1. 1.

Question - CMA251510
Discounted payback method is considered better than the payback method of calculating
payback period of the project because:
a) Considers accounting income.
b) Cash flows for the entire life of the project are considered.
c) Time value of money is considered.
d) It can be used even when cash inflows are not in the nature of annuity.
Option C is correct
Discounted payback method of calculating payback period of the project considers the time
value of money by discounting the annual cash inflows and outflows and is considered better
than payback method.

2. 2. Question - CMA251531
Mars Inc. is evaluating projects with the following investments and inflows:
Particulars Project A Project B
Inflow
Outflows Outflows Inflows
s
Year 0 120,000 - 110,000 -
Year 1 - 20,000 - 30,000
Year 2 - 50,000 - 50,000
Year 3 - 60,000 - 40,000
Year 4 - 30,000 - 60,000
Year 5 - 20,000 - 20,000
Present value of $1 @10% from year one to year five are: 0.909, 0.826, 0.751, 0.683 and
0.621.
The
a) Project B only.
b) Project A or B.
c) Project A only.
Option B is correct.
If there is limitation of funds, all the projects with higher profitability index (PI) should be
chosen.
Calculating PI of both the projects:
PI of project A = PV of future cash inflows / Initial Investment.
PV of future cash inflows = (0.909 x 20,000) + (0.826 x 50,000) + (0.751 x 60,000) + (0.683
x 30,000) + (0.621 x 20,000) =$137,450.
PI of project A = $137,450 / $120,000 = 1.15.
NPV of project B = PV of future cash inflows / Initial Investment.
PI of future cash inflows = (0.909 x 30,000) + (0.826 x 50,000) + (0.751 x 40,000) + (0.683 x
60,000) + (0.621 x 20,000) = $152,010.
PI of project B = $152,010 / $110,000 = 1.38.
As the PI of project B is higher than that of Project A, company should invest in Project B.
3. 3. Question - PART250046
Testra Foods is considering opening a new restaurant. The expected purchase price is
$270,000, expected annual revenues are $150,000, and expected annual costs are $90,000,
including $22,500 of depreciation. The investment has a payback period of approximately
a) 1.8 years.
b) 3.0 years.
c) 3.3 years.
d) 4.5 years.
Option C is correct
When the expected cash inflows for an investment are the same each year for the life of the
project, the payback period is the initial investment divided by the annual cash inflow. In this
question, not enough information is given to calculate after-tax operating cash flow or the tax
shield related to the depreciation, so the only thing to do is subtract cash costs (excluding the
depreciation) from revenues to determine annual net operating cash flow.
Total annual costs are $90,000, including $22,500 of depreciation (a non-cash expense),
so cash costs excluding the depreciation are $67,500.
Thus annual net cash flow is $150,000 minus $67,500, or $82,500 per year.
The initial investment of $270,000 divided by $82,500 equals 3.27, or 3.3 years to pay back
the initial investment.

4. 4. Question - PART250061
McLean Inc. is considering the purchase of a new machine that will cost $160,000. The
machine has an estimated useful life of 3 years. Assume that 30% of the depreciable base will
be depreciated in the first year, 40% in the second year, and 30% in the third year. The new
machine will have a $10,000 resale value at the end of its estimated useful life. The machine
is expected to save the company $85,000 per year in operating expenses. McLean uses a 40%
estimated income tax rate and a 16% hurdle rate to evaluate capital projects.
Discount rates for a 16% rate are as follows:
Year 1 2 3
Present Value of $1 0.862 0.743 0.641
Present Value of an Ordinary Annuity of 0.862 1.605 2.246
$1
What is the net present value of this project?
a) $8,834
b) $6,270
c) $5,842
d) $30,910
Option B is correct
The cash flows are as follows: Year 0 Year 1 Year 2 Year 3
Initial Investment (160,000)
Depreciation 48,000 64,000 48,000
Depreciation Tax Shield (Depr. × 0.40) 19,200 25,600 19,200
Calculation of Cash flow
Cash from disposition (after tax) (10,000 - 40%tax) 6,000
Operating cash flows 85,000 85,000 85,000
Less: Tax on operating cash flow at 40% (34,000) (34,000) (34,000)
51,000 51,000 51,000
Add: Tax shield 19,200 25,600 19200
Net Cash Flow 70,200 76,600 76,200
 Discount factor: 16% 0.862 0.743 0.641
Discounted Cash Flow (160,000) 60,512 56,914 48,844
The net present value is $(160,000) + $60,512 + $56,914 + $48,844 = $6,270

5. 5. Question - PART250074
A firm with an 18% cost of capital is considering the following projects (on January 1, year
1):
January 1, Year 1 Cash December 31, Year 5 Cash Year 5 Project Internal
Outflow (000's Omitted) Inflow (000's Omitted) Rate of Return
Project $3,500 $7,400 16%
A
Project $4,000 $9,950
B
Present Value of $1 Due at the End of "N" Periods N
12% 14% 15% 16% 18% 20% 22%
4 .6355 .5921 .5781 .5523 .515 .4823 .4230
8
5 .5674 .5194 .4972 .4761 .437 .4019 .3411
1
6 .5066 .4556 .4323 .4104 .370 .3349 .2751
4
Using the net-present-value (NPV) method, project A's net present value is
a) $23,140-
b) $265,460
c) $316,920-
d) $316,920
Option B is correct
There is only one cash inflow to this project, and it occurs 5 years after the initial cash
outflow. The firm's cost of capital is 18%. Therefore, the correct Present Value of $1 factor
(from the table given) to use in discounting the cash inflow is 0.4371. The present value of
the cash inflow is 0.4371 × $7,400,000, or $3,234,540. Subtracting the initial investment of
$3,500,000 from the present value of the cash inflow of $3,234,540, we get $(265,460).

6. 6. Question - PART250092
A company invested $500,000 in a new project. The project is expected to yield annual
incremental cash flows of $175,000 for 4 years. What is the approximate internal rate of
return for this project?
a) 10%.
b) 15%.
c) 35%
d) 40%
Option B is correct
The Internal Rate of Return is the interest rate (i.e., the discount rate) at which the present
value of expected cash inflows from a project equals the present value of expected cash
outflows. The present value of expected cash inflows for an annuity consisting of equal
payments is the annual amount multiplied by the factor for the Present Value of an Annuity
using the appropriate discount rate and term. Therefore, solving the equation 175,000X =
500,000 for the value of X will result in the present value factor for the relevant annuity.
Once we have the factor, we can look across the 4-year line on the factor table to locate the
 closest factor or factors and get the rate, which will be the IRR. 175,000X = 500,000 X =
2.85714 Looking across the 4-Year line on the table for Present Value of an Annuity, we find
a factor of 2.855 for a 15% discount rate. Therefore, the IRR is approximately 15%.

7. 7. Question - PART250096
The primary advantage of using the internal rate of return method to evaluate capital
budgeting projects is that
a) It is easy to understand and communicate.
b) assumes a conservative reinvestment rate.
c) results in decisions that will maximize shareholder wealth.
d) results in decisions that will maximize income.
Option A is correct
IRR is easily understood. This is a primary advantage of this method.

8. 8. Question - PART250099
Kampit, Inc. is contemplating a 5-year capital investment project with estimated revenues of
$80,000 per year and estimated cash operating expenses of $50,000 per year. The initial cost
of the plant and equipment for the project is $50,000, and the company expects to sell the
equipment for $5,000 at the end of the 5th year. P&E will be fully depreciated over 4 years
on a straight-line basis for tax purposes. The project requires a working capital investment of
$20,000 at its inception. The cost of capital for Kampit is 10%. Assume a 40% marginal tax
rate for the company. The Discounted Payback Period is3.82 years.4.82 years.3.04 years.2.82
years.
Option A is correct
The payback period based on discounted cash flows is calculated using each year’s
discounted cash flow. Because a separate discounted cash flow amount is needed for each
year of the project, each year’s cash flow needs to be discounted separately using the Present
Value of 1 factor. The initial investment is $50,000 P&E plus $20,000 working capital, or
$70,000 total. Annual before-tax operating cash flow is $30,000 ($80,000 expected revenues
less $50,000 expected expenses). After-tax operating cash flow is $30,000 × (1 − 0.40) =
$18,000. Annual depreciation for the first four years of the project will be $50,000 ÷ 4 years
= $12,500 per year. The depreciation tax shield is $12,500 × 0.40, or $5,000 per year for
Years 1 through 4. Therefore, the annual net after-tax cash flow for Years 1 through 4 is
$23,000 ($18,000 + $5,000). The cash flow for the fifth year will be different. 1. The after-
tax cash flow from operations will be the same: $18,000. 2. Because the equipment will be
fully depreciated at the end of Year 4, there will be no depreciation tax shield. 3. The cash
flow will be increased by $20,000 due to the release of the working capital. 4. The cash flow
will be increased by the after-tax cash flow from the disposal of the equipment. Since the
equipment will be fully depreciated for tax purposes when it is sold, the full amount of the
equipment’s sale price is a taxable gain, so the after-tax cash flow from the disposal is $5,000
× (1 – 0.40) = $3,000. The cash flow in Year 5 will be $41,000: the after-tax operating cash
flow of $18,000 + $20,000 released working capital + $3,000 after-tax cash flow from the
disposal of the equipment.
The discounted cash flows for each year and the cumulative discounted cash flows are as
follows:
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Cash flows (70,000) 23,000 23,000 23,000 23,000 41,000
PV factor @ 10% 1.000 0.9091 0.8264 0.7513 0.6830 0.6209
Discounted CF (70,000) 20,909 19,007 17,280 15,709 25,457
Cumulative disc. CF (70,000) (49,091) (30,084) (12,804) 2,905 28,362
The final year in which the cumulative discounted cash flow is negative is Year 3.
To calculate the fraction of Year 4 required to break even on a discounted basis, divide Year
3’s negative cumulative discounted cash flow of $12,804 by the Year 4 cash flow of $15,709.
$12,804 ÷ $15,709 = 0.82.
Therefore, the discounted payback period is 3.82 years.

Option B is incorrect
Due to incorrect calculation

Option C is incorrect
Due to incorrect calculation

Option D is incorrect
Due to incorrect calculation
9. Question - PART250107The net present value (NPV) and the internal rate of return (IRR)
capital budgeting methods make assumptions about the reinvestment rate of cash inflows
over the life of the project. Which one of the following statements is correct with respect to
this reinvestment rate of cash inflows?Under both NPV and IRR the reinvestment rate is the
risk-free rate of return.Under NPV and IRR the reinvestment rates are the cost of capital rate
and the risk-free rate of return, respectively.Under NPV and IRR the reinvestment rates are
the cost of capital rate and the internal rate of return, respectively.Under NPV and IRR the
reinvestment rates are the cost of capital rate and the asset risk premium rate, respectively.
Option C correct
When NPV is used, the assumption is made that the cash inflows from the project will be
reinvested at the discount rate used to calculate the net present value of the project, which is
usually the firm’s cost of capital. The assumption when IRR is used is that the cash inflows
from the project will be reinvested at the internal rate of return.

Option A is incorrect
This is not the reinvestment rate under NPV or under IRR.

Option B is incorrect
This is not the reinvestment rate under NPV or under IRR.

Option D is incorrect
This is not the reinvestment rate under IRR.

10. Question - PART250125

The following selected data pertain to a 4-year project being considered by Metro Industries:
• A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is
expected to have a $200,000 salvage value at the end of 4 years, qualifies as 3-year property
under the Modified Accelerated Cost Recovery System (MACRS).
• The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold
on the same January 1 for $180,000.
• The project is expected to provide added annual sales of 30,000 units at $20. Additional
cash operating costs are: variable, $12 per unit; fixed, $90,000 per year.
• A $50,000 working capital investment that is fully recoverable at the end of the fourth year
is required.
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar.
Assume that any gain or loss affects the taxes paid at the end of the year in which it
occurred.
The company uses the net present value method to analyze investments and will employ the
following factors and rates.
Period 1 2 3 4
Present Value of $1 at 12% 0.89 0.80 0.71 0.64
Present Value of $1 Annuity at 0.89 1.69 2.40 3.04
12%
MACRS 33% 45% 15% 7%
The overall discounted-cash-flow impact of the working capital investment on Metro's
project is
$(18,000).$(59,200).$(50,000).$(2,800).
Option A is correct
The Year 0 cash outflow will be $50,000. The $50,000 working capital investment will be
recovered at the end of the fourth year.
Therefore, the discounted cash inflow will be ($50,000 × 0.64), or $32,000.
So the net overall discounted cash flow impact of the working capital investment will be
$32,000 − $50,000, or $(18,000).

Option B is incorrect
With a cash outflow of $50,000 in Year 0 and a cash inflow in Year 4, the net discounted
cash flow for working capital cannot possibly be an outflow that is greater than the initial
outflow.

Option C is incorrect
The cash outflow of $50,000 will occur in Year 0. However, there will be a cash inflow in
Year 4 which will reduce the net discounted cash flow amount.

Option D is incorrect
The net discounted cash flow for working capital needs to include the $50,000 cash outflow
in Year 0 net of the present value of the cash inflow in Year 4.
11. Question - PART250133The rankings of mutually exclusive investments determined
using the internal rate of return method (IRR) and the net present value method (NPV) may
be different whenMultiple projects have unequal lives and the size of the investment for each
project is different.The required rate of return equals the IRR of each project.The required
rate of return is higher than the IRR of each project.The lives of the multiple projects are
equal and the size of the required investments are equal.
Option A is correct
When projects have unequal lives and the sizes of the investments are different, it is possible
that NPV and IRR will rank the projects in a different order.

Option B is incorrect
If the required rate of return equals the IRR of each project, NPV will be zero and the NPV
method and the IRR method will rank the investments the same.

Option C is incorrect
If the required rate of return is higher than the IRR of each project, NPV will be negative and
both NPV and IRR will return a decision to reject the project.
Option D is incorrect
When the lives of multiple projects are equal and the size the required investments are equal,
the IRR method and the NPV method will return the same accept-reject decision.
12. Question - PART250140
Wearwell Company is considering three investment projects. Wearwell's president asked the
controller to prepare a report and recommend an appropriate investment decision. The results
of the controller's calculations for the three projects are as follows.
Project A B C
Net present value $20,680 $30,300 $15,000
Internal rate of return 12% 10% 13%.
The company expects a minimum net present value (NPV) of $20,000 from accepted
projects.
The projects are mutually exclusive and Wearwell's cost of capital is 8%.
Which one of the following options should the controller recommend to the president?
Project C because it has the highest internal rate of return (IRR).Project B because it has the
highest net present value (NPV).Projects A, B, and C because each of the projects have an
IRR greater than the cost of capital.Projects A and B because they exceed the minimum
expected NPV.
Option B is correct
The controller should recommend Project B because it has the highest net present value.
Project B will increase shareholder wealth by more than the other projects because its NPV is
higher than the others'.
Project C has a higher IRR, but that is probably because the amount of the investment is
small.
Project C has an NPV of only $15,000, so it is well behind project B in its ability to increase
shareholder wealth.
All three projects are not an option because these projects are mutually exclusive.
"Mutually exclusive" means if one project is chosen, the other or others cannot be chosen.
Projects A and B are also not an option for the same reason.

Option A is incorrect
Project C does have the highest IRR, but that is probably because the amount of the
investment is small. Project C has an NPV of only $15,000, so it is well behind the other
projects in its ability to increase shareholder wealth.

Option C is incorrect
This is not an option because these projects are mutually exclusive. "Mutually exclusive"
means if one project is chosen, the other or others cannot be chosen. An example of mutually
exclusive projects is a piece of land on which either a plant or an office building can be
constructed, but not both.

Option D is incorrect
This is not an option because these projects are mutually exclusive. "Mutually exclusive"
means if one project is chosen, the other or others cannot be chosen. An example of mutually
exclusive projects is a piece of land on which either a plant or an office building can be
constructed, but not both.
13. Question - PART25111002
All of the following need to be considered in determining cash inflows from capital
investments except
proceeds from financing
reduction in working capital
cash savings on regular expenses
salvage value of old machine
Option A is correct
Proceeds from financing are not considered to be a cash inflow in assessing capital budgeting
projects. Financing cash flows associated with the project—cash inflows from financing and
principal and interest payments on new debt or dividends on new stock issued—are irrelevant
and are not a part of any capital budgeting analysis. The initial investment is considered a
cash outflow for capital budgeting as though there were no financing in place, and the cost of
the financing is captured in the discount rate, or hurdle rate, used to discount the future cash
flows for discounted cash flow methods. To include the cash flows for financing in the
analysis would be to double count them. If financing can be obtained on a more favorable
basis than anticipated, it could add value to the project; however, the financing cash flows are
never included in the capital budgeting analysis that is used to decide whether or not to accept
a proposed capital budgeting project.

Option B is incorrect
A reduction in working capital that occurs at the end of the project is considered to be a cash
inflow in assessing capital budgeting projects.

Option C is incorrect
Cash savings on regular expenses are considered to be a cash inflow in assessing capital
budgeting projects.

Option D is incorrect
The salvage value of the old machine, that is, the cash expected to be received from its
disposal, is considered to be a cash inflow in assessing capital budgeting projects. The cash
inflow is net of any income tax on a gain or plus any income tax benefit of a loss.
14. Question - PART251475
Salem Co. is considering a project that yields annual net cash inflows of $420,000 for years 1
through 5, and a net cash inflow of $100,000 in year 6. The project will require an initial
investment of $1,800,000. Salem's cost of capital is 10%. Present value information is
presented below:
Present value of $1 for 5 years at 10% is .62.
Present value of $1 for 6 years at 10% is .56.
Present value of an annuity of $1 for 5 years at 10% is 3.79.
What was Salem's expected net present value for this project?
$83,000.
($108,200).
($152,200).
($442,000).
Option C is correct
Net Present Value is the difference between the present value of cash inflows and the present
value of cash outflows. It is calculated as follows:
Present value of Cash inflows = (($420,000 x 3.79 + $100,000 x .56) = $1,647,800
NPV = $1,647,800 - $1,800,000 = ($1,52,200).

Option A is incorrect
based on the aforesaid explanation.
Option B is incorrect
based on the aforesaid explanation.

Option D is incorrect
based on the aforesaid explanation.
15. Question - PART251476
When estimating cash flow for use in capital budgeting, depreciation is
Included as a cash or other cost.
Excluded for all purposes in the computation.
Utilized to estimate the salvage value of an investment.
Utilized in determining the tax costs or benefit.
Option D is correct.
Depreciation expense must be taken into account when estimating cash flows for use in
capital budgeting. While depreciation is not a cash expense that directly affects cash flow, it
decreases a firm's net income and therefore, lowers its tax bill for the year. Depreciation Tax
Shield thereby creates more cash for the company at the end of the year and results in a tax
benefit.

Option A is incorrect
because depreciation is non cash item as it does not involve any cash outflow.

Option B is incorrect
because depreciation is used to determine the tax shield.

Option C is incorrect
because depreciation is determined by estimating the salvage value.
16. Question - PART251488
A company invested in a new machine that will generate revenues of $35,000 annually for
seven years. The company will have annual operating expenses of $7,000 on the new
machine. Depreciation expense, included in the operating expenses, is $4,000 per year. The
expected payback period for the new machine is 5.2 years. What amount did the company
pay for the new machine?
$145,600.
$161,200.
$166400.
$182,000.
Option C is correct
Payback period is calculated as follows:
Initial investment / After tax net cash flows
Operating expense before depreciation = $7,000 - $4,000 = $3,000.
Net Operating Annual Cash flows = $35,000 - $3,000 = $32,000.
Therefore, Initial Investment = 5.2 x $32,000 = $166,400.

Option A is incorrect
due to improper calculations.

Option B is incorrect
due to improper calculations.

Option D is incorrect
due to improper calculations.

17. Question - PART250126A company with a 40% tax rate is deciding whether to keep an
old machine or replace it with a new machine. Annual depreciation expense is $3,000 for the
old machine and would be $5,000 for the new machine. When using net present value to
determine if the new machine should be purchased, depreciation would increase the
incremental annual cash inflows of the investment by$0.00$800.00$1,200.00$2,000
Option B is correct
Depreciation expense will increase by $2,000 if the old machine is replaced with the new
machine. The company's tax rate is 40%. The company's taxable income will decrease by
$2,000, so the income tax paid on the company's net taxable income will decrease by 40% of
$2,000, or by $800. The decrease in income tax paid related to the new machine is equivalent
to an incremental cash inflow of $800.

Option A is incorrect
The company will have an incremental increase in its cash inflow as a result of the increased
depreciation expense. The company's taxable income will decrease by the amount of the
increase in depreciation expense and the income tax paid on the company's net taxable
income will decrease by 40% of the amount of the decrease in the company's taxable income.
The decrease in income tax paid is equivalent to an incremental cash inflow.

Option C is incorrect
$1,200 is 40% of the company's current annual depreciation expense. It is not the incremental
annual cash inflows of the new investment related to the depreciation. The company's
depreciation expense will increase as a result of purchasing the new machine. The company's
taxable income will decrease by the amount of the increase in depreciation expense and the
income tax paid on the company's net taxable income will decrease by 40% of the amount of
the decrease in the company's taxable income. The decrease in income tax paid is equivalent
to an incremental cash inflow. Option

Option D is incorrect
$2,000 is 40% of the new annual depreciation expense ($5,000) if the company replaces the
old machine with a new one. $2,000 is also the amount of change in the annual depreciation
expense as a result of purchasing the new machine ($5,000 − $3,000). But $2,000 is not the
incremental annual cash inflows of the new investment related to the depreciation. The
company's depreciation expense will increase as a result of purchasing the new machine. The
company's taxable income will decrease by the amount of the increase in depreciation
expense and the income tax paid on the company's net taxable income will decrease by 40%
of the amount of the decrease in the company's taxable income. The decrease in income tax
paid is equivalent to an incremental cash inflow.
18. Question - PART250121A company installed new equipment with a four-year useful life
and no salvage value. The new equipment cost $600,000 and will generate pretax cash
savings of $150,000 annually. Old equipment with a book value of $50,000 and a remaining
life of two years was sold for $20,000 when the new equipment was purchased. The company
uses straight-line depreciation and its effective income tax rate is 40%. The second year’s
relevant after-tax cash flow is$150,000.00$140,000.00$110,000.00$90,000
Option B is correct
The second year's relevant after-tax cash flow is the after-tax operating cash savings plus the
depreciation tax shield. The annual after-tax operating cash savings is $150,000 × (1 − 0.40),
which equals $90,000. The depreciation tax shield for the second year is 40% of the
difference between what the depreciation would have been on the old equipment, had it been
kept, and the depreciation on the new equipment. The depreciation on the old equipment, had
it been kept, would have been $50,000 ÷ 2 remaining years of life, or $25,000. The
depreciation on the new equipment is $600,000 ÷ 4, or $150,000. The difference, or the
incremental depreciation expense, is $125,000. The depreciation tax shield is 40% of
$125,000, or $50,000. The second year's relevant after-tax cash flow is $90,000 + $50,000 =
$140,000.

Option A is incorrect
The second year's relevant after-tax cash flow is the after-tax operating cash savings plus the
depreciation tax shield. An answer of $150,000 results from calculating the depreciation tax
shield incorrectly, by multiplying the annual depreciation expense on the new equipment by
the tax rate. Since the new machine is replacing an old machine and the old machine would
have had continued depreciation expense if it had been kept, the depreciation tax shield for
the second year is 40% of the difference between what the depreciation would have been on
the old equipment, had it been kept, and the depreciation on the new equipment.

Option C is incorrect
The second year's relevant after-tax cash flow is the after-tax operating cash savings plus the
depreciation tax shield. An answer of $110,000 results from calculating the after-tax
operating cash savings incorrectly by multiplying the pre-tax cash savings by the tax rate of
40%. The pre-tax cash savings should be multiplied by (1 − the tax rate) to convert it to its
after-tax equivalent.

Option D is incorrect
The second year's relevant after-tax cash flow is the after-tax operating cash savings plus the
depreciation tax shield. $90,000 is the after-tax operating cash savings only.
19. Question - PART250073
Jackson Corporation uses net present value techniques in evaluating its capital investment
projects. The company is considering a new equipment acquisition that will cost $100,000,
fully installed, and have a zero salvage value at the end of its five-year productive life.
Jackson will depreciate the equipment on a straight-line basis for both financial and tax
purposes. Jackson estimates $70,000 in annual recurring operating cash income and $20,000
in annual recurring operating cash expenses. Jackson's cost of capital is 12% and its effective
income tax rate is 40%. What is the net present value of this investment on an after-tax basis?
$940.00$8,150.00$36,990.00$51,410.00
Option C is correct
Annual after-tax operating cash flows will be [($70,000 − $20,000) × (1 − 0.40)], which
equals $30,000.
The annual depreciation tax shield is ($100,000 ÷ 5) × 0.40, which is $8,000.
Therefore, the total annual after-tax cash flow is $38,000.
The present value of these net inflows for a 5-year period is $136,990 ($38,000 x 3.605
present value of an ordinary annuity for 5 years at 12%), and the NPV of the investment is
$36,990 ($136,990 − $100,000 initial investment).

Option A is incorrect
This answer results from calculating the after-tax operating cash flows incorrectly, by
multiplying the before-tax operating cash flow of $50,000 by the tax rate instead of by 1
minus the tax rate.

Option B is incorrect
This answer ignores the depreciation tax savings.

Option D is incorrect
This answer results from two errors: (1) using the before-tax operating cash flow instead of
the after-tax operating cash flow to calculate the PV of the operating cash flow, and (2)
subtracting the PV of the depreciation tax shield from the PV of the operating cash flow
instead of adding it to the PV of the operating cash flow.
20. Question - PART250098A fast food restaurant is considering the addition of a new menu
item. Introduction of the new menu item would require an initial investment of $874,200, and
the project is projected to produce $300,000 of after-tax cash flows for each of the next four
years. The fast food restaurant has a weighted average cost of capital of 15%, and makes
project investment decisions on the basis of internal rate of return (IRR). What is the IRR of
the new menu item project, and should the fast food restaurant accept or reject the project?
9%, reject the project.14%, reject the project.19%, accept the project.37%, accept the project.
Option B is correct
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. When annual after-tax cash inflows are the same
for every year of the project’s life, the IRR can be found by first, dividing the net initial
investment by the annual cash flow amount. The result will be a factor that represents the
present value of an annuity. Then, on a present value of an annuity factor table, look at the
line for the number of years of the project’s life. Look along that line until you locate the
factor on that line that is closest to the factor you just calculated. Follow that column up to
the rate at the top of the column, and you will have a rate of return that is close to the internal
rate of return of the project. Dividing $874,200 by $300,000 results in a factor of 2.914. On
the four-year line of a PV of an annuity factor table, 2.914 is the factor for 14%, so the IRR
of the project is exactly 14%. The project should be rejected because its 14% return is lower
than the restaurant’s 15% weighted average cost of capital.

Option A is incorrect
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. At a discount rate of 9%, the new menu project has
a Net Present Value of $97,800, using a present value of an annuity discount factor of 3.24.
Since the internal rate of return is the discount rate at which the NPV is equal to zero, 9%
cannot be the internal rate of return for the new menu project.

Option C is incorrect
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. At a discount rate of 19%, the new menu project
has a Net Present Value of $(82,620), using a present value of an annuity discount factor of
2.6386. Since the internal rate of return is the discount rate at which the NPV is equal to zero,
19% cannot be the internal rate of return for the new menu project.
Option D is incorrect
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. At a discount rate of 37%, the new menu project
has a Net Present Value of $(293,550), using a present value of an annuity discount factor of
1.9355. Since the internal rate of return is the discount rate at which the NPV is equal to zero,
37% cannot be the internal rate of return for the new menu project.
21. Question - CMA251526
Calculate the internal rate of return for the entire life of the project based on the following
data:
Beginning
Investments ($) Inflows ($)
of
Year 1 25,700 0
Year 2 25,700 35,700
Year 3 25,700 35,700
Year 4 25,700 35,700
Present value ordinary annuity of $1
No. of years 8% 10% 12% 15%
2 1.783 1.736 1.690 1.626
3 2.577 2.487 2.402 2.283
4 3.312 3.170 3.037 2.855
15%
10%
12%
8%
Option D is Correct.
Internal rate of return is a rate of return at which the net present value (NPV) is equal to zero
i.e. the present value of cash inflows should be equal to the present value of investments
made.
Net present value = zero.
PV of cash inflows = Present value of cash outflows.
PV of cash inflows = $35,700 x PV factor for ordinary annuity for 3 years*.
PV of cash outflows = $25,700** + ($25,700 x PV factor for ordinary annuity for 3 years).
$35,700 x PV of ordinary annuity for 3 years = $25,700 + ($25,700 x PV factor for ordinary
annuity for 3 years).
$10,000 PV of ordinary annuity for 3 years = $25,700.
PV factor for annuity for 3 years = 2.57.
Now, 2.57 should be located in the annuity table against 3 year period which comes to 8%.
* As the outflows and inflows are at the beginning of years, the life of the project will be 3
years.
** As this outflow is at the beginning of year 1, it will not be discounted and thus considered
as initial investment.
Thus, the internal rate of return for the project is 8%.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option C is incorrect
based on the above explanation.
22. Question - PART250089
A firm with an 18% cost of capital is considering the following projects (on January 1, year
1):
January 1, Year 1 Cash December 31, Year 5 Cash Year 5 Project Internal
Outflow (000's Omitted) Inflow (000's Omitted) Rate of Return
Project $3,500 $7,400 16%
A
Project $4,000 $9,950
B
12% 14% 15% 16% 18% 20% 22%
4 .6355 .5921 .5781 .5523 .515 .4823 .4230
8
5 .5674 .5194 .4972 .4761 .437 .4019 .3411
1
6 .5066 .4556 .4323 .4104 .370 .3349 .2751
4
Project B's internal rate of return is closest to:
20%18%16%15%
Option A is correct
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. To determine the internal rate of return from the
information given, we need to first know what discount factor for five years would result in a
present value of $9,950 that is equal to $4,000. To arrive at that factor, we divide $4,000 by
$9,950, and we get 0.402. We then look along the line of factors for five years on the factor
table given to locate a factor close to 0.402. That is 0.4019, which is in the 20% column.
Thus, the internal rate of return is closest to 20%.

Option B is incorrect
18% is the company's cost of capital, which is given in the question.

Option C is incorrect
16% is approximately the internal rate of return for project A, but the question asks for the
internal rate of return for project B.

Option D is incorrect
The internal rate of return is the discount rate at which the present value of the expected cash
inflows from a project equals the present value of the expected cash outflows, or the discount
rate at which the net present value is zero. A positive NPV would result from using a discount
rate of 15%, so that cannot be the project's IRR.
23. Question - PART250002The Moore Corporation is considering the acquisition of a new
machine. The machine can be purchased for $90,000; it will cost $6,000 to transport to
Moore's plant and $9,000 to install. It is estimated that the machine will last 10 years, and it is
expected to have an estimated salvage value of $5,000. Over its 10-year life, the machine is
expected to produce 2,000 units per year with a selling price of $500 and combined material
and labor costs of $450 per unit. Federal tax regulations permit machines of this type to be
depreciated using the straight-line method over 5 years with no estimated salvage value.
Moore has a marginal tax rate of 40%. What is the net cash flow for the third year that Moore
Corporation should use in a capital budgeting analysis?$79,000$64,200$68,000$68,400
Option D is correct
Operating cash flow will be $100,000 (2,000 units per year × $50 unit contribution margin,
calculated as the selling price of $500 per unit less the material and labor costs of $450 per
unit. Moore's marginal tax rate is 40%, so the operating cash flow net of tax will be $100,000
× (1 − 0.40) or $60,000. The total capitalized cost of the machine will be $105,000 ($90,000
purchase price + $6,000 transportation costs + $9,000 installation costs), 100% of which will
be depreciated for tax purposes over 5 years. Thus, depreciation will be $105,000 ÷ 5, or
$21,000 per year for years 1 through 5. Therefore, the depreciation tax shield in those years
will be $21,000 × 0.40, or $8,400. The operating cash flow net of tax ($60,000) plus the
depreciation tax shield ($8,400) results in net cash flow for the third year of $68,400.

Option A is incorrect
An answer of $79,000 results from subtracting the annual depreciation amount from the gross
operating cash flow. It does not include the effect of income taxes, nor does it recognize that
depreciation is a non-cash expense.

Option B is incorrect
An answer of $64,200 results from depreciating the initial costs of the machine over a ten-
year period (its estimated life) rather than for the five-year period that will be used for tax
purposes. The period and method of depreciation used for taxes must be used in capital
budgeting because that determines the taxes due which is a component of cash flow.

Option C is incorrect
An answer of $68,000 results from deducting the salvage value from the cost to determine the
depreciable base. However, the problem tells us that federal tax regulations permit machines
of this type to be depreciated using the straight-line method over 5 years with no estimated
salvage value. The method of depreciation used for taxes must be used in capital budgeting
because that determines the taxes due which is a component of cash flow.
24. Question - PART250103
SwitchOver Inc. is considering the purchase of a new electronic machine for its production
facilities. The production manager considers the new machine to be necessary because the
current electronic machine is at the end of its useful life and maintenance costs for the
machine have significantly increased during the past year. The company has received bids
from two different suppliers: Santoni and Flainox. The electronic machines from Santoni and
Flainox are similar but there are differences in the cost of the machines and their estimated
cost savings. Management needs to decide which electronic machine to purchase. The
following information is given on the two machines. Santoni Flainox Cost of electronic
machines $350,300 $607,100 Estimated annual cash cost savings (after tax) 50,000 90,000
The two electronic machines both have estimated useful lives of 10 years. SwitchOver uses
the internal rate of return to evaluate investments of this type, and SwitchOver's required rate
of return is 10%. Which machine should SwitchOver purchase, if either?
A) SwitchOver should reject the Santoni bid and purchase the Flainox machine.
B) SwitchOver should reject the Flainox bid and purchase the Santoni machine.
SwitchOver should reject the Santoni bid and purchase the Flainox machine.SwitchOver
should reject the Flainox bid and purchase the Santoni machine.SwitchOver should reject
both machines and seek other bids.The two machines are equivalent, so it makes no
difference which one SwitchOver selects.
Option C is correct
SwitchOver should reject both machines and seek other bids.
The Internal Rate of Return is the interest rate at which the present value of expected cash
inflows from a project equals the present value of expected cash outflows. The present value
of expected cash inflows for an annuity consisting of equal payments is the annual amount
multiplied by the factor for the Present Value of an Annuity using the appropriate discount
rate and term.
The internal rate of return for the Santoni machine is determined using the formula 50,000X
= 350,300.
Solving for X, X = 7.006.
On the 10-year line on the factor table for the Present Value of an Annuity, the closest factor
to 7.006 is the factor for 7%, which is 7..
Therefore, the IRR for the Santoni machine is approximately 7%, which is lower than
SwitchOver’s required rate of return of 10%.
Therefore, SwitchOver should reject the Santoni machine.
The internal rate of return for the Flainox machine is determined using the formula 90,000X
= 607,100.
Solving for X,
X = 6.7456.
On the 10-year line on the factor table for the Present Value of an Annuity, 6.7456 is in
between the factors for 7% (7.0236) and 8% (6.7101).
Therefore, the IRR for the Flainox machine is between 7% and 8%,
which is also lower than SwitchOver’s 10% required rate of return,
so SwitchOver should also reject the Flainox machine.

Option A is incorrect
SwitchOver should also reject both the machine as IRR of both the machine is less than
required IRR 10%.

Option B is incorrect
SwitchOver should also reject both the machine as IRR of both the machine is less than
required IRR 10%.

Option D is Incorrect
The two machines are not equivalent they have different IRR. However, SwitchOver should
also reject both the machine as IRR of both the machine is less than required IRR 10%.

25. Question - PART251508

Notes receivables carrying interest rate which is lower than the market rate, should be valued
at:
Present value of the note discounted at the market interest rate.
Future value of the note discounted at the market interest rate.
Present value of the note discounted at the receivables interest rate.
Future value of the note discounted at the receivables interest rate.
Option A is correct.
A Note Receivable (N/R) is a formal promissory note, a written promise to pay a sum of
money at a specific future date.
N/R are generally interest bearing and have a stated rate of interest.
Companies generally record N/R that are long-term at the present value of the cash inflow
expected to be collected.
When the interest stated on the note equals the market (effective) rate of interest, the note
sells at face value.
When the stated rate differs from the market rate, the company records the difference either
as premium or discount and amortizes it over the life of the note to the approximate effective
rate (market rate).
If Stated rate >Market rate, the note is issued at premium.
If Stated rate <Market rate, the note is issued at discount.
Therefore, if a note receivable carrying rate/stated rate is lower than the market rat/effective
rate,
the present value of the note is discounted at the market interest rate.
The Payee amortizes the discount and recognizes the interest revenue annually using the
effective interest rate method. This can be illustrated with the help of an example:
ABC Inc. lends XYZ Company $20,000, with payment due in five years. The note receivable
has a stated interest rate of 6 percent and has Market interest rate (effective interest rate) of 8
percent.
Present value of notes receivable = Present value of face amount + Present value of interest
payments
Going to the present value of 1 table, the factor at the intersection of 8 percent and five year
periods is .6806. Thus, PV of face amount = $20,000 x .6806 is $13,612.
At the stated rate, interest is $1,200 per year ($20,000 x .06)
Present Value Factor for an Ordinary Annuity for $1 at 8 percent and five year periods is
3.9927
The present value of the interest is $4,791 ($1,200 x 3.9927)
Add the two present value figures to get the carrying value of the note, which is $18,403
($13,612 + $4,791). Subtract $18,403 from the face value of the note receivable to get the
discount of $1,597 ($20,000 – $18,403). This discount is then amortized over the period of 5
years.

