Investment Decisions

A project requires an initial investment of $100,000 and generates annual cash flows of $30,000 for 5 years. What is the payback period?

Which of the following capital budgeting techniques accounts for the time value of money?

If a project has a net present value (NPV) of zero, what does this indicate?

A company is evaluating two mutually exclusive projects. Project A has an NPV of $50,000 and an IRR of 18%. Project B has an NPV of $70,000 and an IRR of 15%. Which project should the company select and why?

When calculating the cash flows for a capital budgeting analysis, which of the following should be included?

A project has an initial cost of $200,000, a useful life of 5 years, no salvage value, and is depreciated using straight-line. Annual revenues are $120,000 and annual cash operating expenses are $60,000. The tax rate is 25%. What is the annual after-tax cash flow?

Which of the following best describes the profitability index (PI) method?

A company is considering a project with the following cash flows: Year 0: -$500,000; Year 1: $200,000; Year 2: $200,000; Year 3: $200,000. The cost of capital is 10%. What is the approximate NPV?

A firm is comparing two projects with different useful lives. Project X lasts 3 years with an NPV of $30,000, and Project Y lasts 6 years with an NPV of $50,000. The cost of capital is 10%. Which method should be used to make a valid comparison?

A company plans to invest $1 million in a project that will generate after-tax cash flows of $180,000 per year for 10 years. The cost of capital is 12%. The project also requires $50,000 in working capital that will be recovered at the end of year 10. What is the approximate NPV of the project?

Which capital budgeting method calculates the discount rate at which the NPV of a project equals zero?

In capital budgeting, sunk costs should be:

The discounted payback period differs from the regular payback period because it:

A project with a profitability index greater than 1.0 indicates that:

Which of the following cash flows should be included in a capital budgeting analysis?

The capital budgeting process typically begins with:

Depreciation affects capital budgeting cash flows because it:

When using the NPV method, a project should be accepted if its NPV is:

The cost of capital used as the discount rate in NPV analysis represents:

Terminal value in capital budgeting refers to:

Which of the following is a limitation of the payback period method?

Working capital investments in capital budgeting are typically:

The modified internal rate of return (MIRR) addresses a limitation of the traditional IRR by:

A company is evaluating a project that requires a $50,000 initial investment and generates $15,000 per year for 5 years. What is the payback period?

A post-audit in capital budgeting involves:

In capital budgeting, incremental cash flows are defined as:

Which of the following best describes capital rationing?

Sensitivity analysis in capital budgeting involves:

The depreciation tax shield is calculated as:

When evaluating a replacement decision, the relevant cash flows include:

A risk-adjusted discount rate is used in capital budgeting when:

In a lease vs. buy analysis, the relevant comparison is between:

Scenario analysis differs from sensitivity analysis because scenario analysis:

MACRS (Modified Accelerated Cost Recovery System) is used in capital budgeting because it:

A real option in capital budgeting gives a firm the right, but not the obligation, to:

Which capital budgeting method is most useful for ranking projects when a company faces capital constraints?

In capital budgeting, financing costs such as interest expense should be:

A company should accept an independent project when its IRR is:

The initial investment in a capital budgeting project typically includes:

Monte Carlo simulation in capital budgeting is used to:

A project has an initial investment of $200,000 and generates cash flows of $60,000 in Year 1, $80,000 in Year 2, $70,000 in Year 3, and $50,000 in Year 4. At a 10% discount rate, what is the discounted payback period?

A company is considering purchasing new equipment for $300,000. The equipment will generate after-tax cash savings of $75,000 per year for 6 years and has no salvage value. The cost of capital is 12%. What is the NPV?

When NPV and IRR give conflicting rankings for mutually exclusive projects, the conflict is usually caused by:

A project has an initial cost of $120,000 and generates after-tax cash flows of $40,000 per year for 4 years. The cost of capital is 10%. What is the profitability index?

A company is evaluating a project that requires $500,000 in initial investment and $30,000 in working capital. The project generates after-tax operating cash flows of $140,000 per year for 5 years. At the end of Year 5, the working capital is fully recovered and the equipment has a salvage value of $50,000 (after tax). If the cost of capital is 10%, what are the Year 5 total cash flows?

A machine costs $400,000 and will be depreciated using MACRS over 5 years. The Year 1 MACRS rate is 20%. If the tax rate is 30%, what is the depreciation tax shield in Year 1?

A company is considering replacing an old machine with a new one. The old machine has a book value of $40,000 and can be sold for $25,000. The tax rate is 25%. What is the after-tax cash flow from selling the old machine?

When evaluating a capital project, an increase in accounts receivable should be treated as:

A project has the following cash flows: Year 0: -$100,000; Year 1: +$230,000; Year 2: -$132,000. How many IRRs can this project potentially have?

