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Net Investment in capital budgeting can be computed as the Initial Cost of Investment + Installation Cost - Net Proceeds from the Sale of Old Equipment + Gain from the sale of Old Equipment

F

Capital budgeting involves choosing among various capital projects to find one(s) that will maximize a company’s cost on its financial investment

F

Although accrual accounting has its advantages over cash-basis accounting, for purposes of capital budgeting, estimated cash inflows and outflows are preferred including Annual Rate and Return as inputs into capital budgeting decision tools.

F

Most capital budgeting decision methods employ cash flow numbers rather than accrual accounting revenues and expenses.

T

Incremental costs is when a firm has the opportunity to add a project that will utilize factory capacity that is currently not being used.

T

Depreciation expense is always included in the computation of net cash flow as it reflects the impact of fixed asset purchases

F

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

F

How should the following projects be listed in order of increasing risk?

A. Replacement, expansion, new venture.

B. New venture, replacement, expansion.

C. Expansion, replacement, new venture.

D. Replacement, new venture, expansion

A

A capital investment decision is essentially a decision to:

A. exchange current cash flow from operating activities for future cash inflows from investing activities.

B. exchange current assets for current liabilities.

C. exchange current cash outflows for the promise of receiving future cash inflows.

D. exchange current cash inflows for future cash outflows.

C

When disposing of an old asset and replacing it with a new one, tax effect on

A. gain on sale of the old asset reduces the basis of the new asset

B. loss on sale of the old asset reduces the basis of the new asset

C. loss on sale of the old asset reduces the basis of the new asset

D. gain on sale of the old asset increases the basis of the new asset or loss on sale of the old asset reduces the basis of the new asset

D

In capital budgeting, sensitivity analysis is used

A. to see how a decision would be affected by changes in variables.

B. to determine whether an investment is profitable.

C. to evaluate mutually exclusive investments.

D. to test the relationship of the IRR and NPV.

A

All other things being equal, as cost of capital increases

A. the company will probably want to borrow money rather than issue stock.

B. more capital projects will probably be acceptable

C. more capital projects will probably be acceptable.

D. fewer capital projects will probably be acceptable.

E. the number of capital projects that are acceptable will change, but the direction of the change is not determinable just by knowing the direction of the change in cost of capital.

D

A major difference between an investment in working capital and one in depreciable assets is that

A. an investment in working capital is returned in full at the end of a project’s life, while an investment in depreciable assets has no residual value.

B. because an investment in working capital is usually returned in full at the end of the project’s life, it is ignored in computing the amount of the investment required for the project.

C. an investment in working capital is never returned, while most depreciable assets have some residual value.

D. an investment in working capital is not tax-deductible when made, nor taxable when returned, while an investment in depreciable assets does allow tax deductions.

D

In evaluating high-tech projects,

A. only intangible benefits should be considered

B. neither tangible nor intangible benefits should be considered

C. only tangible benefits should be considered.

D. both tangible and intangible benefits should be considered.

D

When evaluating any capital project proposal, the cost of capital is dependent upon the source of the funds obtained to fund that project.

T

The tax advantage that comes from debt financing is of special benefit to a firm that is losing money.

F

The cost of capital is the rate of return required by the market suppliers of capital

T

The cost of preferred stock depends on the dividend growth rate.

F

A firm's aftertax cost of debt will increase if there is a decrease in the company's tax rate.

T

A firm's overall cost of capital is simply the sum of the firm's cost of debt, preferred stock and equity

F

Depreciation is added back to net operating income when computing the net annual cash flow.

T

In the WACC calculation, the weight of equity is based on the number of shares outstanding and the book value per share.

F

A firm's pre-tax cost of debt is based on the current yield to maturity of the firm's outstanding bonds

T

A company's WACC will most likely decrease if the firm replaced its preferred stock with debt.

T

A firm's aftertax cost of debt will increase if there is an increase in the credit rating of the company's bonds.

F

Preferred stock is a form of ownership and the stock will never mature.

T

Cost of equity share capital is greater than the cost of debt because:

A. equity shares carry a higher risk than debts.

B. new equity shares are difficult to issue.

C. equity shares do not provide a fixed dividend rate

D. par value of equity shares is lower than face value of debts

A

To approximate annual cash inflow, depreciation is

A. subtracted from net income because it is an outflow of cash

B. subtracted from net income because it is an expense

C. added back to net income because it is not an outflow of cash

D. added back to net income because it is an inflow of cash

C

Which of the following is not a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

A. Retained earnings

B. Common stock

C. Long-term debt

D. Accounts payable

D

Ideally, the firm's optimal capital structure is the one that balances the cost of debt and equity capital and their associated risk levels. The optimal capital structure minimizes the firm's:

A. earnings per share

B. weighted average cost of capital

C. cost of debt

D. cost of equity capital

B

The dividend growth model:

A. considers the risk that future dividends may be volatile.

B. considers the effects of market conditions.

C. depends on the reliability of the estimated rate of growth.

D. can only be used if historical dividend information is available.

C

Which of the following factors impacting cost of capital is controllable by the firm?

A. tax rates

B. level of interest rates

C. dividend policy

D. all of the above

C

In weighted average cost of capital, management can affect the company's cost of capital through:

A. dividend policy

B. capital structure policy

C. all of the above.

D. investment policy

C

The use of debt in financing asset/investment is called:

A. financial leverage

B. operating leverage

C. production leverage

D. solvency

A

The inexpensive nature of long-term debt in a firm’s capital structure is due to the facts that

A. the debt holders are the true owners of the firm

B. equity capital has a fixed return

C. long-term debt has a fixed return and a maturity date

D. dividends payment are tax-deductible

C

As debt is substituted for equity in the capital structure and the debt ratio increase, the behavior of the overall cost of capital is partially explained by

A. the tax deductibility of interest payments

B. the increase in the number of common shares outstanding

C. the reduction in risk as perceived by the common shareholders

D. the decrease in the cost of equity

A

The optimal capital structure is the one that balance

A. return and risk factors in order to maximize profits

B. return and risk factors in order to maximize earnings per share

C. return and risk factors in order to maximize market value

D. return and risk factor in order to maximize dividends

C

Based on the information below, what is the firm’s optimal capital structure

A. debt = 40%; equity = 60%; eps = P2.95; stock price = P26.50

B. debt = 50%; equity = 50%; eps = P3.05; stock price = P28.90

C. debt = 60%; equity = 40%; eps = P3.18; stock price = P31.20

D. debt = 80%; equity = 20%; eps = P3.42; stock price = P30.40

C