Option B is incorrect
based on the above explanation.

Option C is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.
26. Question - PART251498
Tam Co. is negotiating for the purchase of equipment that would cost $100,000, with the
expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were
acquired. The equipment’s estimated useful life is 10 years, with no residual value, and
would be depreciated by the straight-line method. Tam’s predetermined minimum desired
rate of return is 12%.
Present value of an annuity of 1 at 12% for 10 period is 5.65. Present value of 1 due in 10
period at 12% is .322.
Accrual accounting rate of return based on initial investment is
30%
20%
12%
10%
Option D is correct
Accounting rate of return (ARR) is a method that computes an approximate rate of return
which ignores the time value of money and does not consider actual cash flows.
ARR = Accounting income / Average investment.
Accounting income = Cash flows (or savings in cost) - Depreciation = $20,000 - ($100,000 /
10) = $10,000.
Average investment = $100,000.
ARR = 10,000 / 100,000 = 10%.

Option A is incorrect
because the depreciation is incorrectly added to cash flows rather than being subtracted.

Option B is incorrect
because depreciation has to be subtracted from cash flows.

Option C is incorrect
because that is the minimum desired rate of return.

27. Question - PART250014A company can sell its existing building for $500,000 in order
to purchase a larger facility for $750,000. The existing building was purchased five years ago
for $450,000 and has a current book value of $350,000. The pre-tax net cash outflow from
the purchase of the new building is$100,000.00$250,000.00$300,000.00$400,000.00
Option B is correct
Since the question asks for the pre-tax net cash outflow from the purchase of the new
building, we do not need to be concerned with the income tax to be paid on the gain from the
sale of the existing building. The pre-tax net cash outflow is the difference between the
amount paid for the new building and the amount received from the sale of the existing
building. That is a $750,000 outflow for the new building and a $500,000 inflow from the
sale of the existing building, for a net $250,000 outflow, pre-tax.

Option A is incorrect
$100,000 is the difference between the historical cost of the existing building and its current
book value. It is not the pre-tax net cash outflow from the purchase of the new building. The
pre-tax net cash outflow from the purchase of the new building is the difference between the
amount paid for the new building and the amount received from the sale of the existing
building.

Option C is incorrect
$300,000 is the difference between the cost of the new building ($750,000) and the historical
cost of the existing building ($450,000). It is not the pre-tax net cash outflow from the
purchase of the new building. The pre-tax net cash outflow from the purchase of the new
building is the difference between the amount paid for the new building and the amount
received from the sale of the existing building.

Option D is incorrect
$400,000 is the difference between the cost of the new building ($750,000) and the current
book value of the existing building ($350,000). It is not the pre-tax net cash outflow from the
purchase of the new building. The pre-tax net cash outflow from the purchase of the new
building is the difference between the amount paid for the new building and the amount
received from the sale of the existing building.
28. Question - PART250005Which one of the following statements concerning cash flow
determination for capital budgeting purposes is not correct?Tax depreciation must be
considered because it affects cash payments for taxes.Sunk costs are not incremental flows
and should not be included.Book depreciation is relevant because it affects net income.Net
working capital changes should be included in cash flow forecasts.29. Question -
PART25111333
AGC Company is considering an equipment upgrade. AGC uses discounted cash flow (DCF)
analysis in evaluating capital investments and has an effective tax rate of 40%. Selected data
developed by AGC is as follows.
Existing Equipment New
Original cost $50,000 $95,000
Accumulated 45,000 -
depreciation
Current market value 3,000 95,000
Accounts receivable 6,000 8,000
Accounts payable 2,100 2,500
Based on this information, what is the initial investment for a DCF analysis of this proposed
upgrade
$92,400
$92,800
$95,800
$96,200
30. Question - CMA251525
A project has an initial investment of $600,000 at the beginning of year 1. There is an annual
inflow of $262,800 at the beginning of each year starting with year 2. The cost of capital of
the project is 10%. The internal rate of return (IRR) for the project is close to:
Present value of 1$
No. of years 10% 12% 15%
0.82
2 0.797 0.756
6
0.75
3 0.712 0.658
1
0.68
4 0.636 0.572
3
Present value ordinary annuity of $1
No. of years 10% 12% 15%
1.73
2 1.690 1.626
6
 2.48
3 2.402 2.283
7
3.17
4 3.037 2.855
0
10%
12%
15%
18%
31. Question - PART250039
Foster Manufacturing is analyzing a capital investment project that is forecasted to produce
the following cash flows and net income.
Cash Net Income
Flows
0 $(20,000) 0
1 6000 2000
2 6000 2000
3 8000 2000
4 8000 2000
The payback period of this project will be
2.5 years.2.6 years.3.0 years.3.3 years.32. Question - PART250021A financial analyst
determines the after-tax operating cash flow for a proposed project’s first year using the
following estimates. Sales revenue $2,000,000 Operating costs $1,000,000 Depreciation $
200,000 Income tax rate 35% The total after-tax operating cash flow for this project in its
first year is$520,000.00$650,000.00$720,000.00$850,000.0033. Question -
PART250143The value of a real option in capital budgeting isthe weighted average of the
possible payoffs of the real option.the standard deviation of the expected returns of the
project with the real option.the value of the project with the real option minus the value of the
project without the real option.the amount of future potential project value increases.34.
Question - PART251456
Which of the following statements about investment decision models is true?
The discounted payback rate takes into account cash flows for all periods.
The payback rule ignores all cash flows after the end of the payback period.
The net present value model says to accept investment opportunities when their rates of
return exceed the company's incremental borrowing rate.
The internal rate of return rule is to accept the investment if the opportunity cost of capital is
greater than the internal rate of return.
35. Question - PART250054Kell Inc. is analyzing an investment for a new product expected
to have annual sales of 100,000 units for the next 5 years and then be discontinued. New
equipment will be purchased for $1,200,000 and cost $300,000 to install. The equipment will
be depreciated on a straight-line basis over 5 years for financial reporting purposes and 3
years for tax purposes. At the end of the fifth year, it will cost $100,000 to remove the
equipment, which can be sold for $300,000. Additional working capital of $400,000 will be
required immediately and needed for the life of the product. The product will sell for $80,
with direct labor and material costs of $65 per unit. Annual indirect costs will increase by
$500,000. Kell\'s effective tax rate is 40%. In a capital budgeting analysis, what is the
expected cash flow at time = 3 (3rd year of operation) that Kell should use to compute the net
present value?$800,000.00$300,000.00$720,000.00$760,000.0036. Question -
PART250131
If income tax considerations are ignored, how is depreciation handled by the following
capital budgeting techniques?
Internal Rate of Return & Payback
I. Excluded ; Excluded
II. Excluded ; Included
III. Included ; Included
IV. Included ; Excluded
I.II.III.IV.37. Question - PART250003
The Moore Corporation is considering the acquisition of a new machine. The machine can be
purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install.
It is estimated that the machine will last 10 years, and it is expected to have an estimated
salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units
per year with a selling price of $500 and combined material and labor costs of $450 per unit.
Federal tax regulations permit machines of this type to be depreciated using the straight-line
method over 5 years with no estimated salvage value. Moore has a marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Moore Corporation should use
in a capital budgeting analysis?
$100,000$63,000$65,000$68,40038. Question - PART250007The term that refers to costs
incurred in the past that are not relevant to a future decision isSunk costFull absorption
cost.Discretionary cost.Underallocated indirect cost.39. Question - PART251506
A limitation of using the discounted payback method to evaluate a project is that it ignores
which of the following?
Cash flows after the payback period.
Duration of funds being tied up.
A project's cost of capital.
A project's break-even point.
40. Question - PART251462
A company purchases an item for $43,000. The salvage value of the item is $3,000. The cost
of capital is 8%. Pertinent information related to this purchase is as follows:
Net cash flows Present value factor at 8%
Year 10,000 0.926
1
Year 15,000 0.857
2
Year 20,000 0.794
3
Year 27,000 0.735
4
What is the discounted payback period in years?

3.10
3.25
2.90
3.14
Option B is correct
The discounted payback period is calculated as follows:
Year Cash Flows PVF PV of Cash Flows Cumulative Cash Flows
1 $10,000 x 0.926 = $9,260 $9,260
2 15,000 x 0.857 = 12,855 22,115
3 20,000 x 0.794 = 15,880 37,995
4 27,000 x 0.735 = 19,845
Payback occurs in year 4. It occurs specifically when $5,005 ($43,000-$37,995) of the cash
flow is received in that year.
The payback period is 3.25 years (3 + ($5,005/$1,9845).
The discounted payback period does not include salvage value of the asset.

Option A is incorrect
because it considers the salvage value of $3,000 for calculating discounted payback period.

Option C is incorrect
due to improper calculation of the discounted payback period.

Option D is incorrect
due to improper calculation of the discounted payback period.

41. Question - CMA251528

An initial investment for a project is $85,000. Inflows over the six years of the project,
starting with year one to year six are $5,000, $15,000, $15,000, $20,000, $30,000 and
$30,000 respectively. The cost of capital of the project is 15%. What is the payback period of
the project when: Present value of $1 @15% from year one to year six are: 0.870, 0.756,
0.658, 0.572, 0.497 and 0.433.
More than six years.
Six years.
Five years.
Less than five years.
42. Question - PART251471
Which of the following rates is most commonly compared to the internal rate of return to
evaluate whether to make an investment?
Short-term rate on U.S. Treasury bonds.
Prime rate of interest.
Weighted-average cost of capital.
Long-term rate on U.S. Treasury bonds.
Option C is correct
IRR is the discount rate at which the present value of cash inflows equals the present value of
cash outflows in a capital budgeting analysis, where all future cash flows are discounted to
determine their present values.
In order to evaluate whether to make an investment based on internal rate of return, the
Internal rate of return is compared to a hurdle rate, which is the firm's minimum acceptable
rate of return for the project
Cost of capital represents the minimum desired rate of return (i.e., a weighted average cost of
debt and equity capital).In general, the IRR method indicates that a project whose IRR is
greater than or equal to the firm's cost of capital should be accepted, and a project whose IRR
is less than the firm's cost of capital should be rejected.

Option A is incorrect
because these would be appropriate only if the company could borrow at any one of those
rates.

Option B is incorrect
because these would be appropriate only if the company could borrow at any one of those
rates.

Option D is incorrect
because these would be appropriate only if the company could borrow at any one of those
rates.
43. Question - PART250025Fast Freight, Inc. is planning to purchase equipment to make its
operations more efficient. This equipment has an estimated life of 6 years. As part of this
acquisition, a $75,000 investment in working capital is anticipated. In a discounted cash flow
analysis, the investment in working capitalShould be amortized over the useful life of the
equipment.Should be treated as an immediate cash outflow that is later recovered at the end
of 6 years.Can be disregarded because no cash is involved.Should be treated as an immediate
cash outflow.
Option B is correct
When we speak of an expected increase in working capital, we mean we expect accounts
receivable and inventory to increase because of the project under consideration. Raw
materials inventory may need to be purchased. Accounts receivable will increase as soon as
sales are made. The cash to fund these increases will come from profits, so it is a cash
outflow. We also expect that accounts payable related to the purchased inventory and other
current liabilities such as wages payable related to the project will increase. The increase in
accounts payable and other current liabilities will be a cash inflow. The investment in net
working capital should not be amortized over the useful life of the equipment. The
investment in working capital is not an amortizable item.

Option A is incorrect The increase in accounts payable and other current liabilities will not
be as great as the increases in accounts receivable and inventory. Thus, net working capital
will increase incrementally by the amount of the increase in current assets (accounts
receivable and inventory) less the increase in current liabilities (accounts payable and other
current liabilities). This incremental increase in net working capital requires cash. Cash is
needed to purchase the inventory. And the increase in accounts receivable represents goods
supplied or services rendered for which the company has incurred expenses, but for which it
has not yet received payment. The net incremental increase is a net cash outflow. The
incremental increase in net working capital will be recovered at the end of the project's life,
when the final accounts receivable are collected, the final inventory is sold, and the final
payables are paid.

Option C is incorrect Cash is involved, as increases in accounts receivable and inventory

require cash while increases in accounts payable and other current liabilities are a source of
cash.

Option D is incorrect Although it is true that the investment in net working capital is an
immediate cash outflow, this is not the best answer choice

44. Question - PART25111339

A capital investment project has the following expected incremental values next year
Revenue $1,000,000
Operating costs 200,000
Depreciation 300,000
If the income tax rate is 25%, the incremental after-tax operating cash flow is
$125,000
$375,000
$675,000
$900,000
Option C is Correct
A decrease in the discount rate would increase the incremental tax savings from depreciation
because a lower discount rate increases the present value of the future cash flows.
Revenue 1000,000
Less Operating costs 200,000
Less depreciation 300,000
Income before Tax 500,000
Tax at 25% 125,000
Income after tax 375,000
Add depreciation 300,000
Cash flow after tax 675,000

Option B is Incorrect
A decrease in the marginal tax rate would cause the incremental tax savings from
depreciation to decrease.

Option A is incorrect
A decrease in the useful life of the asset would increase the incremental tax savings from
depreciation because the cost of the asset would be allocated over fewer years.

Option D is incorrect
If the U.S. tax laws were changed so that the salvage value of an asset was deducted from the
cost to calculate the depreciable base, and if the salvage value of the asset were subsequently
decreased for tax purposes, the decrease in the salvage value of the asset would increase the
incremental tax savings from depreciation because there will be a higher depreciation
expense each year as the depreciable base of the asset increases.
45. Question - PART250051The accountant of Ronier, Inc. has prepared an analysis of a
proposed capital project using discounted cash flow techniques. One manager has questioned
the accuracy of the results because the discount factors employed in the analysis have
assumed the cash flows occurred at the end of the year when the cash flows actually occurred
uniformly throughout each year. The net present value calculated by the accountant willbe
unusable for actual decision making.be slightly understated but usable.not be in error.be
slightly overstated.
Option B is correct
Assuming that cash flows occur at the end of the year will result in a slightly understated net
present value. However, the analysis will still be usable.

Option A is incorrect
The results will not be unusable for actual decision making.

Option C is incorrect
It cannot be said that the net present value calculated by the account will not be in error,
because the actual cash flows will probably occur uniformly throughout the year.

Option D is incorrect
The net present value will not be overstated by assuming that the cash flows will occur at
year end. The cash flows will probably occur uniformly throughout each year, so discounting
them as though they occur at the end of each year instead will lead to a slight understatement,
not a slight overstatement.
46. Question - PART250149The CFO of a company is concerned about the impact that
inflation will have on the company’s reported financial results and wonders whether sales
will be comparable from year to year. The company had sales of $500,000 in Year 3 and the
price index for its industry has risen from 200 in Year 3 to 220 in Year 4. The level of sales
that the company must reach in Year 4 to achieve a real growth of 15%
is$550,000.00$575,000.00$632,500.00$690,000.00
Option C is correct
The rate of inflation is 10% year over year, calculated as (220 / 200) − 1 = 0.10 or as (220 −
200) / 200 = 0.10.
We need to find the nominal rate of growth that corresponds to a 15% real rate of growth at
an inflation rate of 10%.
We will then increase the Year 3 sales of $500,000 by that nominal growth rate to find the
level of sales that the company must reach in Year 4 to achieve a real growth rate of 15% in
sales.
The formula for the nominal rate of growth is: Nominal growth rate = ([1 + real rate] × [1 +
inflation rate]) − 1.
The desired real growth rate is 15% and the inflation rate is 10%.
Therefore, the desired nominal growth rate is: Nominal growth rate = (1.15 × 1.10) − 1
Nominal growth rate = 0.265
Next, we multiply $500,000 by 1.265 to find the level of sales the company must reach to
achieve a real growth rate of 15% in Year 4: $500,000 × 1.265 = $632,500
Alternative: The correct answer can also be calculated by simply multiplying $500,000 by
1.10 and then by 1.15: $500,000 × 1.10 × 1.15 = $632,500

Option B is incorrect
$550,000 is a 10% nominal increase over Year 3's $500,000 in sales. 10% is the rate of
inflation year over year, calculated as (220 / 200) − 1 or as (220 − 200) / 200. However, the
CFO wants to achieve a real growth rate of 15% in sales for Year 4, and sales of $550,000
would represent only level real sales with no real growth. Please see the correct answer
explanation for more information.

Option B is incorrect
$575,000 is a 15% nominal increase over Year 3's $500,000 in sales. However, the CFO
wants to achieve a 15% real growth rate in sales for Year 4, not a 15% nominal growth rate.
Please see the correct answer explanation for more information.

Option D is incorrect
This answer results from using an inflation rate of 20% based on the difference between the
price index in Year 4 and the price index in Year 3 (220 − 200 = 20). The rate of inflation
should be calculated as (220 − 200) / 200 = 0.10 or as (220 / 200) − 1 = 0.10. Please see the
correct answer explanation for more information.
47. Question - PART250040
Andyco is considering the acquisition of scanning equipment to mechanize its procurement
process. The equipment will require extensive testing and debugging, as well as user training
prior to its operational use. Projected after-tax cash flows are shown below.
Time Period Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
After-Tax Cash (550,000) (500,000) 450,000 350,000 250,000 150,000
Inflow/(Outflow) $
Management anticipates the equipment will be sold at the beginning of year 6 for $50,000
when its book value is zero.
Andyco's internal hurdle and effective tax rates are 14% and 40%, respectively.
The project's payback period will be
2.3 years.3.0 years.3.5 years.4.0 years.
Option D is correct
The payback period is 4.0 years, calculated as follows:
Time Period Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
After-Tax Cash (550,000) (500,000) 450,000 350,000 250,000 150,000
Inflow/(Outflow) $
Cumulative Cash Flow (550,000) (1,050,000) (600,000) (250,000) 0 150,000
The cumulative after-tax cash flow reaches zero at the end of the 4th year.
Therefore, the payback period is 4.0 years.

Option A is incorrect
After 2.3 years, the project will still have a negative cumulative after-tax cash flow,
calculated as follows: $(550,000) + $(500,000) + $450,000 + (0.3 × $350,000) = $(495,000).

Option B is incorrect
After 3.0 years, the project will still have a negative cumulative after-tax cash flow,
calculated as follows: $(550,000) + $(500,000) + $450,000 + $350,000 = $(250,000).

Option C is incorrect
After 3.5 years, the project will still have a negative cumulative after-tax cash flow,
calculated as follows: $(550,000) + $(500,000) + $450,000 + $350,000 + (0.5 × $250,000) =
$(125,000).
48. Question - PART250049
A company is planning to purchase a new machine that will cost $475,000 and will have
delivery and setup costs of $25,000. The machine will be depreciated using the straight-line
method over five years with a zero salvage value at the end. It is expected that the machine
will help the company generate additional after-tax revenues of $180,000 annually. The
company is subject to a 20% income tax rate. The machine payback period is
2.25 years.2.38 years.2.50 years.2.78 years.
Option C is correct
Since the expected annual cash flows are constant, the payback period is calculated as: Initial
net investment ÷ Periodic constant expected cash inflow The initial net investment is the
purchase cost of the machine ($475,000) plus the delivery and setup costs ($25,000), for a
total of $500,000. The periodic constant expected cash inflow is the $180,000 annual after-
tax revenues given in the question plus the depreciation tax shield, calculated as ($500,000 ÷
5) x 0.20 = $20,000, for a total annual after-tax cash inflow of $200,000. The payback period
is $500,000 ÷ $200,000 = 2.5 years.

Option A is incorrect
This answer results from subtracting the delivery and setup costs from the cost of the new
machine to calculate the annual after-tax cash inflow. The delivery and setup costs should be
added to the purchase cost, not subtracted from it. Please see the correct answer explanation
for more information.
Option B is incorrect
This answer results from not including the delivery and setup costs with the purchase cost of
the new machine. Please see the correct answer explanation for more information. Option

Option D is incorrect
This answer results from omitting the depreciation tax shield from the annual after-tax cash
inflow. Please see the correct answer explanation for more information.
49. Question - PART2514100
Which of the following decision-making models equates the initial investment with the
present value of the future cash inflows?
Accounting rate of return.
Payback period.
Internal rate of return.
Cost-benefit ratio.
Option C is correct
The internal rate of return method is a decision making model which equates the present
value of future cash inflows to the investment outlay.

Option A is incorrect
because the accounting rate of return computes an approximate rate of return by dividing
annual net income by the initial investment. Present value of future cash inflows are not
equated to the investment outlay.

Option B is incorrect
because the payback period evaluates investments on the length of time until recapture of the
investment and does not equate the initial investment with the present value of the future cash
inflows.

Option D is incorrect
because cost benefit ratio attempts to identify the relation between the costs and benefits of a
proposed project.
50. Question - PART250081Garwood Company has purchased a machine that will be
depreciated on a straight-line basis over an estimated useful life of 7 years with no salvage
value. The machine is expected to generate net after-tax cash flows of $80,000 in each of the
7 years. Garwood’s required rate of return is 12%. Assuming a positive net present value of
$12,720, what was the cost of the machine?$240,400.00$253,120.00$352,384.00377,840.00
Option C is correct
The present value of the annual cash flows from an investment minus the initial investment
equals the net present value of the investment. The cash flows from this project are equal for
each of the 7 years of the project at $80,000 after tax. Therefore, the present value as of Year
0 of the seven $80,000 annual cash flows, discounted at 12%, is $80,000 × 4.5638, or
$365,104. If the net present value of the project is $12,720, the cost of the machine must be
$365,104 − $12,720, or $352,384. Alternatively, algebra can be used to solve this problem.
The formula would be: (80,000 × 4.5638) – X = 12,720
365,104 – X = 12,720 −X = −352,384 X = $352,384

Option A is incorrect
The amount calculate above is incorrect
Option B is incorrect
The amount calculated above is incorrect

Option D is incorrect
The amount calculated above is incorrect
51. Question - PART251482
A company has a required rate of return of 15% for five potential projects. The company has
a maximum of $500,000 available for investment and cannot raise any capital. Details about
the five projects are as follows:
Projec Initial outlay Net present value at 15% Internal rate of return
t
1 $500,000 $125,000 23%
2 250,000 75,000 17%
3 150,000 25,000 35%
4 100,000 50,000 25%
5 150,000 50,000 25%
The company should choose which of the following projects?
Project 1 only.
Projects 2, 3, and 4 only.
Projects 2, 4, and 5 only.
Projects 3, 4, and 5 only.
Option C is correct.
Projects 2,4,5 taken together generate the highest NPV of $175,000.
In case the company had unlimited funds all the projects could be selected as all the Projects
generate positive NPV and the IRR exceeds the rate of return of 15% for all the investments.
Since capital is being rationed at $500,000, all projects cannot be chosen.

Option A is incorrect
because NPV is only $125,000.

Option B is incorrect
because combined NPV for the Projects 2,3 and 4 is only $150,000.

Option D is incorrect
because combined NPV of Projects 3,4 and 5 is only $125,000.
52. Question - CMA251527
Calculate the net present value of the project based on the following data if the cost of capital
for the project is 10%:
Beginning
Investments ($) Inflows ($)
of
Year 1 25,700 0
Year 2 25,700 35,700
Year 3 25,700 35,700
Year 4 25,700 35,700
Present value ordinary annuity of $1
No. of years 8% 10% 12% 15%
2 1.783 1.736 1.690 1.626
3 2.577 2.487 2.402 2.283
4 3.312 3.170 3.037 2.855
$830
($830)
$31,700
($31,700)
Option B is correct.
The inflows and outflows are at the beginning of each year. The life of the project will be 3
years and the beginning of year 1 will be considered as end of Year 0 and likewise beginning
of year 4 will be considered as end of Year 3.
Net present value (NPV) = PV of cash inflows – PV of cash outflows.
PV of cash inflows = $35,700 x PV of annuity for 3 years @10% = $35,700 x 2.487=
$88,785.9.
PV of cash outflows = $25,700 + ($25,700 x PV of annuity for 3 years @10%) = $25,700 +
($25,700 x 2.487) = $ 89,615.9.
Thus, NPV = $88,785.9 - $89,615.9 = ($830).

Option A is incorrect
because this would be the result when inflows are subtracted from outflows.

Option C is incorrect
because this would be the result if the project life is considered to be of 4 years [i.e. ($35,700
- $25,700) x 3.17].

Option D is incorrect
because this would be the result if the project life is considered to be of 4 years and also when
outflows are subtracted from inflows.
53. Question - PART250018A firm is considering a capital project. According to the project
plan, an existing piece of equipment with a historical cost of $400,000 and a current selling
price of $10,000 will be disposed. The old equipment has been depreciated on a straight-line
basis with no salvage value for 18 of its estimated 20-year useful life. The new equipment has
a cost of $500,000, and the firm expects it will have to invest $20,000 in inventory and
$24,000 in accounts receivable in the new project. The firm’s effective income tax rate is
40%. The required net initial investment for the new project
is$498,000.00$522,000.00$534,000.00$544,000.00
Option B is correct
The cash flows connected to the initial investment into this project are: $10,000 cash inflow
from the sale of the old equipment. $12,000 cash inflow from the tax loss on the sale of the
old equipment. The equipment had a book value of $40,000 when it was sold for $10,000.
That $30,000 tax loss creates tax savings for the company because it reduces taxable income
by $30,000. With a 40% tax rate, that leads to a $12,000 tax saving that is treated as a cash
inflow. $500,000 cash outflow to purchase the new equipment. $20,000 cash outflow for the
purchase of inventory. $24,000 cash outflow connected to the increase in working capital as a
result of this project. Adding all of these together gives a cash outflow of $522,000.
OR
Cost= 400000
Usefule life= 20 years
Salvage value= 0
Depreciation= (cost-salvage value)/useful life
Depreciation per year= (400000-0)/20= 20000
Depreciation for 18 years= 20000*18= 360000
Book value= 400000-360000= 40000
Sale value= 10000 (Cash inflow)
Tax saving on the loss= 30000*0.40= 12000 (cash inflow)
Cash outflow= 500000+20000+24000= 544000
Net investment= 544000-10000-12000= 522000

Option A is incorrect
This choice does not take into account the increase in working capital, which is treated as a
cash outflow.

Option C is incorrect
This choice does not take into account the tax saving that results from the sale of the old
equipment at a tax loss. This tax savings reduces the amount of cash that is needed for the
initial investment.

Option D is incorrect
This choice does not take into account either the cash received from the sale of the old
equipment or the tax saving that results from the sale of the old equipment at a tax loss. This
tax savings reduces the amount of cash that is needed for the initial investment

54. Question - CMA251514

Accounting rate of return method of evaluating investment has an advantage of:
Considering time value of money.
Considering project risk.
Giving a clear picture of profitability of the project.
Using only straight-line method for calculating depreciation.
Option C is correct.
Accounting rate of return method of evaluating investment gives a clear picture of the
profitability of the project because the method recognizes the concept of net earnings i.e.
earnings after tax and depreciation which is a vital factor in the appraisal of an investment
proposal.

Option B is incorrect
because this method does not consider time value of money and project risk.

Option A is incorrect
because this method does not consider time value of money and project risk.

Option D is incorrect
because this method does not restrict using straight line method of depreciation because of
which the profitability of the project can be easily changed with changes in depreciation
methods.
55. Question - PART25111342
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 return, respectively?
Adjust for inflation @ Adjust for inflationAdjust for inflation @ Do not adjust for
inflationDo not adjust for inflation @ Adjust for inflationDo not adjust for inflation @ Do not
adjust for inflation
Option A is correct
Future cash operating costs need to be adjusted for inflation, and the required rate of return
needs to be adjusted for inflation as well. If we adjust one, we must adjust the other.

Option B is incorrect
Future cash operating costs need to be adjusted for inflation, and the required rate of return
needs to be adjusted for inflation as well. If we adjust one, we must adjust the other.

Option C is incorrect
Future cash operating costs need to be adjusted for inflation, and the required rate of return
needs to be adjusted for inflation as well. If we adjust one, we must adjust the other.

Option D is incorrect
Future cash operating costs need to be adjusted for inflation, and the required rate of return
needs to be adjusted for inflation as well. If we adjust one, we must adjust the other.
56. Question - PART250017
Kampit, Inc. is contemplating a 5-year capital investment project with estimated revenues of
$80,000 per year and estimated cash operating expenses of $50,000 per year. The initial cost
of the plant and equipment for the project is $50,000, and the company expects to sell the
equipment for $5,000 at the end of the 5th year.
P&E will be fully depreciated over 4 years on a straight-line basis for tax purposes.
The project requires a working capital investment of $20,000 at its inception.
The cost of capital for Kampit is 10%. Assume a 40% marginal tax rate for the company.
The IRR for the project is
less than 10%.between 20% and 30%.between 10% and 20%.more than 30%.
Option B is correct
The IRR is the discount rate at which NPV is zero. Since the question is a multiple-choice
question with possible rates given, use the answer choices:
10%, 20%, and 30%.
First, calculate the NPV using a discount rate of 20% to determine whether the actual IRR is
higher or lower than 20%.
If the NPV at a 20% required rate of return is positive, that will mean that the IRR is higher
than 20%.
If the NPV at 20% is negative, the IRR is lower than 20%.
The initial investment is $50,000 P&E plus $20,000 working capital, or $70,000 total.
Annual before-tax operating cash flow is $30,000 ($80,000 expected revenues less $50,000
expected expenses).
After-tax operating cash flow is $30,000 × (1 − 0.40) = $18,000.
Annual depreciation for the first four years of the project will be $50,000 ÷ 4 years = $12,500
per year.
The depreciation tax shield is $12,500 × 0.40, or $5,000 per year for Years 1 through 4.
Therefore, the annual net after-tax cash flow for Years 1 through 4 is $23,000 ($18,000 +
$5,000).
The cash flow for the fifth year will be different.
1. The after-tax cash flow from operations will be the same: $18,000.
2. Because the equipment will be fully depreciated at the end of Year 4, there will be no
depreciation tax shield.
3. The cash flow will be increased by $20,000 due to the release of the working capital.
4. The cash flow will be increased by the after-tax cash flow from the disposal of the
equipment.
Since the equipment will be fully depreciated for tax purposes when it is sold, the full amount
of the equipment’s sale price is a taxable gain, so the after-tax cash flow from the disposal is
$5,000 × (1 – 0.40) = $3,000.
The cash flow in Year 5 will be $41,000: the after-tax operating cash flow of $18,000 +
$20,000 released working capital + $3,000 after-tax cash flow from the disposal of the
equipment.
The first four years of equal cash flows can be discounted as the present value of an annuity.
The Year 5 cash flow is discounted as the present value of a single amount.
The NPV at a discount rate of 20% is: Cash flow discounted at 20% for 4 years: $23,000 ×
2.5887 = $ 59,540
Final year CF discounted at 20%: $41,000 × 0.4019 = 16,478
Present value of cash flows $ 76,018 Less: initial investment (70,000) NPV $ 6,018
Since the NPV at a 20% discount rate is positive, the IRR must be above 20%.
Therefore, the correct answer is either b, between 20% and 30% or d, more than 30%.
Since the NPV at a 20% discount rate is not a large number, the IRR is probably between
20% and 30%,
but the NPV should be calculated using a 30% discount rate just to make sure.
The NPV at a discount rate of 30% is: Cash flow discounted at 30% for 4 years: $23,000 ×
2.1662 = $ 49,823
Final year CF discounted at 30%: $41,000 × 0.2693 = 11,041
Present value of cash flows $ 60,864 Less: initial investment (70,000)
NPV $ (9,136)
Since the NPV is negative when cash flow is discounted at 30%, the IRR must be less than
30%.
Therefore, the correct answer is b, between 20% and 30%.

Option A is incorrect
The amount consider above is incorrect

Option C is incorrect
The amount consider above is incorrect

Option D is incorrect
The amount consider above is incorrect
57. Question - PART250124
The following selected data pertain to a 4-year project being considered by Metro Industries:
• A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is
expected to have a $200,000 salvage value at the end of 4 years, qualifies as 3-year property
under the Modified Accelerated Cost Recovery System (MACRS).
• The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold
on the same January 1 for $180,000.
• The project is expected to provide added annual sales of 30,000 units at $20. Additional
cash operating costs are: variable, $12 per unit; fixed, $90,000 per year.
• A $50,000 working capital investment that is fully recoverable at the end of the fourth year
is required.
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar.
Assume that any gain or loss affects the taxes paid at the end of the year in which it occurred.
The company uses the net present value method to analyze investments and will employ the
following factors and rates.
Year 1 2 3 4
Period Present Value of $1 at 12% 0.89 0.80 0.71 0.64
Present Value of $1 Annuity at 12% 0.89 1.69 2.40 3.04
MACRS 33% 45% 15% 7%
The expected incremental sales will provide a discounted, net-of-tax contribution margin over
4 years of
$57,600.00$437,760.00$273,600.00$92,160.00
Option B is correct
Incremental revenue per year is expected to be 30,000 units × $20 per unit, or $600,000 per
year. Incremental variable expense is expected to be 30,000 units × $12 per unit, or $360,000
per year. The incremental (before tax) contribution margin is $600,000 minus $360,000 per
year, or $240,000. Income tax is 40%, so the after-tax contribution margin is $240,000 × (1 −
0.40), or $144,000 per year. Since the amount is the same for each year, the annual amounts
can be discounted as an annuity. So the discounted, net-of-tax contribution margin over 4
years, using the present value of an annuity factor of 3.04 for four years, is (144,000 × 3.04)
= $437,760.

Option A is incorrect
$57,600 results from subtracting $90,000 and $360,000 from the fourth year's incremental
revenue of $600,000. Multiplying the result ($150,000) by (1 − 0.40) provides a net-of-tax
amount of $90,000, which when discounted for four years using a factor of 0.64 yields
$57,600. However, there are two problems with this approach. First, the $90,000 in
incremental fixed costs should not be subtracted from the incremental revenue to calculate
the contribution margin, because it is a fixed cost. Second, the question asks for the
discounted, net-of-tax contribution margin over four years, not for the fourth year only.

Option C is incorrect
$273,600 results from subtracting both the incremental fixed cost and the incremental
variable cost from the incremental revenue, netting out the tax effect, and discounting the
resulting amount as an annuity for four years. However, the $90,000 in incremental fixed cost
should not be included in the calculation of a contribution margin. The contribution margin is
revenue less variable costs only. $92,160 results from subtracting the variable cost of
$360,000 from the fourth year's incremental revenue of $600,000. Multiplying the result
($240,000) by (1 − 0.40) provides a net-of-tax amount of $144,000. $144,000 discounted for
4 years using the present value of $1 factor for 12% for 4 years of 0.64 equals $92,160.
However, the present value of an annuity factor should be used to discount the equal payment
stream instead.

Option D is incorrect
As explained above
58. Question - PART251506
A limitation of using the discounted payback method to evaluate a project is that it ignores
which of the following?
Cash flows after the payback period.
Duration of funds being tied up.
A project's cost of capital.
A project's break-even point.
Option A is correct
Payback period is a capital budgeting technique which determines the length of time it takes
for the initial cash outlay for the investment to be recovered in cash. There are two methods:
simple payback period and discounted payback period, the difference between the two being
that, under the discounted payback method, time value of money is considered. However, this
method ignores overall project profitability; i.e., cash flow after the payback period is not
considered for evaluation.
Discounted payback period is computed as
Initial Investment /Discounted cash inflows = number of years

Option B is incorrect
because, discounted pay back method tells us the time period required to recover the original
investment. Therefore, it indicates for how much period of time the funds are tied up taking
into consideration the present value of expected future cash flows.

Option C is incorrect
because, discounted payback period method does not ignore the project’s cost of capital. The
expected future cash inflows are discounted by the project’s cost of the capital.

Option D is incorrect
because, discounted payback method does not ignore the break-even point; rather it tells us
the project’s actual break-even point, taking into consideration the discounted cash flows. It
tells the total time required before the original investment is reduced to zero. (i.e, original
investment is recovered).
59. Question - PART250087The internal rate of return for a project can be determinedBy
finding the discount rate that yields a net present value of zero for the project.Only if the
project cash flows are constant.By subtracting the firm's cost of capital from the project's
required rate of return.If the internal rate of return is greater than the firm's cost of capital.
Option A is correct
The internal rate of return is the discount rate which, when used to calculate the net present
value of a project, yields a net present value of zero.

Option B is incorrect
While the internal rate of return is easier to calculate when the project's cash flows are
constant each year, it is not impossible to calculate it when the project's cash flows vary.
When the project's cash flows vary, the internal rate of return can be found by trial and error.

Option C is incorrect
The IRR is not calculated by subtracting the firm's cost of capital from the project's required
rate of return. The firm's cost of capital is frequently used as the project's required rate of
return.

Option D is incorrect
The internal rate of return can be determined regardless of whether it is greater, lesser, or the
same as the firm's cost of capital.
60. Question - PART250083HighFlux Inc. is reviewing a five-year capital investment that
requires an initial cash outlay of $450,500 for equipment. Management anticipates an
additional working capital investment of $50,000 to be needed at the beginning of the project,
which will be recovered at the project’s end. The equipment will have no salvage value at the
end of the five-year period. The project’s five-year expected cash inflows, including the after-
tax operating cash inflows and the inflow from the depreciation tax shield, are: Year 1
$150,025 Year 2 $138,775 Year 3 $144,025 Year 4 $152,275 Year 5 $162,025 The
company’s anticipated tax rate is 25%, and the company’s required rate of return for similar
projects is 10%. What is the NPV of the investment?-$22,083$94,336$63,286$8,967
Option B is Correct
To determine the NPV of the investment, discount the future expected cash flows at 10% and
calculate the cumulative discounted cash flow; or sum the annual expected discounted cash
inflows and subtract the initial investment and initial working capital.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial investment (450,500) Working capital ( 50,000) 50,000
Year 0 Year 1 Year 2 Year 3 Year 4 Year
5
Expected cash inflows 150,025 138,775 144,025 152,275 162,025
Net cash flow (500,500) 150,025 138,775 144,025 152,275 212,025
PV of $1 factor @ 10% 0.000 0.909 0.826 0.751 0.683 0.621
PV of cash flow (500,500) 136,373 114,628 108,163 104,004 131,668
Cumulative net cash flow (500,500) (364,127) (249,499) (141,336) (37,332) 94,336
The net present value is $(500,500) + $136,373 + $114,628 + $108,163 + $104,004 +
$131,668 = $94,336.

