Chap010 - Making Capital Investment Decisions

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National University of Singapore *

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Apr 28, 2024

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Chapter 10 - Making Capital Investment Decisions Chapter 10 Making Capital Investment Decisions Multiple Choice Questions 1. The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's: A. incremental cash flows. B. internal cash flows. C. external cash flows. D. erosion effects. E. financing cash flows. 2. The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? A. underlying value principle B. stand-alone principle C. equivalent cost principle D. salvage principle E. fundamental principle 3. Which one of the following costs was incurred in the past and cannot be recouped? A. incremental B. side C. sunk D. opportunity E. erosion 4. The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following? A. salvage value B. wasted value C. sunk cost D. opportunity cost E. erosion 10-1

Chapter 10 - Making Capital Investment Decisions 5. Which one of the following best describes the concept of erosion? A. expenses that have already been incurred and cannot be recovered B. change in net working capital related to implementing a new project C. the cash flows of a new project that come at the expense of a firm's existing cash flows D. the alternative that is forfeited when a fixed asset is utilized by a project E. the differences in a firm's cash flows with and without a particular project 6. Which one of the following best describes pro forma financial statements? A. financial statements expressed in a foreign currency B. financial statements where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales C. financial statements showing projected values for future time periods D. financial statements expressed in real dollars, given a stated base year E. financial statements where all accounts are expressed as a percentage of last year's values 7. Which one of the following is the depreciation method which allows accelerated write-offs of property under various lifetime classifications? A. IRR B. ACRS C. AAR D. straight-line to zero E. straight-line with salvage 8. The depreciation tax shield is best defined as the: A. amount of tax that is saved when an asset is purchased. B. tax that is avoided when an asset is sold as salvage. C. amount of tax that is due when an asset is sold. D. amount of tax that is saved because of the depreciation expense. E. amount by which the aftertax depreciation expense lowers net income. 10-2

Chapter 10 - Making Capital Investment Decisions 9. The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following? A. yearly incremental costs B. sunk costs C. opportunity costs D. erosion cost E. equivalent annual cost 10. Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? A. storing supplies in the same space currently used for materials storage B. utilizing the basket manager to oversee wreath production C. hiring additional employees to handle the increased workload should the firm accept the wreath project D. researching the market to determine if wreath sales might be profitable before deciding to proceed E. planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt 11. Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary A. I and II only B. III and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV 10-3

Chapter 10 - Making Capital Investment Decisions 12. The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? A. sunk B. total C. variable D. incremental E. fixed 13. Which one of the following is an example of a sunk cost? A. $1,500 of lost sales because an item was out of stock B. $1,200 paid to repair a machine last year C. $20,000 project that must be forfeited if another project is accepted D. $4,500 reduction in current shoe sales if a store commences selling sandals E. $1,800 increase in comic book sales if a store commences selling puzzles 14. G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? A. opportunity B. fixed C. incremental D. erosion E. sunk 15. Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? A. providing both ketchup and mustard for its customer's use B. repairing the roof of the hot dog stand because of water damage C. selling fewer hot dogs because hamburgers were added to the menu D. offering French fries but not onion rings E. losing sales due to bad weather 10-4

Chapter 10 - Making Capital Investment Decisions 16. Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product A. I and III only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV 17. You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the: A. longest life. B. highest annual operating cost. C. lowest annual operating cost. D. highest equivalent annual cost. E. lowest equivalent annual cost. 18. The bid price is: A. an aftertax price. B. the aftertax contribution margin. C. the highest price you should charge if you want the project. D. the only price you can bid if the project is to be profitable. E. the minimum price you should charge if you want to financially breakeven. 19. Which one of the following will increase a bid price? A. a decrease in the fixed costs B. a reduction in the net working capital requirement C. a reduction in the firm's tax rate D. an increase in the salvage value E. an increase in the required rate of return 10-5

Chapter 10 - Making Capital Investment Decisions 20. All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero? I. purchase of $1,400 of parts inventory needed to support the project II. loan of $125,000 used to finance the project III. depreciation tax shield of $1,100 IV. $6,500 of equipment needed to commence the project A. I and II only B. I and IV only C. II and IV only D. I, II, and IV only E. I, II, III, and IV 21. Changes in the net working capital requirements: A. can affect the cash flows of a project every year of the project's life. B. only affect the initial cash flows of a project. C. only affect the cash flow at time zero and the final year of a project. D. are generally excluded from project analysis due to their irrelevance to the total project. E. reflect only the changes in the current asset accounts. 22. Which one of the following is a project cash inflow? Ignore any tax effects. A. decrease in accounts payable B. increase in inventory C. decrease in accounts receivable D. depreciation expense based on MACRS E. equipment acquisition 23. Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project. 10-6

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