Multiple Choice

Select the best answer to each question. Space is provided for computations after the quantitative questions.

____ 1. (CMA) Amster Corporation has not yet decided on its required rate of return for use in the evaluation of capital-budgeting projects for the current year. This lack of information prohibits Amster from calculating a projects

AARR

NPV

IRR

a.

no

no

no

b.

yes

yes

yes

c.

no

yes

yes

d.

no

yes

no

e.

yes

no

yes

____ 2. (CPA adapted) Brewster Co. is reviewing the following data relating to an energy-saving investment proposal:

Net initial investment

$50,000

After-tax cash flow from disposal of the investment at the end of 5 years

10,000

Present value of an annuity of $1 at 12% for 5 years

3.60

Present value of $1 at 12% in 5 years

0.57

What is the amount of after-tax annual savings (including the depreciation effects) needed for the investment to provide a 12% return?

a. $ 8,189

b. $11,111

c. $12,306

d. $13,889

___ 3. (CMA) Making the common assumption in capital-budgeting analysis that cash inflows occur in a lump sum at the end of individual years during the life of an investment project when, in fact, they flow more or less continuously during those years:

a. results in increasingly overstating NPV as the life of the investment project increases.

b. is done because present value tables for continuous flows cannot be constructed.

c. results in understating NPV of the investment project.

d. results in inconsistent errors being made in NPV such that projects cannot be evaluated reliably.

e. results in a higher IRR of the investment project.

___ 4. (CPA adapted) Apex Corp. is considering the purchase of a machine costing $100,000. The machines expected useful life is five years. The estimated annual after-tax cash flow from operations is: $60,000 in year 1, $30,000 in year 2, $20,000 in year 3, $20,000 in year 4, and $20,000 in year 5. Assuming these cash flows will be received evenly during each year, the payback is:

a. 2.50 years.

b. 3.00 years.

c. 3.33 years.

d. none of the above.

___ 5. (CMA) Fast Freight Inc. is planning to purchase equipment to make its operations more efficient. The equipment has an estimated life of six years. At the time of acquiring the equipment, a $9,000 investment in working capital is required. In a discounted cash-flow analysis, this investment in working capital:

a. should be amortized over the useful life of the equipment.

b. should be disregarded because no cash is involved.

c. should be treated as a recurring annual cash outflow that is recovered at the end of six years.

d. should be treated as an immediate cash outflow.

e. should be treated as an immediate cash outflow that is recovered at the end of six years.

____ 6. Assume in the current year that a profitable company pays $10,000 for advertising and has depreciation of $10,000. If the income tax rate is 40%, the after-tax effects on cash flow before considering time value of money are a net outflow of:

a. $4,000 for advertising and a net inflow of $4,000 for depreciation.

b. $6,000 for advertising and a net inflow of $6,000 for depreciation.

c. $4,000 for advertising and a net inflow of $6,000 for depreciation.

d. $6,000 for advertising and a net inflow of $4,000 for depreciation.

____ 7. (CMA) Garfield Inc. is considering a 10-year capital investment project with forecasted cash revenues of $40,000 per year and forecasted cash operating costs of $29,000 per year. The initial cost of the equipment for the project is $23,000, and Garfield expects to sell the equipment for $9,000 at the end of the tenth year. The equipment will be depreciated on a straight-line basis over seven years for tax purposes. The project requires a working capital investment of $7,000 at its inception and another $5,000 at the end of year 5. The working capital is fully recoverable at the end of the life of the project. Assuming a 40% tax rate, expected net after-tax cash flow from the project for the tenth year is:

a. $32,000.

b. $24,000.

c. $20,000.

d. $11,000.

e. $12,000.

___ 8. (CMA) Superstrut is considering replacing an old press that cost $80,000 six years ago with a new one with a purchase cost of $225,000. Shipping and installation cost an additional $20,000. The old press has a book value of $15,000 and can be sold currently for $5,000. The increased production of the new press would increase inventories by $4,000, accounts receivable by $16,000, and accounts payable by $14,000. Superstruts net initial investment for analyzing the acquisition of the new press, assuming a 40% income tax rate is:

a. $256,000.

b. $242,000.

c. $250,000.

d. $245,000.

e. $236,000.

___ 9. (CMA) Brownel Inc. currently has annual cash revenues of $240,000 and annual operating costs of $185,000 (all cash items except depreciation of $35,000). The company is considering the purchase of a new mixing machine costing $120,000 that would increase cash revenues to $290,000 per year and operating costs (including depreciation) to $205,000 per year. The new machine would increase depreciation to $50,000 per year. Using a 40% income tax rate, Brownels annual incremental after-tax cash flow from the new mixing machine is:

a. $33,000.

b. $24,000.

c. $30,000.

d. $18,000.

e. $68,000.

____ 10. (Appendix) If the nominal rate of interest is 16% and the inflation rate is 5%, the real rate of interest (rounded to the nearest tenth of a percent) is:

a. 12.0%.

b. 11.6%.

c. 10.5%.

d. 10.1%.