Option A is incorrect
The amount consider above for calculation is incorrect

Option C is incorrect
The amount consider above for calculation is incorrect

Option D is incorrect
The amount consider above for calculation is incorrect
61. Question - PART25111344
For each of the next six years Atlantic Motors anticipates net income of $10,000, straight-line
tax depreciation of $20,000, a 40% tax rate, a discount rate of 10%, and cash sales of
$100,000. The depreciable assets are all being acquired at the beginning of year 1 and will
have a salvage value of zero at the end of six years.

The present value of the total depreciation tax savings would be

$8,000
$27, 072
$34,840
$87,100
Option C is correct
The depreciation is $20,000 and the tax rate is 0.40. Therefore, the annual tax savings due to
the depreciation will be $20,000 × 0.40, or $8,000. The tax savings due to the depreciation
expense is called the depreciation tax shield. The present value of the total depreciation tax
shield would be $8,000 discounted using the PV of an annuity factor for 10% for 6 years.
$8,000 × 4.355 = $34,840.

Option A is incorrect
This is the annual tax savings due to the depreciation. The tax savings due to the depreciation
expense is called the depreciation tax shield. The question asks for the present value of the
depreciation tax shield.

Option B is incorrect
This is $8,000 (the annual depreciation tax shield) × 6 years × 0.564 (the present value of $1
factor for 6 years at 10%). The annual depreciation tax shield is an annuity, and this is not the
correct way to calculate the present value of an annuity. The present value of an annuity
factor should be used.

Option D is incorrect
This is the present value of the depreciation expense. The question asks for the present value
of the tax savings due to the depreciation expense. The tax savings due to the depreciation
expense is called the depreciation tax shield.
62. Question - PART251507
The discount rate (hurdle rate of return) must be determined in advance for the
Payback period method.
Time adjusted rate of return method.
Net present value method.
Internal rate of return method.
Option C is correct.
It is the net present value method that requires determination of a discount rate in advance,
because this discount rate is used to calculate the present value of cash flows. Payback period
does not use any discount rate. Under both the time-adjusted rate of return method and the
internal rate of return method, calculations are not based on the discount rate, a rate of return
is calculated and compared to the discount rate.

Options A is incorrect
based on the above explanation.

Options B is incorrect
based on the above explanation.

Options D is incorrect
based on the above explanation.
63. Question - PART250104A capital budgeting analyst makes the following two
statements. I. Internal rate of return (IRR) is the discount rate that causes the net present value
to be $0. II. When we use the IRR method for evaluating projects, we are assuming that all
cash flows are reinvested at IRR%. Which of the analyst’s statements is (are) true?I only.II
only.Both I and II.Neither I nor II.
Option C is correct
Both of these are true statements in regards to IRR.

Option A is incorrect
Both of these are true statements in regards to IRR.
Option B is incorrect
Both of these are true statements in regards to IRR.

Option D is incorrect
Both of these are true statements in regards to IRR.
64. Question - PART25111328
Colvern Corporation is considering the acquisition of a new computer-aided machine tool to
replace an existing, outdated model. Relevant information includes the following
Projected annual cash savings $28,400
Annual depreciation - new machine 16,000
Annual depreciation - old machine 1,600
Income tax rate 40%
Annual after-tax cash flows for the project would amount to
$5,600
$7,440
$17,040
$22,800
Option D is correct
The annual after-tax expected cash flows for the project are:
Annual cash savings after tax: $28,400 × 0.60 = $17,040
Increase in annual depreciation tax shield: $14,400 increase in annual depreciation × 0.40 =
5,760
Total annual after-tax cash flows $22,800

Option A is incorrect
This answer results from two errors: 1) The annual before-tax cash savings is multiplied by
the tax rate to find the after-tax savings. To calculate the after-tax cash savings, the before-tax
cash savings should be multiplied by (1 − the tax rate). 2) The depreciation tax shield (the
amount of change in the depreciation multiplied by the tax rate) is subtracted from the after-
tax cash savings to calculate the after-tax cash flow for the project. The depreciation tax
shield is a cash inflow, so it should be added to the after-tax cash savings to find the after-tax
cash flow.

Option B is incorrect
This is the $16,000 annual depreciation on the new equipment subtracted from the $28,400
annual cash savings, and then the difference is multiplied by 1 − the tax rate (0.60).
Depreciation does not reduce cash flow, because it is a non-cash transaction. Because of the
depreciation tax shield, depreciation causes an increase in cash flow. Furthermore, the
relevant depreciation amount is the amount by which depreciation will change as a result of
the new equipment.

Option C is incorrect
This is the increase in the after-tax cash flow resulting from the cost savings. This is not the
only after-tax cash flow for the project. The increase in the annual depreciation will cause an
increase in the depreciation tax shield.
65. Question - PART250038The technique that measures the number of years required for
the after-tax cash flows to recover the initial investment in a project is called theAccounting
rate of return method.Net present value method.Payback method.Internal Rate of Return.
Option C is correct
The Payback Method is used to determine the number of periods that must pass before the net
after-tax cash inflows from the investment will equal (or "pay back") the initial investment
cost. If the expected cash inflows are constant over the life of the project, the payback period
is the net initial investment divided by the periodic expected cash flow. If the expected cash
inflows are not constant over the life of the project, the cash inflows are added to determine
on a cumulative basis when the inflows will equal the outflows. The payback method ignores
all cash flows beyond the payback period, does not include the time value of money, and does
not include any factor for the cost of capital. However, it is widely used because it is simple
and it can be useful when a project is judged to be very risky with uncertain cash flows in the
later years. In this case, it may be used to determine how quickly the investment will be
recouped so that if necessary, the company can abandon the project without too great a loss.

Option A is incorrect
The accounting rate of return does not measure the number of years required for the after-tax
cash flows to recover the initial investment in a project. The accounting rate of return is a
ratio of the increase in expected annual average after tax accounting net income to the net
initial investment.

Option B is incorrect
The net present value method does not measure the number of years required for the after-tax
cash flows to recover the initial investment in a project. The net present value method is a
discounted cash flow method which calculates the value of a project by discounting the after-
tax expected cash flows for the project over its life to time period zero using the company's
minimum required rate of return. The present value of the future expected cash inflows minus
the net initial investment equals the net present value.

Option D is incorrect
The Internal Rate of Return calculates the discount rate at which the present value of the
expected cash inflows from a project is equal to the present value of the expected cash
outflows from the project. It is not a technique that measures the number of years required for
the after-tax cash flows to recover the initial investment in a project.
66. Question - PART250088A weakness of the internal rate of return (IRR) approach for
determining the acceptability of investments is that itimplicitly assumes that the firm is able
to reinvest project cash flows at the project's internal rate of return.implicitly assumes that the
firm is able to reinvest project cash flows at the firm's cost of capital.does not consider the
time value of money.is not a straightforward decision criterion.
Option A is correct
The Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV)
of a project is zero. As such, it assumes that the cash flows from the project will be reinvested
at the same rate. This is a disadvantage, because the cash flows from the project may not be
able to be reinvested at the Internal Rate of Return.

Option D is incorrect
If the required rate of return used in an NPV calculation is the firm's cost of capital, the
calculation of the NPV assumes that the firm is able to reinvest the project's cash flows at the
same rate. However, the IRR is not the firm's cost of capital. The IRR may be higher or lower
than the firm's required rate of return.

Option C is incorrect
The Internal Rate of Return does consider the time value of money.
Option D is incorrect
The Internal Rate of Return is a straightforward decision criterion. If a project's IRR is
greater than the firm's required rate of return, the project is acceptable.
67. Question - PART251459
A project has an initial outlay of $1,000. The projected cash inflows are:
Year 1 $200
Year 2 200
Year 3 400
Year 4 400
What is the investment's payback period?
4.0 years.
3.5 years.
3.4 years.
3.0 years.
Option B is correct answer
Payback period is the length of time it takes for the initial cash outlay for the investment to be
recovered in cash. If the cash flows are even, then the payback period is equal to the initial
investment divided by the annual net cash inflow. If the cashflows are uneven, start with the
initial investment, and then subtract each year's cash inflow until the entire investment is
recovered. As in this case, the cash inflows are uneven, payback period for $1,000 initial
investment is calculated as follows:
Yea Cash Inflows Payback in Dollars
r
Initial Investment $1,000
1 $200 (200)
2 200 (200)
3 400 (400)
3.5 200 (200)
Total $0
Cumulative cash inflow at the end of year 3 is $800. Assuming that the remaining $200 is
collected in the middle of the 4th year (200/1000 = 0.5), the total payback period is 3.5
years.

Option A is incorrect
Because of the above explanation

Option C is incorrect
Because of the above explanation

Option D is incorrect
Because of the above explanation
68. Question - PART251495
Lin Co. is buying machinery it expects will increase average annual operating income by
$40,000. The initial increase in the required investment is $60,000, and the average increase
in required investment is $30,000. To compute the accrual accounting rate of return, what
amount should be used as the numerator in the ratio?
$20,000
$30,000
$40,000
$60,000
Option C is correct.
Accounting Rate of Return (ARR) is a method that computes an approximate rate of return
while ignoring the time value of money and actual cash flows. It is calculated by taking
accounting income divided by the investment, where accounting income = cash flow -
depreciation.
Since depreciation is not given, increase in average annual operating income of $40,000 will
be considered as accounting income and taken in the numerator of the ratio.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.
69. Question - PART25111350
Janet Jones, an analyst with All Purpose Heater Company, plans to use a Monte Carlo
experiment to estimate the simulated daily demand for All Purpose’s heaters. The probability
distribution for the daily demand for heaters is as follows.
Daily demand for heaters Probability Random number as intervals
0 .10 00-09
1 .15 10-24
2 .20 25-44
3 .20 45-64
4 .25
5 .10
Jones is trying to assign random number intervals for each of the demand levels. She has
done so for the first four levels. If a total of 100 two-digit numbers are used in a simulation,
what random number intervals should Jones assign to the 4 and 5 heaters demand levels,
respectively
65-69; 70-88
65-84; 85-99
64-84; 85-99
65-89; 90-99
Demand Pro Cumulative probability Nos
b
0 0.1 10 0-9
1 0.15 10 + 15 = 25 10-24
2 0.2 25 + 20 = 45 25-44
3 0.2 45 + 20 = 65 45-64
4 0.25 65 + 25 = 90 65-89
5 0.1 90 + 10 = 100 90-99
Option D is Correct
Start with the next available #; 25 multiples for demand of 4
and 10 multiples for demand of 5.

Option A is incorrect
The amount consider for calculation is incorrect

Option B is incorrect
The amount consider for calculation is incorrect

Option C is incorrect
The amount consider for calculation is incorrect

70. Question - PART251499

Pole co. is investing in a machine with a 3-year life. The machine is expected to reduce
annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3.
Present values of an annuity of $1 at 14% are:
Year 1 Year 2 Year 3
Present Values of an annuity of $1 @ 14% 0.88 1.65 2.32
Using a 14% cost of capital, what is the present value of these future savings?
$59,600
$60,800
$62,900
$69,500
Option C is correct
The present value of an annuity is used to determine the present value when there are a series
of same amount of cash flow at the end of each year for a specific number of years at a
specific interest rate. Present value of $1 for a specific year is used if there are different cash
flows each year. For the first two years the cash flow (or savings in cost) is the same amount
of $30,000 at 14%, the present value of annuity of $1 for two years at 1.65 is used to
calculate the present value. Thus, the present value for the first two years = $30,000 x 1.65 =
$49,500. The third year is a different amount of $20,000 and thus the present value of $1 at
14% for year 3 has to be used. Present value of $1 for year 3 = PV of annuity for year 3 - PV
of annuity for year 2 = 2.32 - 1.65 = 0.67. Present value of cash flow for year 3 = $20,000 x
0.67 = $13,400. Total present value of cash flows for the three years = $49,500 + $13,400 =
$62,900.
An alternative method that could be used is to add the present value of annuity of $20,000 of
three years = $20,000 x 2.32 = $46,400 and present value of annuity of $10,000 for two years
= $10,000 x 1.65 = $16,500 = $62,900.

Option A is incorrect
due to inaccurate calculations.

Option B is incorrect
due to inaccurate calculations.

Option D is incorrect
due to inaccurate calculations.

71. Question - PART250042

During a presentation on non-discounted cash flow models for capital budgeting decisions, an
analyst made the following two statements concerning the payback method.
Statement 1: It is the best decision criterion for accepting/rejecting the project.
Statement 2: It may encourage excessive investments in short-term projects at the expense of
investments in long-term projects.
The analyst is correct regarding
statement 1, only.statement 2, only.neither statement 1 nor statement 2.both statement 1 and
statement 2.
Option B is Correct
Statement 2 is true. The payback method may encourage excessive investments in short-term
projects at the expense of investments in long-term projects because it ignores all cash flows
beyond the payback period. Therefore, a project that has large expected cash flows in the
latter years of its life could be rejected in favor of a less profitable project that has a larger
portion of its cash flows in its early years.
Statement 1 is not true. The payback method is not the best decision criterion for
accepting/rejecting the project because (1) the method does not incorporate the time value of
money, so interest on the investment lost while the company waits to receive money from the
investment is not considered at all; and (2) it ignores the cost of capital, so the company could
accept a project for which it will pay more for its capital than the project can return.

Option A is incorrect
as statement 1 is incorrect

Option C is incorrect
as Statement 2 is correct while statement 1 is incorrect

Option D is incorrect
as Statement 2 is correct while statement 1 is incorrect

72. Question - PART251461

Which of the following limitations is common to the calculations of payback period,
discounted cash flow, internal rate of return, and net present value?
They do not consider the time value of money.
They require multiple trial and error calculations.
They require knowledge of a company's cost of capital.
They rely on the forecasting of future data.
Option D is correct
The payback period, discounted cash flow, internal rate of return and net present value
method of capital budgeting use future value of cash flows to evaluate an investment today,
hence all these rely on forecasting of future data.

Option A is incorrect
because discounted cash flow, internal rate of return, net present value methods consider time
value of money.

Option B is incorrect
because only internal rate of return requires multiple trial and error calculations.

Option C is incorrect
because only the net present value and the internal rate of return methods require the
knowledge of the company's cost of capital.
73. Question - CMA251541
A manufacturing company is experiencing production stoppages because of power outages. It
is estimated that each hour of power outage costs a company loss in profits of $40. There is
compulsory power outage each day for 1 hour. The company is considering hiring a power
generator at a rent of $500 per month. If the company goes with renting the generator, what
will be the additional cost or profits per month for the company, assuming a month of 30
days?
Additional profit of $1,200.
Additional cost of $460.
Additional cost of $500.
Additional profit of $700.
Option D correct.
The company is losing in profits $1,200 (i.e. $40 x 30 days) because of power outage.
Alternatively, hiring the generator would bring $1,200 profits back with an additional cost of
$500, which would come out to be $700 (i.e. $1,200 - $500) additional profits.

Option A is incorrect
because additional profit of $1,200 would be the result when additional cost is not deducted
from the recovery of lost profits.

Option B is incorrect
because this would be the result when loss in profit of only one power outage is considered.
Then, the calculation would be:
Additional cost (rent of generator) = $500.
Recovery of lost profit = $40.
Thus, additions cost would come as $460.

Option C is incorrect
because this would be the result when only additional cost, i.e. rent of generator is considered
and the recovery of lost profits is not considered.

74. Question - PART25111326

Olson Industries needs to add a small plant to accommodate a special contract to supply
building materials over a five-year period. The required initial cash outlays at Time 0 are as
follows.

Land $ 500,000
New building 2,000,000
Equipment 3,000,000

Olson uses straight-line depreciation for tax purposes and will depreciate the building over 10
years and the equipment over 5 years. Olson’s effective tax rate is 40%.

Revenues from the special contract are estimated at $1.2 million annually, and cash expenses
are estimated at $300,000 annually. At the end of the fifth year, the assumed sales values of
the land and building are $800,000 and $500,000, respectively. It is further assumed the
equipment will be removed at a cost of $50,000 and sold for $300,000.
As Olson utilizes the net present value (NPV) method to analyze investments, the net cash
flow for period 3 would be

$60,000.
$860,000.
$880,000.
$940,000.
Option B is Correct
The third year's cash flow would be: Cash flow from operations after tax: ($1,200,000 −
$300,000) × 0.6 = $540,000 Depreciation tax shield: Depreciation on building = $2,000,000
÷ 10 = $200,000 per year for 10 years1 Depreciation on equipment = $3,000,000 ÷ 5 =
$600,000 per year for 5 years1 Total depreciation in Year 3 would be $200,000 + $600,000,
or $800,0002 The depreciation tax shield in Year 3 is $800,000 × 0.4, or $320,000 Total cash
flow for Year 3 is $540,000 cash flow from operations after tax + $320,000 depreciation tax
shield, or $860,000. 1For tax purposes, the depreciable base is 100% of an asset's cost,
regardless of which depreciation method is used and regardless of whether salvage value is
expected or not. 2Depreciation on land is not included because land is not depreciated.

Option A is incorrect
This answer results from multiplying the pre-tax net cash flow by the tax rate, 0.40, to
calculate the after-tax net cash flow. The pre-tax cash flow should be multiplied by 1 − the
tax rate to calculate after-tax cash flow.

Option C is incorrect
This answer results from depreciating the land along with the building. However, land is
never depreciated, either for tax purposes or book purposes. Option D is incorrect This
answer results from depreciating the building over a 5 year period instead of over 10 years.

Option D is incorrect
As explained above
75. Question - PART250091For 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
thehurdle rate.payback rate.internal rate of return.cost of capital.
Option C is correct
The internal rate of return of a project is the rate of return at which its NPV is zero. When the
NPV is zero, it means the present value of the cash inflows equals the present value of the
cash outflows. Therefore, the interest rate at which the present value of the cash inflows
equals the present value of the cash outflows is the internal rate of return.

Option A is incorrect
The hurdle rate is the company's required rate of return. The required rate of return may be
the company's cost of capital, or it may be the company's cost of capital adjusted for various
factors. It is not impossible for the hurdle rate to be the same as the interest rate at which the
present value of the cash inflows equals the present value of the cash outflows, but there is no
reason why it must be the same.

Option B is incorrect
There is no such thing as the payback rate.
Option D is incorrect
The cost of capital is what the company pays for the various sources of capital it accesses. It
is not impossible for the cost of capital to be the same as the interest rate at which the present
value of the cash inflows equals the present value of the cash outflows, but there is no reason
why it must be the same.
76. Question - PART250135The internal rate of return on an investmentDisregards
discounted cash flows.May produce different rankings from the net present value method on
mutually exclusive projects.Usually coincides with the company's hurdle rate.Would tend to
be reduced if a company used an accelerated method of depreciation for tax purposes rather
than the straight-line method.
Option B is correct
If two investments are mutually exclusive, then accepting one means we cannot accept the
other. This can occur if, for example, the cash flows of one will be adversely impacted by the
acceptance of the other; or if the use of land for one project precludes its use for another
project. When mutually exclusive investments are being considered, there may be a conflict
between the NPV results and the IRR results in determining which of the two mutually
exclusive projects should be accepted. One may have a higher IRR, while the other has a
higher NPV.

Option A is incorrect
The internal rate of return is the discount rate at which the NPV of a project is equal to zero.
Thus, it does not disregard discounted cash flows.

Option C is incorrect
The internal rate of return is compared with the company's hurdle rate (i.e., its required rate
of return) in determining whether a project is worthwhile. However, it would be strictly
coincidental if the internal rate of return on a given project were to coincide exactly with the
company's hurdle rate.

Option D is incorrect
The internal rate of return on a project would tend to be increased if a company used an
accelerated method of depreciation for tax purposes rather than the straight-line method,
because an accelerated method of depreciation would result in a higher depreciation tax
shield in the early years of the investment. This in turn would lead to a higher present value
for the future expected cash flows, which would result in an increased internal rate of return.
77. Question - PART250066Crown Corporation has agreed to sell some used computer
equipment to Bob Parsons, one of the company's employees, for $5,000. Crown and Parsons
have been discussing alternative financing arrangements for the sale. Crown has offered to
accept a $1,000 down payment and to set up a note receivable for Bob Parsons that calls for a
$1,000 payment at the end of this year and the next three years. Bob Parsons has agreed to the
immediate down payment of $1,000 but would like the note for $4,000 to be payable in full at
the end of the fourth year. Because of the increased risk associated with the terms of this
note, Crown Corporation would apply an 8% discount rate. The present value of this note
would be$3,940$2,577$2,940$3,312
Option C is correct
Using the Present Value of $1 table, the present value of a single $4,000 payment in 4 years
is $4,000 × 0.735, which equals $2,940.

Option A is incorrect
An answer of $3,940 results from discounting the principal repayment of $4,000 at 8% for
four years and adding the down payment of $1,000 without discounting it. However, the
question asks for the present value of the note, not the present value of the whole transaction.

Option B is incorrect
An answer of $2,577 results from discounting a series of payments of $1,000 at 8% for three
years. However, the term of the note is four years, and the note is payable at the end of the
term, not in annual payments.

Option D is incorrect
An answer of $3,312 results from discounting a series of payments of $1,000 at 8% for four
years. However, the note is payable at the end of the term, not in annual payments.
78. Question - PART250054Kell Inc. is analyzing an investment for a new product expected
to have annual sales of 100,000 units for the next 5 years and then be discontinued. New
equipment will be purchased for $1,200,000 and cost $300,000 to install. The equipment will
be depreciated on a straight-line basis over 5 years for financial reporting purposes and 3
years for tax purposes. At the end of the fifth year, it will cost $100,000 to remove the
equipment, which can be sold for $300,000. Additional working capital of $400,000 will be
required immediately and needed for the life of the product. The product will sell for $80,
with direct labor and material costs of $65 per unit. Annual indirect costs will increase by
$500,000. Kell\'s effective tax rate is 40%. In a capital budgeting analysis, what is the
expected cash flow at time = 3 (3rd year of operation) that Kell should use to compute the net
present value?$800,000.00$300,000.00$720,000.00$760,000.00
Option A is correct
The cash flows in the third year will be: The contribution margin is $15/unit. For 100,000
units sold, the contribution margin will be $1,500,000 annually. The increase in annual
indirect costs will be $500,000. Therefore, annual operating cash flow before tax will
increase by $1,500,000 - $500,000, or $1,000,000. Annual operating cash flow after tax will
increase by $1,000,000 x 0.60, or $600,000. Tax depreciation will be $500,000 each year for
the first 3 years ($1,500,000 ÷ 3); so the Depreciation Tax Shield for Year 3 will be 40% of
the annual tax depreciation, or $200,000. The increase in expected net cash flow for Year 3
will be $600,000 + $200,000 = $800,000.

Option B is incorrect
This is the incremental indirect costs after tax. The net cash flow for the third year consists of
that plus other components.

Option C is incorrect
This answer results from depreciating the equipment over 5 years. The question says "The
equipment will be depreciated on a straight-line basis over 5 years for financial reporting
purposes and 3 years for tax purposes." In capital budgeting, we always use the depreciation
method that is used for tax purposes to calculate the depreciation tax shield.

Option D is incorrect
This answer results from subtracting the salvage value ($300,000) from the initial cost
($1,500,000) and dividing the net amount ($1,200,000) by 3 to calculate the amount of annual
straight-line depreciation and the depreciation tax shield. For capital budgeting purposes,
100% of the asset's initial cost must be depreciated. We do that because we are calculating
the amount of tax savings that results from the annual depreciation. Tax regulations in the
U.S. require that 100% of an asset's cost be depreciated on the tax return (this is different
from U.S. GAAP requirements to use the net of the cost less the salvage value). Since we are
calculating the tax savings, we must use the depreciation method required on the tax return.
79. Question - PART2110611
On December 9,20X0, U.S. Company X acquired inventory from a British supplier
for £100,000, with payment due in pounds on January 8, 20X1. Spot exchange rates for the
pound were: December 9,20X0. $1.50; December 31, 20X0, $1.55; and January 8,20X1,
$1.57 for Company X with a December 31,20X0 closing, these transactions resulted in a
foreign currency transaction
Loss of $0 in 20X0 and loss of $7,000 in 20X1
Loss of $5,000 in 20X0 and loss of $2,000 in 20X1
Gain of $5,000 in 20X0 and gain of $2,000 in 20X1
Gain of $50 in 20X0 and gain of $7,000 in 20X1
Option B is Correct
The loss that should be recognized in 20X0 is equal to the increase in the number of dollars
that will be required to settle the liability between the date of purchase and the end of the
year.
At the date of purchase Dec 9,20X0, Company X would have had to spend $150,000 to buy
the £100,000, needed to settle the amount. At December 31, 20X0, they would have needed
to spend $155,000 to buy the same number of pounds. This increase of $5,000 is the amount
of loss that needs to be recognized in 20X0.
The loss that needs to be purchaser recognized in 20X1 is the amount by which the number of
dollars needed to settle the liability has increased between December 31, 20X0 and the date
on which it is settled, January 8,20X1.
We know that it would have taken $155,000 to settle the invoice on December 31 20X0, and
it took $157,000 to settle the amount on January 8, 20X1. This $2,000 increase is recognized
as a loss in 20X1

Option A is incorrect
Loss of $0 in 20X0 and loss of $7,000 in 20X1
Dec 9 20X0 (1 Pound = $1.50) - Dec 31 20X0 (1 Pound = $1.55) and Dec 31 20X0 (1 Pound
= $1.55) - Jan 8 20X1(1 Pound = $1.57) = Loss of $5,000 in 20X0 and loss of $2,000 in
20X1

Option C is incorrect
Gain of $5,000 in 20X0 and gain of $2,000 in 20X1
Dec 9 20X0 (1 Pound = $1.50) - Dec 31 20X0 (1 Pound = $1.55) and Dec 31 20X0 (1 Pound
= $1.55) - Jan 8 20X1(1 Pound = $1.57) = Loss of $5,000 in 20X0 and loss of $2,000 in
20X1

Option D is incorrect
Gain of $50 in 20X0 and gain of $7,000 in 20X1
Dec 9 20X0 (1 Pound = $1.50) - Dec 31 20X0 (1 Pound = $1.55) and Dec 31 20X0 (1 Pound
= $1.55) - Jan 8 20X1(1 Pound = $1.57) = Loss of $5,000 in 20X0 and loss of $2,000 in
20X1
80. Question - PART2110709
A proposed investment is not expected to have any salvage value at the end of its 5-year life.
Because of realistic depreciation practices, the net carrying amount and the salvage value are
equal at the end of each year. For present value purpose, cash flows are assumed to occur at
the end of each year. The company uses a 12% after-tax target rate of return.
Year Purchase Cost and Carrying Amount Annual Net After-Tax Cash Flows
0 $500,000 $0
1 336,000 240,000
2 200,000 216,000
3 100,000 192,000
4 36,000 168,000
5 0 144,000
Discount Factors for a 12% Rate of Return
Year Present Value of $1 at the End of Each Period Present Value of $1 a
1 .89 .89
2 .80 1.69
3 .71 2.40
4 .64 3.04
5 .57 3.61
6 .51 4.12

The profitability index is

.425
1.425
.860
.608
Option B is correct
Profitability Index= PV value of future cash flows/Initial investment.
Total PV CI = 712500 | Investment = 500,000 | PI = 712500/500,000 = 1.425

Option A is incorrect
This option is a result of incorrect formula application.

Option C is incorrect
This option is a result of incorrect formula application.

Option D is incorrect
This option is a result of incorrect formula application.
81. Question - CMA251545
Capital budgeting has various stages. When would management assessing capital budgeting
projects apply present value techniques?
Financing stage.
Identifying stage.
Selection stage.
Search stage.
Option C is correct
Management will apply present value techniques when they would look to select which
capital project they need to undertake considering the various alternatives in front on them.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.
82. Question - CMA251542
A company wants to invest in a project on which the actual return the company expects to
earn should be more than the minimum return to be earned on the project to breakeven,
considering only cash inflows and outflows. Which of the following calculations would be
helpful for a company to pick up such an investment?
I. Net present value.
II. Payback period.
III. Internal rate of return.
IV. Accounting rate of return.
I and III only.
III and IV only.
I and IV only.
All of above.
Option A is correct.
The minimum rate of return that a company should earn to breakeven (i.e. inflows equal to
outflows) is called as internal rate of return (IRR). Also, if the company wants to earn more
than the minimum rate i.e. IRR, then the net present value (NPV) of the investment should be
more than zero. Thus, to evaluate any such project, both, IRR and NPV need to be known.

Option B is incorrect
because these include either accounting rate of return or payback period. Accounting rate of
return is neither the minimum rate of return required on a project to breakeven, nor the rate of
return which is based on cash inflows and outflows. The payback period also does not take
into account any of the rates of returns, thus making them not required for such a project
evaluation.

Option C is incorrect
because these include either accounting rate of return or payback period. Accounting rate of
return is neither the minimum rate of return required on a project to breakeven, nor the rate of
return which is based on cash inflows and outflows. The payback period also does not take
into account any of the rates of returns, thus making them not required for such a project
evaluation.

Option D is incorrect
because these include either accounting rate of return or payback period. Accounting rate of
return is neither the minimum rate of return required on a project to breakeven, nor the rate of
return which is based on cash inflows and outflows. The payback period also does not take
into account any of the rates of returns, thus making them not required for such a project
evaluation.
83. Question - PART250108
Gro-well Inc., which has a cost of capital of 12%, invested in a project with an internal rate of
return of 14%. The project is expected to have a useful life of four years and will produce net
cash inflows as follows:
Year 1 2 3 4
Net Cash Flows $10,000 20,000 40,000 40,000
The initial investment in this project was
$125,000.00$116,000.00$96,470.00$74,830.00
Option D is correct
A project’s IRR is the discount rate at which the NPV of the project is zero.
The net present value of a project is the present value of the cash inflows minus the initial
investment. In order for the net present value of the project to be zero, the initial investment
must be equal to the present value of the net cash inflows.
Therefore, the initial investment in the project is equal to the sum of the present values of the
annual future net cash inflows of the project, discounted at the 14% IRR, as follows:
Net Cash Inflow PV of $1 Factor at 14%
Present Value
Year 1 $10,000 0.877 $ 8,770
Year 2 20,000 0.769 15,380
Year 3 40,000 0.675 27,000
Year 4 40,000 0.592 23,680
PV of net cash flows $74,830 >The initial investment in the project was $74,830 because the
present value of the net cash inflows ($74,830) minus the initial investment ($74,830) equals
zero.

Option A is incorrect
The amount consider above for calculation is incorrect

Option B is incorrect
The amount consider above for calculation is incorrect

Option C is incorrect
The amount consider above for calculation is incorrect

84. Question - PART250003

The Moore Corporation is considering the acquisition of a new machine. The machine can be
purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install.
It is estimated that the machine will last 10 years, and it is expected to have an estimated
salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units
per year with a selling price of $500 and combined material and labor costs of $450 per unit.
Federal tax regulations permit machines of this type to be depreciated using the straight-line
method over 5 years with no estimated salvage value. Moore has a marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Moore Corporation should use
in a capital budgeting analysis?
$100,000$63,000$65,000$68,400
Option B is correct
By the tenth year of the project, 100% of the capitalized cost will have been depreciated
because the machine will have been depreciated over five years for tax purposes. Therefore,
there will be no depreciation tax shield. Cash flow will consist of $100,000 in operating cash
flow (2,000 units per year × $50 unit contribution margin, calculated as the selling price of
$500 per unit less the material and labor costs of $450 per unit), plus the $5,000 salvage
value of the equipment, for total gross cash flow of $105,000. Since the equipment is fully
depreciated, the $5,000 cash inflow from the sale of the equipment is fully taxable as a gain.
Moore's marginal tax rate is 40%, so the cash flow net of tax will be $105,000 × (1 − 0.40) =
$63,000.

Option A is incorrect $100,000 is the annual gross operating cash flow. However, that is
only one component of the tenth year's net cash flow.

Option C is incorrect
An answer of $65,000 results from adding the operating cash flow net of tax to the salvage
value. However, it ignores the tax on the gain on the disposition.

Option D is incorrect
An answer of $68,400 includes the depreciation tax shield based on a five-year depreciation
schedule. This should not be included. The machine is completely depreciated long before the
tenth year, since Federal tax regulations permit machines of this type to be depreciated over 5
years. Furthermore, since the cost of the machine will be 100% depreciated, the amount
received as salvage value at the end of the project will be 100% taxable as a gain. This
answer does not include the amount received for the disposal net of tax.
85. Question - PART250028
On January 1, Crane Company will acquire a new asset that costs $400,000 and is anticipated
to have a salvage value of $30,000 at the end of 4 years. The new asset • Qualifies as 3-year
property under the Modified Accelerated Cost Recovery System (MACRS). • Will replace an
old asset that currently has a tax basis of $80,000 and can be sold now for $60,000. • Will
continue to generate the same operating revenues as the old asset ($200,000 per year).
However, savings in operating costs will be experienced as follows: a total of $120,000 in
each of the first 3 years and $90,000 in the fourth year. Crane is subject to a 40% tax rate and
rounds all computations to the nearest dollar. Assume that any gain or loss affects the taxes
paid at the end of the year in which it occurred. The company uses the net present value
method to analyze projects using the following factors and rates:
Period 1 2 3 4
Present Value of $1 at 14% 0.88 0.77 0.68 0.59
Present Value of $1 at 14% annuity 0.88 1.65 2.33 2.92
MACRS 33 45% 15% 7%
%
The discounted net-of-tax amount that should be factored into Crane Company\'s analysis for
the disposal transaction is
$45,760.00$67,040.00$68,000.00$60,000.00
Option B is correct
We are told in the question, "Assume that any gain or loss affects the taxes paid at the end of
the year in which it occurred." Therefore, the tax savings that results from the $20,000 loss on
the sale of the old equipment that occurs in year 0 must be discounted for one year. The tax
savings is $8,000 ($20,000 × 0.40). Discounted for one year at 14%, it is $8,000 × 0.88, or
$7,040. Cash flow from the disposal in year 0 is $60,000, and no discounting is necessary
because the present value of year 0 cash flows is equal to the year 0 cash flows.
Thus, the discounted net-of-tax amount to factor into Crane Company's analysis for the
disposal transaction is $60,000 + $7,040,
or $67,040.

Option A is incorrect
An answer of $45,760 results from two errors: One, discounting the $60,000 cash that is
received in year 0 for one year, which is incorrect because the cash received in year 0 needs
no discounting. And two, the answer results from subtracting the present value of the tax
savings from the present value of the cash received in the disposition, which is incorrect. The
tax savings is an increase to cash, not a decrease.

Option C is incorrect
An answer of $68,000 results from using the tax savings from the loss on the disposition at its
gross, undiscounted value. We are told in the question, "Assume that any gain or loss affects
the taxes paid at the end of the year in which it occurred." Therefore, the tax savings from the
loss on the disposition should be discounted for one year. Option

Option D is incorrect
$60,000 is the cash flow from the disposition of the old asset, but that is not the only
component of the discounted net-of-tax amount that should be factored into Crane Company's
analysis for the disposal transaction. The tax savings from the loss on the disposition must
also be considered.
86. Question - PART251486
A company invests $100,000 in property. The company has a contract to sell it for $120,000
in one year. The bank has a guaranteed interest rate of 10%. What is the net present value of
the company's investment in the property?
$9,091.
$10,000.
$109,091.
$110,000.
Option A is correct.
Net Present Value is the difference between the present value of cash inflows and the present
value of cash outflows.
Present value of Sale price of the property = $109,091($120,000 / 1.1).
Net Present Value = $9,091($109,091 - $100,000).

Option B is incorrect
due to improper calculations.

Option C is incorrect
due to improper calculations.

Option D is incorrect
due to improper calculations.
87. Question - PART250070
On January 1, Crane Company will acquire a new asset that costs $400,000 and is anticipated
to have a salvage value of $30,000 at the end of 4 years. The new asset • Qualifies as 3-year
property under the Modified Accelerated Cost Recovery System (MACRS). • Will replace an
old asset that currently has a tax basis of $80,000 and can be sold now for $60,000. • Will
continue to generate the same operating revenues as the old asset ($200,000 per year).
However, savings in operating costs will be experienced as follows: a total of $120,000 in
each of the first 3 years and $90,000 in the fourth year. Crane is subject to a 40% tax rate and
rounds all computations to the nearest dollar. Assume that any gain or loss affects the taxes
paid at the end of the year in which it occurred. The company uses the net present value
method to analyze projects using the following factors and rates:
Period 1 2 3 4
Present Value of $1 at 14% 0.88 0.77 0.68 0.59
Present Value of $1 at 14% annuity 0.88 1.65 2.33 2.92
MACRS (Depreciation) 33 45% 15% 7%
%
The present value of the depreciation tax shield for the fourth year MACRS depreciation of
Crane Company's new asset is
$6,608.00$6,112.00$16,520.00$0.00
Option A is correct
Although this question involves replacing one asset with another asset, we are not given
information that would enable us to do an incremental analysis of the difference (if any)
between the depreciation on the new asset versus the depreciation on the old asset.
Furthermore, the question asks only for the present value of the depreciation tax shield on the
new asset. Thus, we will analyze this as a new asset purchase, not as a replacement of an
existing asset.
Since depreciation under MACRS is applied to the gross purchase price of the asset
($400,000) and the fourth year's depreciation will be 7% of $400,000, the fourth year's
depreciation will be $28,000.
Crane's tax rate is 40%, so the depreciation tax shield is $28,000 × 0.40, or $11,200.
Since the question asks for the present value of the depreciation tax shield for the fourth year,
we will discount it using 0.59 from the table (the PV of $1 at 14% for 4 years).
$11,200 × 0.59 = $6,608,
which is the present value of the depreciation tax shield for the fourth year of MACRS
depreciation.

