Capital Budgeting Paper 9

1

Sarah Birdsong has prepared a net present value (NPV) analysis for a 15-year equipment modernization program. Her initial calculations include a series of depreciation tax savings, which are then discounted. Birdsong is now considering the incorporation of inflation into the NPV analysis. If the depreciation tax savings were based on original equipment cost, which of the following options correctly shows how she should handle the program’s cash operating costs and the firm’s required rate of return respectively?
Cash Operating Costs
Required Rate of Return






2

If the present value of expected cash inflows from a project equals the present value of expected cash outflows, the discount rate is the






3

Bell Delivery Co. is financing a new truck with a loan of $30,000 to be repaid in five annual installments of $7,900 at the end of each year. What is the approximate annual interest rate Bell is paying?






4

All of the following are methods used to evaluate investments for capital budgeting decisions except






5

For a given investment project, the interest rate at which the present value of the cash inflows equals the present value of the cash outflows is called the






6

The net present value of an investment project represents the






7

Wilcox Corporation won a settlement in a law suit and was offered four different payment alternatives by the defendant’s insurance company. A review of interest rates indicates that % is appropriate for analyzing this situation. Ignoring any tax considerations, which one of the following four alternatives should the controller recommend to Wilcox management?






8

Verla Industries is trying to decide which one of the following two options to pursue. Either option will take effect on January 1st of the next year.
Option One - Acquire a New Finishing Machine. The cost of the machine is $1,000,000, and it will have a useful life of 5 years. Net pre-tax cash flows arising from savings in labor costs will amount to $100,000 per year for 5 years. Depreciation expense will be calculated using the straight-line method for both financial and tax reporting purposes. As an incentive to purchase, Verla will receive a trade-in allowance of $50,000 on their current fully depreciated finishing machine.
Option Two - Outsource the Finishing Work. Verla can outsource the work to LM, Inc., at a cost of $200,000 per year for 5 years. If they outsource, Verla will scrap their current fully depreciated finishing machine. Verla’s effective income tax rate is 40%. The weighted-average cost of capital is 10%. Verla’s net present value of acquiring the new finishing machine is






9

An investment decision is acceptable if the






10

Which of the following is not a shortcoming of the internal rate of return (IRR) method?






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