In a replacement analysis, the tax impact of selling the old asset at a price above its book value results in:

A firm uses a risk-adjusted discount rate of 15% for high-risk projects instead of its WACC of 10%. A high-risk project has expected annual cash flows of $50,000 for 5 years and an initial cost of $170,000. What is the approximate NPV using the risk-adjusted rate?

A company must choose between two mutually exclusive projects with different lives. Project A has a 3-year life and an NPV of $45,000. Project B has a 5-year life and an NPV of $60,000. The cost of capital is 10%. Using the EAA approach, Project A's EAA is $18,095 and Project B's EAA is $15,828. Which project should be selected?

The option to expand a project if initial results are favorable is an example of:

When a firm faces capital rationing and must choose among several independent projects, it should select the combination that:

A company purchases a machine for $200,000 with a 5-year MACRS life. After 3 years, the accumulated MACRS depreciation is $152,000 and the machine is sold for $70,000. If the tax rate is 30%, what is the after-tax cash flow from the sale?

In a sensitivity analysis, the variable to which the project's NPV is most sensitive is called the:

A project requires an initial outlay of $250,000 and will be depreciated straight-line over 5 years with no salvage value. It generates annual revenues of $150,000 and annual cash operating costs of $70,000. The tax rate is 40%. What is the annual after-tax cash flow?

A lease vs. buy analysis should use which discount rate for the lease payments?

An investment project has the following cash flows: Year 0: -$80,000; Year 1: $30,000; Year 2: $35,000; Year 3: $25,000; Year 4: $20,000. What is the payback period?

When using MACRS depreciation in capital budgeting, compared to straight-line depreciation, the NPV of a project will be:

A company evaluates two mutually exclusive projects. Project X has an IRR of 20% and an initial investment of $50,000. Project Y has an IRR of 15% and an initial investment of $500,000. The WACC is 10%. Why might Project Y be preferred despite having a lower IRR?

In capital budgeting, the cannibalization effect refers to:

A company is considering a $1 million project. It runs three scenarios: Best case (NPV = $400,000, probability 25%), Base case (NPV = $100,000, probability 50%), Worst case (NPV = -$300,000, probability 25%). What is the expected NPV?

The option to abandon a project if results are poor has value because it:

A project generates the following after-tax cash flows: Year 1: $40,000; Year 2: $50,000; Year 3: $60,000. The cost of capital is 8%. What is the present value of these cash flows?

When a project has non-conventional cash flows (multiple sign changes), the best capital budgeting method to use is:

A firm is evaluating a project in a country with high inflation. The project's nominal cash flows are $50,000 per year and the nominal discount rate is 15%. The expected inflation rate is 5%. The real discount rate is approximately:

A company evaluates a new product line that will require $80,000 in additional inventory and $20,000 in additional accounts receivable, partially offset by $30,000 in additional accounts payable. What is the net working capital investment?

An investment has a profitability index of 0.85. This means:

In a replacement decision, the incremental depreciation used in calculating the depreciation tax shield is:

A project's coefficient of variation of NPV is 1.5, while another project's coefficient of variation is 0.8. Which statement is correct?

Under MACRS, a 5-year class asset is depreciated over 6 calendar years because:

A company is considering two projects under capital rationing with a $300,000 budget. Project A: cost $200,000, NPV $45,000, PI 1.225. Project B: cost $150,000, NPV $30,000, PI 1.200. Project C: cost $100,000, NPV $18,000, PI 1.180. Which combination maximizes total NPV?

A post-audit review reveals that a project's actual cash flows are 20% below original projections. The most likely benefit of this finding is that it:

The option to defer (timing option) in real options analysis is most valuable when:

A company invests $600,000 in a project and expects the following cash flows: Year 1: $150,000; Year 2: $200,000; Year 3: $250,000; Year 4: $180,000. At a 10% discount rate, the cumulative discounted cash flow through Year 3 is $478,927. What is the discounted payback period?

In capital budgeting, an externality refers to:

A project has an IRR of 14% and the company's WACC is 10%. If the company uses a risk premium of 5% for this project's risk class, should the project be accepted?

In a lease vs. buy decision, a key advantage of leasing is:

A company can invest $400,000 in a project that will save $95,000 per year in operating costs for 6 years. The equipment will have a salvage value of $40,000 at the end of Year 6 (assume fully depreciated by then). The tax rate is 25%. What is the after-tax salvage cash flow in Year 6?

A company is evaluating a project with the following details: Initial cost $400,000; 5-year life; straight-line depreciation to zero salvage; expected salvage value $50,000; annual revenue $250,000; annual cash operating costs $120,000; tax rate 30%; WACC 12%. What is the NPV of this project?

A company is considering a replacement decision. The old machine has a book value of $60,000, market value of $45,000, and remaining life of 5 years. The new machine costs $200,000, has a 5-year life, and generates annual cost savings of $50,000. Both machines are depreciated straight-line to zero. The tax rate is 25%. What is the initial outlay for the replacement (Year 0 cash flow)?