Option B is incorrect
An answer of $6,112 results from using the gross asset cost less the salvage value to calculate
the depreciation. However, under MACRS, the depreciation rate is applied to the gross asset
cost, not the depreciable base.

Option C is incorrect
An answer of $16,520 results from discounting the fourth year's depreciation amount to year
0. The question asks for the present value of the fourth year's depreciation tax shield, not the
present value of the fourth year's depreciation.

Option D is incorrect
An answer of $0 results from failing to recognize that under MACRS, the "half-year
convention" is normally used. Under the half-year convention, one-half of one year's
depreciation is taken in the first year the asset is placed in service. For an asset with a three-
year life, one year's depreciation would then be taken in each of years 2 and 3; and one-half
of one year's depreciation would be taken in year 4. Thus, the present value of the
depreciation tax shield for the fourth year could not be zero because the depreciation in year 4
would not be zero.
88. Question - PART250078The Eat-Right Company has been disappointed by previous
capital budgeting decisions using the payback method. A new requirement has been
implemented that requires discounted cash flow analysis to be used to compute the net
present value of proposed purchases over $300,000. The Food Processing Department of the
Eat-Right Company is considering the acquisition of a new machine that will reduce labor
costs by a pre-tax amount of $175,000 per year. Other information regarding the possible
acquisition is as follows: • The machine will cost $450,000. Installation charges will amount
to an additional $25,000. • The machine will have a useful life of three years, with no salvage
value. Depreciation rates for tax purposes are 25%, 38%, and 37% for years one, two and
three, respectively. • Eat-Right's cost of capital, 12%, is considered the appropriate discount
rate. • The income tax rate is 40%. • Cash flows are assumed to occur at the end of the
calendar year, which coincides with Eat-Right's fiscal year-end. Which of the following best
indicates the net present value of the proposed investment, and the appropriate acquisition
decision?Approximately $73,000; recommend making the investment.Approximately
($73,000); recommend not making the investmentApproximately $55,000; recommend
making the investment.Approximately ($55,000); recommend not making the investment.
Option B is correct
The calculation of the project's net present value is as follows: Year 0 Year 1 Year 2 Year 3
Investment $(475,000) After-tax cash flow ($175,000 × (1 − 0.40) $105,000 $105,000
$105,000 Depreciation tax shield __________ ($475,000× 0.25×0.40) 47,500 ($475,000×
0.38×0.40) 72,200 ($475,000× 0.37×0.40) 70,300 Total expected after-tax cash flow
$(475,000) $152,500 $177,200 $175,300 Present value factors @ 12% 1.00 0.893 0.797
0.712 Discounted cash flow $(475,000) $136,183 $141,228 $124,814 NPV = $(475,000) +
$136,183 + $141,228 + $124,814 = $(72,775). This is approximately $(73,000). Because the
NPV is negative, the appropriate acquisition decision recommendation is to not make the
investment.

Option A is incorrect
This answer results from reversing the positive and negative numbers in the calculation of
NPV.

Option C is incorrect
This answer results from two errors: 1. Using the cost of the machine as the amount of the
investment and the depreciable base for the new machine. 2. The amount of the investment
and the depreciable base include not only the cost of the machine but also the installation
costs. Reversing the positive and negative numbers in the calculation of NPV.

Option D is incorrect
This answer results from using the cost of the machine as the amount of the investment and
the depreciable base for the new machine. The amount of the investment and the depreciable
base include not only the cost of the machine but also the installation costs.
89. Question - CMA211547
Assume you are depositing $100,000 at 5% in a bank. How many years will it take to double
the amount?
10.25
11.74
12.94
14.21
Option D is correct
The easiest way to solve the question is to make the equation and input the given answer
options in the equations:
$100,000 × (1.05)^14.21 = 2 X $100,000.

Option A is incorrect
because $100,000 × (1.05)^10.25 = $164,888.

Option B is incorrect
because $100,000 × (1.05)^11.74 = $177,321.

Option C is incorrect
because $100,000 × (1.05)^12.94 = $188,014.
90. Question - CMA251515
Which of the following does an accounting rate of return (ARR) method considers when
calculating and evaluating return on investment?
Project risk.
Present value factor.
Hurdle rate.
Tax payable.
Option D is correct
The accounting rate of return (ARR) method considers profits after depreciation and taxes
(even if payable). Thus, ARR method considers taxes payable when calculating return on
investment.

Option A is incorrect
because project risk is not considered. It ignores the period in which the profits are earned
which is not proper because longer the term of the project, greater is the risk involved.

Option B is incorrect
because present value factor which is used to adjust cash inflows and outflows for time value
of money is not used for calculating accounting rate of return.

Option C is incorrect
because hurdle rate or cost of capital is not used for calculating accounting rate of return.
91. Question - CMA251517
Internal rate of return (IRR) method of evaluating investments assumes that cash inflows
from a project:
Cannot be reinvested.
Can be reinvested at accounting rate of return percentage.
Can be reinvested at market rate of return.
Can be reinvested at internal rate of return percentage.
Option D is correct.
The internal rate of return (IRR) method of evaluating investments assumes that when
positive cash flows are generated during the course of a project (not at the end), the money
will be reinvested at the project’s rate of return.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option C is incorrect
based on the above explanation.
92. Question - PART250128An advantage of the net present value method over the internal
rate of return model in discounted cash flow analysis is that the net present value methodCan
be used when there is no constant rate of return required for each year of the
project.Computes a desired rate of return for capital projects.Uses a discount rate that equates
the discounted cash inflows with the outflows.Uses discounted cash flows whereas the
internal rate of return model does not.
Option A is correct
Since each year's net cash flow is calculated individually and may be discounted individually
using net present value analysis, the net present value method can incorporate varying rates
of returns during the various years of the project's life. In contrast, the internal rate of return
method is used to determine the single discount rate at which the net present value of a
project is zero. Thus, the internal rate of return model cannot be used when there is no
constant rate of return required for each year of a project.

Option B is incorrect
The net present value method does not compute a desired rate of return for capital projects.
The desired rate of return must be determined by management and then is used to determine
the present value of the cash flows, both positive and negative.

Option C is incorrect
The internal rate of return is the discount rate that equates the discounted cash inflows with
the outflows for a project. However, the net present value method does not use the project's
internal rate of return as the discount rate when determining the present value of the cash
inflows and outflows.

Option D is incorrect
Both the net present value method and the internal rate of return method use discounted cash
flows.
93. Question - PART250072Future, Inc. is in the enviable situation of having unlimited
capital funds. The best decision rule, in an economic sense, for it to follow would be to invest
in all projects in which theInternal rate of return is greater than zero.Net present value is
greater than zero.Internal rate of return is less than the company's required rate of return.The
breakeven time is greater than management's desired breakeven time.
Option B is correct
If a company has unlimited capital funds, it should invest in all projects in which the net
present value is greater than zero, assuming none of the projects are mutually exclusive.

Option A is incorrect
If a project's internal rate of return is greater than zero but lower than the company's required
rate of return, the project should not be undertaken.

Option C is incorrect
If a project's internal rate of return is lower than the company's required rate of return, the
project should not be undertaken.

Option D is incorrect
Breakeven time is another name for the discounted payback period. The discounted payback
period is based on the same concept as the payback method, but before calculating the
payback period, the expected cash flows are discounted to their present values using the
company's hurdle rate. If the breakeven time is greater than management's desired breakeven
time, the project is not acceptable and should not be undertaken.
94. Question - PART251455
The discount rate is determined in advance for which of the following capital budgeting
techniques?
Payback.
Accounting rate of return.
Net present value.
Internal rate of return.
Option C is correct
Net present value is a capital budgeting technique that determines the present value of cash
flows using a discount rate determined in advance.

Option A is incorrect
because Payback period in capital budgeting refers to the length of time required to recover
the cost of investment. It does not take into account the time value of money.

Option B is incorrect
because accounting rate of return is a financial ratio used in capital budgeting, it ignores the
time value of money and does not consider actual cash flows.

Option D is incorrect
because the internal rate of return is an annualized effective compounded rate of return that
makes the net present value of all cash flows from a particular investment equal to zero.
95. Question - CMA251511
Which of the following methods of capital budgeting does not consider the cash flows over
the entire life of the project?
Net present value.
Internal rate of return.
Accounting rate of return.
Payback method.
Option D is correct.
Payback method calculates the period by when the original investment in the project will be
recovered. It does not consider cash flows for the entire life of the project, i.e. after the
payback period.

Option A is incorrect
because net present value method calculates the excess of discounted cash inflows over
discounted cash outflows through the entire life of the project.

Option B is incorrect
because internal rate of return calculates the rate of return at which the present value of cash
inflows equals present value of cash outflows. Cash inflows and outflows are considered for
the entire life of the project.

Option C is incorrect
because accounting rate of return calculates the rate of return of a project on the basis of
accounting income, where accounting income is considered for the entire life of the project.
96. Question - PART251458
In considering the payback period for three projects, Fly Corp. gathered the following data
about cash flows:
Year 1 Year 2 Year 3 Year 4 Year 5
Project A $(10,000 $3,000 $3,00 $3,000 $3,000
) 0
Project B (25,000) 15,000 15,00 (10,000) 15,000
0
Project C (10,000) 5,000 5,000
Which of the projects will achieve payback within three years?
Projects A, B and C.
Projects B and C.
Project B only.
Projects A and C.
Option B is correct
Payback period = Initial investment / After tax net cash flows
Payback period for project A = $10,000/ $3,000 = 3.33 years.
Payback period for project B = $25,000/ $15,000 = 1.67 years. (Project B will cost $25,000
and will recover $ 15,000 in each of the first 2 periods and as a result, will be recovered in 1
2/3 years.)
Payback period for project C = 10,000/ $5,000 = 2 years.

Option A is incorrect
as per the above explanation.

Option C is incorrect
as per the above explanation.

Option D is incorrect
as per the above explanation.
97. Question - PART250106Tendulkar Inc. has a project that requires a $40,000,000 initial
investment and is expected to generate annual after-tax cash flows of $6,000,000 for 12
years. Tendulkar’s weighted average cost of capital is 14%. This project’s net present value
(NPV) and the approximate internal rate of return (IRR) areNPV of $(6,040,000) and an IRR
of 10%.NPV of $(6,040,000) and an IRR of 12%.NPV of $(232,000) and an IRR of
10%.NPV of $(232,000) and an IRR of 12%.
Option A is correct
The NPV of the project is the annual cash flow of the project multiplied by the Present Value
of an Annuity factor for 14% for 12 years minus the initial investment. $6,000,000 × 5.660 $
33,960,000 Less: Initial investment 40,000,000 NPV $ (6,040,000) The IRR of the project is
the discount rate that produces an NPV of zero. The equation is 6,000,000X = 40,000,000
Where X = the Present Value of an Annuity factor for 12 years that equates the left and right
sides of the equation. X = 40,000,000 ÷ $6,000,000 X = 6.667 The factor on the 12-year line
of a Present Value of an Annuity table closest to 6.667 is 6.814, which appears under the 10%
heading in the table. Thus the IRR is approximately 10%.

Option B is Incorrect
The amount calculated above is incorrect
Option C is Incorrect
The amount calculated above is incorrect

Option D is Incorrect
The amount calculated above is incorrect
98. Question - PART250020QLP Corporation is planning to build a new plant but wishes to
complete a capital budgeting analysis before deciding to proceed with construction. The
following cost data has been collected. The land on which the plant will be built was
purchased eight years ago for $835,000, but a recent appraisal indicates that the current value
of the land is $2.2 million. The plant will cost $8.4 million to construct. Last year, QLP paid
a consulting company $800,000 for an environmental impact study on the new plant. What
total cost figure should QLP Corporation use in a capital budgeting analysis of the new plant?
$9,235,000.00$10,035,000.00$10,600,000.00$11,400,000.00
Option C is Correct
To calculate the cost of the new plant, the current value of the land should be used because
the alternative to building on the land is selling it, and by building on the land the company
gives up receiving the current value for it. This is $2.2 million. The $8.4 million of
construction costs should also be included. The $800,000 paid for the environmental impact
study is a sunk cost that is not part of the cost of the plant and would not be included in the
capital budgeting process as part of the cost of the plant.

Option A is incorrect
This answer includes the land at its cost, when it should be included at current value because
the alternative to building on the land is selling it, and by building on the land the company
gives up receiving the current value for it. Option

Option B is incorrect
This answer incorrectly includes the cost of the environmental impact study, which is not part
of the cost of the new plant. It is a sunk cost and cannot be recovered, no matter what
decision is made. This answer also includes the land at its cost, when it should be included at
its current value because the alternative to building on the land is selling it, and by building
on the land the company gives up receiving the current value for it.

Option D is incorrect
This answer incorrectly includes the cost of the environmental impact study, which is not part
of the cost of the new plant. It is a sunk cost and cannot be recovered, no matter what
decision is made.
99. Question - PART250139In evaluating independent capital investment projects, the best
reason for a firm to accept such projects is a(n)net present value greater than zero.internal rate
of return greater than the accounting rate of return.accounting rate of return greater than
zero.initial investment were greater than the present value of the expected future cash inflows
Option A is correct
When the net present value is greater than zero, that means the present value of the cash
inflows from the project is greater than the present value of the cash outflows from the
project. And that, in turn, means that the project will enhance the wealth of the shareholders
and is a project that should be accepted.

Option B is incorrect
The internal rate of return and the accounting rate of return are different measurements and
provide very different information. Evaluating one against the other is not meaningful.
Option C is incorrect
The accounting rate of return is the increase in the expected annual average after-tax
accounting net income divided by the net initial investment or the average investment. The
accounting rate of return is a percentage rate of return and zero is not a percentage rate of
return.

Option D is incorrect
If the initial investment were greater than the present value of the expected future cash
inflows, the project would have a negative net present value and would be unacceptable
100. Question - PART250116Of the following decisions, capital budgeting techniques
would least likely be used in evaluating theAcquisition of new aircraft by a cargo
company.Adoption of a new method of allocating nontraceable costs to product lines.Trade
for a star quarterback by a football team.Design and implementation of a major advertising
program.
Option B is correct
Capital budgeting is used for evaluating long-term capital investment projects. The adoption
of a new method of allocating nontraceable costs to product lines would not be evaluated
with capital budgeting techniques, because it does not involve any investment or change in
cash flows. Option

Option A is incorrect
The acquisition of new aircraft by a cargo company would very likely be evaluated using
capital budgeting techniques, because it entails a long-term investment. Option

Option C is incorrect
A star quarterback would be an investment for a football team, and the investment would not
be made if it were not expected to be a profitable investment. Therefore, capital budgeting
techniques would probably be used in evaluating the trade. Option

Option D is incorrect
A major advertising program would involve significant expenditures that would be expected
to return a profit. As such, it would be appropriate to evaluate it using capital budgeting
techniques.
101. Question - PART250057The net present value method of capital budgeting assumes
that cash flows are reinvested atThe cost of debt.The discount rate used in the analysisThe
risk-free rate.The rate of return of the project.
Option B is correct
The net present value method of capital budgeting involves the assumption that the resulting
cash flows will be able to be invested at the rate of return that is used as a discount rate in the
analysis.

Option A is incorrect
The cost of debt for a capital investment is not the rate that the resulting cash flows are
assumed to be reinvested at in net present value analysis.

Option C is incorrect
The risk-free rate is not a part of net present value analysis of a capital budgeting project.

Option D is incorrect
The internal rate of return method of analyzing a capital investment project assumes that the
resulting cash flows will be able to be reinvested at the rate of return of the project, but the
net present value method does not.
102. Question - PART250005Which one of the following statements concerning cash flow
determination for capital budgeting purposes is not correct?Tax depreciation must be
considered because it affects cash payments for taxes.Sunk costs are not incremental flows
and should not be included.Book depreciation is relevant because it affects net income.Net
working capital changes should be included in cash flow forecasts.
Option C is correct
It is not correct to say that book depreciation is relevant because it affects net income. Book
depreciation is the depreciation expense recorded under generally accepted accounting
principles, and it does affect the net income reported on the financial statements. However,
the depreciation used in capital budgeting analyses is the type of depreciation used for tax
purposes, which is different from the type of depreciation used for book purposes. The type
of depreciation for tax purposes is relevant to a capital budgeting analysis because it impacts
the amount of income tax due, and the income tax due is a relevant cash flow item.

Option A is incorrect
It is correct to say that tax depreciation must be considered because it affects cash payments
for taxes. The tax depreciation reduces taxable income which reduces income taxes due.
Option

Option B is incorrect
It is correct to say that sunk costs are not incremental flows and should not be included. The
only cash flows that are relevant in a capital budgeting analysis are those that will occur as a
direct result of the project under consideration. Sunk costs by definition are those which have
already occurred and cannot be changed.

Option D is incorrect
It is correct to say that net working capital changes should be included in cash flow forecasts.
Net working capital changes as a result of a capital budgeting project are cash inflows and
outflows for that project.
103. Question - PART251470
Which of the following events would decrease the internal rate of return of a proposed asset
purchase?
Decrease tax credits on the asset.
Decrease related working capital requirements.
Shorten the payback period.
Use accelerated, instead of straight-line depreciation.
Option A is correct
The Internal rate of return determines the rate of discount at which the present value of the
future cash flows equals the investment outlay (i.e the rate that results in an NPV of zero).
A tax credit is a tax incentive which allows certain taxpayers to subtract the amount of the
credit from the total they owe the state. A decrease in the tax credits on the asset would result
in increase in the initial outlay for the asset. This increase would cause the present value
factor to increase and would result in a decline in internal rate of return. As a result the
internal rate of return will decrease.

Option B is incorrect
because a decrease in the related working capital requirements decreases the initial outlay
thereby resulting in an increase in the internal rate of return.

Option C is incorrect
because a decrease in the working capital requirement would result in a decrease in the initial
outlay and hence an increase in the internal rate of return for NPV = 0.

Option D is incorrect
because the use of accelerated depreciation would result in an increase in the cash flows
resulting in a higher internal rate of return for NPV = 0. The calculation of IRR becomes
difficult in case of uneven cash flows as is the case when accelerated depreciation method is
used because in such a case there may be no unique internal rate of return.

104. Question - PART250141Assume that an investment project's assumed cash flows are
not changed, but the assumed weighted average cost of capital is reduced. What impact
would this have on the net present value (NPV) and the internal rate of return (IRR) of this
project?NPV would increase and IRR would increase.NPV would decrease and IRR would
increase.NPV would not change and IRR would not change.NPV would increase and IRR
would not change.
Option D is correct
When the required rate of return is decreased, all other things being equal, the NPV will
increase because the present values of the future expected cash flows will be greater. The IRR
would not change. The IRR is the discount rate at which the NPV of an investment will be
equal to 0. The required rate of return (the discount rate used to calculate the present values
of the future cash flows) is not an input to the calculation of the IRR at all. The IRR is thus
not affected the discount rate used to calculate the project's net present value.

Option A is incorrect
When the required rate of return is decreased, all other things being equal, the NPV will
increase because the present values of the future expected cash flows will be greater.
However, the IRR would not increase. The IRR is the discount rate at which the NPV of an
investment will be equal to 0. The required rate of return (the discount rate used to calculate
the present values of the future cash flows) is not an input to the calculation of the IRR at all.

Option B is incorrect The NPV would not decrease as a result of using a lower discount rate.
When the required rate of return is decreased, all other things being equal, the present values
of the future expected cash flows will be greater. The IRR would not increase. The IRR is the
discount rate at which the NPV of an investment will be equal to 0. The required rate of
return (the discount rate used to calculate the present values of the future cash flows) is not an
input to the calculation of the IRR at all.

Option C is incorrect
The NPV would change as a result of using a lower discount rate. When the required rate of
return is decreased, all other things being equal, the present values of the future expected cash
flows will be greater. The IRR would not change. The IRR is the discount rate at which the
NPV of an investment will be equal to 0. The required rate of return (the discount rate used to
calculate the present values of the future cash flows) is not an input to the calculation of the
IRR at all. The IRR is thus not affected the discount rate used to calculate the project's net
present value.
105. Question - PART250100
A company’s marginal cost of new capital (MCC) is 11% up to $600,000. MCC increases 1%
for the next $400,000 and another 2% thereafter. Several proposed projects are under
consideration, with projected cost and internal rates of return (IRR) as follows: Project Cost
IRR
A $100,000 10.5%
B 300,000 14.0%
C 450,000 10.8%
D 350,000 11.5%
E 400,000 11.0%
What should the company’s capital budget be?
$300,000.00$650,000.00$1,050,000.00$1,500,000.00
Option B is correct
The capital budget will consist of those projects that will be profitable for the company.
Profitable projects are projects with IRRs that exceed their cost of capital. The first step is to
prioritize the projects according to their IRRs, and the next step is to determine the marginal
cost of capital for each project in order to know which of the projects have IRRs exceeding
their marginal cost of capital.
The priority of the projects according to their IRRs is: #1: B for $300,000, IRR 14.0% #2: D
for $350,000, IRR 11.5% #3: E for $400,000, IRR 11.0% #4: C for $450,000, IRR 10.8% #5:
A for $100,000, IRR 10.5%
Next, determine for which of these projects the marginal cost of capital will be lower than the
project’s IRR. Only those projects with IRRs that are greater than their marginal cost of
capital should be accepted, and the total of the projects that should be accepted will be the
amount of the company’s capital budget.
The company’s marginal cost of new capital is 11% up to $600,000, 12% from $600,001
through $1,000,000, and 14% from $1,000,001 and higher.
Project B for $300,000 with an IRR of 14.0% has the highest IRR. The capital will be
allocated according to priority of the projects, so Project B will be allocated capital that costs
11%. Project B’s IRR is higher than its marginal cost of capital, so Project B will be
selected.
Project D for $350,000 with an IRR of 11.5% has the second highest IRR. Project D will be
allocated capital at 11% until $600,000 of capital has been used by B and D, so $300,000 of
Project D’s capital will be at a cost of 11%. The remainder of the capital for the project, or
$50,000, will be at a cost of 12%. Since its cost of capital consists of two different rates, the
cost will be a weighted average.
The weighted average marginal cost of capital for Project D is therefore ($300,000/$350,000
× 0.11) + ($50,000/$350,000 × 0.12) = 11.14%,
which is lower than its IRR of 11.5%,
so Project D will be selected.
Project E requiring $400,000 with an IRR of 11.0% has the third highest IRR. Project E will
be allocated capital costing 12% until the $400,000 of capital available at 12% has been used
by Projects D and E.
Project D uses $50,000 of the capital available at 12%, so $350,000 at 12% is available for
Project E. The remainder of the capital for Project E will be at a cost of 14%. Both 12% and
14% are higher than Project E’s IRR of 11.0%, so Project E will not be selected. The other
two projects, C and A, also will not be selected because their marginal costs of capital are
higher than their IRRs. Project C’s IRR is 10.8% and Project A’s IRR is 10.5%, and the
marginal cost of capital for both is 14%.
The total investment in the projects with IRRs that are greater than their marginal cost of
capital will be the company’s capital budget, as follows:
Project B for $300,000 + Project D for $350,000 = $650,000.

Option A is incorrect
As the amount consider for the calculation is incorrect

Option C is incorrect
As the amount consider for the calculation is incorrect

Option D is incorrect
As the amount consider for the calculation is incorrect
106. Question - CMA251539
A company is considering investing in a five-year project that has an initial investment of
$400,000 and a cost of capital of 10%. The annual pre-tax cash inflows and outflows are
$150,000 and $12,000. The depreciation provided in the books per annum is $80,000
(ignoring the salvage value) but the income tax disallows $10,000 from the depreciation
charged in books before charging the tax rate of 30%. Calculate net present value of the
investment when the selling price of the equipment at the end of five years is $40,000.
PV of annuity of $1 for 5 years @10% is 3.791.
PV of $1 for 5th year @10% is 0.621.
$63,209.6
($63,209.6)
$70,661.6
($70,661.6)
Option A is correct
The net present value will be calculated as follows:
Present value of cash outflows:
Initial investment = $400,000.
Annual outflows (after tax saving) = $12,000 × (1 – 0.3) × 3.791 = $31,844.4.
PV of tax on profits on sale of equipment at the end of year 5 = Profit (i.e. Sale value - Book
value) × 0.3 × 0.621 = (40,000 – 0) × 0.3 × 0.621 = $7,452,
Total present value of cash outflows = $400,000 + $31,844.4 + $7,452 = $439,296.4.
Present value of cash inflows:
PV of annual inflows (after tax) = $150,000 × (1 - 0.3) × 3.791 = $398,055.
PV of annual tax shield on depreciation = $70,000 × 0.3 × 3.791 = $79,611.
PV of salvage value at the end of year 5 = $40,000 × 0.621 = $24,840.
Total present value of cash inflows = $398,055 + $79,611 + $24,840 = $502,506.
Thus, NPV of the investment = PV of cash inflows – PV of cash outflows = $502,506 –
$439,296.4 = $63,209.6.

Option B is incorrect
because this would be the result when calculations are done as per (a) and the PV of cash
inflows are deducted from PV of cash outflows.

Option C is incorrect
because this would be the result when tax on profit on sale of equipment is not considered.
Then the calculation would be as [skipping tax on profit on sale of equipment from
calculations as per (a) above]:
Total present value of cash outflows = $400,000 + $31,844.4 = $431,844.4.
Total present value of cash inflows = $398,055 + $79,611 + $24,840 = $502,506.
Thus, NPV of the investment = PV of cash inflows – PV of cash outflows = $502,506 –
$431,844.4 = $70,661.6

Option D is incorrect
because this would be the result calculations are done as per (c) above and also when the PV
of cash inflows are deducted from PV of cash outflows.
107. Question - PART251468
A multiperiod project has a positive net present value. Which of the following statements is
correct regarding its required rate of return?
Less than the company's weighted average cost of capital.
Less than the project's internal rate of return.
Greater than the company's weighted average cost of capital.
Greater than the project's internal rate of return.
Option B is correct
Relationship between the Net Present Value (NPV) and the Internal Rate of Return (IRR)
method can be summarized as follows:
NPV IRR
NPV > 0 IRR >Discount Rate
NPV = 0 IRR = Discount Rate
NPV < 0 IRR < Discount Rate
Therefore, when the net present value for a project is positive, its required rate of return is
less than the project's internal rate of return.

Option A is incorrect
based on the relationship between the NPV and IRR method.

Option C is incorrect
based on the relationship between the NPV and IRR method.

Option D is incorrect
based on the relationship between the NPV and IRR method.

108. Question - PART250151Which one of the following conditions can cause a conflicting
decision when applying both the net present value (NPV) and internal rate of return (IRR)
methods to two mutually exclusive projects?When the required rate of return is greater than
the IRR for each project.When the size and cost of each project is substantially similar to
each other.When NPV and IRR are properly calculated, a conflicting decision will not
occur.When significant timing differences are present with respect to cash flows.
Option D is correct
Significant timing differences in cash flows can cause a conflicting decision when applying
both the net present value (NPV) and internal rate of return (IRR) methods to two mutually
exclusive projects. A project that begins with a net cash outflow followed by several years of
cash inflows is considered a conventional project. When analyzing two mutually exclusive
projects that are both conventional projects, both NPV and IRR will lead to the same accept-
or-reject decision. However, not all projects are conventional projects, and if one or both of
the projects is unconventional, that can lead to conflicting results between the net present
value and the internal rate of return capital budgeting methods. An unconventional project
may start out with a cash inflow followed by cash outflows. For example, Project A, an
unconventional project, starts out with a cash inflow followed by cash outflows, whereas
Project B, a conventional project, starts out with a cash outflow followed by inflows. The
effective result of the Project A is that money is borrowed instead of invested, and the NPVs
and IRRs of each project may present conflicting information. Furthermore, an
unconventional project may start out with a cash outflow but instead of the outflow being
followed by several years of cash inflows, it may be followed by some years of cash inflows
and some years of cash outflows. That situation can cause the project to have more than one
IRR. Multiple IRRs can occur when the sign of the cash flow changes more than once during
a project’s life, leading to uncertain interpretation of the results. In all cases, when the results
are conflicting, the NPV should be relied on for decision-making.

Option A is incorrect
required rate of return that is greater than the IRR for each project will not lead to a
conflicting decision when applying both the net present value (NPV) and internal rate of
return (IRR) methods of capital budgeting to two mutually exclusive projects. If the required
rate of return is greater than the IRR for a project, the project's NPV will be negative, and
both results will lead to a decision to reject the project. Please see the correct answer
explanation for more information.

Option B is incorrect
The size and cost of each project being substantially similar to each other will not lead to a
conflicting decision when applying both the net present value (NPV) and internal rate of
return (IRR) methods of capital budgeting to two mutually exclusive projects. Please see the
correct answer explanation for more information.

Option C is incorrect
A conflicting decision can occur when NPV and IRR are properly calculated. Please see the
correct answer explanation for more information.
109. Question - PART250058
Willis Inc. has a cost of capital of 15% and is considering the acquisition of a new machine
which costs $400,000 and has a useful life of 5 years. Willis projects that earnings and cash
flow will increase as follows:
1 2 3 4 5
Net Year After-Tax Earnings $100,000 100,000 100,000 100,000 200,000
Cash Flow $160,000 140,000 100,000 100,000 100,000
15% Interest Rate factors Period
1 2 3 4 5
Present Value of $1 0.87 0.7 0.66 0.57 0.50
6
Present Value of an annuity of 0.87 1.6 2.29 2.86 3.36
$1 3
The net present value of this investment is:
Positive, $200,000.Negative, $14,000.Negative, $64,000.Positive, $18,600.
Option D is correct
The net present value is the present value of all future cash inflows minus the present value of
all future cash outflows.
The present value of the Year 0 cash flow is equal to the Year 0 cash flow.
To calculate the present value of the cash flows after year 0, you could discount each
individual cash flow amount by the appropriate present value of $1 factor.
However, that is not the most time-effective way to do it. If you recognize that all the annual
cash flow amounts contain an amount such as $100,000 and $100,000 is the exact amount of
the cash flow for at least two of the years, you can save time by calculating first the present
value of an annuity for the $100,000; then calculating the present value of $1 individually for
any amounts over the $100,000 amount. In this case, we have 5 years of $100,000 cash flows,
and the discount factor given for the PV of an annuity for 5 years is 3.36. We also have
$60,000 to be discounted for one year and $40,000 to be discounted for two years using the
appropriate present value of $1 factors. Thus, the present value of the cash inflows is
($100,000 × 3.36) + ($60,000 × 0.87) + ($40,000 × 0.76) = $418,600. The net present value
is $418,600 less the initial investment of $400,000, or $18,600.
or
PV of Cash Outflow = $400,000
PV of Cash Inflow = $160,000 x 0.87 + $140,000 x 0.76 + 100,000 x 0.66 + 100,000 x 0.57 +
100,000 x 0.50
= 139,200 +106,400 + 66,000 + 57,000 + 50,000= $418600
NPV = PV of Cash Inflow - PV of Cash Outflow = $418600 - $400,000
NPV = $18,600

Option A is incorrect
An answer of $200,000 results from subtracting the initial investment from the total of the
undiscounted cash inflows. Option

Option B is incorrect
An answer of a negative $14,000 results from using the net earnings amounts instead of the
after-tax cash flow amounts in the net present value analysis.

Option C is incorrect
An answer of a negative $64,000 NPV results from using annual cash flows of $100,000, and
forgetting to discount the additional cash flows of $60,000 in Year 1 and $40,000 in Year 2
110. Question - PART251474
Net present value as used in investment decision-making is stated in terms of which of the
following options?
Net income.
Earnings before interest, taxes, and depreciation.
Earnings before interest and taxes.
Cash flow.
Option D is correct
Net Present Value is used in capital budgeting to analyze the profitability of a projected
investment or project using the cash flows from the project. It represents the difference
between the present value of cash inflows and the present value of cash outflows.

Option A is incorrect
because net income comprises of both cash and noncash items and is adjusted for noncash
items to arrive at the cash flows for computation of the NPV.

Option B is incorrect
because earnings before interest, taxes, and depreciation and earnings before interest and
taxes are required to be adjusted for the noncash items to arrive at the cash flows for the Net
present value calculations.
Option C is incorrect
because earnings before interest, taxes, and depreciation and earnings before interest and
taxes are required to be adjusted for the noncash items to arrive at the cash flows for the Net
present value calculations.
111. Question - PART251460
Which of the following statements is true regarding the payback method?
It does not consider the time value of money.
It is the time required to recover the investment and earn a profit.
It is a measure of how profitable one investment project is compared to another.
The salvage value of old equipment is ignored in the event of equipment replacement.
Option A is correct
The payback method evaluates investments on the basis of the length of time until recapture
(return) of the investment. It does not take into account the time value of money.

Option B is incorrect
because payback period is only the time required to recover the investment and does not
include the time required to earn profit.

Option C is incorrect
because it does not compare the profitability of one investment project with another.

Option D is incorrect
because the payback method ignores the salvage value of old equipment.
112. Question - PART251490
Which of the following phrases defines the internal rate of return on a project?
The number of years it takes to recover the investment.
The discount rate at which the net present value of the project equals zero.
The discount rate at which the net present value of the project equals one.
The weighted-average cost of capital used to finance the project.
Option B is correct
Internal rate of return determines the rate of discount at which the present value of the future
cash inflows equals the present value of investment outlay (i.e the rate that results in a NPV
of zero).

Option A is incorrect
because the number of years it takes to recover the investment in a project is the Payback
period.

Option C is incorrect
because there is no such measure.

Option D is incorrect
because the weighted average cost of capital is the minimum acceptable rate of return at
which a company yields returns for its investors.
113. Question - PART250011The following schedule reflects the incremental costs and
revenues for a capital project. The company uses straight-line depreciation. The interest
expense reflects an allocation of interest on the amount of this investment, based on the
company's weighted average cost of capital. Revenues $650,000 Direct costs $270,000
Variable overhead 50,000 Fixed overhead 20,000 Depreciation 70,000 General &
administrative 40,000 Interest expense 8,000 Total costs 458,000 Net profit before taxes
$192,000 The annual cash flow from this investment, before tax considerations, would
be$192,000.00$200,000.00$262,000.00$270,000.00
Option D is correct
The annual cash flow from the investment before tax considerations is:
Revenues $650,000 Less costs: Direct costs $270,000 Variable overhead 50,000 Fixed
overhead 20,000 General & administrative 40,000 Total costs 380,000
Net operating cash flow before taxes $270,000
The depreciation is not included because this is a cash flow analysis, and depreciation is a
non-cash expense. The only effect depreciation would have on a capital budgeting analysis is
in the depreciation tax shield, and since this is a before-tax analysis, there is no effect from
depreciation. The interest expense is not included because the financing of a capital
investment is a different process from the capital budgeting cash flow analysis. Furthermore,
when a capital budgeting analysis uses discounted cash flow analysis, the discount rate
incorporates a financing charge. So the information about interest expense is irrelevant
information.

Option A is incorrect
This answer results from including depreciation and interest expense as cash outflows. The
depreciation should not be included because this is a cash flow analysis, and depreciation is a
non-cash expense. The only effect depreciation would have on a capital budgeting analysis is
in the depreciation tax shield, and since this is a before-tax analysis, there is no effect from
depreciation. The interest expense should not be included because the financing of a capital
investment is a different process from the capital budgeting cash flow analysis. Furthermore,
when a capital budgeting analysis uses discounted cash flow analysis, the discount rate
incorporates a financing charge. So the information about interest expense is irrelevant
information.

Option D is incorrect
This answer results from including depreciation as a cash outflow. The depreciation should
not be included because this is a cash flow analysis, and depreciation is a non-cash expense.
The only effect depreciation would have on a capital budgeting analysis is in the depreciation
tax shield, and since this is a before-tax analysis, there is no effect from depreciation.

Option C is incorrect
This answer results from including interest expense as a cash outflow. The interest expense
should not be included because the financing of a capital investment is a different process
from the capital budgeting cash flow analysis. Furthermore, when a capital budgeting
analysis uses discounted cash flow analysis, the discount rate incorporates a financing charge.
So the information about interest expense is irrelevant information.
114. Question - PART250024
Depreciation is incorporated explicitly in the discounted cash flow analysis of an investment
proposal because it
is a cash inflow.is a cost of operations that cannot be avoided.represents the initial cash
outflow spread over the life of the investment.reduces the cash outlay for income taxes.
Option D is correct
Depreciation is explicitly included in the calculation of the discounted cash flow of an
investment proposal because it is a deductible expense for the purpose of calculating income
tax liability. Thus, the cash outlay for income taxes is reduced by the depreciation and other
income is shielded from tax.
Option A is incorrect
Depreciation is itself neither a cash inflow nor a cash outflow. However, because it can shield
other income from tax, it may result in a decrease in cash outflow, if the firm has other
income to shield from tax. Option

Option B is incorrect
Depreciation is not incorporated in the discounted cash flow analysis of an investment
proposal because it is a cost of operations that cannot be avoided. It is, rather, included
because it affects cash flow and thus the discounted cash flow analysis for an investment
proposal.

