Capital Decision
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The test will measure your knowledge on finance concepts such as Payback period, NPV, IRR, MIRR, Depreciation and other concepts involved in making capital decisions.
- 1.When evaluating a new project, the firm should consider all of the following factors except:
- A.
Changes in working capital attributable to the project.
- B.
Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes
- C.
The current market value of any equipment to be replaced.
- D.
The resulting difference in depreciation expense if the project involves replacement.
- E.
All of the statements above should be considered.
- 2.Other things held constant, which of the following would increase the NPV of a project being considered?
- A.
A shift from MACRS to straight-line depreciation.
- B.
Making the initial investment in the first year rather than spreading it over the first 3 years
- C.
A decrease in the discount rate associated with the project.
- D.
The sale of the old machine in a replacement decision at a capital loss rather than at book value.
- E.
An increase in required working capital.
- 3.Which of the following statements is correct?
- A.
Because discounted payback takes account of the cost of capital, a project's discounted payback is normally shorter than its regular payback.
- B.
The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
- C.
If the cost of capital is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur.
- D.
The IRR method assumes that the cash flows are reinvested at the WACC.
- E.
For the mutually exclusive projects, NPV/IRR conflict will occur even if their NPV profiles do not cross.
- 4.Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?
- A.
All else equal, a project's IRR increases as the cost of capital declines.
- B.
All else equal, a project's NPV increases as the cost of capital declines.
- C.
All else equal, a project's MIRR is unaffected by changes in the cost of capital.
- D.
All else equal, a projects payback period increases as the cost of capital declines.
- E.
All else equal, a project's NPV increases as the cost of capital increases.
- 5.Two projects being considered by a firm are mutually exclusive and have the following projected cash flows. Project A Project B Year Cash Flow Cash Flow 0 ($100,000) ($100,000) 1 39,500 0 2 39,500 0 3 39,500 133,000 Based only on the information given, which of the two projects would be preferred, and why?
- A.
Project A, because it has a shorter payback period.
- B.
Project B, because it has a higher IRR.
- C.
Indifferent, because the projects have equal IRRs.
- D.
Include both in the capital budget, since the sum of the cash inflows exceeds the initial investment in both cases.
- E.
Choose neither, since their NPVs are negative.
- 6.Which of the following statement completions is incorrect? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce
- A.
Higher depreciation charges in the early years of an asset's life.
- B.
Larger cash flows in the earlier years of an asset's life.
- C.
Larger total undiscounted profits from the project over the project's life.
- D.
Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes.
- E.
None of the above. (All of the above are correct.)
- 7.In theory, the decision maker should view market risk as being of primary importance. However, within-firm, or corporate, risk is relevant to a firm's
- A.
Well-diversified stockholders, because it may affect debt capacity and operating income.
- B.
Management, because it affects job stability.
- C.
Creditors, because it affects the firm's credit worthiness.
- D.
All of the answers above are correct.
- E.
Only answers a and b are correct.
- 8.Monte Carlo simulation
- A.
Can be useful for estimating a project's stand-alone risk.
- B.
Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable.
- C.
Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR.
- D.
All of the answers above.
- E.
Only answers a and b are correct.
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