A project costs $500,000 and generates after-tax cash flows of $120,000 per year for 7 years. The project's MIRR is calculated assuming cash inflows are reinvested at the WACC of 10% and cash outflows are financed at the WACC. What is the terminal value of the reinvested cash inflows?

A company must choose between two projects with unequal lives: Project X (3-year life, cost $100,000, annual cash flow $50,000, WACC 10%) and Project Y (5-year life, cost $150,000, annual cash flow $45,000, WACC 10%). Using the EAA method, which project is preferred?

A firm is evaluating a project that requires $250,000 in equipment (MACRS 5-year property) and $40,000 in net working capital. Year 1 MACRS rate is 20%, Year 2 is 32%. Annual revenues are $180,000 and annual cash operating costs are $80,000. The tax rate is 35%. What is the after-tax operating cash flow in Year 2?

A company is evaluating a project in a foreign country. The project's cash flows in local currency are expected to be LC 500,000 per year for 5 years. The current exchange rate is $1 = LC 5. The local currency is expected to depreciate by 3% per year against the dollar. The domestic WACC is 12%. What is the approximate dollar value of Year 3 cash flows?

A firm has a WACC of 10% and is evaluating a project with a beta of 1.5. The risk-free rate is 4% and the market risk premium is 6%. Using the pure play method, what discount rate should be used for this project?

A project has an initial cost of $1,000,000 and generates the following after-tax cash flows: Year 1: $300,000; Year 2: $400,000; Year 3: $350,000; Year 4: $200,000. The WACC is 11%. An abandonment option allows the firm to sell the project assets for $450,000 (after tax) at the end of Year 2. If the project performs poorly and Year 3+ cash flows drop to $100,000/year, should the firm exercise the abandonment option at Year 2?

A company is deciding between buying equipment for $500,000 (5-year straight-line depreciation, $50,000 maintenance/year) or leasing it for $125,000/year. The tax rate is 30% and the after-tax borrowing rate is 5.6%. What is the present value of the after-tax cost of buying?

A company has identified three independent projects but can only spend $400,000. Project A: cost $200,000, PI 1.35. Project B: cost $250,000, PI 1.28. Project C: cost $180,000, PI 1.20. Which combination maximizes shareholder value?

A company is evaluating whether to accept a project with the following characteristics: Year 0: -$200,000 investment; Years 1-5: $65,000 annual cash flows; WACC: 10%. Inflation is expected to be 3% per year. If the cash flows are stated in real (constant) terms, what adjustment is needed?

A project's NPV at a 10% discount rate is $50,000 and at a 15% discount rate is -$20,000. Using linear interpolation, the approximate IRR is:

A company is evaluating an expansion project that will increase sales by $500,000 per year but will also reduce sales of an existing product by $80,000 per year. Variable costs for the new product are 60% of sales. Fixed costs increase by $50,000. The tax rate is 25%. Depreciation on new assets is $40,000/year. What is the annual incremental after-tax cash flow?

A company uses simulation analysis for a project and generates 10,000 NPV scenarios. The results show: mean NPV of $200,000, standard deviation of $150,000. Assuming a normal distribution, what is the approximate probability that the NPV will be negative?

A project requires a $300,000 investment today and another $100,000 investment in Year 2. It generates cash flows of $80,000 in Year 1, $120,000 in Year 2, $150,000 in Year 3, and $100,000 in Year 4. The WACC is 10%. What is the NPV?

A company is comparing two depreciation methods for a $600,000 asset with a 4-year life and no salvage value. Under straight-line, depreciation is $150,000/year. Under MACRS (4-year property: 33.33%, 44.45%, 14.81%, 7.41%), Year 1 depreciation is $200,000. If the tax rate is 30% and WACC is 10%, what is the PV advantage of MACRS over straight-line in Year 1?

A firm has the opportunity to invest in a gold mine. The mine costs $10 million today and will produce gold worth $2.5 million per year for 6 years. Operating costs are $800,000 per year. The firm can wait one year to invest, at which point gold prices will be either 20% higher (probability 60%) or 30% lower (probability 40%). The WACC is 12%. What is the expected NPV if the firm waits one year?

A company uses the certainty equivalent approach instead of a risk-adjusted discount rate. The project's risky expected cash flow in Year 3 is $200,000 and the certainty equivalent coefficient is 0.75. The risk-free rate is 4%. What is the present value of the Year 3 cash flow using the certainty equivalent method?

A company is considering a project with an option to expand. The base project costs $500,000 and has an NPV of -$30,000. However, if the project succeeds (probability 40%), the company can invest an additional $300,000 to expand, which would have an NPV of $250,000 at that point. If the project fails (probability 60%), the expansion option is worthless. Should the company invest in the base project?

A company evaluates a project using both NPV and MIRR. The project costs $350,000, generates $100,000/year for 5 years, and the WACC is 10%. The MIRR reinvests inflows at 10%. What is the MIRR?