Option C is incorrect
Depreciation does represent the initial cash outflow spread over the life of the investment.
However, this is not the reason depreciation is incorporated in the discounted cash flow
analysis of an investment proposal.
115. Question - PART251485
A company uses its company-wide cost of capital to evaluate new capital investments. What
is the implication of this policy when the company has multiple operating divisions, each
having unique risk attributes and capital costs?
High-risk divisions will over-invest in new projects and low risk divisions will under-invest
in new projects.
High-risk divisions will under-invest in high-risk projects.
Low-risk divisions will over-invest in low-risk projects.
Low-risk divisions will over-invest in new projects and high risk divisions will under-invest
in new projects.
Option A is correct.
If a company is traditionally using a single cost of capital for all projects undertaken within
each of the several operating divisions (or companies ) that have very different risk
characteristics, it will result in the high risk divisions of the company over investing in high
risk projects and low risk divisions under investing in low risk projects.

Option B is incorrect
because high risk divisions will over invest in high risk projects.

Option C is incorrect
because low risk divisions will under invest in low risk projects.

Option D is incorrect
because low risk divisions will under invest in low risk new projects and high risk investment
will over invest in high risk new project.
116. Question - PART250008
The tax impact of equipment depreciation affects capital budgeting decisions. Currently, the
Modified Accelerated Cost Recovery System (MACRS) is used as the depreciation method
for most assets for tax purposes. The MACRS method of depreciation for assets with 3, 5, 7
and 10-year recovery periods is most similar to which one of the following depreciation
methods used for financial reporting purposes?
Units-of-production.Straight-line.200% declining-balance.Sum-of-the-years'-digits.
Option C is correct
The MACRS method of depreciation is most similar to the 200% declining balance method
(double-declining balance) of depreciation.

In capital budgeting decisions, the tax impact of equipment depreciation plays a significant
role. Depreciation refers to the allocation of the cost of an asset over its useful life. This
allocation is important for tax purposes because it allows businesses to deduct the
depreciation expense from their taxable income, thereby reducing their tax liability.
The Modified Accelerated Cost Recovery System (MACRS) is the depreciation method used
for most assets for tax purposes in many countries, including the United States. Under
MACRS, assets are assigned specific recovery periods (e.g., 3, 5, 7, or 10 years) based on
their class. Each class has a predetermined depreciation schedule, specifying the percentage
of the asset's cost that can be depreciated each year.
Now, the question asks which depreciation method used for financial reporting purposes is
most similar to the MACRS method for assets with 3, 5, 7, and 10-year recovery periods. The
answer is the "200% declining-balance" method.
The 200% declining-balance method is a common depreciation method used for financial
reporting purposes. It allows for accelerated depreciation, where a higher percentage of an
asset's value is depreciated in the earlier years. In this method, the depreciation expense is
calculated by applying a fixed percentage (usually 200%) to the asset's book value.
The MACRS method for assets with 3, 5, 7, and 10-year recovery periods is similar to the
200% declining-balance method because both methods allow for accelerated depreciation in
the earlier years of an asset's life. They allocate a higher percentage of the asset's cost as
depreciation expense in the initial years, which results in higher tax deductions and lower
taxable income during those periods.
Therefore, the 200% declining-balance method is the most similar depreciation method used
for financial reporting purposes to the MACRS method for assets with 3, 5, 7, and 10-year
recovery periods.

Option A is incorrect
The MACRS method of depreciation is not similar to the units-of-production method of
depreciation. Option

Option B is incorrect
The MACRS method of depreciation is not similar to straight-line depreciation. Option

Option D is incorrect
The MACRS method of depreciation is not similar to the sum-of-the-years'-digits method of
depreciation.
117. Question - PART250039
Foster Manufacturing is analyzing a capital investment project that is forecasted to produce
the following cash flows and net income.
Cash Net Income
Flows
0 $(20,000) 0
1 6000 2000
2 6000 2000
3 8000 2000
4 8000 2000
 The payback period of this project will be
2.5 years.2.6 years.3.0 years.3.3 years.
Option C is correct
The Payback Method is used to determine the number of periods that must pass before the net
after-tax cash inflows from the investment equals (or "pays back") the initial investment cost.
We will calculate the cumulative net cash flows to see how long it takes for this investment to
pay back the initial investment cost:
0 1 2 3 4
Years After-Tax Cash Flows $(20,000) 6,000 6,000 8,000 8,000
Cumulative Net Cash Flows $(20,000) (14,000) (8,000) 0 8,000
The payback period of this project will be exactly 3.0 years, because that is when the
cumulative net cash flow reaches zero. At that point, the initial investment has been paid
back. Usually, payback periods do not work out so evenly, so the formula given in your book
is needed. Here we can use the formula, but we don't need to. If we were to use the formula,
our calculation would be: 2 + 8,000 / 8,000 = 2 + 1 = 3, or 3.0.

Option A is incorrect
This is not the correct answer. Please see the correct answer for an explanation. We have
been unable to determine how to calculate this incorrect answer choice. If you have
calculated it, please let us know how you did it so we can create a full explanation of why this
answer choice is incorrect.

Option B is incorrect
This is not the correct answer. Please see the correct answer for an explanation. We have
been unable to determine how to calculate this incorrect answer choice. If you have
calculated it, please let us know how you did it so we can create a full explanation of why this
answer choice is incorrect.

Option D is incorrect
This is not the correct answer. Please see the correct answer for an explanation. We have
been unable to determine how to calculate this incorrect answer choice. If you have
calculated it, please let us know how you did it so we can create a full explanation of why this
answer choice is incorrect.
118. Question - PART250082CTI-Invest is considering making an investment in
StarTextile. The acquisition would require an initial investment of $50 million and would be
expected to increase after-tax cash flow by $4.2 million per year in perpetuity. Assuming that
CTI’s cost of capital is 8%, should CTI-Invest make the investment?Yes, because the NPV is
a positive $3 million.No, because the cost of capital is greater than the IRR.Yes, because the
NPV is a positive $2.5 million.No, because the NPV is a negative $2.5 million.
Option C is correct
The present value of a cash flow in perpetuity is the annual cash flow divided by the required
rate of return/cost of capital.
The PV of the cash flow in perpetuity is $52.5 million ($4.2 million divided by 0.08),
so the Net Present Value is $2.5 million ($52.5 million minus the initial investment of $50
million).
Therefore, CTI-Invest should make the investment.

Option A is incorrect
NPV is positive but it is $2.5 million not $3 million
Option B is incorrect
the best way to take decision, whether to invest or not is to first check NPV should be
positive.

Option D is Incorrect
NPV is positive as per the calculation.
119. Question - PART250119Calvin Inc. is considering the purchase of a new state-of-art
machine to replace its hand-operated machine. Calvin\'s effective tax rate is 40%, and its cost
of capital is 12%. Data regarding the existing and new machines are presented below.
Existing Machine New Machine Original cost $50,000 $90,000 Installation costs 0 4,000
Freight and insurance 0 6,000 Expected end salvage value 0 0 Depreciation method straight-
line straight-line Expected useful life 10 years 5 years The existing machine has been in
service for seven years and could be sold currently for $25,000. Calvin expects to realize a
before-tax annual reduction in labor costs of $30,000 if the new machine is purchased and
placed in service. If the new machine is purchased, the incremental cash flows for the fifth
year would amount to$18,000.00$24,000.00$26,000.00$30,000.00
Option C is correct
The Year 5 incremental cash flows are as follows: Operating cash flow: $30,000 labor cost
savings × (1 − 0.40) $18,000 Depreciation tax shield: ($100,000 ÷ 5 × 0.40) 8,000 Total
incremental cash flow $26,000

Option A is incorrect
This is the labor savings less the tax impact and does not take into consideration the
depreciation tax shield.

Option B is incorrect
This answer uses the difference between the depreciation on the new machine in Year 5 and
the depreciation on the current machine to calculate the depreciation tax shield for the Year 5
incremental cash flow. However, the current machine has been owned for 7 years already and
has a 10 year life. Therefore, it has only 3 years of life and depreciation left, so by Year 5 of
the new machine's life, there would be no depreciation taken on the old machine. This is the
labor savings and does not include the depreciation or the tax impact.

Option D is incorrect
As explained above
120. Question - CMA211533
Following is the details of 4 projects a company is evaluating with the total funds of $70,000
to invest:
Project 2
Project 1 ($) Project 3 ($) Project 4 ($)
($)
Initial
50,000 20,000 30,000 45,000
investment
Net present value 3,350 -1,000 2,154 5,625
Which projects should the company invest in?
Project 2 and Project 4.
Project 2 and Project 3.
Project 4 only.
Project 1 and Project 3.
Option C is correct.
When limited funds are available, projects should be ranked on the basis of higher
profitability index (PI).
PI = Present value (PV) of future cash inflows / Initial investment.
OR
PI = 1 + [NPV / Initial Investment]

PV of future cash inflows are not mentioned. We can calculate PV of future cash inflows by
adding net present value (NPV) to Initial investment.
PI of Project 1 = (50,000 + 3,350) / 50,000 = 1.067.
PI of Project 2 = (20,000 – 1,000) / 20,000 = 0.95.
PI of Project 3 = (30,000 + 2,154) / 30,000 = 1.072.
PI of Project 4 = (45,000 + 5,625) / 45,000 = 1.125.
Project would be ranked as: Project 4, Project 3, Project 1 and Project 2.
Investment should be made in the above order. First investment should be made in Project 4.
After investment in project 4, $25,000 is left out of the initial $70,000 which can’t be
invested in project 3 and 1 because they need more investment. Thus, skipping project 1 and
3 next would be project 2. Though, the investment amount for project 2 is within budget, the
net present value (NPV) of the project is negative. Thus, project 2 should not be invested in,
leaving project 4 as the best investment option.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.

121. Question - PART250145Which of the following statements about mutually exclusive

capital investments is least accurate?The internal rate of return is a reliable method for
selecting between projects of different sizes.
If a project's internal rate of return is less than the cost of capital, the project should be
rejected.

The net present value indicates how much the value of the firm will change if the project is
accepted.If a project’s net present value is less than zero, the project should be rejected.
Option A is correct
If two potential projects are mutually exclusive, only one project can be chosen. For
independent projects, the internal rate of return and the net present value give the same
accept/reject decisions. However, for mutually exclusive projects, the internal rate of return is
not reliable for selecting between projects of different sizes. Since the IRR is a rate of return,
a project with a smaller initial investment can show a higher IRR than a project requiring a
larger initial investment, even though the project with the larger initial investment but lower
IRR has a higher NPV and would increase the value of the firm by a greater amount.

Option B is incorrect
See the correct answer for an explanation.
Option C is incorrect
See the correct answer for an explanation.

Option D is incorrect
See the correct answer for an explanation.
122. Question - CMA251518
Which of the following methods of evaluating an investment assumes that the cash inflows
from the project are reinvested at the rate of cost of capital?
Net present value.
Internal rate of return.
Accounting rate of return.
Payback period.
Option A is correct.
Net present value method of evaluating an investment assumes that the cash inflows from the
project are reinvested at the rate of cost of capital or hurdle rate or discount rate.

Option B is incorrect
because internal rate of return (IRR) method of evaluating an investment assumes that the
cash inflows from the project are reinvested at the rate of IRR percentage.

Option C is incorrect
because both of them do not make any such assumptions.

Option D is incorrect
because both of them do not make any such assumptions.
123. Question - PART12110172
Projected monthly sales of Wallstead Corporation for January, February, March, and April
are as follows.
January $300,000
February 340,000
March 370,000
April 390,000

 The company bills each month's sales on the last day of the month.
 Receivables are booked gross and credit terms of sale are: 2/10, n/30.
 50% of the billings are collected within the discount period, 30% are collected by the
end of the month, 15% are collected by the end of the second month, and 5% become
uncollectible.

Budgeted cash collections for Wallstead Company during April would be

$343,300.
$347,000
$349,300
$353,000.
Option A is correct
Budgeted cash collections for Wallstead Company during April would be = $343,300
Feb $340,000 x 15% = $51,000
March $ 370,000 x 30% + $370,000 x 50%(1-2%) = $111,000+ $181,300 = $292,000
Option B is incorrect
Correct Answer explained in Option A

Option C is incorrect
Correct Answer explained in Option A

Option D is incorrect
Correct Answer explained in Option A
124. Question - PART250117
Regal Industries is replacing a grinder purchased 5 years ago for $15,000 with a new one
costing $25,000 cash. The original grinder is being depreciated on a straight-line basis over
15 years to a zero salvage value; Regal will sell this old equipment to a third party for $6,000
cash. The new equipment will be depreciated on a straight-line basis over 10 years to a zero
salvage value. Assuming a 40% marginal tax rate, Regal's net cash investment at the time of
purchase if the old grinder is sold and the new one purchased is
$15,000.00$25,000.00$17,400.00$19,000.00
Option C is correct
The net cash flows in Year 0 include:
(1) Cash inflow from the sale of the old equipment - $6,000.
(2) Tax effect of the sale of the old equipment:
Book value of old equipment = $10,000 ($15,000 original purchase price minus [$15,000 ÷
15 × 5]).
Loss on sale = $6,000 sale price minus $10,000 book value = $(4,000).
At a 40% tax rate, the tax benefit from the loss is a $1,600 cash inflow from decreased taxes
owed ($4,000 × 0.40).
(3) The purchase price of $25,000 for the new equipment is a cash outflow.
The net initial cash investment is $6,000 + $1,600 − $25,000 = $(17,400).

Option A is incorrect
$15,000 is the initial investment in the old machine.

Option B is incorrect
$25,000 is the investment in the new machine, but it is not the net cash investment.

Option D is incorrect
$19,000 is the $25,000 initial investment minus the $6,000 sale price for the old equipment,
but it does not include the tax benefit from the loss on the sale of the old equipment.
125. Question - CMA251536
A company is considering the purchase of an equipment to save its costs. The relevant data
for cost savings and costs involved are as follows:
Cost of the equipment: $300,000.
Annual cash savings on account of purchase of equipment (before tax and depreciation):
$80,000.
Useful life of the equipment: five years with no salvage value.
Depreciation is calculated using straight line method.
Income tax rate: 40%.
Cost of capital for a company: 10%.
PV factors of 1$ @10% from year 1 to year 5 are: 0.909, 0.826, 0.751, 0.683 and 0.621.
PV factors of annuity of 1$ @10% from year 1 to year 5 are = 0.909, 1.736, 2.487, 3.170 and
3.791.
What is the net present value of the investment?
$94,264
($118,032)
($27,048)
$27,048
126. Question - CMA251528
An initial investment for a project is $85,000. Inflows over the six years of the project,
starting with year one to year six are $5,000, $15,000, $15,000, $20,000, $30,000 and
$30,000 respectively. The cost of capital of the project is 15%. What is the payback period of
the project when: Present value of $1 @15% from year one to year six are: 0.870, 0.756,
0.658, 0.572, 0.497 and 0.433.
More than six years.
Six years.
Five years.
Less than five years.
Option C is correct.
The payback period is a time period required to recover the original investment. Also, to
calculate payback period, cash inflows and outflows are not discounted. Thus, the PV factors
and cost of capital is ignored. The cost recovered by the end of year 5 is $85,000 (i.e. $5,000
+ $15,000 + $15,000 + $20,000 + $30,000). Thus, it can be said that the payback period of
the project is 5 years.

Option A is incorrect
because this would be the result if the cash inflows and outflows are discounted.

Option B is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.
127. Question - PART250130When determining net present value in an inflationary
environment, adjustments should be made toIncrease the estimated cash inflows and increase
the discount rate.Increase the discount rate, only.Increase the estimated cash inflows but not
the discount rate.Decrease the estimated cash inflows and increase the discount rate.
Option A is correct
In an environment of inflation, both the discount rate used and the future expected cash flows
should be increased. The discount rate is increased because the firm will require a higher rate
of return to compensate for the increased inflation. The future expected cash flow amounts
need to be increased because inflation will cause the dollar to be worth less in the future, and
the amounts of cash (both inflows and outflows) will therefore increase in the future.

Option B is incorrect
The discount rate does need to be increased, because the firm will require a higher rate of
return to compensate for the increased inflation. However, this is not the only adjustment that
is necessary to determine net present value in an inflationary environment.

Option C is incorrect
The estimated future cash inflows do need to be increased, to reflect the lower value of the
dollar in the future as a result of the inflation. However, the discount rate also needs to be
increased, because the firm will require a higher rate of return to compensate for the
increased inflation.

Option D is incorrect
The estimated future cash inflows need to be increased, not decreased, to reflect the lower
value of the dollar in the future as a result of the inflation.
128. Question - PART250131
If income tax considerations are ignored, how is depreciation handled by the following
capital budgeting techniques?
Internal Rate of Return & Payback
I. Excluded ; Excluded
II. Excluded ; Included
III. Included ; Included
IV. Included ; Excluded
I.II.III.IV.
Option A is correct
If income tax considerations are to be ignored, then the depreciation tax shield is ignored.
Therefore, the income tax savings from the depreciation are not included in the capital
budgeting analyses.
If the income tax savings from the depreciation are excluded,
then depreciation is ignored in the calculations of internal rate of return and payback.

Option B is incorrect
If income tax considerations are to be ignored, depreciation would be excluded from the
payback period calculation, because the payback period calculation is based upon cash flows,
not book income.

Option C is incorrect
If income tax considerations are ignored, depreciation would be excluded from the IRR and
payback calculations, because the IRR and the payback period are based upon cash flows.

Option D is incorrect
If income tax considerations are to be ignored, depreciation would be excluded from the IRR
calculation, because the IRR calculation is based upon cash flows, not book income.
129. Question - PART250084
HighFlux Inc. is reviewing a five-year capital investment that requires an initial cash outlay
of $450,500 for equipment. Management anticipates an additional working capital investment
of $50,000 to be needed at the beginning of the project, which will be recovered at the
project’s end. The equipment will have no salvage value at the end of the five-year period.
The project’s five-year expected cash inflows, including the after-tax operating cash inflows
and the inflow from the depreciation tax shield, are:
Yr 1 Yr2 Yr 3 Yr 4 Yr 5
Cash 150,025 138,775 144,025 152,275 162,025
Inflow
DF @10% 0.909 0.826 0.751 0.683 0.621
The company’s anticipated tax rate is 25%, and the company’s required rate of return for
similar projects is 10%. The investment’s discounted payback period is closest to
4.37 years.
4.92 years.4.45 years.
4.28 years.
Option A is correct
The discounted payback period is the length of time until the initial investment is repaid,
using discounted cash flows.
Calculation for the discounted payback period is:

Year 0 Year 1 Year 2 Year 3 Year 4

Year 5
Initial investment (450,500)
Working capital (50,000)
Expected cash inflows 150,025 138,775 144,025 152,275
162,025
Net cash flow (500,500) 150,025 138,775 144,025 152,275
162,025
PV of $1 factor @ 10% 0.909 0.826 0.751 0.683
0.621
PV of cash flow (500,500) 136,373 114,628 108,163 104,004
100,618
Cumulative net cash flow (500,500) (364,127) (249,499) (141,336) (37,332)
63,286
The final year of negative cumulative discounted cash flows is Year 4.
The final negative cumulative discounted cash flow divided by the net discounted cash flow
for the following year is
37,332 ÷ 100,618, or 0.37.
The discounted payback period is therefore 4 + 0.371 years, or 4.37 years.
Yr 1 Yr2 Yr 3 Yr 4 Yr 5
Cash Inflow 150,025 138,775 144,025 152,275 162,025
DF @10% 0.909 0.826 0.751 0.683 0.621
PVCI 136372.7 114628.2 108162.8 104003.8 100,667.5
Cumulative Cash Flow 136372.7 251000.9 359163.7 463167.5 594835

Option B is incorrect
The amount calculated above is incorrect, Due to incorrect amount consider in calculation.

Option C is incorrect
The amount calculated above is incorrect, Due to incorrect amount consider in calculation.

Option D is incorrect
The amount calculated above is incorrect, Due to incorrect amount consider in calculation.
130. Question - CMA251534
Depreciation is deducted from cash inflows to calculate tax and then added back to arrive at
after tax cash inflows because:
Tax saving of depreciation is considered as cash inflow.
Depreciation is considered as an outflow.
Depreciation is not a tax deductible expense.
Of difference in the tax saving rate applicable on depreciation only.
Option A is correct
Deducting depreciation from cash inflows to calculate tax and then adding back to arrive at
after tax cash inflows would provide the benefit of tax saving from depreciation without
actually deducting depreciation from cash inflows. Thus, tax saving because of deduction of
depreciation to calculate tax, is considered as cash inflow.

Option B is incorrect
because depreciation is a non-cash expense and is not considered an outflow. Depreciation is
not deducted from inflows to arrive at cash inflows; it is only deducted to calculate taxes.

Option C is incorrect
because depreciation being a tax deductible expense is deducted from cash inflows to
calculate tax.

Option D is incorrect
because there is one tax rate which is applied to cash inflows after depreciation.
131. Question - PART250095Pane Software Inc. has total capital of $100 million, and its
cost of capital was 12%. A new project has been proposed that will require additional capital
of $10 million. The firm estimates that the additional capital can be raised at a pre-tax cost of
10%. The company's marginal income tax rate is 36%. What discount rate should Pane use in
evaluating the new project?6.40%.7.56%.10.00%.11.82%
Option A is correct
To evaluate future (or new) projects, we should use the after-tax marginal cost of capital.
This is the cost of the capital that will be used to finance the new project. The new capital
will have a pre-tax cost of 10% and since the tax rate is 36%, the after tax cost of capital is
6.4%. This is the discount rate that should be used to evaluate the new project.

Option B is incorrect
The marginal cost of capital should be used to evaluate new projects. The marginal cost of
capital is the after-tax cost of the new source of capital that will be used to finance the new
project. This answer uses the cost of capital which is all past sources of financing.

Option C is incorrect
The after-tax marginal cost of capital should be used to evaluate new projects. This is the
before-tax marginal cost of capital.

Option D is incorrect
The after tax marginal cost of capital should be used to evaluate new projects.
132. Question - PART250093
The Financial Analysis Department of Stover Inc. has analyzed a proposed capital investment
and calculated the appropriate incremental cash flows as follows. Year Cash Flow 0
(100,000) outflow 1 80,000 inflow 2 80,000 inflow 3 80,000 inflow 4 (100,000) outflow
A net present value (NPV) of approximately $25,000 and an internal rate of return (IRR) of
minus 29% were calculated for the project and the project was submitted to the board of
directors for approval. Which one of the following statements is correct?
The project has another IRR in addition to the minus 29% rate.The IRR calculation must have
contained an error.In the NPV calculation, the project's cash flows are assumed to be
reinvested at Stover's cost of capital.The board of directors should not approve the project.
133. Question - PART250075
Olson Industries needs to add a small plant to accommodate a special contract to supply
building materials over a five-year period. The required initial cash outlays at Time 0 are as
follows: Land 500,000 New building 2,000,000 Equipment 3,000,000 Olson uses straight-
line depreciation for tax purposes and will depreciate the building over 10 years and the
equipment over 5 years. Olson's effective tax rate is 40%. Revenues from the special contract
are estimated at $1.2 million annually, and cash expenses are estimated at $300,000 annually.
At the end of the fifth year, the assumed sales values of the land and building are $800,000
and $500,000, respectively. It is further assumed the equipment will be removed at a cost of
$50,000 and sold for $300,000. As Olson utilizes the net present value (NPV) method to
analyze investments, the net cash flow for period 5 would
be$1,710,000.00$2,070,000.00$2,230,000.00$2,390,000.00

134. Question - PART250037

Yipann Corporation is reviewing an investment proposal. The initial cost as well as other
related data for each year are presented in the schedule below. All cash flows are assumed to
take place at the end of the year. The salvage value of the investment at the end of each year
is equal to its net book value, and there will be no salvage value at the end of the investment's
life. Yipann uses a 24% after-tax target rate of return for new investment proposals. The
discount figures for a 24% rate of return are given. The traditional payback period for the
investment proposal is

2.250
years.1.833 years.Over 5 years.0.875 Years
Option A is correct
The cash flow analysis is as follows: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial Investment in Equipment (105,000
)
After-Tax Cash Flow 0 50,000 45,000 40,000 35,000 30,000
Total After-Tax Cash Flows (105,000 50,000 45,000 40,000 35,000 30,000
)
Cumulative Cash Flow (105,000) (55,000) (10,000) 30,000 65,000 95,000
The cumulative cash flow from the project becomes positive during Year 3.
Assuming that the cash flows occur evenly throughout the year, the payback period is 2.25
years,
calculated as follows: Number of the project year in the final year when cash flow is
negative: 2 Plus: a fraction consisting of Numerator = the positive value of the negative
cumulative inflow amount from the final negative year, which is 10,000 Denominator = cash
flow for the following year, which is 40,000 or: 2 + 10,000/40,000 = 2.25 Note that the
present value factors given are irrelevant to answering this question, because the payback
method is not a discounted cash flow technique.

Option B is incorrect
An answer of 1.833 years results from using the yearly book values of the investment instead
of the after-tax cash flows for the years subsequent to year 0.

Option C is incorrect
An answer of "over 5 years" results from using the annual net income amounts instead of the
after-tax cash flows for the years subsequent to year 0.

Option D is incorrect
An answer of 0.875 years results from combining the book values of the investment and the
net after-tax cash flows instead of using the after tax cash flows alone for the years
subsequent to year 0.
135. Question - PART250110Doria Chung, controller of Nanjing Manufacturing, is
evaluating two projects and wishes to do a cash flow analysis of each of the projects. Both
projects have positive cash inflows starting in year 1 and have similar initial investments. The
cost of capital is expected to fluctuate during the life of the projects, and Chung has selected
the net present value method for her analysis. Did Chung select the most appropriate method
for her analysis?Yes, the net present value method is the most appropriate method because it
can properly consider the fluctuating cost of capital.No, she should have selected the payback
method to properly consider the initial investments and time value of money.No, she should
have selected the discounted payback method since it will properly consider the time value of
money.No, she should have selected the internal rate of return method to properly consider
the fluctuating cost of capital.
Option A is correct
When NPV is being used to evaluate a project, it is not necessary to use the same discount
rate for every year of the project’s life. If the required rate of return is expected to fluctuate
throughout the life of the project, each year’s cash flow can be discounted in multiple steps,
with each step utilizing one of the discount rates in effect and the number of years it will be
in effect before the receipt of that cash flow. Net Present Value is the only capital budgeting
method that can incorporate a fluctuating required rate of return.

Option B is incorrect
Yes, Chung did select the most appropriate method for her analysis.

Option C is incorrect
Yes, Chung did select the most appropriate method for her analysis.

Option D is incorrect
Yes, Chung did select the most appropriate method for her analysis.
136. Question - PART25111333
AGC Company is considering an equipment upgrade. AGC uses discounted cash flow (DCF)
analysis in evaluating capital investments and has an effective tax rate of 40%. Selected data
developed by AGC is as follows.
Existing Equipment New
Original cost $50,000 $95,000
Accumulated 45,000 -
depreciation
Current market value 3,000 95,000
Accounts receivable 6,000 8,000
Accounts payable 2,100 2,500
Based on this information, what is the initial investment for a DCF analysis of this proposed
upgrade
$92,400
$92,800
$95,800
$96,200
Option B is correct
The initial investment is the net cash outflow for the new equipment ($95,000) plus the
outflow for the increase in working capital that will be needed, adjusted for the after-tax
amount received from the sale of the old equipment. Working capital for the existing
equipment is $6,000 A/R minus $2,100 A/P, for net working capital of $3,900. Working
capital for the new equipment will be $8,000 A/R minus $2,500 A/P, for net working capital
of $5,500. The increase in working capital is $5,500 – $3,900, a cash outflow of $1,600. The
old equipment has a book value of $5,000 and can be sold for $3,000.
There will be a capital loss of $2,000 on the sale, since it is being sold for less than book
value.
There will be an inflow of $3,000 cash received from the sale, plus there will also be a tax
benefit to be received from the loss on the sale.
The loss on the sale is $2,000 and the tax rate is 0.40, so the tax benefit is $2,000 × 0.40, or
$800.
The after-tax cash inflow from the sale of the existing equipment is $3,000 + $800, or
$3,800.
So the initial investment will be: (95,000) + (1,600) + 3,800 = (92,800).

Option A is incorrect
This answer results from calculating the tax credit for the capital loss expected on the sale of
the existing equipment as 40% of the $3,000 cash received from the sale. Instead, the amount
of the tax credit should be 40% of the amount of the loss. The loss is $2,000 ($3,000 received
less book value of $5,000).

Option C is incorrect
This answer results from omitting the $3,000 cash received from selling the existing
equipment.

Option D is incorrect
This is not the correct answer. Please see the correct answer for an explanation. We have
been unable to determine how to calculate this incorrect answer choice. If you have
calculated it, please let us know how you did it so we can create a full explanation of why this
answer choice is incorrect.
137. Question - PART250036Jasper Company has a payback goal of 3 years on new
equipment acquisitions. A new sorter is being evaluated that costs $450,000 and has a 5-year
life. Straight-line depreciation will be used; no salvage is anticipated. Jasper is subject to a
40% income tax rate. To meet the company's payback goal, the sorter must generate
reductions in annual cash operating costs of$100,000.00$150,000.00$190,000.00$114,000
Option C is correct
The additional after-tax cash flow per year from all sources required to pay back the cost of
the new sorter within three years is $450,000 ÷ 3, or $150,000. The depreciation tax shield
per year is $450,000 ÷ 5 × 0.4, or $36,000. Therefore, the required after-tax reduction in
operating costs per year is $150,000 − $36,000, or $114,000. The equivalent before-tax
required reduction in operating costs per year is $114,000 ÷ 0.6, or $190,000.

Option A is incorrect
$100,000 in annual before-tax cash flow would equal $60,000 in annual after-tax cash flow.
When $60,000 is added to the depreciation tax shield of $36,000 per year, the resulting
$96,000 of annual net cash flow increase would not achieve a payback period of 3 years.

Option B is incorrect
$150,000 is the net after-tax cash flow increase required each year to achieve a payback
period of 3 years on a $450,000 investment. However, that is not what the question asks.

Option D is incorrect
$114,000 is the amount of increased cash flow from operations net of tax that is required.
However, it is not the amount that the sorter must generate in annual reductions of cash
operating costs in order to achieve a three-year payback.
138. Question - PART251466
Which of the following is a limitation of the profitability index?
It uses free cash flows.
It ignores the time value of money.
It is inconsistent with the goal of shareholder wealth maximization.
It requires detailed long-term forecasts of the project's cash flows.
Option D is correct
Profitability index is an investment appraisal technique that is calculated by dividing the
present value of future cash flows of a project by the initial investment required.
Profitability Index requires long term forecasts regarding the project's cash flows and
corresponding present value calculations, thereby not providing immediate results. This is a
limitation of the method.

Option A is incorrect
because these are essentially advantages of PI method.

Option B is incorrect
because these are essentially advantages of PI method.

Option C is incorrect
because PI considers time value of money.
139. Question - PART250013Charles Company owns a building that originally cost
$400,000 and has a current book value of $250,000. The building was financed by a loan that
has one payment of $20,000 outstanding, which must be paid off upon the sale of the
building. Charles Company would like to purchase a new building for $600,000. If the new
building is purchased, the existing building would be sold for $380,000. Charles Company’s
income tax rate is 40%. If the new building is purchased, the relevant initial cash flows would
total$272,000.00$292,000.00$372,000.00$392,000.00
Option B is correct
The relevant initial net cash outflow is $292,000, as follows:
Cash from sale of old building $380,000
Less: Mortgage payoff (20,000)
Calculation of tax due on gain on sale: $380,000 − $250,000 = $130,000 gain on sale
Tax on gain = $130,000 × 0.40= 52,000
Purchase of new building (600,000)
Net cash outflow $(292,000)

Option A is incorrect
This answer results from not deducting the mortgage payoff required on the old building.
Before title to the building can be transferred to the buyer, the mortgage must be paid off.
The payoff of the mortgage will be deducted from the cash received for the sale by Charles
Company.

Option C is incorrect
This answer results from two errors: (1) Not deducting the mortgage payoff required on the
old building. Before title to the building can be transferred to the buyer, the mortgage must be
paid off. The payoff of the mortgage will be deducted from the cash received for the sale by
Charles Company. (2) Incorrectly calculating the income tax due on the sale of the old
building. The income tax is based on the amount of the gain, not on the amount of the sale.
The amount of the gain is the difference between the sale price and the book value of the old
building.

Option D is incorrect
This answer results from incorrectly calculating the income tax due on the sale of the old
building. The income tax is based on the amount of the gain, not on the amount of the sale.
The amount of the gain is the difference between the sale price and the book value of the old
building.
140. Question - PART250021A financial analyst determines the after-tax operating cash
flow for a proposed project’s first year using the following estimates. Sales revenue
$2,000,000 Operating costs $1,000,000 Depreciation $ 200,000 Income tax rate 35% The
total after-tax operating cash flow for this project in its first year
is$520,000.00$650,000.00$720,000.00$850,000.00
Option C is correct
The total after-tax cash flow for the project's first year is
After-tax operating cash flow
= ((Operating Cost $1000,000 - Depreciation $200,000) (1- 35%)) Add Depreciation
$200,000
= $720,000
or
= Operating Cost $1000,000 - Tax 35% $1000,000 =
Add: Tax Shiel or Tax Saving on Depreciation $200,000 x 35% = $70,000
= $720,000

Option A is incorrect
This is ($2,000,000 revenue − $1,000,000 operating costs − $200,000 depreciation) × (1 −
0.35) = $520,000.
$520,000 is roughly equivalent to after-tax accounting income, although the amounts used for
sales revenue and operating costs are cash flow projections, not accrual accounting
projections. The depreciation expense should not be included as a reduction because
depreciation is a non-cash expense. Furthermore, the depreciation tax shield is omitted.
Please see the correct answer explanation for more information.

Option B is incorrect
This is ($2,000,000 revenue − $1,000,000 operating costs) × (1 − 0.35) = $650,000.
This cash flow amount omits the depreciation tax shield. Please see the correct answer
explanation for more information. Option

Option B is incorrect
This is ([$2,000,000 revenue − $1,000,000 operating costs] × [1 − 0.35]) + $200,000
depreciation = $850,000.
The depreciation expense should not be included as an addition to the net after-tax operating
cash flow. The amount that should be added is the depreciation tax shield, which is the
depreciation multiplied by the income tax rate. Please see the correct answer explanation for
more information.
141. Question - PART25111346
Skytop Industries is analyzing a capital investment project using discounted cash flow (DCF)
analysis. The new equipment will cost $250,000. Installation and transportation costs
aggregating $25,000 will be capitalized. and skytop needs additional working capital of
$15000. The appropriate five-year depreciation schedule (20%, 32%, 19%, 14.5%, 14.5%)
will be employed with no terminal value factored into the computations. Annual incremental
pre-tax cash inflows are estimated at $75,000. Skytop’s effective income tax rate is 40%.
Assuming the machine is sold at the end of Year 5 for $30,000, the after-tax cash flow for
Year 5 of the project would amount to
$63,950
$72,950
$93,950
$86,925
Option C is correct
The after-tax cash flows for Year 5 will be:
Release of working capital $15,000
After-tax cash flow from operations: $75,000 × 0.60 = $ 45,000
Depreciation tax shield: Total cost of $275,000 × 0.145 × 0.40 = $ 15,950
Sale of machine (fully depreciated): $30,000 cash from sale (fully taxable as gain) × 0.60 = $
18,000
Net after-tax cash flow = $93,950

Option A is incorrect
This answer results from calculating the net after-tax cash from operations by multiplying the
annual incremental pre-tax cash inflows by 0.40, which is the tax rate. To find the net after-
tax cash flow, the pre-tax cash inflows should be multiplied by 1 − the tax rate.

Option B is incorrect
This answer results from calculating the net after-tax cash received from the sale of the
equipment by multiplying the cash received by 0.40, which is the tax rate. To find the net
after-tax cash flow, the cash received should be multiplied by 1 − the tax rate.

Option D is incorrect
This answer results from calculating the depreciation tax shield by multiplying the Year 5
depreciation by 0.60, which is 1 − the tax rate. The depreciation tax shield is calculated by
multiplying the Year 5 depreciation by the tax rate.
142. Question - PART251504
Ryan Hong Enterprises is analysing an investment in Vietnam and its analyst has projected
the following cash flow streams for the project. In which of the following project scenarios,
will IRR be unreliable in the capital budgeting decision?
Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
–
Scenario 1 6,000 6,000 6,000 6,000 6,000
20,000
–
Scenario 2 8,000 7,000 6,000 5,000 4,000
20,000
– 14,00
Scenario 3 –8,000 6,000 0 19,000
20,000 0
–
Scenario 4 9,000 7,500 –1,000 5,000 9,000
20,000
Scenario 1.
Scenario 2.
Scenario 3.
Scenario 4.
Option D is correct
In this case, the cash flows are unconventional which means there is a cash outflow
happening after a series of cash inflows. Unconventional cash flows will result in multiple
IRR’s. There is a cash outflow happening in Year 3. As the cash flow sign changes twice
(Year 1 and Year 3) there will be two IRR’s. Thus, IRR method will be unreliable.
As per the Descartes rule of signs in financial mathematics, the number of IRRs depends on
the number of sign changes in cash flow stream. If there are there sign changes, then there
will be three IRRs. Also, note that the financial calculators and MS Excel can only show the
lowest IRR.
It should be noted that the sum of all future cash inflows needs to exceed the magnitude of
the initial outflow in order that an IRR exists.

