The capital budgeting decision involves the planning of expenditures for projects with a life of at least:
a. one year
b. five years
c. ten years
d. fifteen years
a. one year
The biggest problem facing a manager is:
a. the cost of financing
b. competitive pressures
c. the farther out the time horizon moves, the greater the uncertainty
d. changing economic conditions
c. the farther out the time horizon moves, the greater the uncertainty
All of the following are steps in the decision-making process of a good capital budgeting process except:
a. obtaining the necessary financing
b. collection of data
c. evaluation and decision making
d. re-evaluation and adjustment
a. obtaining the necessary financing
Perhaps the most important step in the decision making process is:
a. collection of data
b. search and discovery of investment opportunities
c. evaluation and decision making
d. re-evaluation and adjustment
b. search and discovery of investment opportunities
In most capital budgeting decisions, the emphasis is on:
a. reported income
b. cash flows
c. short-term profits
d. maximization of shareholder wealth
b. cash flows
All of the following are widely used methods for evaluating capital expenditures except;
a. payback period
b. internal rate of return
c. net present value
d. weighted average cost of capital
d. weighted average cost of capital
Under the payback period:
a. we compute the time required to recoup the original investment
b. there is no consideration of inflows after the cutoff period
c. the time value of money is ignored
d. all of the above are correct
d. all of the above are correct
One of the main advantages of the payback period is:
a. it is easy to use and places a premium on liquidity
b. it ignores the time value of money
c. all inflows related to the decision are considered
d. outflows are equated with inflows using the rate of return
a. it is easy to use and places a premium on liquidity
Under the net present value method:
a. the interest rate is determined that equates inflows and outflows
b. the time value of money is not taken into account
c. inflows are discounted back to determine if they exceed outflows
d. the basic discount rate is the internal rate of return
c. inflows are discounted back to determine if they exceed outflows
The basic discount rate used in net present value analysis is:
a. the internal rate of return
b. the cost of common equity
c. the net discount rate
d. the cost of capital to the firm
d. the cost of capital to the firm
The internal rate of return method:
a. does not consider inflows after the cutoff period
b. calculates the interest rate that equates outflows with subsequent inflows
c. determines the time required to recoup the initial investment
d. determines whether future benefits justify current expenditures
b. calculates the interest rate that equates outflows with subsequent inflows
All of the following are true regarding capital rationing except:
a. it places on artificial constraint on funds that many be invested
b. it may result out of a fear of growth
c. it may result out of a hesitation to use external sources of funds
d. it will help the overall profitability of the firms
d. it will help the overall profitability of the firms
All of the following are true of capital cost allowance except:
a. it is a non-cash expense
b. it is not tax-deductible
c. it provides tax shield benefits
d. it should not be disregarded in capital budgeting decisions
b. it is not tax-deductible
With mutually exclusive projects:
a. both projects can be accepted
b. the project with the higher NPV is accepted
c. both projects are rejected
d. only one project is accepted
d. only one project is accepted
In a replacement decision, all of the following should be considered except:
a. the cost of the new equipment
b. interest costs
c. the capital loss or gain on the sale of the old equipment
d. the difference in capital cost allowance tax shields between the old and new equipment
b. interest costs
average accounting return (AAR):
This profitability measure is calculated as average earnings after tax divided by average book value.
capital cost allowance (CCA):
Declining balance method of amortization allowed by the Income Tax Act as a tax-deductible expense.
capital rationing:
Occurs when a corporation has more dollars of capital budgeting projects with positive net present values than it has money to invest in them. Therefore, some projects that should be accepted are excluded because financial capital is rationed.
CCA tax shield:
The reduction of taxes otherwise payable because the corporation can expense capital costs and therefore reduce taxable income.
decremental cash flows:
The cash flows that are subtracted as a result of an investment decision.
incremental cash flows:
The identification of only those cash flows that are added as the result of an action or decision.
internal rate of return (IRR):
A discounted cash flow method for evaluating capital budgeting projects. The IRR is a discount rate that makes the present value of the cash inflows equal to the present value of the cash outflows.
investment tax credit (ITC):
For capital investments in certain industries or regions of the country, a specified percentage of the capital cost can be deducted from income taxes payable.
mutually exclusive:
The selection of one choice precludes the selection of any competitive choice. For example, several machines can do an identical job in capital budgeting. After one machine is selected, the other machines are not used.
net present value (NPV):
The NPV equals the present value of the cash inflows minus the present value of the cash outflows, with the cost of capital used as a discount rate. This method is used to evaluate capital budgeting projects. If the NPV is positive, a project should be accepted.
net present value profile:
A graphic presentation of the potential net present values of a project at different discount rates. It is very helpful in comparing the characteristics of two or more investments.
payback period:
A value that indicates the time period required to recoup an initial investment. The payback does not include the time-value-of-money concept.
profitability index:
This measure is the ratio of cash inflows to cash outflows in present value terms.
recapture:
The inclusion in income of the capital cost allowance previously taken, when an asset pool closes and the last asset is sold for more than the undepreciated capital cost (UCC). Provided no capital gains occur, the difference between the sale price and the UCC is added to income.
resultant cash flows:
These are the cash flows that stem from a possible investment decision.
terminal loss:
A deduction from income occurring when the last item in a CCA pool is sold and the sale price is less than the undepreciated capital cost (UCC). The difference is the amount of the deduction.
undepreciated capital cost (UCC):
The amount within a given CCA class (or pool) of assets available for tax-deductible amortization. The maximum amount of CCA that can be expensed in a given year in relation to a particular CCA class is the UCC multiplied by the applicable CCA rate. Special adjustments have to be made for in-year purchases and sales of assets in the class.
