_____ 1. If you had to choose only one of the following criteria for evaluating proposed investments, which rule would be considered the best method?

a. IRR

b. payback period

c. AAR

d. NPV

e. profitability index

_____ 2. Which of the following decision rules is designed for valuing short-term projects for which cash flows beyond a specified point and the time value of money can be ignored?

a. payback period

b. NPV

c. AAR

d. profitability index

e. IRR

_____ 3. If you are only given the book value of the investment and the expected net income for a capital investment project, which of the following could you calculate?

a. NPV

b. IRR

c. AAR

d. payback period

e. profitability index

_____ 4. What is the decision rule for AAR?

a. accept if AAR>0

b. accept if AAR>IRR

c. accept if AAR>100%

d. accept if AAR>target AAR

e. accept if AAR>target IRR

_____ 5. What is the decision rule for NPV?

a. accept if NPV>0

b. accept if NPV>AAR

c. accept if NPV>cost

d. accept if NPV>target NPV

e. accept if NPV is negative, as long as IRR is positive

_____ 6. A project costs $475 and has cash flows of $100 for the first year and $75 each year for the next 8 years. What is the payback period for the project?

a. never

b. 5 years

c. 6 years

d. 6.333 years

e. 7.5 years

_____ 7. Would a company which required a 3 year payback accept a $60,000 investment with the following cash flows?

YearCash Flow

1 20,000

2 25,000

3 10,000

4 10,000

5 5,000

a. Yes

b. No

_____ 8. A taxable gain occurs when an asset is sold for more than its book value. For capital budgeting purposes, the taxes on the sale

a. are added to the sales price

b. are a noncash event similar to depreciation

c. are subtracted from the book value

d. are subtracted from other taxes

e. are subtracted from the sales price

_____ 9. The government has been trying to decide whether or not to purchase any stealth bombers. One of the arguments in favor of purchasing the bombers is that since so much money has been spent on their development, it would be a waste of money not to buy any. What is the major problem with this argument?

a. It doesn't consider the opportunity cost of the money that has been spent.

b. It includes sunk costs in the decision.

c. It includes possible erosion of the purchase of other bombers.

d. It includes changes in net working capital.

e. It includes financing costs in the decision.

_____ 10. You discover that a glue which your company developed ten years ago can be formed into a super bouncy ball if cooked at the right temperature. How should you treat the original $125,000 of R & D expenditures that went into developing the glue in your present capital budgeting analysis of the proposed ball project?

a. As a cash outflow at the beginning of the project.

b. As a part of the initial investment.

c. As a cash inflow since the formula has obviously increased in value.

d. As a sunk cost.

e. As a sunk cost only if the glue cannot be made by another manufacturer.

Questions 11-13 refer to the following tax depreciation tables:

Year3-year5-year7-year

133.33%20.00%14.29%

244.4432.0024.49

314.8219.2017.49

4 7.4111.5212.49

511.52 8.93

6 5.76 8.93

7 8.93

8 4.45

_____ 11. Your company has just purchased a new distillation unit for $160,000 to be used in R & D. Such equipment has a 3-year MACRS classification. What is the book value of the distillation unit at the end of year 2?

a. $18,892

b. $35,568

c. $39,998

d. $46,664

e. $88,896

_____ 12. Your company has just purchased a new computer system for $160,000. Computers have a 5-year MACRS classification. What is the depreciation for this system in year 6?

a. $ 0

b. $5,120

c. $7,104

d. $8,000

e. $9,216

_____ 13. You company has just bought some new equipment for its manufacturing plant. The equipment cost $1,000,000 and has a 7-year MACRS classification. If the equipment is sold at the end of year 3 for $224,900, what is the after tax cash flow from the sale? (Assume that the company's tax rate is 34%.)

a. $ 27,784

b. $ 66,000

c. $ 72,216

d. $172,216

e. $297,116

14. Two mutually exclusive projects are being considered which have the following projected cash flows:

YearProject AProject B

0($50,000)($50,000)

1 $15,625 $ 0

2 $16,000 $ 0

3 $15,000 $ 0

4 $16,000 $ 0

5 $15,500 $99,500

a. Calculate the NPV for each of these projects using a 10% rate of return. Also, indicate which project should be chosen based on the NPV calculation.

b. Calculate the payback periods for each of the above projects. Also, indicate whether either of the projects would be chosen by a company which requires a payback period of 4 years.

c. Briefly explain in your own words why the two analyses yield differing results.

d. Calculate the profitability index for each of the above potential projects.

15. A proposed new investment has projected sales of 15,000 units in year 1 and 20,000 units in year 2. The sales price for both years will be $10 per unit. The project will terminate after the second year. Variable costs are expected to be 50% of sales. Fixed costs will be $25,000 per year. The investment will cost $20,000 and will be depreciated straight line to $0 over the 2 year period. The tax rate is 34% for both years and the investment will be worthless after 2 years. Please prepare projected income statements for each of the 2 years and calculate the operating cash flow for each year.