Option A is incorrect
because these have conventional cash flows.

Option B is incorrect
because these have conventional cash flows.

Option C is incorrect
because these have conventional cash flows.
143. Question - PART251484
A company purchased property that it expects to sell for $14,000 next year. The net present
value of the investment is $1,000. The company is guaranteed an interest rate of 12% by the
bank. What amount did the company pay for the property?
$11,500.
$12,500.
$13,000.
$13,500.
Option A is correct
Net Present value is calculated as follows:
(Present value of cash inflows) - ( Present value of cash outflows)
Present value of expected cash inflow =$12,500 ($14,000 / 1.12).
Therefore, Present value of cash outflow = $12,500- $1,000 = $11,500.

Option B is incorrect
due to improper calculations.

Option C is incorrect
due to improper calculations.

Option D is incorrect
due to improper calculations.
144. Question - PART25111335
Albany Industries is building a temporary manufacturing plant which will be completely
removed after 5 years. The required initial cash outlays at Time 0 are as follows.

Land $ 500,000
New building 2,000,000
Equipment 3,000,000

Albany uses straight-line depreciation for tax purposes and will depreciate the building over
10 years and the equipment over 5 years. Albany’s effective tax rate is 40%

Revenues from the new plant are estimated at $1.5 million annually and cash expenses are
estimated at $300,000 annually. At the end of the fifth year, the assumed sales values of the
land and building are $700,000 and $800,000, respectively. The equipment will be removed
at a cost of $80,000 and sold for $200,000.

Albany’s net cash flow for period 5 would be

$1,040,000
$1,200,000
$2,612,000
$2,660,000
Option C is Correct
Revenue $ 1,500,000

Cash exp. -300,000

Depreciation - 800,000
Pretax Income $ 400,000
Tax at 40% -160,000
Add back depreciation 800,00
1,040,000
Sell land 700,000
Tax on gain /land -80,000
Sell building 800,000
Tax on loss/building 80,000
Sell equipment 120,000
Tax on on gain /equipment -48,000
 2,612,000
Option A is incorrect
The amount consider above for calculation is incorrect

Option B is incorrect
The amount consider above for calculation is incorrect

Option D is incorrect
The amount consider above for calculation is incorrect

145. Question - PART250097One disadvantage of using internal rate of return is that

itprovides a result that cannot be compared to other projects.may not be used when cash
flows vary from positive to negative in different years.is difficult for managers to understand
the results of the calculation.can only use a limited number of years in calculating the result.
Option B is correct
Whenever a project has a negative cash flow or flows in any subsequent year(s) after Year 0,
it is called a nonconventional project. A project like this can have more than one IRR,
because more than one discount rate will cause the project’s NPV to be zero. The number of
IRRs will be equal to the number of sign changes in the cash flows.

Option A is incorrect
IRR provides a result that can be compared to other projects.

Option C is incorrect
IRR is not difficult to understand.

Option D is incorrect
IRR can use any number of years in calculating the result.
146. Question - CMA251523
Which of the following statement is true concerning relationship between net present value
(NPV) and internal rate of return (IRR)?
NPV of more than zero for the project would mean that IRR is less than the cost of capital.
NPV of less than zero for the project would mean that IRR is more than the cost of capital.
NPV equal to zero for the project would mean that IRR is equal to cost of capital.
NPV calculated at IRR is always more than zero.
Option C is correct.
Internal rate of return (IRR) is the rate of return, at which net present value (NPV) is equal to
zero. Thus, NPV equal to zero for the project would mean that IRR is equal to cost of capital.

Option A is incorrect
because NPV of more than zero for the project would mean that IRR is more (not less) than
the cost of capital i.e. the discount rate.

Option B is incorrect
because NPV of less than zero for the project would mean that IRR is less (not more) than the
cost of capital i.e. the discount rate.

Option D is incorrect
because IRR is the rate of return at which NPV is equal to zero. Thus, NPV calculated at IRR
is always equal to (not more than) zero.
147. Question - PART251489
An investment in a new product will require an initial outlay of $20,000. The cash inflow
from the project will be $4,000 a year for the next six years. The payment will be received at
the end of each year. What is the net present value of the investment at 8% using the correct
factor from below?
Present value of $1 to be received after six periods 0.63017
Present value of an ordinary annuity of $1 per period for six periods 4.62288
Present value of an ordinary annuity due of $1 per period for six periods 4.99271
Future value of $1 at the end of six periods 1.5868

($skyline
.92).
($1,508.48).
($ 29.16).
$18,084.88.
Option B is correct
Net present value is calculated as follows :
NPV = (Present value of cash inflows) - ( Present value of cash outflows)
As the cash inflows are received at the end of each year therefore, the present value of
Ordinary annuity of $1 is used
Present value of cash inflows = $4,000 x 4.62288 = $18,491.52.
NPV = $18,491.52 - $20,000 = ($1,508.48).

Option A is incorrect
due to improper calculations.

Option D is incorrect
due to improper calculations.

Option C is incorrect
because it uses the present value of annuity due to calculate the present value of cash
inflows.
148. Question - CMA211497
A project should be accepted if the present value of cash inflows from the project is
Equal to the initial investment.
Less than the initial investment.
Greater than the initial investment.
Equal to zero.
Option C is correct.
The Net Present Value (NPV) is the excess of the present value of the cash inflows over the
outflows, discounted using the time value of the money in the investment. A project should
be accepted if there is a positive NPV, that is the present value of cash flows from the project
is greater than the initial investment.

Option A is incorrect
because if the present value of inflow is equal to the initial investment, it does not provide
any gain and there is no benefit in investing in the project.

Option B is incorrect
because if the present value of inflow is less than the initial investment, it is a loss to invest in
the project.

Option D is incorrect
because if the present value of inflow is equal to zero, it means that the project does not give
any returns and thus should not be accepted.
149. Question - PART250055
Jorelle Company's financial staff has been requested to review a proposed investment in new
capital equipment. Applicable financial data is presented below. There will be no salvage
value at the end of the investment's life and, due to realistic depreciation practices, it is
estimated that the salvage value and net book value are equal at the end of each year. All cash
flows are assumed to take place at the end of each year. For investment proposals, Jorelle
uses a 12% after-tax target rate of return.

The net present value for the investment proposal is

-$97,970$106,160$356,160$96,560150. Question - PART250022
A company is analyzing the purchase of production machinery for a new product. The
following facts relate to Year 5, the final year, of the project.
• $20,000 proceeds will be realized from the sale of the fully depreciated machinery.
• The initial $50,000 investment in working capital will be recovered.
• The machinery, with an initial total cost of $500,000, was depreciated on a straight-line
basis over five years.
• An accrual of $50,000 will be established on a straight-line basis over the useful life of the
asset to cover the costs to restore the site where the machinery is located. However, the actual
net decommissioning costs are forecast to be only $40,000.
• The machinery generates 10,000 units of product with a sales price of $5 per unit. The cost
of production is $2.50 per unit.
What is the after-tax cash flow that the company must consider for Year 5 in its capital
budgeting analysis of the project using a 30% effective income tax rate?
$68,500.00$83,500.00$89,500.00$97,000.00151. Question - PART251469
What is an internal rate of return?
A net present value.
An accounting rate of return.
A payback period expected from an investment.
A time-adjusted rate of return from an investment.
Option D is correct
Internal rate of return is the rate of interest that equates the present value of cash outflows and
the present value of the cash inflows. It is also known as the time adjusted rate of return from
an investment.

Option A is incorrect
because the internal rate of return is not the net present value; it is the rate of interest that
equates the present value of cash outflows and the present value of the cash inflows.

Option B is incorrect
because the internal rate of return is not the accounting rate of return.

Option C is incorrect
because payback period is the length of time to recoup the amount of investment and the
internal rate of return is the rate of interest that equates the present value of cash outflows and
the present value of the cash inflows.
152. Question - PART250041
During a presentation on non-discounted cash flow models for capital budgeting decisions, an
analyst made the following two statements concerning the payback method.
Statement 1: It is the best decision criterion for accepting/rejecting the project.
Statement 2: It may encourage excessive investments in short-term projects at the expense of
investments in long-term projects.
The analyst is correct regarding
statement 1, only.statement 2, only.neither statement 1 nor statement 2.both statement 1 and
statement 2.
Option B is Correct:
The payback method may encourage excessive investments in short-term projects at the
expense of investments in long-term projects because it ignores all cash flows beyond the
payback period. Therefore, a project that has large expected cash flows in the latter years of
its life could be rejected in favor of a less profitable project that has a larger portion of its
cash flows in its early years.

Option A is Incorrect:
The payback method is not the best decision criterion for accepting/rejecting the project
because (1) the method does not incorporate the time value of money, so interest on the
investment lost while the company waits to receive money from the investment is not
considered at all; and (2) it ignores the cost of capital, so the company could accept a project
for which it will pay more for its capital than the project can return.

Option C is Incorrect:
Only one of the statements is true.
Option D is Incorrect
One of the statements is true.
153. Question - PART251480
Which of the following is an advantage of net present value modeling?
It is measured in time, not dollars.
It uses accrual basis, not cash basis accounting for a project.
It uses the accounting rate of return.
It accounts for compounding of returns.
Option D is correct.
The advantage of Net present value method is that the cash generated by a project is
immediately reinvested to generate a return at a rate that is equal to the discount rate used in
the present value analysis. Therefore, NPV considers compounding of returns.

Option A is incorrect
because NPV is measured in dollars.

Option B is incorrect
because NPV uses cash basis of accounting for a project instead of the accrual basis of
accounting.

Option C is incorrect
because NPV does not use the accounting rate of return.
154. Question - PART250118All decisions by financial managers should be driven by the
primary goal toMaximize revenues.Minimize fixed costs and variable costs.Stabilize
growth.Maximize stockholder wealth.
Option D is correct
Ideally all decisions are made with the best interests of the owners of the company in mind.
This is done by making decisions that maximize shareholder wealth.

Option A is incorrect
The company exists in order to provide a return to its owners. Therefore, management of the
company should operate in such a way so as to maximize the wealth that is generated for the
shareholders. The maximization of revenue does not automatically do that.

Option B is incorrect
The company exists in order to provide a return to its owners. Therefore, management of the
company should operate in such a way so as to maximize the wealth that is generated for the
shareholders. Minimizing fixed and variable costs may not automatically do that.

Option C is incorrect
The company exists in order to provide a return to its owners. Therefore, management of the
company should operate in such a way so as to maximize the wealth that is generated for the
shareholders. Stable growth does not automatically do that.
155. Question - PART2510212
The following data pertain to a 4-year project being considered by Metro Industries:
A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is
expected to have a $200,000 salvage value at the end of 4 years, qualifies as 3-year property
under the Modified Accelerated Cost Recovery System (MACRS).
The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold
on the same January 1 for $180,000.
The project is expected to provide added annual sales of 30,000 units at $20. Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
A $50,000 working capital investment that is fully recoverable at the end of the fourth year is
required.
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar.
Assume that any gain or loss affects the taxes paid at the end of the year in which it occurred.
The company uses the net present value method to analyze investments and will employ the
following factors and rates.
Perio Present Value of $1 at 12 % Present Value of $1 Annuity at 12% MACRS
d
1 0.89 0.89 33%
2 0.80 1.69 45
3 0.71 2.40 15
4 0.64 3.04 7
The discounted cash flow for the fourth year MACRS depreciation on the new asset is
$17,920.
$26,880.
$21,504.
$0.
156. Question - PART251501
Tam Co. is negotiating for the purchase of equipment that would cost $100,000, with the
expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were
acquired. The equipment’s estimated useful life is 10 years, with no residual value, and
would be depreciated by the straight-line method. Tam’s predetermined minimum desired
rate of return is 12%. Present value of an annuity of 1 at 12% for 10 period is 5.65. Preset
value of 1 due in 10 period at 12% is 0.322.
In estimating the internal rate of return, the factor in the table of present value of an annuity
should be taken from the columns closest to
0.65
1.30
5.00
5.65
Option C is correct.
The internal rate of return is the discount rate at which the net present value is zero. It is
where the rate of return equates the present value (PV) of cash outflows and PV of cash
inflows.
Internal rate of return = Initial investment / After-tax net cash flows = PV factor.
PV factor = $100,000 / $20,000 = 5. The internal rate of return is the rate at which the factor
in the PV annuity table for 10 years is closest to 5.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.
157. Question - PART2110685
Nittany Co. is considering purchasing one of the two different machines for their factory.
Both machines would be used to introduce a new product to Nittany's already diversified
product line. There is, however, great disagreement among management as to which of
the projects should be invested in by Nittany. There are only enough funds for one of the
following projects to be invested in. You have been hired as a consultant to assist
management in making a decision as to which of these two machines should be purchased.
Information about the 2 machines is below:
Machine 1 Machine 2
Initial Cost $100,000 $200,000
Transportation & Installation $ 20,000 $40,000
Estimated Salvage Value $10,000 $90,000
Expected Useful Life 5 years 8 years
Tax Depreciation Method Straight- Straight
Line* Line*
Estimated increased revenues each period $30,000 $52,000
Estimated Cost Savings each period $20,000 $ 6,000
Investment in Working Capital at the beginning of the project & $16,000 $8,000
$4,000 at the end of the year 4

* In the calculation of tax depreciation expense, the salvage value of the machine is not taken
into account and the entire initial cost of the asset will be depreciated over the useful life of
the asset.
The cost of capital for Nittany is 10% and Nittany generally does not invest in any project
that does not return at least 12%. Nittany's tax rate is 30%.
What is the internal rate of return for Machines 1 and 2, respectively?

17.69% and 14.20%

33.74% and 23.71%
19.83% and 14.65%
35.04% and 24.72%
158. Question - PART25111331
Mintz Corporation is considering the acquisition of a new technologically efficient packaging
machine at a cost of $300,000. The equipment requires an immediate, fully recoverable,
investment in working capital of $40,000. Mintz plans to use the machine for five years, is
subject to a 40% income tax rate, and uses a 12% hurdle rate when analyzing capital
investments. The company employs the net present value method (NPV) to analyze projects.

The overall impact of the working capital investment on Mintz’s NPV analysis is
$(10,392)
$(13,040)
$(17,320)
$(40,000)
Option C is correct
The overall impact of the working capital on the analysis is that $40,000 is a cash outflow in
Year 0 and $40,000 is a cash inflow in Year 5. The Year 0 outflow is not discounted, and the
Year 5 inflow is discounted using the PV of $1 factor for 12% for 5 years. Then the two
amounts are netted together. Year 0: $(40,000) × 1.000 = $(40,000) Year 5: $40,000 × 0.567
= $22,680 The overall impact on the NPV analysis is thus $(40,000) + $22,680, which is
$(17,320). This is the amount by which the project's NPV is reduced by the impact of the
working capital investment.

Option A is incorrect
This is the net overall impact of the working capital investment on the NPV multiplied by 0.6
to calculate an after-tax value. The working capital increase and the subsequent release of the
working capital at the end of the project are not income items, so they are not subject to
income tax.

Option B is incorrect
This answer results from discounting the working capital cash outflow for one year and the
working capital cash inflow for five years. Discounting the cash inflow for five years is
correct, but the cash outflow takes place at Year 0 and thus should not be discounted.

Option D is incorrect
This is the amount of the working capital investment. The overall impact of the working
capital on the analysis is that $40,000 is a cash outflow in Year 0 and $40,000 is a cash
inflow in Year 5. The Year 0 outflow is not discounted, and the Year 5 inflow is discounted
using the PV of $1 factor for 12% for 5 years. Then the two amounts are netted together to
calculate the overall impact of the working capital investment on the NPV.
159. Question - PART250007The term that refers to costs incurred in the past that are not
relevant to a future decision isSunk costFull absorption cost.Discretionary
cost.Underallocated indirect cost.
Option A is correct
A sunk cost is one that has already been incurred and therefore is not a relevant cost. Sunk
costs are not taken into account in the decision making process because the money has
already been spent, and those costs will not be changed by one decision or another.

Option B is incorrect
Full absorption costing is a form of costing that includes both variable and fixed production
costs in product costs that follow inventory and are expensed as cost of goods sold only when
the inventory is sold.

Option C is incorrect
A discretionary cost is a cost that is not a committed cost. It can be increased or decreased at
the discretion of the decision maker. Advertising, employee training, preventive maintenance,
and research and development are examples of discretionary costs.

Option D is incorrect
An underallocated indirect cost is a cost that has not yet been allocated to production,
although it is a cost of production.
160. Question - PART251538
A company is considering investing in a five year project that has an initial investment of
$400,000 and cost of capital of 10%. Per year cash inflows and outflows are $150,000 and
$12,000. Depreciation provided in the books per annum is $80,000 but the income tax
disallows $10,000 from the depreciation charged in books before charging the tax rate of
30%. Calculate the net cash inflow from the investment in year 2.
PV of $1 for 2nd year @10% is 0.826.
$162,000
$97,138
$200,600
$117,600
Option D is correct.
Net cash inflow from the investment is calculated as follows:
Outflow for year 2 (after tax saving) = 12,000 x (1 - 0.30) = $8,400.
Inflow for year 2 (after taxes) = 150,000 x (1 - 0.30) = $ 105,000.
Tax shield on depreciation [to be calculated on depreciation allowed as per income tax i.e.
$70,000] = $70,000 x 0.30 = $21,000.
Thus, net cash inflow for year 2 = $105,000 + $21,000 - $8,400 = $117,600.

Option A is incorrect
because this would be the result when taxes are not considered for inflows and outflows and
tax shield on depreciation is calculated at depreciation charged in the books i.e. $80,000.
Then the calculations would be as:
Outflow for year 2 = $12,000.
Inflow for year 2 = $150,000.
Tax shield on depreciation = $80,000 x 0.30 = $24,000.
Thus, net cash inflow for year 2 = $150,000 + $24,000 - $12,000 = $162,000.

Option B is incorrect
because this would be the result when the inflows and outflows are discounted. The question
does not ask about present value of net cash inflows for year 2. Then the calculations would
be as:
Thus, PV of net cash inflow for year 2 = 117,600 x 0.826 = $97,138.

Option C is incorrect
because this would be the result when and tax shield on depreciation is calculated at
depreciation charged in the books i.e. $80,000. Then the calculations would be as:
Tax shield on depreciation = $80,000 x 0.30 = $24,000.
Thus, net cash inflow for year 2 = $105,000 + $24,000 - $8,400 = $200,600.
161. Question - PART251477
A corporation is considering purchasing a machine that costs $100,000 and has a $20,000
salvage value. The machine will provide net annual cash inflows of $25,000 per year and has
a six-year life. The corporation uses a discount rate of 10%. The discount factor for the
present value of a single sum six years in the future is 0.564. The discount factor for the
present value of an annuity for six years is 4.355. What is the net present value of the
machine?
($2,405).
$8,875.
$20,155.
$28,875.
Option C is correct.
Net Present Value is the difference between the present value of cash inflows and the present
value of cash outflows. It is calculated as follows:
NPV = (Present value of cash inflows) - (Present value of cash outflows).
Present value of cash inflows = $108,875 = ($25,000 x 4.355).
Present value of the salvage value = $11,280 = ( $20,000 x 0.564 ).
Total Present value of cash inflows = $120,155 = ($108,875 + $11,280).
NPV = $120,155 - $100,000 = $20,155
Option B is incorrect
because it does not consider the salvage value for the computation NPV.

Option A is incorrect
because of improper calculation of NPV.

Option D is incorrect
because of improper calculation of NPV.
162. Question - CMA251512
Which of the following methods of capital budgeting considers non-cash expenses as an
outflow?
Net present value.
Internal rate of return.
Accounting rate of return.
Payback method.
Option C correct.
Accounting rate of return uses accounting income as a basis of calculating return on the
initial investment. Accounting income is arrived at after deducting all non-cash expenses as
well from the cash inflows. Thus, accounting rate of return method of capital budgeting
considers non- cash expenses also as an outflow.

Option A is incorrect
because all of these methods consider only cash inflows and cash outflows to evaluate an
investment.

Option B is incorrect
because all of these methods consider only cash inflows and cash outflows to evaluate an
investment.

Option D is incorrect
because all of these methods consider only cash inflows and cash outflows to evaluate an
investment.
163. Question - CMA251544
Tam Co. is negotiating for the purchase of equipment that would cost $100,000, with the
expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were
acquired. The equipment’s estimated useful life is 10 years, with no residual value and would
be depreciated by the straight-line method. Tam’s predetermined minimum desired rate of
return is 12%. The present value of an annuity of 1 at 12% for 10 period is 5.65. The present
value of 1 due in 10 period at 12% is .322. Net present value is:
$5,760
$6,440
$12,200
$13,000
Option D is correct.
Present value of the annuity amount $20,000 for 10 years = Present value of an annuity of 1
at 12% for 10 periods × Annuity amount = $20,000 × 5.65 = $113,000.
NPV = PV of annuity – Initial investment = $113,000 – $100,000 = $13,000.

Option A is incorrect
due to inaccurate calculations.

Option B is incorrect
because this is calculated as [i.e. $6,440 = 0.322 × $20,000].

Option C is incorrect
due to inaccurate calculations.
164. Question - CMA251540
In capital budgeting, the possibility of adjustments that a firm can make after a project is
accepted exists under which of the following techniques?
Net present value.
Real options.
Internal rate of return.
Profitability index.
Option B is correct
Real options is a capital budgeting technique where the company has an option to expand the
project, if demand turns out to be higher than expected or abandon the project if demand
turns out to be lower than expected or delay a project if underlying variables are changing
with a favorable trend. Thus, a real option is a capital budgeting technique where possibility
of adjustments that a firm can make exists after a project is accepted.

Options A is incorrect
because these are the techniques where once the project is accepted based on the results of
these techniques, no adjustments can be made.

Options C is incorrect
because these are the techniques where once the project is accepted based on the results of
these techniques, no adjustments can be made.

Options D is incorrect
because these are the techniques where once the project is accepted based on the results of
these techniques, no adjustments can be made.
165. Question - PART250030
Jorelle Company's financial staff has been requested to review a proposed investment in new
capital equipment. Applicable financial data is presented below. There will be no salvage
value at the end of the investment's life and, due to realistic depreciation practices, it is
estimated that the salvage value and net book value are equal at the end of each year. All cash
flows are assumed to take place at the end of each year. For investment proposals, Jorelle
uses a 12% after-tax target rate of return.
Investment Proposal Purchase Cost and Book Annual Net After-Tax Annual Net
Year Value ($) Cash Flow ($) Income ($)
0 $250,000 0 0
1 168,000 120,000 35,000
2 100,000 108,000 39,000
3 50,000 96,000 43,000
4 18,000 84,000 47,000
5 0 72,000 51,000
Discount Factors for a 12% Rate of Return:
Year 1 2 3 4 5 6
Year Present Value of $1 Received at the End of Period 0.89 0.80 0.71 0.6 0.57 0.51
4
Present Value of Annuity of $1 Received at End of Each Period 0.89 1.69 2.40 3.0 3.61 4.12
4
The traditional payback period for the investment proposal is
2.23 years.Over 5 years.1.65 years.2.83 years.
Option A is correct
When cash flows are not constant over the life of the project, we must find the cumulative
cash inflows for each year to determine when the inflows will equal the outflows.
The cash flows are as follows: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net initial investment (250,000)
After-tax cash flows from 0 120,000 108,000 96,000 84,000 72,000
operations
Cumulative cash flows (250,000) (130,000) (22,000) 74,000 158,000 230,000
The cumulative cash flow from the project becomes positive sometime during year 3. If the
cash flows are assumed to occur evenly throughout the year, the exact payback period is 2.23
years, calculated as follows: Number of the project year in the final year when cash flow is
negative: 2 Plus: a fraction consisting of Numerator = the positive value of the negative
cumulative inflow amount from the final negative year: 22,000 Denominator = cash flow for
the following year: 96,000 OR: 2 + (22,000/96,000) = 2.23
The initial investment will be recouped after 2.23 years.

Option B is incorrect
An answer of "over 5 years" could result from using the annual net income amounts instead
of the annual after-tax cash flows to calculate the payback period.

Option C is incorrect
An answer of 1.65 years results from adding together the annual after-tax cash flow and the
annual net income for each year and using the total to determine the payback period.
However, the payback period should be determined using annual after-tax cash flow only.

Option D is incorrect
An answer of 2.83 years results from using the discounted annual after-tax cash flows to
determine the payback period. However, the traditional payback period uses undiscounted
cash flows to calculate the payback period.
166. Question - PART250056The NPV of a project has been calculated to be $215,000.
Which one of the following changes in assumptions would decrease the NPV?Decrease the
estimated effective income tax rate.Extend the project life and associated cash
inflows.Decrease the initial investment amount.Increase the discount rate.
Option D is correct
Increasing the discount rate will decrease the present value of the cash inflows, which will
decrease the NPV.

Option A is incorrect
Decreasing the estimated effective income tax rate will increase the net of tax cash inflows,
which will increase the NPV.

Option B is incorrect
Extending the life of the project will increase the cash flows and thus increase the NPV.

Option C is incorrect
Decreasing the initial investment amount will increase the NPV.
167. Question - PART251481
A client wants to know how many years it will take before the accumulated cash flows from
an investment exceed the initial investment, without taking the time value of money into
account. Which of the following financial models should be used?
Payback period.
Discounted payback period.
Internal rate of return.
Net present value.
Option A is correct
Payback period method evaluates investments based on the length of time until recapture
(return) of the investment. It does not take into account the time value of money. Therefore,
the client should use the payback period method to know the number of years it will take
before the accumulated cash flows from an investment exceed the initial investment.

Option B is incorrect
because discounted payback period method takes into account the time value of money.

Option C is incorrect
because both internal rate of return and net present value method use time value of money.

Option D is incorrect
because both internal rate of return and net present value method use time value of money.
168. Question - PART250148
A company is considering two investments. Both have an estimated useful life of 5 years and
require an initial cash outflow of $15,000. The cash inflow for each project is shown below.
Year 1 Year Year 3 Year 4 Year 5
2
Project A $7000 $8000 $9000 $0 $0
Project Z $0 $5000 $5000 $5000 $25,000
The company requires an 8% rate of return and uses straight-line depreciation. Present value
factors at a rate of 8% are as follows:
Year 1 Year 2 Year 3 Year Year 5
4
PV of $1 0.962 0.857 0.794 0.735 0.681
PV of Annuity 0.962 1.783 2.577 3.312 3.993
Which one of the following capital budgeting evaluation methods would result in an initial
recommendation of the less profitable project as the better choice?
Payback period.Accounting rate of return.Internal rate of return.Net present value.
Option A is correct
Project A’s cash flows are all received in the first three years of the project, whereas Project
Z’s cash flows are received in Years 2 through 5, with its largest cash flow not received until
Year 5.
The Payback Period for Project A is 2 years ($7,000 + $8,000 = $15,000, the amount of the
investment).
The Payback Period for Project Z is 4 years ($0 + $5,000 + $5,000 + 5,000 = $15,000).
Therefore, according to the Payback Period, Project A is the better project to invest in
because its payback period is shorter.
The NPVs of both projects are as follows:
Project A: ($7,000 × 0.926) + ($8,000 × 0.857) + ($9,000 × 0.794) − $15,000 = $5,484
Project Z: ($5,000 × 0.857) + ($5,000 × 0.794) + ($5,000 × 0.735) + ($25,000 × 0.681) −
$15,000 = $13,955.
Since the NPV of Project Z is higher than the NPV of Project A, Project A is less profitable
than Project Z.
Therefore, the use of the Payback Method would result in an initial recommendation of the
less profitable project as the better choice.
(Note: The problem does not give the company’s tax rate. Therefore, it is not possible to
calculate the depreciation tax shields for these projects. However, because the initial
investments and the lengths of the two projects are the same, the depreciation and thus the
depreciation tax shield will be the same for both projects and so it is not relevant to a
comparison of which NPV is higher.)

Option B is Incorrect
This is not the correct answer. Please see the correct answer for an explanation. Option

Option C is incorrect
This is not the correct answer. Please see the correct answer for an explanation.

Option D is incorrect
This is not the correct answer. Please see the correct answer for an explanation.
169. Question - PART250001The Moore Corporation is considering the acquisition of a new
machine. The machine can be purchased for $90,000; it will cost $6,000 to transport to
Moore's plant and $9,000 to install. It is estimated that the machine will last 10 years, and it is
expected to have an estimated salvage value of $5,000. Over its 10-year life, the machine is
expected to produce 2,000 units per year with a selling price of $500 and combined material
and labor costs of $450 per unit. Federal tax regulations permit machines of this type to be
depreciated using the straight-line method over 5 years with no estimated salvage value.
Moore has a marginal tax rate of 40%. What is the net cash outflow at the beginning of the
first year that Moore Corporation should use in a capital budgeting analysis?-$96,000-
$105,000-$90,000-$85,000
Option B is correct
The net cash outflow at the beginning of the first year includes the purchase price of $90,000,
the transportation cost of $6,000, and the installation cost of $9,000, for a total of $105,000.
There is no income tax effect in Year 0, since these costs will all be capitalized and
depreciated over the life of the machine.

Option A is incorrect
A cash outflow of $96,000 includes the purchase price of the machine ($90,000) and the
transportation cost ($6,000). However, these are not the only costs that will be cash outflows
at the beginning of the project.

Option C is incorrect
A cash outflow of $90,000 is equal to the purchase price of the machine. However, this is not
the only cost that will be a cash outflow at the beginning of the project.

Option D is incorrect
A cash outflow of $85,000 is equal to the purchase price of the machine less the expected
salvage value. However, netting out the salvage value at the beginning of the project is
incorrect. Furthermore, the purchase price of the machine is not the only cost that will be a
cash outflow at the beginning of the project.
170. Question - PART250004Lawson Inc. is expanding its manufacturing plant, which
requires an investment of $4 million in new equipment and plant modifications. Lawson's
sales are expected to increase by $3 million per year as a result of the expansion. Cash
investment in current assets averages 30% of sales; accounts payable and other current
liabilities are 10% of sales. What is the estimated total investment for this expansion?$4.3
million.$4,9 million.$3.4 million.$4.6 million.
Option D is correct
The total investment includes the costs for the new equipment and plant modifications plus
the increase in net working capital as a result of the project. The investment in net working
capital will be 20% of sales (30% of sales invested in current assets less 10% of sales in
current liabilities). Thus, the increase in working capital required will be $3,000,000 × 0.20,
or $600,000. The investment in new equipment and plant modifications is $4,000,000. The
total investment is therefore $4,600,000.

Option A is incorrect
An answer of $4.3 million results from using 10% of sales as the increase in net working
capital. 10% of sales is the amount by which accounts payable and other current liabilities
will increase, but the amount of increase in net working capital is the amount of increase in
current assets minus the amount of increase in current liabilities.

Option B is incorrect
An answer of $4.9 million results from using 30% of sales as the increase in net working
capital, which is incorrect. Net working capital also includes related accounts payable and
other current liabilities. The amount of increase in net working capital is the amount of
increase in current assets minus the amount of increase in current liabilities.

Option C is incorrect
An answer of $3.4 million results from subtracting the net working capital increase from the
initial investment in new equipment and plant modifications, which is incorrect. An increase
in net working capital is a cash outflow, so it increases the total investment amount.
171. Question - PART250101Essential Manufacturing is considering investing $1,000,000
in a new project. The project is expected to yield annual incremental net cash flows of
$305,500 for 5 years. What is the approximate internal rate of return for this project?
13%10%16%More than 20%
Option C is correct
The Internal Rate of Return is the interest rate at which the present value of expected net cash
inflows from a project equals the present value of expected cash outflows. The present value
of expected net cash inflows for an annuity consisting of equal payments is the annual
amount multiplied by the factor for the Present Value of an Annuity using the appropriate
discount rate and term. Therefore, solving the equation 305,500X = 1,000,000 for the value
of X will result in the present value factor for the relevant annuity. Once that factor is known,
we can look across the 5-year line on the factor table to locate the closest factor or factors and
get the approximate rate, which will be the IRR. 305,500X = 1,000,000 X = 3.2733 Looking
across the 5-year line on the table for the Present Value of an Annuity, we find a factor of
3.2743 for a 16% discount rate. Therefore, the IRR is approximately 16%.
Option A is Incorrect
The amount consider above for calculation is incorrect

Option B is Incorrect
The amount consider above for calculation is incorrect

Option D is Incorrect
The amount consider above for calculation is incorrect
172. Question - PART250143The value of a real option in capital budgeting isthe weighted
average of the possible payoffs of the real option.the standard deviation of the expected
returns of the project with the real option.the value of the project with the real option minus
the value of the project without the real option.the amount of future potential project value
increases.
Option C is correct
The value of a real option on a project is the difference between the value of the project with
the real option and the value of the project without the real option.

Option A, B, D is incorrect
As explained above
173. Question - PART250031Which one of the following statements about the payback
method of investment analysis is correct? The payback methodUses discounted cash flow
techniques.Does not consider the time value of money.Generally leads to the same decision
as other methods for long-term projects.Considers cash flows after the payback has been
reached.
Option B is correct
The payback method uses undiscounted cash flows and thus does not incorporate the time
value of money in the analysis. That is one of its weaknesses. Another weakness is that it
does not take into account any cash flows that are received after the payback point has been
reached.

Option A is incorrect
The payback method does not use discounted cash flow techniques, and that is one of its
weaknesses.

Option C is incorrect
The payback method does not necessarily lead to the same decision as other methods of
analyzing long-term projects do. Here are some examples of how and why the payback
method can lead to a different accept-reject decision from the Net Present Value method: •
The payback method ignores all cash flows beyond the payback period. For example, a
company may require that a project achieve payback within 3 years. A project with large
expected cash flows in Year 4 but lower expected cash flows in Years 1 through 3 could
easily fail that test. However, if the same project is evaluated for its Net Present Value, that
project might have a very high NPV. So the payback method would lead to a "reject"
decision whereas the NPV method would lead to an "accept" decision. • Since the payback
method does not use discounting of future cash flows, the cost of capital is not included in a
payback analysis. The only place the cost of capital is included in a capital budgeting cash
flow analysis is in calculation of the present value of expected future cash flows. A project
might appear acceptable using the payback method because the initial investment is recouped
within the company's required time period. But when the same project is evaluated using the
present value of future expected cash flows, discounted at the company's cost of capital, it
may have a negative NPV.

Option D is incorrect
The payback method does not take into account any cash flows expected to be received after
the payback point has been reached.

174. Question - PART251496

The following information pertains to Krel Co.'s computation of net present value relating to
a contemplated project:
Discounted expected cash inflows $1,000,000
Discounted expected cash outflows $700,000
Net present value is ?
$300,000
$700,000
$850,000
$1,000,000
Option A is correct.
Net Present Value (NPV) is the excess of present value of cash inflows over outflows (the
investment today) discounted using the time value of money in the investment.
Formula to calculate NPV is:
P.V. of Cash Inflows - P.V. of Cash Outflows
$1,000,000 - $700,000 = $300,000 (+ve NPV).

Option B is incorrect
based on the above computation.

Option C is incorrect
based on the above computation.

Option D is incorrect
based on the above computation.
175. Question - CMA251535
The income tax has a significant effect on the future cash flows from the project and should
be taken into account while evaluating a project because income taxes would decrease:
No @ NoYes @ NoNo @ YesYes @ Yes
Option D is correct.
Income taxes decrease the future costs of a project as well as future benefits from a project.
For example:
A company expects to generate $10,000 cash from its operations. Also there is a tax
deductible expense of $5,000.The tax rate of the company is 30%.
After tax cash inflow (benefits) = (1 – Tax rate) × Taxable cash receipt = (1 – 0.3) × $10,000
= 0.7 × $10,000 = $7,000.
After-tax cost = (1 – Tax rate) × Tax deductible cash expense = (1 – 0.3) × $5,000= $3,500.
Thus, both the future costs and benefits of a project decreases.

Option A is incorrect
based on the above explanation.

Option B is incorrect
based on the above explanation.

Option C is incorrect
based on the above explanation.
176. Question - PART25111329
Bell Inc. has a new project available which is expected to generate annual sales of 200,000
units for the next 8 years and then be discontinued. New equipment will be purchased for
$1,600,000 and cost $200,000 to install. The equipment will be depreciated on a double-
declining basis over its useful life. At the end of the eighth year, it will cost $50,000 to
remove the equipment, which can be sold for $150,000. Additional working capital of
$400,000 will be required immediately and needed for the life of the product. Annual indirect
costs will increase by $300,000. Bell’s effective tax rate is 40%.

In a capital budgeting analysis, what is the cash outflow at time 0 (initial investment) that
Bell should use to compute the net present value?
$1,600,000
$1,750,000
$1,800,000
$2,200,000
Option D is correct
Bell’s initial investment is $2,200,000 as shown below.
Equipment $1,600,000
Installation 200,000
Working capital 400,000
Initial investment $2,200,000

Option A is incorrect
The amount consider for calculation is incorrect

Option B is incorrect
The amount consider for calculation is incorrect

Option C is incorrect
The amount consider for calculation is incorrect
177. Question - CMA251522
Calculation of internal rate of return (IRR) for a project would not use:
Initial investment.
Present value factor.
After tax net cash inflows.
Life of the project.
Option B is correct.
Present value (PV) factor is not used to calculate internal rate of return (IRR) for a project
because present value factor has to be first calculated which is located against the life of the
project to arrive at the IRR rate.

