d.
2.6 years
ANS: D
Present value
PV of Year 1 = 250,000/1.15 = 217,391
PV of Year 2 = 250,000/1.15
2
=
189,036
PV of Year 3 = 250,000/1.15
3
=
164,379
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.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document (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?
a.
23.4%
b.
15.0%
c.
34.9%
d.
100.0%
ANS: C
Let r represent 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?
a.
1.4
b.
0.4
c.
2.0
d.
1.0
ANS: A
(250,000/1.15 + 250,000/1.15
2
+ 250,000/1.15
3
+ 250,000/1.15
4
)/500,000 = 713,745/500,000 = 1.4
DIF:
E
REF:
8.6 Profitability IndexNAR:
Gamma Electronics
NARRBEGIN: Exhibit 81 Invst Csh Prj
Exhibit 81
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
8.
Refer to Exhibit 81. What’s the payback period of the project? If a firm’s cutoff payback period is 3
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview. Sign up
to
access the rest of the document.
This note was uploaded on 03/24/2012 for the course BUS 3897 taught by Professor Simac during the Spring '12 term at CSU Dominguez Hills.
 Spring '12
 simac

Click to edit the document details