Option A is incorrect
because initial investment is used as a numerator to calculate the PV factor which is then used
to arrive at the IRR rate.
Option C is incorrect
because after tax net cash inflows is used as a denominator to calculate the PV factor which is
then used to arrive at the IRR rate.

Option D is incorrect
because life of the project has to be known to calculate IRR. The calculated PV factor is
located against the life of the project to arrive at the IRR rate.
178. Question - PART250015The management of a company is considering making a
capital investment to acquire a machine for its manufacturing facility at a total cost of
€600,000 for equipment and installation. The machine has a useful life of 5 years and a zero
salvage value at the end of its useful life. The management of the company uses the straight-
line depreciation method for all machinery acquired. How much would the company’s annual
tax savings be upon acquiring the machine if the company’s income tax rate is 30%?
€36,000.00€84,000.00€120,000.00€180,000.00
Option A is correct
The annual depreciation expense will be €600,000 ÷ 5, or €120,000. At an income tax rate of
30%, the depreciation tax shield will be 30% of €120,000, or €36,000.

Option B is incorrect
€84,000 is the amount of the annual depreciation less the amount of the depreciation tax
shield. The annual tax savings for the company is only the amount of the depreciation tax
shield.

Option C is incorrect
€120,000 is the amount of the annual depreciation on the equipment. The annual tax savings
for the company is the amount of the annual depreciation multiplied by the company's tax
rate.

Option D is incorrect
€180,000 is 30% of the €600,000 investment. The annual tax savings for the company is the
amount of the annual depreciation on the investment multiplied by the company's tax rate.
179. Question - PART25111001
Which one of the following items is least likely to directly impact an equipment replacement
capital expenditure decision?
The net present value of the equipment that is being replaced
The depreciation rate that will be used for tax purposes on the new asset
The amount of additional accounts receivable that will be generated from increased
production and sales
The sales value of the asset that is being replaced.
Option A is correct
Anything that will influence or affect future cash flows of the project will have a direct
impact on the decision. The net present value of the equipment that is being replaced is not
information that is relevant to a capital budgeting decision because it is not a cash flow
(though it may give an indication of potential future cash flows of the old equipment). The
salvage, or sales value, of the asset that is being replaced is relevant information because it is
a cash inflow and it therefore has a direct impact on the decision. The depreciation rate that
will be used for tax purposes on the new asset is relevant information because it will affect
the depreciation tax shield, which is one of the cash flows connected with the new project.
The amount of additional accounts receivable that will be generated from increased
production and sales is relevant because an increase in accounts receivable will impact net
working capital, which is one of the cash flows considered in a project.

Option B is incorrect
Anything that will influence or affect future cash flows of the project will have a direct
impact on the decision. The depreciation rate that will be used for tax purposes on the new
asset is relevant information because it will affect the depreciation tax shield, which is one of
the cash flows connected with the new project.

Option C is incorrect
Anything that will influence or affect future cash flows of the project will have a direct
impact on the decision. The amount of additional accounts receivable that will be generated
from increased production and sales is relevant because an increase in accounts receivable
will impact net working capital, which is one of the cash flows considered in a project.

Option D is incorrect
Anything that will influence or affect future cash flows of the project will have a direct
impact on the decision. The salvage, or sales value, of the asset that is being replaced is
relevant information because it is a cash inflow and it therefore has a direct impact on the
decision.
180. Question - PART250060The use of an accelerated method instead of the straight-line
method of depreciation in computing the net present value (NPV) of a project has the effect
ofRaising the hurdle rate necessary to justify the project.Lowering the net present value of the
project.Increasing the cash outflows at the initial point of the project.Increasing the present
value of the depreciation tax shield.
Option D is correct
The depreciation tax shield is the amount by which the tax payment owed by the company
will be reduced as a result of the tax deductibility of the depreciation. This reduction of the
tax payable is essentially a cash inflow for the company. The use of an accelerated method of
depreciation for tax purposes will result in higher depreciation in the early years of a project
and lower depreciation in the later years, when compared with straight-line depreciation.
Higher cash flow in the early years of a project has a greater present value than higher cash
flow in the later years. Thus, accelerated depreciation for tax purposes will increase the
present value of the depreciation tax shield.

Option A is incorrect
The use of an accelerated method of depreciation in computing the net present value of a
project has no effect on the hurdle rate. The hurdle rate, or the required rate of return, to be
used to calculate the net present value of a capital budgeting project is determined by
management. It is usually based on the company's cost of capital and is adjusted to reflect the
amount of risk perceived by management.

Option B is incorrect
The use of an accelerated method of depreciation in computing the net present value of a
project does not lower the net present value of the project. It has the opposite effect.

Option C is incorrect
Cash outflows at the initial point of the project are not affected by the method used to
depreciate it later.
181 Question - PART250033
McLean Inc. is considering the purchase of a new machine that will cost $160,000. The
machine has an estimated useful life of 3 years. Assume that 30% of the depreciable base will
be depreciated in the first year, 40% in the second year, and 30% in the third year. The new
machine will have a $10,000 resale value at the end of its estimated useful life. The machine
is expected to save the company $85,000 per year in operating expenses. McLean uses a 40%
estimated income tax rate and a 16% hurdle rate to evaluate capital projects. Discount rates
for a 16% rate are as follows:
Year 1 2 3
Present Value of $1 0.862 0.743 0.641
Present Value of an Ordinary Annuity of $1 0.862 1.605 2.246
The payback period for this investment would be
1.88 years.3.00 years.1.53 years.2.19 years.
Option D is correct
The cash flows are as follows:
Year 0 Year 1 Year 2 Year 3
Depreciation 30% X 40%X 30%
$160,000 = $160,000 X$160,000
$48,000 $64,000 $48,000
Tax Saving on Depreciation (40%) $19,200 $25,600 $19,200
(Depreciation Tax Sheild) (A)
Operating Cashflow $85,000 $85,000 $85,000
Less: Tax on Operating Cash Flow at (34,000) (34,000) (34,000)
40%
Operating Cashflow (B) 51,000 51,000 51,000
Net Cash Flow (adjusted Tax Shield) (160,000 70,200 76,600 70,200
( A + B) )
Payback Period = 2 Year + 13200/70200 = 2.19 Year
Note:
When calculating the payback period, operating cash flows are usually assumed to be
received evenly throughout each year of the project's life. However, the $6,000 received from
disposition of the asset is not received until the end of the project, which is at the end of Year
3. Therefore, it is handled differently from operating cash flows. It is not included in the
calculation of the payback period in this case, because it occurs at the end of the year, while
operating cash flows are assumed to occur evenly throughout the year. Thus, the payback
period would end before the disposition occurs. Note that it is not a part of the net cash flow
used to calculate the payback period.

Option A is incorrect
An answer of 1.88 years results from dividing the net investment of $160,000 by the annual
operating cash flow of $85,000. However, the operating cash flow of $85,000 is not the only
component of cash flow to be used to calculate the payback period. The annual cash flows are
not uniform over the life of this project.

Option B is incorrect
Since the useful life of the machine is 3 years, an answer of 3.00 would result from using the
annual depreciation as the annual cash flow.

Option C is incorrect
An answer of 1.53 years results from using the annual depreciation instead of the
depreciation tax shield as an increase to the annual net cash flows.
182. Question - PART251503
An individual received an inheritance from a grandparent's estate. The money can be invested
and the individual can either a) receive a $20,000 lump-sum amount at the end of 10 years or
b) receive $1,400 at the end of each year for the next 10 years. The individual wants a rate of
return of 12% and uses the following information:
Present value of $1 = 0.322.
Present value of annuity of $1 = 5.650.
What is the preferred investment option and what is its net present value?
Option b; $451.
Option a; $6,440.
Option b; $7,910.
Option a; $113,000.
Option C is correct
The present value of an annuity is used to determine the present value when there are a series
of same amount of cash flow at the end of each year for a specific number of years at a
specific interest rate.
Present value of $1 for a specific year is used if there is a single cash flow in a specific year.
If the individual receives a lump-sum of $20,000 at the end of 10 years,
the present value of the lump-sum amount today at a rate of 12%= .322 x $20,000 = $6,440.
If the individual receives $1,400 at the end of each year for the next 10 years,
the present value of annuity for 12% for 10 years is used to calculate the present value today
= $1,400 x 5.650 = $7,910.
Option B should be the preferred investment option as it gives a higher present value of
$7,910.

Option A is incorrect
because it wrongly uses the PV of $1 instead of using PV of annuity for option (b) as it is a
series of payments.

Option B is incorrect
because option (b) has a higher present value and would thus be preferred.

Option D is incorrect
because it wrongly used PV of annuity for option (a) instead of PV of $1 as it is a one time
payment.
183. Question - PART250064
The Keego Company is planning a $200,000 equipment investment which has an estimated
5-year life with no estimated salvage value. The company has projected the following annual
cash flows for the investment.
Year 1 2 3 4 5
Projected Cash Inflows $120,000 60,000 40,000 40,000 40,000
Present Value of $1 0.91 0.76 0.63 0.53 0.44
Totals $300,000 3.27 The net present value for the investment is:
$18,800$130,800$218,800$100,000
Option A is correct
The net present value is the net expected monetary gain or loss from a project when all the
expected future cash inflows and outflows are discounted to the point of the investment,
using the firm's required rate of return. Discounting the annual cash inflows using the
discount factors given results in annual discounted cash inflows of ($120,000 × 0.91) +
($60,000 × 0.76) + ($40,000 × 0.63) + ($40,000 × 0.53) + ($40,000 × 0.44) = $218,800. The
discounted total annual cash flows minus the initial investment of $200,000 equals $18,800,
which is the NPV.

Option B is incorrect
$130,800 results from discounting the initial investment for 5 years and subtracting the
discounted value from the present value of the future cash inflows. However, the initial
investment which occurs in Year 0 does not need to be discounted in order to calculate net
present value, because it is already expressed at its present value in the analysis.

Option C is incorrect
$218,800 is the total of the present values of the future cash inflows, but this is not net
present value.

Option D is incorrect
$100,000 results from subtracting the initial investment of $200,000 from the total of the
undiscounted cash flows, which is $300,000. This is not the correct way to calculate NPV.

184. Question - PART250132

Amster Corporation has not yet decided on its hurdle rate for use in the evaluation of capital
budgeting projects. This lack of information will prohibit Amster from calculating a project's
Net Present Value Internal Rate of Return
I. No No
II. Yes Yes
III. No Yes
IV. Yes No
I.II.III.IV.
Option D is correct
Not knowing the hurdle rate will not prevent the calculation of the Internal Rate of Return
(though it will prevent interpretation of the IRR). However, it will prohibit the company from
calculating NPV, because in order to calculate NPV, the future cash flows need to be
discounted using the hurdle rate.

Option A is incorrect
NPV cannot be calculated unless the hurdle rate is first determined, because in order to
calculate NPV, the future cash flows need to be discounted using the hurdle rate.

Option B is incorrect
Internal Rate of Return can be calculated without knowing the hurdle rate, because the IRR is
the discount rate that causes NPV to be zero.

Option C is incorrect
NPV cannot be calculated unless the hurdle rate is first determined, because in order to
calculate NPV, the future cash flows need to be discounted using the hurdle rate. The Internal
Rate of Return can be calculated without knowing the hurdle rate.
185. Question - PART250113
In capital budgeting, the main difference between a project's NPV and its IRR is
only the NPV takes into account the time value of money.the IRR is concerned with the
period in which the cash inflows and outflows occur.only the IRR may be used to rank
different investment opportunities to determine which project should be funded.the NPV
results in a monetary amount of return whereas the IRR results in a percentage of return.
Option D is correct
The net present value of a capital project is a monetary amount of return, whereas the
project's internal rate of return is a percentage rate.

Option A is incorrect
Both NPV and IRR take into account the time value of money, so this is not a difference
between them. Please see the correct answer explanation for more information.

Option B is incorrect
Both NPV and IRR are concerned with the period in which the cash inflows and outflows
occur, so this is not a difference between them. Please see the correct answer explanation for
more information.

Option C is incorrect
Both NPV and IRR can be used to rank different investment opportunities as part of the
evaluation of which project should be funded, so this is not a difference between them.
186. Question - PART250094With regard to a capital investment project, which one of the
following statements best describes the relationship between the cost of capital and the
expected internal rate of return?The internal rate of return must exceed the cost of capital for
the project to be acceptable.If the internal rate of return exceeds zero, the project will be
profitable.The cost of capital must exceed the internal rate of return for the project to be
acceptable.The cost of capital must exceed the internal rate of return for the project to be
acceptable.
Option A is correct
If the internal rate of return is lower than the cost of capital, the project will not be beneficial
to the company. If the IRR is greater than the cost of capital the project will be beneficial to
the company.

Option B is incorrect
If the internal rate of return exceeds zero but is lower than the firm's cost of capital, the
project will not be profitable.

Option C is incorrect
If the cost of capital exceeds the internal rate of return, the project will not be profitable and
thus will not be acceptable.

Option D is incorrect
The internal rate of return should be compared to the firm's cost of capital, and in order for
the project to be beneficial (profitable) the internal rate of return needs to exceed the cost of
capital. If the company wants to have a minimum benefit from the project, they may choose
to compare its internal rate of return to a pre-determined benchmark, but that benchmark
must be higher than the cost of capital.
187. Question - PART250115In equipment-replacement decisions, which one of the
following does not affect the decision-making process?Original fair value of the old
equipment.Operating costs of the old equipment.Cost of the new equipment.Current disposal
price of the old equipment
Option A is correct
The original fair value of the old equipment is not relevant to the decision-making process
because it will not change as a result of the decision that is made.

Option B is incorrect
The operating costs of the old equipment, as well as the operating costs of the new
equipment, are relevant to the decision-making process because they will change as a result
of the decision that is made.

Option C is incorrect
The cost of the new equipment is relevant to the decision-making process because the cost
will either be incurred or not incurred, depending upon the decision that is made.

Option D is incorrect
The current disposal price of the old equipment is relevant to the decision-making process
because it will either be received or not received, depending on the decision that is made.
188. Question - PART251492
How are the following used in the calculation of the internal rate of return of a proposed
project? Ignore income tax considerations.
Include residual sales value of project,exclude depreciation expense.
Exclude residual sales value of project, include depreciation expense.
Include residual sales value of project,include depreciation expense.
Exclude residual sales value of project,exclude depreciation expense.
Option A is correct.
Internal Rate of Return (IRR) is the discount rate at which the net present value is zero. It is
used to compare alternative investments, i.e., only the projects with highest IRR are
considered for investment. IRR or PV factor is the ratio of initial investment (cash outflow) to
cash inflows. Generally cash inflow used in IRR includes annuity cash inflows,
expected residual sale value of project, and depreciation expense (tax saving from
depreciation is inflow) if tax is considered.
As income tax is not considered in this problem, depreciation expense is ignored in
IRR calculation.

Option B is incorrect
because of above explanation.

Option C is incorrect
because of above explanation.

Option D is incorrect
because of above explanation.
189. Question - PART251505
IRR assumes that:
The cash flows are reinvested at the internal rate of return.
The inflation remains constant during a project’s life.
The project has only systematic risk as the unsystematic risk can be diversified.
The project will have a cash outflow only at year zero.
Option A is correct
One of the fundamental assumptions of IRR is that the cash flows are reinvested at the IRR.
Option B is incorrect
because inflation has no impact on IRR as it does not depend on the discount rate.

Option C is incorrect
because in the context of an equity portfolio, the unsystematic risk can be diversified.
However, for individual projects both systematic and unsystematic risks exist.

Option D is incorrect
because IRR does not assume that the cash outflow happens only at year zero. The issue of
multiple IRRs raises only when there are sign changes in the cash flows. There will be only
one IRR if there are cash outflows in first three years and inflows afterwards.
190. Question - PART251457
Harvey Co. is evaluating a capital investment proposal for a new machine. The investment
proposal shows the following information:
Initial cost $500,000
Life 10 years
Annual net cash inflows 200,000
Salvage value 100,000
If acquired, the machine will be depreciated using the straight-line method. The payback
period for this investment is
3.25 years.
2.67 years.
2.5 years.
2 years.
Option C is correct
Payback period is calculated as follows:
Initial investment / After tax net cash flows
Payback period = $500,000 /$200,000 = 2.5 years.

Option A is incorrect
as per the above explanation.

Option B is incorrect
as per the above explanation.

Option D is incorrect
as per the above explanation.
190. Question - PART250093
The Financial Analysis Department of Stover Inc. has analyzed a proposed capital investment
and calculated the appropriate incremental cash flows as follows. Year Cash Flow 0
(100,000) outflow 1 80,000 inflow 2 80,000 inflow 3 80,000 inflow 4 (100,000) outflow
A net present value (NPV) of approximately $25,000 and an internal rate of return (IRR) of
minus 29% were calculated for the project and the project was submitted to the board of
directors for approval. Which one of the following statements is correct?
The project has another IRR in addition to the minus 29% rate.The IRR calculation must have
contained an error.In the NPV calculation, the project's cash flows are assumed to be
reinvested at Stover's cost of capital.The board of directors should not approve the project.
Option A is correct
The IRR is the discount rate at which the NPV of an investment will be equal to 0. This is the
discount rate at which the present value of the expected cash inflows from a project equals
the present value of the expected cash outflows. Whenever a project has a negative cash flow
or flows in any subsequent year(s) after Year 0, it can have more than one IRR, because more
than one discount rate will cause the project’s NPV to be zero. The number of IRRs will be
equal to the number of sign changes in the cash flows. Furthermore, one or more of the IRRs
will frequently be negative. That is obviously what has occurred here. The project has a
negative cash flow in Year 4. Therefore, the project will have two IRRs: one due to the
normal sign change from negative in Year 0 to positive in Year 1, and one due to the sign
change from positive in Year 3 to negative in Year 4.

Option D is incorrect
The IRR is the discount rate at which the NPV of an investment will be equal to 0. This is the
discount rate at which the present value of the expected cash inflows from a project equals
the present value of the expected cash outflows. The error occurred in submitting the negative
IRR to the board. Whenever a project has a negative cash flow or flows in any subsequent
year(s) after Year 0, it can have more than one IRR, because more than one discount rate will
cause the project’s NPV to be zero. The Financial Analysis Department should have
determined what the correct (positive) IRR was before submitting anything to the board.

Option C is incorrect
In the calculation of NPV, the assumption is made that all cash inflows from the project will
be reinvested at the firm's required rate of return, not at the firm's cost of capital. The firm's
required rate of return may be equal to its cost of capital, but it also may not be equal to its
cost of capital.

Option D is incorrect
Whether or not the board of directors should approve the project depends upon a great many
factors. That is a judgment that cannot be made on the basis of the limited facts given.
191. Question - PART250034The length of time required to recover the initial cash outlay of
a capital project is determined by using theDiscounted cash flow method.Weighted net
present value method.Payback method.Net present value method.
Option C is correct
The Payback Method is used to determine the number of periods that must pass before the net
after-tax cash inflows from the investment will equal (or "pay back") the initial investment
cost. If the incoming cash flows are constant over the life of the project, the payback period
may be calculated with a simple division as follows: Initial net investment ÷ Periodic
constant expected cash flow. If the cash flows are not constant over the life of the project, we
must add up the cash inflows and determine on a cumulative basis when the inflows equal the
outflows.

Option A is incorrect
Methods of capital budgeting analysis that utilize discounted cash flow concepts are Net
Present Value (NPV) and Internal Rate of Return (IRR). NPV can be used to determine the
difference between the present value of all future cash inflows and the present value of all
(the initial as well as all future) cash outflows, using the required rate of return. A project
with a positive NPV is acceptable. The IRR is the discount rate at which the NPV of an
investment will be equal to 0, or the discount rate at which the present value of the expected
cash inflows from a project equals the present value of the expected cash outflows. If this rate
is higher than the required rate of return, the investment is acceptable. However, neither of
these discounted cash flow methods can be used to determine the length of time required to
recover the initial cash outlay of a capital project.

Option B is incorrect
A probability-weighted Net Present Value for a capital project cannot be used to determine
the length of time required to recover the initial cash outlay of a capital project.

Option D is incorrect
The Net Present Value method of capital budgeting analysis cannot be used to determine the
length of time required to recover the initial cash outlay of the capital project.
192. Question - PART250144
Pomegranate, Inc., has estimated that a proposed project's 10-year annual net cash benefit,
received each year end, will be $2,500 with an additional terminal benefit of $5,000 at the
end of the tenth year. Assuming that these cash inflows satisfy exactly Pomegranate's
required rate of return of 8 percent, calculate the initial cash outlay.
$16,775.00$19,091.00$25,000.00$30,000.00
Option B is correct
If the present value of the cash inflows exactly satisfies Pomegranate’s required rate of return
of 8%, that means that the NPV of the project at a discount rate of 8% is zero. If the NPV of
the project is zero, the net cash inflows throughout the life of the project, when discounted
back to Year 0 at 8%, must be exactly equal to the initial cash outlay. The present value of
the cash inflows is ($2,500 × 6.7101) + ($5,000 × 0.4632) = $16,775 + $2,316 = $19,091.
The initial cash outlay must be $19,091.

Option A is incorrect
The amount consider in calculation is incorrect

Option C is incorrect
The amount consider in calculation is incorrect

Option D is incorrect
The amount consider in calculation is incorrect
193. Question - PART250069
Yipann Corporation is reviewing an investment proposal. The initial cost as well as other
related data for each year are presented in the schedule below. All cash flows are assumed to
take place at the end of the year. The salvage value of the investment at the end of each year
is equal to its net book value, and there will be no salvage value at the end of the investment's
life.
Investment Proposal Year Initial Net After-Tax Cash Flows Annual Net Income
Cost and Book Value Annual
0 $105,000 $0 $0
1 70,000 50,000 15,000
2 42,000 45,000 17,000
3 21,000 40,000 19,000
4 7000 35,000 21,000
50 30,000 23,000
Yipann uses a 24% after-tax target rate of return for new investment proposals. The discount
figures for a 24% rate of return are given.
Year 1 2 3 4 5 6 7
Present Value of $1 Received at the End of Period 0.8 0.65 0.52 0.42 0.34 0.28 0.22
1
Present Value of Annuity of $1 Received at End of Each 0.8 1.46 1.98 2.40 2.74 3.02 3.24
Period 1
The net present value of the investment proposal is
$10,450.00$(55,280).$115,450.00$4,600.00

194. Question - PART251487

Colter Corp. is conducting an analysis of a potential capital investment. The project is
expected to increase sales by $100,000 and reduce costs by $50,000 annually. Depreciation
expense is $30,000 per year. Colter's marginal tax rate is 40%. What is the annual operating
cash flow for the project?
$42,000.
$72,000.
$90,000.
$102,000.
Option D is correct
The increase in Operating Cash Inflows =
Increase in Annual Sales ($100,000) + Decrease in Annual costs ($50,000) = $150,000.
Increase in Annual Operating cash flow after tax = $150,000 x (1- 0.4) = $90,000.
Tax benefit on depreciation = $30,000 x 0.4 = $12,000.
Total Increase in Annual Operating cash flow for the project = $90,000 + $12,000 =
$102,000.

Option A is incorrect
due to improper calculations.

Option B is incorrect
due to improper calculations.

Option C is incorrect
due to improper calculations.
195. Question - PART250079A company is interested in a capital project that has a net
present value of $0. The company shouldaccept the project because the company's required
rate of return has been met.accept the project because the company's value will increase.reject
the project because its cash inflows equal the project's cash outflows.reject the project
because its internal rate of return is 0%.
Option A is correct
This is the best answer from among the answer choices given. Technically, a project with a
zero NPV is acceptable because the present value of the future expected cash inflows,
discounted at the company's required rate of return, is equal to the initial investment. Thus the
company's required rate of return is met. Only projects with at least a zero NPV but more
probably a positive NPV are acceptable to a company from a financial standpoint. If the
project has a zero NPV, the value of the project is questionable. Although the company
would not lose money on the project, it would not earn anything on the project either.

Option B is incorrect
When a project has a zero NPV, the present value of its expected future cash inflows is
exactly equal to the amount of the initial investment, so the project will neither increase nor
decrease shareholder wealth.
Option C is incorrect
The present value of the company's cash inflows equal the project's cash outflows, but its
cash inflows (undiscounted) are not equal to its cash outflows.

Option D is incorrect
The internal rate of return on the project is equal to the required rate of return used to
discount the expected future cash flows from the project.
196. Question - PART250027When evaluating projects, breakeven time is best described
asThe point where cumulative cash inflows on a project equal total cash outflows.Annual
fixed costs ÷ monthly contribution margin.Project investment ÷ annual net cash inflows.The
point at which discounted cumulative cash inflows on a project equal discounted total cash
outflows.
Option D is correct
The breakeven time is also called the discounted payback period. The payback method
(undiscounted) determines the number of periods that must pass before the net after-tax cash
inflows from the investment will equal (or "pay back") the initial investment cost. However,
the payback method has a weakness: it does not consider the time value of money. The
breakeven time, or discounted payback method, is an attempt to deal with that weakness. The
discounted payback method uses the present value of cash flows instead of cash flows in
calculating the payback period. Each year's cash flow is discounted using the required rate of
return, and those discounted cash flows are used to calculate the payback period.

Option A is incorrect
The point where cumulative cash inflows on a project are equal to total cash outflows is the
payback period, not the breakeven time.

Option B is incorrect
Annual fixed costs ÷ monthly contribution margin is a meaningless calculation. Annual fixed
costs ÷ the unit contribution margin results in the breakeven point in number of units to be
sold per year to break even. And annual fixed costs ÷ the contribution margin ratio results in
the breakeven point in terms of dollars of revenue. However, breakeven time is a completely
different concept from breakeven point.

Option C is incorrect
If and only if the annual net cash inflows from a project are all the same, the Project
Investment ÷ the Annual Net Cash Inflows equals the Payback Period. However, this is
different from breakeven time.
197. Question - PART250129The capital budgeting model that is generally considered the
best model for long-range decision making is theDiscounted cash flow model.Unadjusted rate
of return model.Accounting rate of return model.Payback model.
Option A is correct
Discounted cash flow methods of capital budgeting, including net present value and internal
rate of return, are generally considered the best model for long-range capital budgeting
decision making.

Option B is incorrect
The unadjusted rate of return model, or accounting rate of return model, is not generally
considered the best model for long-range decision making, because it does not incorporate
time value of money concepts.
Option C is incorrect
The accounting rate of return model, or unadjusted rate of return model, is not generally
considered the best model for long-range decision making, because it does not incorporate
time value of money concepts.

Option D is incorrect
The payback method is not generally considered the best model for long-range decision
making, because it does not incorporate time value of money concepts.
198. Question - PART250009A depreciation tax shield isa reduction in income taxes.the
cash provided by recording depreciation.an after-tax cash outflow.the expense caused by
depreciation.
Option A is correct
The depreciation tax shield is the amount by which income taxes will be lower due to the
depreciation expense reported on the income tax return and the resulting decrease in taxable
income. The depreciation tax shield is so-named because it shields other income of the
company from taxation.

Option B is incorrect
Although depreciation is an expense that does not require a cash outflow at the time it is
recorded (because the cash outflow occurred when the asset was originally purchased), cash
is not provided by the recording of depreciation.

Option C is incorrect
A depreciation tax shield is neither a cash inflow nor a cash outflow. It does, however, reduce
cash outflow for income taxes.

Option D is incorrect
The depreciation tax shield is not the expense caused by depreciation. Depreciation expense
is itself an expense. This expense, in turn, can reduce income taxes due because it reduces
taxable income, assuming the firm has taxable income and can use the expense to reduce its
taxes.
199. Question - PART25111347
The management of a utility company is considering making a series of investments over the
next five years to construct a new energy plant. Rather than commit to the full five-year
investment schedule on day one, management wants to retain the flexibility in the timing and
amount of each investment in order to take into consideration future business conditions at
each stage of construction. Based on this information, which one of the following real options
is the most appropriate for this situation?
Abandon
Delay
Expand
Scale back
Option B is correct
By waiting to get more information at each stage of the project, the company is applying the
real option of delay.

Option A is incorrect
Abandoning the project would mean exiting the project after it had already been started.
Option C is incorrect
Expanding would be the option when the company is making an addition to an already
existing project.

Option D is incorrect
Scaling back would be done when a company makes an existing investment smaller.
200. Question - PART250111In capital budgeting, multiple internal rates of return occur
whenthere is more than one cost of capital estimate.the projects are mutually exclusive.the
project cash flows change between negative and positive more than once.the projects have
embedded real options.
Option C is correct
Multiple internal rates of return occur when a project's total cash flows change from negative
to positive more than once during the project's life, such as when an additional investment is
required midway during the project that causes that year's total expected cash flow to become
negative.

Option A is incorrect
Multiple cost of capital estimates used to evaluate a capital budgeting project will not cause
the project to have multiple internal rates of return. Different required rates of return can be
used to discount different components of a project's expected cash flows, and/or different
rates can be used to discount different years of a project's life without causing the project to
have multiple internal rates of return. Please see the correct answer explanation for more
information.

Option B is incorrect
The existence of mutually exclusive projects will not cause a project or projects to have
multiple internal rates of return. If projects are mutually exclusive, it simply means that if one
project is selected, another project cannot also be selected, for example if both projects under
consideration would utilize the same physical facilities. Please see the correct answer
explanation for more information.

Option D is incorrect
The existence of real options will not cause a project to have multiple internal rates of return.
Real options add value to a project because, for example, they provide expansion
opportunities or give the investor the option to abandon a project if conditions become
unfavorable. Please see the correct answer explanation for more information.

201. Question - PART250065When using the net present value method for capital budgeting
analysis, the required rate of return is called all of the following except theCost of
capital.Discount rate.Hurdle rateRisk-free rate.
Option D is correct
The required rate of return, which is the rate used to discount future cash flows in a capital
budgeting analysis, is not the risk-free rate. There is risk inherent in all capital budgeting
projects, and the required rate of return incorporates a risk premium.

Option A is incorrect
The required rate of return may be equal to the firm's cost of capital, if the firm has not seen
fit to adjust its cost of capital to reflect higher or lower risk.
Option B is incorrect
The required rate of return is the discount rate used in a capital budgeting analysis.

Option C is incorrect.
The required rate of return may be called the "hurdle rate" because it is the minimum rate of
return that is acceptable for an investment. A firm should invest money in a project only if the
project provides a higher rate of return than this rate. Investments with a return higher than
the hurdle rate will increase the value of the firm and thus stockholders' wealth.
202. Question - PART250142
Capital Invest Inc. uses a 12% hurdle rate for all capital expenditures and has done the
following analysis for four projects for the upcoming year.
Project 1 Project 2 Project 3 Project 4
Initial Capital Outlay Cash $200,000 $298,000 $248,000 $272,000
Inflow
Annual net cash inflows
Year 1 $65,000 $100,000 $80,000 $95,000
Year 2 $70,000 $135,000 $95,000 $125,000
Year 3 $80,000 $90,000 $90,000 $90,000
Year 4 $40,000 $65,000 $80,000 $60,000
Net Present Value (3,798) 4,276 14,064 14,662
Internal rate of return 11% 13% 14% 15%
Which project(s) should Capital Invest Inc. undertake during the upcoming year assuming it
has no budget restrictions?
All of the projects.Projects 1, 2, and 3.Projects 2, 3, and 4.Projects 1, 3, and 4.
Option C is correct
When a company has no restrictions on its capital investments, it should undertake all
projects with positive NPVs, because any project with a positive NPV will increase
shareholder wealth. Projects 2, 3 and 4 all have positive NPVs, so all should be accepted.
Note also that the Internal Rates of Return for Projects 2, 3 and 4 are all greater than Capital
Invest's 12% hurdle rate. Thus the NPVs and the IRRs are in agreement.

Option A is incorrect
No project with a negative NPV should be accepted, and Project 1 has a negative NPV.

Option B is incorrect
No project with a negative NPV should be accepted, and Project 1 has a negative NPV. No
project with a negative NPV should be accepted, and Project 1 has a negative NPV.

Option D is incorrect
As explained above
203. Question - PART250035
The Keego Company is planning a $200,000 equipment investment which has an estimated
5-year life with no estimated salvage value. The company has projected the following annual
cash flows for the investment.
year 1 2 3 4 5
Present Value of $1 0.91 0.76 0.63 0.53 0.44
Projected Cash Inflows $120,000 $60,000 $40,00 $40,000 $40,000
 0
Totals = $300,000, 3.27
Assuming that the estimated cash inflows occur evenly during each year, the payback period
for the investment is:
2.50 years.3.94 years.1.50 years.1.67 years.
Option A is correct
Year Year 1 Year 2 Year 3 Year 4
0
Initial Investment (200)
Annual after-tax cash flows 120 60 40 40 40
Total after-tax cash flows (200) 120 60 40 40 40
Cumulative after-tax cash (200) ( 80) (20) 20 60 100
flows
The payback period is, first, the number of the project year in the final year when cumulative
cash flow (including the initial investment) is negative,
plus a fraction consisting of the positive value of the negative cumulative cash inflow
amount from the final negative year divided by the cash flow for the following year. In this
case, the final year in which the cumulative cash flow is zero is Year 2,
because $(200,000) + $120,000 + $60,000 = $(20,000). In the third year, the annual cash flow
is $40,000. So 20,000 ÷ $40,000 = 0.5,
and the payback period is 2.0 + 0.5, or 2.5 years.

Option B is incorrect
This is the discounted payback period, in which all cash flows are discounted and the
cumulative discounted cash flow is used to calculate the payback period. Although the
discount factors are given in this problem, the problem does not ask for the discounted
payback period.

Option C is incorrect
1.5 years results from dividing the total undiscounted cash flows of $300,000 by the initial
cash outflow of $200,000. However, this is not the correct way to calculate the payback
period.

Option D is incorrect
A payback period of 1.67 years would result if the second year's cash flow were the same as
the first year's cash flow. However, that is not the case.
204. Question - PART250102SwitchOver Inc. is considering the purchase of a new
electronic machine for its production facilities. The production manager considers the new
machine to be necessary because the current electronic machine is at the end of its useful life
and maintenance costs for the machine have significantly increased during the past year. The
company has received bids from two different suppliers: Santoni and Flainox. The electronic
machines from Santoni and Flainox are similar but there are differences in the cost of the
machines and their estimated cost savings. Management needs to decide which electronic
machine to purchase. The following information is given on the two machines. Santoni
Flainox Cost of electronic machines $350,300 $607,100 Estimated annual cash cost savings
(after tax) 50,000 90,000 The two electronic machines both have estimated useful lives of 10
years. The discount rate where the NPVs for the two machines would be the same is closest
to8%9%10%11%
Option B is correct
To answer this question, let X equal the present value of an annuity discount factor for 10
years.
The annual cash flow for the Santoni machine multiplied by the discount factor (X), minus its
initial cost,
should be equal to the annual cash flow for the Flainox machine multiplied by the same
discount factor minus its initial cost.
The two cost functions are: Santoni: $50,000X − $350,300
Flainox: $90,000X − $607,100
Set the two cost functions equal to each other and solve for X:
50,000X – 350,300 = 90,000X – 607,100
40,000X = 256,800
X = 6.42
The next step is to use the PV of an annuity table and look across the 10-year line to find the
factor closest to 6.42.
The factor under 9% is 6.4177, so the crossover rate is closest to 9%.

Option A is incorrect
Due to incorrect calculation

Option C is incorrect
Due to incorrect calculation

Option D is incorrect
Due to incorrect calculation
205. Question - PART250137The owner of Woofie's Video Rental cannot decide how to
project the real costs of opening a rental store in a new shopping mall. The owner knows the
capital investment required but is not sure of the returns from a store in a new mall.
Historically, the video rental industry has had an inflation rate equal to the economic norm.
The owner requires a real internal rate of return of 10%. Inflation is expected to be 3% during
the next few years. The industry expects a new store to show a growth rate, without inflation,
of 8%. First year revenues at the new store are expected to be $400,000. The revenues for the
second year, using both the real rate approach and the nominal rate approach, respectively,
would be$432,000 real and $444,960 nominal.$432,000 real and $452,000 nominal.$440,000
real and $452,000 nominal.$440,000 real and $453,200 nominal.
Option A is correct
The information that the owner requires a real internal rate of return of 10% is irrelevant to
solving this problem because this problem does not use discounted cash flow methods. The
relevant rates are the 8% real growth rate expected in the industry and the expected 3%
inflation rate. The Year 2 real revenue will be the Year 1 revenue multiplied by 1 + the
expected industry growth rate of 8%: $400,000 × 1.08, or $432,000. The Year 2 nominal
revenue will be the Year 2 real revenue multiplied by 1 + the expected inflation rate:
$432,000 × 1.03, or $444,960. Option

Option B is incorrect
The nominal revenue for Year 2 is calculated as $400,000 × (1 + 0.10 + 0.13), which is
incorrect. The nominal revenue for Year 2 should be calculated as the real revenue for Year 2
multiplied by 1 + the inflation rate. Option

Option C is incorrect
The Year 2 real revenue is calculated as the Year 1 revenue multiplied by 1 + the owner’s
required real internal rate of return of 10%, which is not correct. The owner’s required real
internal rate of return is not relevant for this analysis. The forecasted industry growth rate of
8% should be used. The Year 2 nominal revenue of $452,000 is calculated as $400,000 × (1 +
0.10 + 0.13), which is incorrect. The nominal revenue for Year 2 should be calculated as the
real revenue for Year 2 multiplied by 1 + the inflation rate. Option

Option D is incorrect
The Year 2 real revenue is calculated as the Year 1 revenue multiplied by 1 + the owner’s
required real internal rate of return of 10%, which is not correct. The owner’s required real
internal rate of return is not relevant for this analysis. The forecasted industry growth rate of
8% should be used. The Year 2 nominal revenue of $453,200 is calculated as the incorrect
Year 2 real revenue of $440,000 × 1 + the inflation rate. The correct Year 2 real revenue
should be multiplied by 1 + the inflation rate to calculate the correct Year 2 nominal revenue.
206. Question - PART250147eGoods is an online retailer. The management of eGoods is
interested in purchasing and installing a new server for a total cost of $150,000. The
controller of eGoods has asked an accountant at eGoods to determine the incremental yearly
tax savings should the new server be acquired. The server has an estimated useable life of
approximately four years and no salvage value. eGoods currently uses straight-line
depreciation and is assessed an effective income tax rate of 40%. The accountant calculated
the incremental yearly tax savings to be$15,000.00$22,500.00$37,500.00$60,000.00
Option A is correct
This question is asking for the annual depreciation tax shield. Even though it asks for
incremental cash flow and the new server is replacing an old server, no information is given
regarding the cash flow related to the old server to be replaced. Therefore, treat this as a
purchase that is not replacing an old piece of equipment. The initial investment is $150,000
and the useful life of the asset is 4 years. Since the problem states that the company uses
straight-line depreciation, the annual depreciation expensed will be $150,000 ÷ 4, or $37,500.
Since the company’s tax rate is 40%, the annual depreciation tax shield (tax savings) will be
$37,500 × 0.40, or $15,000.

Option B is incorrect
This question is asking for the annual depreciation tax shield, which is the annual
depreciation amount multiplied by the tax rate. This answer results from multiplying the
annual depreciation amount by (1 − the tax rate) instead of multiplying it by the tax rate.

Option C is incorrect
This question is asking for the annual depreciation tax shield, which is the annual
depreciation amount multiplied by the tax rate. This is the annual depreciation expense, but it
fails to take into account the tax savings connected to the depreciation expense.

Option D is incorrect
This question is asking for the annual depreciation tax shield, which is the annual
depreciation amount multiplied by the tax rate. This answer results from multiplying the full
cost of the new server ($150,000) by the tax rate (0.40). The server will have a 4-year life, so
the annual depreciation amount, not the full cost of the server, needs to be multiplied by the
tax rate to find the yearly tax savings.
207. Question - PART251483
A company is investing in a machine costing $365,000. The following table shows selected
financial data for the company for the next five years:
Year Annual cash flows Annual net income
1 $50,000 $45,000
2 125,000 120,000
3 150,000 145,000
4 50,000 45,000
5 30,000 25,000
What is the payback period on this machine?
3.8 years.
4.0 years.
4.4 years.
5.0 years.
Option A is correct
Payback period is the time period required to recover the original investment. Here the cash
flow is taken into consideration and not the net income because, the net income has non cash
items such as depreciation.
If the cash inflow is the same every year, then the payback is computed as Initial
investment/After-tax net cash inflows.
If the cash inflow is uneven for each period, then we need to compute the cumulative net cash
flow for each period and use the following formula:
Payback period = A + B/C, where
A = The last period with the negaitve cumulative net cash flow (Cumulative net cash flow is
the sum of inflows to date minus the inital ouflow)
B = The absolute value of the cumulative net cash flow at the end of the period A
C = The total cash inflow during the period following the period A.
In the above scenario, the cash inflow is uneven and so the payback period is computed as
follows:
Period Cash Cumulative Net cash Flow
Inflow
0 $(365,000) $(365,000)
1 $50,000 $(315,000)
2 $125,000 $(190,000)
3 (A) $150,000 $(40,000) (B)
4 $50,000 (C) $10,000
Payback period =3 + ( $40,000/$50,000)
=3.8 years.

Options B is incorrect
due to improper calculations of the payback period.

Option C is incorrect
due to improper calculations of the payback period.

Option D is incorrect
due to improper calculations of the payback period.
208. Question - PART251472
Which of the following changes would result in the highest present value?
A $100 decrease in taxes each year for four years.
A $100 decrease in the cash outflow each year for three years.
A $100 increase in disposal value at the end of four years.
A $100 increase in cash inflow each year for three years.
Option A is correct.
A $100 decrease in taxes each year for four years would result in increase in cash flows
thereby resulting in the increase in the present value.

Option B is incorrect
because though a decrease in cash flow would result in an increase in the present value , the
increase would not be as much as would result from the decrease in taxes for four years.

Option C is incorrect
because $100 increase in disposal value at the end of four years would not result in highest
present value.

Option D is incorrect
because $100 increase in cash inflow each year for three years would not result in as much
increase in present value as $100 reduction in taxes each year for four years would result.

209. Question - PART250059A disadvantage of the net present value method of capital
expenditure evaluation is that itIs calculated using sensitivity analysis.Computes the true
interest rate.Does not provide the expected rate of return on investment.Is difficult to apply
because it uses a trial-and-error approach.
Option C is correct
NPV analysis provides a dollar amount by which the present value of the return on a project
is expected to be greater than the expected investment. It does not provide an expected rate of
return for the investment.

Option A is incorrect
Sensitivity analysis, which is a "what if" technique, can be used with NPV analysis to
determine how cash flows and thus NPV can be expected to vary with changes in the
underlying assumptions.

Option B is incorrect
NPV analysis does not compute a true interest rate on an investment.

Option D is incorrect
NPV analysis does not use a trial-and-error approach.
210. Question - PART25111334
Calvin Inc. is considering the purchase of a new state-of-art machine to replace its hand-
operated machine. Calvin's effective tax rate is 40%, and its cost of capital is 12%. Data
regarding the existing and new machines are presented below
Existing Machine New Machine
Original cost $50,000 $90,000
Installation cost 0 4,000
Freight and insurance 0 6,000
Expected end salvage 0 0
value
Depreciation method straight-line straight-line
Expected useful life 10 years 5 years
The existing machine has been in service for seven years and could be sold currently for
$25,000.
If the new machine is purchased Calvin expects to realize a $30,000 before-tax annual
reduction in labor costs.
If the new machine is purchased, what is the net amount of the initial cash outflow at Time 0
for net present value calculation purposes?
$65,000
$75,000
$79,000
$100,000
Option C is correct
The existing machine originally cost $50,000 and it has been in service for 7 years. Its
expected useful life was 10 years when it was purchased and it is being depreciated on the
straight line basis. Therefore, $5,000 is being depreciated each year ($50,000 ÷ 10).
So the book value of the existing machine at the time of replacement would be $50,000 − (7
× $5,000), which is $15,000. If it is sold for $25,000, there will be a taxable gain of $10,000
on the sale ($25,000 − $15,000).
The company's tax rate is 40%, so the tax on the gain will be 40% of $10,000, which is
$4,000. The cost of the new machine, the installation and the freight and insurance on its
shipment will all be capitalized, so the tax rate will not affect those costs in Year 0.
Therefore, the Year 0 net cash outflow will be: Outflows for capitalized equipment:
($90,000) + ($4,000) + ($6,000) = ($100,000) Inflow from sale of existing equipment:
$25,000 before tax Outflow for tax on gain on sale of existing equipment: ($4,000)
The net cash outflow is ($100,000) + $25,000 + ($4,000) = ($79,000)

Option A is incorrect
This is the cost of the new machine minus the sale price of the existing machine. However, it
does not include the installation cost, the freight and insurance, or the tax due on the gain on
the sale of the existing machine.

Option B is incorrect
This is the cost of the new machine plus the installation cost and freight and insurance cost
minus the sale price of the existing machine. However, it does not include the tax due on the
gain on the sale of the existing machine.

Option D is incorrect
This is the cost of the new machine plus the installation cost and the freight and insurance
cost. However, it does not include the net after-tax cash to be received from the sale of the
existing machine.
211. Question - PART25111349
The modeling technique that should be used in a complex situation involving uncertainty is
a(n)
expected value analysis
program evaluation review technique.
Monte Carlo simulation
Markov proces
Option C is correct
Monte Carlo simulation can be used to develop an expected value when the situation is
complex and the values cannot be expected to behave predictably. Monte Carlo simulations
uses repeated random sampling and can develop probabilities of various scenarios coming to
pass that then can be used to compute a result that approximates an expected value.

Option A is incorrect
Expected value analysis is not the modeling technique that should be used in a complex
situation involving uncertainty.

Option B is incorrect
Program evaluation review technique is not the modeling technique that should be used in a
complex situation involving uncertainty.

Option D is incorrect
Markov process is not the modeling technique that should be used in a complex situation
involving uncertainty.
212. Question - PART250134The net present value (NPV) method and the internal rate of
return (IRR) method are used to analyze capital expenditures. The IRR method, as contrasted
with the NPV method,Incorporates the time value of money whereas the NPV method does
not.Is considered inferior because it fails to calculate compounded interest rates.Is preferred
in practice because it is able to handle multiple desired hurdle rates, which is impossible with
the NPV method.Assumes that the rate of return on the reinvestment of the cash proceeds is
at the indicated rate of return of the project analyzed rather than at the discount rate used.
Option D is correct
The internal rate of return is the discount rate at which the net present value of a project is
zero. The internal rate of return method assumes that the cash proceeds of the investment will
be reinvested at the internal rate of return, which may not be the case.

Option A is incorrect
Both the IRR method and the NPV method incorporate the time value of money.

Option B is incorrect
The internal rate of return method does utilize compounded interest rates.

Option C is incorrect
The internal rate of return method cannot handle multiple desired hurdle rates.
213. Question - PART250063All of the following are the rates used in net present value
analysis except for theAccounting rate of return.Discount rate.Hurdle rate.Cost of capital.
Option A is correct
In net present value analysis, the present value of future cash flows less the net cost of the
investment equals the NPV. The rate used to discount the future cash flows to their present
value is called the required rate of return. It can also be referred to as the discount rate or the
hurdle rate. The cost of capital is frequently used as the required rate of return. The
accounting rate of return is not a part of net present value analysis, however.

Option B is incorrect
The discount rate is used in net present value analysis.

Option C is incorrect
The hurdle rate is another name for the required rate of return, or the discount rate, that is
used in net present value analysis.

Option D is incorrect
The cost of capital is frequently used as the required rate of return in discounting future cash
flows to their present value. Thus, it is used in net present value analysis.
214. Question - CMA251520
A three year project with an initial investment of $6,000 has pretax annual cash inflows of
$1,500 after depreciation of $200. The tax rate is 30%. What would be the net present value
of the project discounted at the rate of 12% when the present value of an annuity of $1 for 3
years @12% is 2.402?
($3,477.9)
$2,522.1
($2,997.5)
$3,002.5
Option C is correct.
Net present value = Present value of net cash inflows after tax - Investment.
Where, investment = $6,000.
Present value of net cash inflows after tax = Net cash inflows after tax x PV factor for an
annuity at 12% for 3 years.
Tax = Net cash inflows after depreciation x Tax rate = $1,500 x 30% = $450.
Net cash inflows after tax = Net cash inflows before depreciation – Tax = ($1,500 + $200) -
$450 = $1,250.
So, Present value of net cash inflows after tax = $1,250 x 2.402 = $3,002.5.
Net present value = Present value of net cash inflows after tax- Investment = $3,002.5 -
$6,000 = ($2,997.5).

Option A is incorrect
because ($3,477.9) would be the NPV when depreciation, being a non-cash expense is not
added back to arrive at net cash inflows after tax.

Option B is incorrect
because $2,522.1 would be the result when depreciation, being a non-cash expense is not
added back to arrive at net cash inflows after tax and initial investment of $6,000 is also not
deducted to arrive at the NPV.

Option D is incorrect
because $3,002.5 is the present value of net cash inflows after tax and not the net present
value of the project.
215. Question - PART2110688
Carl Corporation is considering a $1,000,000 investment that will have a three-year life.
Working capital of $250,000 will be required at the beginning of the project. At the end of
the project, the equipment will be sold for an estimated $400,000. Carl Corporation's
required rate of return is 10%. The company expects annual cash flow of $400,000. Carl
Corporation's tax rate is 40%. The equipment will be depreciated over a three-year period for
tax purposes, and the depreciation rates for tax purposes (MACRS) are as follows:

Year Depreciation rate

1 33.33%
 2 44.45%
3 14.81%
4 7.41%
Present value factors are as follows:
Year PV of $1 PV of an Annuity
10% 10% 11% 11% 12% 12%
1 .90909 .90909 .8928 .90909 .90909 .89286
6
2 .82645 81162 .7971 .73554 .71252 .69005
9
3 .75132 .73119 .7117 .48685 .44371 .40183
8
4 .68301 65873 .6355 .16986 .10245 .03735
2
What is the cash flow in the final year?
$568,880
$699,240
$859,240
$818,880
Option D is correct
The final year's cash flow consists of:

Operating cash flow $240,000

Depreciation Tax Shield 59,240
Proceeds from sale,
net of tax on gain:
$400,000-.4*(400,000-74100) 269,640
Released working capital 250,000
Total cash flow 818,880

Option A is incorrect
This option is incorrect as it did not consider released working capital.

Option B is incorrect
This option is a result of incorrect value consideration in calculation.

Option C is incorrect
This option is a result of incorrect value consideration in calculation.

216. Question - PART250114Which one of the following is most relevant to a

manufacturing equipment replacement decision?Original cost of the old equipment.Disposal
price of the old equipment.Gain or loss on the disposal of the old equipment.A lump-sum
write-off amount from the disposal of the old equipment.
Option B is correct
The cash inflow that the company would be able to gain from disposing of the old piece of
equipment is most relevant because this cash inflow will occur only if the decision is made to
dispose of the old piece of equipment.
Option A is incorrect
The original cost of the old equipment is based on historical cost, which is a sunk cost and
therefore not relevant to the decision.

Option C is incorrect
Gain or loss on sale of asset is based on historical cost information, which is a sunk cost and
not relevant in the decision.

Option D is incorrect
A lump-sum write-off of an asset is a sunk cost and not relevant to the decision.
217. Question - PART251509
Management uses capital budgeting techniques to:
Help maximize the cash inflow from the selected investment alternative.
Help minimize the cash outflow from the selected investment alternative.
Identify the investment alternatives.
Evaluate the best investment alternative.
Option D is correct.
The objective of the management in using capital budgeting technique is to identify which
investment alternative is most profitable amongst the given investment alternatives. Thus,
management uses capital budgeting techniques to evaluate the best investment alternative.

Option A is incorrect
because capital budgeting comes before the investment alternative is finally selected. Thus,
based on the above explanation capital budgeting technique does not help maximize the cash
inflow or minimize the cash outflow from the selected investment alternative.

Option B is incorrect
because capital budgeting comes before the investment alternative is finally selected. Thus,
based on the above explanation capital budgeting technique does not help maximize the cash
inflow or minimize the cash outflow from the selected investment alternative.

Option C is incorrect
because capital budgeting technique helps evaluate investment alternatives after they have
been identified.
218. Question - PART250071The technique that recognizes the time value of money by
discounting the after-tax cash flows for a project over its life to time period zero using the
company's minimum desired rate of return is called thePayback method.Net present value
method.Average rate of return method.Accounting rate of return method.
Option B is correct
Net present value of a project is calculated by discounting the after-tax expected cash flows
for the project over its life to time period zero using the company's minimum required rate of
return. The present value of the future expected cash inflows minus the net initial investment
equals the net present value.

Option A is incorrect
The payback method explicitly does not recognize the time value of money.

Option C is incorrect
The average rate of return is not a technique that recognizes the time value of money by
discounting the after-tax cash flows for a project.
Option D is incorrect
The accounting rate of return is the ratio of the amount of increased book income to the
required investment. Since this method uses accrual accounting income, it includes
depreciation. However, it does not take into account the time value of money.
219. Question - PART250032
Willis Inc. has a cost of capital of 15% and is considering the acquisition of a new machine
which costs $400,000 and has a useful life of 5 years. Willis projects that earnings and cash
flow will increase as follows:
Year 1 2 3 4 5
After Tax $100,000 $100,00 $100,000 $100,00 $200,000
Earnings 0 0
Cash Flow $160,000 $140,00 $100,000 $100,00 $100,000
0 0
15% Interest Rate factors
Period 1 2 3 4 5
Present Value of $1 0.87 0.76 0.6 0.57 0.50
6
Present Value of an annuity 0.87 1.63 2.2 2.86 3.36
of 9
What is the payback period of this investment?
3.00 years.1.50 years.4.00 years.4.63 years.
Option A is correct
The payback period is the number of periods that must pass before the net after-tax cash
inflows from the investment will equal (or "pay back") the initial investment. The initial
investment of $400,000 is returned in exactly 3 years, because the cash inflows of Years 1
through 3 -- $160,000, $140,000, and $100,000 -- total $400,000.

Option B is incorrect
The payback method is used to determine the number of periods that must pass before the net
after-tax cash inflows from the investment will equal (or "pay back") the initial investment
cost. After 1.5 years has passed, only $230,000 of the initial $400,000 investment will have
been paid back.

Option C is incorrect
An answer of 4.00 years results from using net earnings instead of after-tax cash flows to
calculate the payback period.

Option D is incorrect
4.63 years is the Discounted Payback Period (also called breakeven time) which results from
calculating the payback period using discounted cash flows. However, the Payback Method
does not use discounted cash flows.
220. Question - PART251467
Which of the following methods should be used if capital rationing needs to be considered
when comparing capital projects?
Net present value.
Internal rate of return.
Return on investment.
Profitability index.
Option D is correct
Profitability Index (PI) is an investment appraisal technique which is calculated by dividing
the present value of future cash flows of a project by the initial investment required. The
solution helps determine whether a project can be accepted or rejected.
In cases where the management has to choose among multiple projects, PI is the best method
to enable such decisions. Projects with a PI higher than one are usually selected; in case of
multiple projects with PI higher than one, the project with the highest PI is chosen.

Option A is incorrect
because when capital rationing is considered PI is a better measure than NPV.

Option B is incorrect
because PI is the most preferred method, when choosing among a group of investments.

Option C is incorrect
because Return on investment method is not a preferred method when choosing among a
group of investments.
221. Question - PART250050After calculating both the simple payback period and the
discounted payback period for a project, the discounted payback period isshorter because the
time value of money raises the value of the cash flows.longer because the time value of
money raises the value of the cash flows.shorter because the time value of money lowers the
value of the cash flows.longer because the time value of money lowers the value of the cash
flows.
Option D is correct
The discounted payback period is calculated using the present values (discounted values) of
the future expected cash flows, whereas the simple payback period is calculated using the
undiscounted cash flows. Because the present values of the future cash flows are lower than
their corresponding undiscounted cash flows, the discounted payback period will be longer
than the simple payback period.

Option A is incorrect
The discounted payback period is not shorter than the simple payback period, and the time
value of money does not raise the values of the cash flows. In fact, the time value of money
lowers the values of the future expected cash flows. Please see the correct answer explanation
for more information.

Option B is incorrect The discounted payback period is longer than the simple payback
period, but it is not because the time value of money raises the values of the cash flows. In
fact, the time value of money lowers the values of the future expected cash flows. Please see
the correct answer explanation for more information.

Option C is incorrect
The time value of money does lower the values of the cash flows, but the discounted payback
period is not shorter than the simple payback period. Please see the correct answer
explanation for more information.
222. Question - PART250006Kore Industries is analyzing a capital investment proposal for
new equipment to produce a product over the next 8 years. The analyst is attempting to
determine the appropriate "end-of-life" cash flows for the analysis. At the end of 8 years, the
equipment must be removed from the plant and will have a net book value of zero, a tax basis
of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000. Kore's effective
tax rate is 40%. What is the appropriate "end-of-life" cash flow related to these items that
should be used in the analysis?$45,000-$18,000$27,000$12,000
Option D is correct
Cash inflow from the sale of the equipment will be $10,000. The equipment's tax basis is
$75,000. Thus, there will be a capital loss for income tax purposes of $65,000, which will be
worth $26,000 in cash for the company ($65,000 × 0.40) from reduced income taxes. The
$40,000 cost to remove will be a net expense after tax of $24,000 ($40,000 × 0.60). Thus, the
net cash flow for the equipment's end of life will be $10,000 + $26,000 − $24,000 = $12,000.

Option A is incorrect
An answer of $45,000 results from counting the equipment's $75,000 tax basis as a cash
inflow and adjusting it by a positive $10,000 for the sale of the equipment and by a negative
$40,000 for the cost to remove. However, the $75,000 tax basis is not a cash inflow.
Furthermore, the tax consequences of the sale and of the cost to remove need to be included.

Option B is incorrect
An answer of $(18,000) results from taking the $10,000 cash inflow from the sale of the
equipment less the $40,000 cash outflow for cost to remove, and then reducing the resulting
$(30,000) by the effect of income tax savings at 40% of the net loss. This assumes that the
$10,000 received for the sale is 100% taxable as a gain because the equipment's book value is
zero. However, the equipment's tax basis is different from its book value.

Option C is incorrect
An answer of $27,000 results from adding the book value of the equipment ($75,000) to the
cash received from its sale ($10,000) and subtracting the cost to remove it ($40,000), then
multiplying the result by 0.60 to express it net of tax. However, the $75,000 book value of the
equipment is not a cash inflow and the $10,000 cash received from the sale of the old
equipment does not represent a taxable gain.
223. Question - PART25111341
At the conclusion of a capital budgeting project, a piece of equipment is expected to be sold
for $500,000. At the time of sale, the book value of the equipment would be $400,000. If the
income tax rate is 35%, what is the after-tax cash flow from the sale of the machine?
$325,000
$400,000
$465,000
$535,000
Option C is correct
There are 2 cash flows that we need to address in this question.
They are: 1) The cash received from the sale of this asset. In this question, that is $500,000
and this is a cash inflow.
2) The income tax effect of this transaction.
When the asset was sold, it was sold at a $100,000 gain and this gain is taxable at the tax rate
of 35%. This sale will require the company to pay $35,000 in taxes and this is a cash
outflow.
These cash flows combine to create a $465,000 cash inflow from the sale of this machine.
This answer results from calculating the income tax due on the sale incorrectly as 35% of the
$500,000 selling price.
The taxable income on the sale is the gain on the sale, which is the selling price minus the
equipment's tax basis.
(The equipment's tax basis is its book value for tax purposes.)
Option A is incorrect
Please see the correct answer explanation for more information.

Option B is incorrect
This question does not take into consideration the tax rate and treats the entire gain on the
sale of the asset as a cash outflow. Please see the correct answer for the answer explanation.

Option D is incorrect
This choice results from incorrectly adding the income tax due on the sale to the cash
received from the sale. Please see the correct answer for the answer explanation.
224. Question - PART250085
A company is considering investing in new equipment costing ¥2,500,000 with a useful life
of three years. The equipment will generate net positive cash flows during Year 1 of
¥700,000, Year 2, ¥1,200,000, and Year 3, ¥1,800,000. The company’s management uses a
10% discount rate when evaluating any new investments. What is the net present value for
this investment?
¥480,390.¥707,739.¥863,636.¥2,980,390.
Option A is correct
The net present value at a discount rate of 10% is as follows: Year Cash Flow
PV Factor Discounted Cash Flow 1 ¥ 700,000 × 0.9091 = ¥ 636,370; 2 ¥1,200,000 × 0.8264
= 991,680; 3 ¥1,800,000 × 0.7513 = 1,352,340
Present Value ¥2,980,390 Initial Cash Outflow (2,500,000) Net Present Value ¥ 480,390

Option B is incorrect
This answer results from discounting the initial cash outflow for one year along with the first
year's expected cash flow. The initial cash outflow is not discounted because it occurs at Year
0. Please see the correct answer explanation for more information.

Option C is incorrect
This answer results from summing the three future expected cash flows and discounting the
sum for one year at 10%, then subtracting the initial cash outflow from the sum. The three
future expected cash flows each need to be discounted separately using the number of years
until their receipt. Please see the correct answer explanation for more information.

Option D is correct
This is the present value of the three future expected cash flows. The net present value is the
present value of the three future expected cash flows minus the initial cash outflow. Please
see the correct answer explanation for more information.
225. Question - PART250120
Calvin Inc. is considering the purchase of a new state-of-the-art machine to replace its hand-
operated machine. Calvin's effective tax rate is 40%, and its cost of capital is 12%. Data
regarding the existing and new machines are presented below.
Existing Machine New Machine Original cost $50,000; $90,000
Installation cost 0 ; 4,000
Freight and insurance 0; 6,000
Expected end salvage value 0; 0
Depreciation method straight-line straight-line Expected useful life 10 years 5 years
The existing machine has been in service for five years and could be sold currently for
$25,000.
Calvin expects to realize annual before-tax reductions in labor costs of $30,000 if the new
machine is purchased and placed in service.
If the new machine is purchased, the incremental cash flows for the first year would amount
to
$30,000.00$45,000.00$18,000.00$24,000.00
Option D is correct
The old machine still has life in it. Its expected useful life is 10 years, but it has been in
service for only 5 years.
Therefore, it could be used for five more years.
Since the question asks for the incremental cash flows for the first year, we must compare the
cash flows for operating the old machine with the cash flows for operating the new machine.
The difference will be the incremental cash flow. The only cash flow associated with the old
machine, if the old machine is kept, is the depreciation tax shield.
When we calculate the depreciation tax shield for the incremental cash flow, then, we must
use the difference between the annual depreciation on the new machine and the annual
depreciation on the old machine.
The depreciation on the new machine will be $20,000 per year.
The depreciation on the old machine is $5,000 per year. The difference is $15,000 per year.
The depreciation tax shield on this difference will be 40% of this $15,000, which is $6,000.
The incremental operating cash flow after tax is $18,000 ($30,000 savings in labor costs ×
0.60),
and the incremental depreciation tax shield is $6,000 ($15,000 × 0.40),
for a total incremental cash inflow in the first year of $24,000.
Note that the question asks only for the incremental cash flows for the first year.
The difference between the annual depreciation on the old machine and the annual
depreciation on the new machine will be a factor only for the first 5 years of the new
machine's life, because the old machine, if kept, would be depreciated for only 5 more years.
Beginning with the 6th year, the "difference" between the annual depreciation on the old
machine and the annual depreciation on the new machine will be equal to the annual
depreciation on the new machine, because the annual depreciation on the old machine will be
zero (since the old machine, if kept, would be fully depreciated by Year 6).

Option A is incorrect
This is the incremental operating cash flow before tax for the first year. The first year's
incremental cash flow consists of the incremental operating cash flow after tax and the
incremental depreciation tax shield for the year.

Option B is incorrect
This is the incremental operating cash flow before tax for the first year plus the difference
between the annual depreciation on the new machine and the annual depreciation on the old
machine. The first year's incremental cash flow consists of the incremental operating cash
flow after tax and the incremental depreciation tax shield for the first year.

Option C is incorrect
This is the incremental operating cash flow after tax ($30,000 savings in labor costs × 0.60)
for the first year. The incremental cash flow consists of the incremental operating cash flow
after tax and the incremental depreciation tax shield.
226. Question - PART25111338
Kell Inc. is analyzing an investment for a new product expected to have annual sales of
100,000 units for the next 5 years and then be discontinued. New equipment will be
purchased for $1,200,000 and cost $300,000 to install. The equipment will be depreciated on
a straight-line basis over 5 years for financial reporting purposes and 3 years for tax purposes.
At the end of the fifth year, it will cost $100,000 to remove the equipment, which can be sold
for $300,000. Additional working capital of $400,000 will be required immediately and
needed for the life of the product. The product will sell for $80, with direct labor and material
costs of $65 per unit. Annual indirect costs will increase by $500,000. Kell’s effective tax
rate is 40%
In a capital budgeting analysis, what is the expected cash flow at time = 3 (3rd year of
operation) that Kell should use to compute the net present value?
$300,000
$720,000
$760,000
$800,000
Option D is Correct
Kell’s 3rd year cash flows are $800,000 as shown below.

After tax cash inflows ($8,000,000 - $6,500,000 - $500,000) x .6 $600,000

Depreciation tax shield ($1,500,000 ÷ 3) x .4 200,000
Cash inflow $800,000

Option A is incorrect
As explained above

Option B is incorrect
As explained above

Option C is incorrect
As explained above
227. Question - PART25111340
All of the following would increase the present value of the incremental tax savings
associated with the depreciation of an asset except a decrease in the
useful life of the asset.
marginal income tax rate
discount rate
salvage value of the asset.
Option B is Correct
A decrease in the marginal tax rate would cause the incremental tax savings from
depreciation to decrease.

Option A is incorrect
A decrease in the useful life of the asset would increase the incremental tax savings from
depreciation because the cost of the asset would be allocated over fewer years.

Option C is incorrect
A decrease in the discount rate would increase the incremental tax savings from depreciation
because a lower discount rate increases the present value of the future cash flows.

Option D is incorrect
If the U.S. tax laws were changed so that the salvage value of an asset was deducted from the
cost to calculate the depreciable base, and if the salvage value of the asset were subsequently
decreased for tax purposes, the decrease in the salvage value of the asset would increase the
incremental tax savings from depreciation because there will be a higher depreciation
expense each year as the depreciable base of the asset increases.
228. Question - PART251479
Which of the following metrics equates the present value of a project's expected cash inflows
to the present value of the project's expected costs?
Net present value.
Return on assets.
Internal rate of return.
Economic value-added.
Option C is correct
IRR is defined as the discount rate that makes the present value of the cash inflows equal to
the present value of the cash outflows in a capital budgeting analysis, where all future cash
flows are discounted to determine their present values.

Option A is incorrect
because Net Present Value is used in capital budgeting to analyze the profitability of a
projected investment or project using the cash flows from the project .It is the difference
between the present value of cash inflows and the present value of cash out flows.

Option B is incorrect
because the return on investment a performance measure used to evaluate the efficiency of an
investment or to compare the efficiency of a number of different investments. ROI measures
the amount of return on an investment relative to the investment's cost.

Option D is incorrect
because economic value added is a measure of a company's financial performance based on
the residual wealth calculated by deducting cost of capital from its operating profit.
229. Question - PART250067Crown Corporation has agreed to sell some used computer
equipment to Bob Parsons, one of the company's employees, for $5,000. Crown and Parsons
have been discussing alternative financing arrangements for the sale. Crown Corporation has
offered to accept a $1,000 down payment and set up a note receivable for Bob Parsons that
calls for a $1,000 payment at the end of each of the next 4 years. If Crown uses a 6% discount
rate, the present value of the note receivable would be$4,465$2,940$3,465$4,212
Option C is correct
The note calls for four annual payments of $1,000. This is an ordinary annuity, since the
payments are due at the end of each period. Therefore, the factor in the present value of an
annuity table can be used as it is given, without adjustment. The present value of a four-year
ordinary annuity of $1,000, discounted at 6%, is $1,000 × 3.465, or $3,465.

Option A is incorrect
An answer of $4,465 results from discounting the note receivable using the present value of
an annuity of $1,000 and a 6% rate for 4 years and then adding the $1,000 down payment at
its undiscounted value of $1,000. However, the question asks only for the present value of the
note receivable, not the present value of the entire transaction.

Option B is incorrect
An answer of $2,940 results from discounting the entire amount of the note ($4,000) at 8%
for four years. This is incorrect for two reasons: (1) The full principle of the note ($4,000) is
assumed to be paid at the maturity date in four years. However, the note calls for annual
principle payments of $1,000. (2) The discount rate used is 8%. However, the discount rate to
be used is 6%.

Option D is incorrect
An answer of $4,212 results from using the present value of an annuity factor for 6% for 5
years. However, the note is for four years.
230. Question - PART250136The following methods are used to evaluate capital investment
projects. • Internal rate of return (IRR) • Payback • Net present value (NPV) Which one of the
following correctly identifies the methods that utilize discounted cash-flow (DCF)
techniques?IRR only.Payback and NPV only.IRR and Payback only.IRR and NPV.
Option D is correct
Both the IRR and NPV methods use discounted cash-flow techniques.

Option A is incorrect
IRR is not the only method that utilized discounted cash-flow techniques.

Option B is incorrect
Payback does not use discounted cash-flow techniques.

Option C is incorrect
Payback does not use discounted cash-flow techniques.
231. Question - CMA251530
Mars Inc. is evaluating projects with the following investments and inflows:
Particulars Project A Project B
Inflow
Outflows Outflows Inflows
s
Year 0 120,000 - 110,000 -
Year 1 - 20,000 - 30,000
Year 2 - 50,000 - 50,000
Year 3 - 60,000 - 40,000
Year 4 - 30,000 - 60,000
Year 5 - 20,000 - 20,000
Present value of $1 @10% from year one to year five are: 0.909, 0.826, 0.751, 0.683 and
0.621.
The firm expects a minimum rate of return of 10%. Assuming no limitation of funds, which
of the following projects should Mars Inc. invest in if the decision has to be taken based on
the net present values (NPV) of the projects?
Projects A and B.
Project B only.
Project A or B.
Project A only.
Option A is correct.
If there is no limitation of funds, all projects with positive net present value (NPV) should be
accepted.
Calculating NPVs of both the projects:
NPV of project A = Discounted cash inflows – Investment.
Discounted cash inflows= (0.909 x 20,000) + (0.826 x 50,000) + (0.751 x 60,000) + (0.683 x
30,000) + (0.621 x 20,000) =$137,450.
NPV of project A = $137,450 – $120,000 = $17,450.
NPV of project B = Discounted cash inflows – Investment.
Discounted cash inflows = (0.909 x 30,000) + (0.826 x 50,000) + (0.751 x 40,000) + (0.683 x
60,000) + (0.621 x 20,000) =$152,010.
NPV of project B =$152,010 – $110,000 = $42,010.
As both the projects have positive NPV and the funds are not limited, both the projects
should be accepted.

Option B is incorrect
based on the above explanation.

Option C is incorrect
based on the above explanation.

Option D is incorrect
based on the above explanation.

232. Question - PART250138Logan Enterprises is at a critical decision point and must

decide whether to go out of business or continue to operate for five more years. Logan has a
labor contract with five years remaining which calls for $1.5 million in severance pay if
Logan's plant shuts down. The firm also has a contract to supply 150,000 units per year, at a
price of $100 each, to Dill Inc. for the next five years. Dill is Logan's only remaining
customer. Logan must pay Dill $500,000 immediately if it defaults on the contract. The plant
has a net book value of $600,000, and appraisers estimate the facility would sell for $750,000
today but would have no market value if operated for another five years. Logan's fixed costs
are $4 million per year, and variable costs are $75 per unit. Logan's appropriate discount rate
is 12%. Ignoring taxes, the optimal decision is toshut down because the annual cash flow is
negative $250,000 per year.keep operating to avoid the severance pay of $1,500,000.shut
down since the breakeven point is 160,000 units while annual sales are 150,000 units.keep
operating since the incremental net present value is approximately $350,000
Option D is correct
To answer this question, first calculate the immediate (Year 0) cost to shut down the plant,
and then compare that with the net present value of continuing to operate the plant for 5
years. The immediate cost to shut down the plant is the net present value (negative) of that
option. Both that and the net present value of continuing to operate the plant will be negative
and so will be losses; but the net present value of one option will be a smaller loss than the
net present value of the other option. Shut down option – immediate (Year 0) costs: Labor
contract: $(1,500,000) Default on customer contract: $(500,000) Cash from sale of plant:
$750,000 Net cash flow from shutting down as of Year 0, which is also the net present value
of shutting down: $(1,250,000) loss. Note: Since this loss occurs at Year 0, it does not need to
be discounted. Operate for 5 years option: Annual cash flow from operations: Contribution
margin 150,000 × ($100 − $75): $3,750,000 per year Fixed costs: 4,000,000 per year Loss
per year: $(250,000). The discount rate is 12%. The PV of an Annuity factor for 12% for 5
years is 3.605. The PV of an annuity of $(250,000) for 5 years at 12% is $(250,000) × 3.605
= $(901,250). The net present value of shutting down the plant is $(1,250,000). The net
present value of operating for 5 years is $(901,250). The difference is $348,750. The
incremental net present value (difference between the two net present values) is
approximately $350,000. The company would be better off continuing to operate the plant for
5 years because it would lose a present value of $901,250 by doing so, as compared to losing
a present value of $1,250,000 if they shut the plant down immediately.

Option A is incorrect
In light of the information given in the problem, calculating the annual cash flow is not the
correct way to approach this problem. To answer this question, first calculate the immediate
(Year 0) cost to shut down the plant, and then compare that with the net present value of
continuing to operate the plant for 5 years.

Option B is incorrect
This is not a reason to continue operating a plant.

Option C is incorrect
In light of the information given in the problem, calculating the breakeven point is not the
correct way to approach this problem. To answer this question, first calculate the immediate
(Year 0) cost to shut down the plant, and then compare that with the net present value of
continuing to operate the plant for 5 years.
233. Question - PART250109Which one of the following statements is correct regarding the
Net Present Value (NPV) and the Internal Rate of Return (IRR) approaches to capital
budgeting?If the IRR of a project is equal to the company’s cost of capital, the NPV of the
project must be 0.Both approaches always provide the same ranking of alternative projects.If
the NPV of a project is negative, the IRR must be greater than the company’s cost of
capital.Both approaches fail to consider the timing of the project's cash flows.
Option A is correct
The NPV of a project is equal to the sum of the present values of the future net cash inflows
minus the initial investment. A project’s IRR is the discount rate at which the NPV of the
project is zero. If the IRR is equal to the discount rate used to calculate the NPV, and if that
discount rate is assumed to be the company’s cost of capital, then the NPV of the project
must be zero.

Option B is incorrect
Both approaches do not always provide the same ranking of alternative projects.

Option C is incorrect
If the NPV of a project is negative, the IRR will be less than the company’s cost of capital.

Option D is incorrect
Both approaches consider the timing of the project's cash flows.