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Exam 12: Strategy and the Analysis of Capital Investments

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Question 41

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All of the following capital budgeting models incorporate the time value of money except:

A) The payback method.
B) The modified internal rate of return (MIRR) method.
C) The profitability index (PI) method.
D) The discounted payback method.
E) The internal rate of return (IRR) method.

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Question 42

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If a company must choose between two mutually exclusive investment projects, the best general method to employ for decision-making purposes is:

A) Cash-flow bailout.
B) Cash-flow break-even.
C) Net present value (NPV) .
D) Discounted payback.
E) Accounting (book) rate of return, based on average investment over the life of each project.

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Question 43

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The after-tax cost of debt for purposes of estimating a company's weighted-average cost of captital

The hurdle rate for accepting new capital investment projects is 4%, after-tax. (Note: To answer this question, students will have to be provided with the Tables provided in Appendix C, Chapter 12. Alternatively, the instructor can provide students with the following PV $1 factors for 4%: for 1 year = 0.962, for year 2 = 0.925, for year 3 = 0.889, for year 4 = 0.855, for year 5 = 0.822; the PV annuity factor for 4%, 5 years = 4.452.) The estimated internal rate of return (IRR) on this investment is:

Paulsen Inc. purchased a $700,000 machine to manufacture a specialty tap for electrical equipment. The tap was in high demand and Paulsen could sell all that it could manufacture for the next five years. The government exempted taxes on profits from new investments in order to encourage capital investments. This legislation was not expected to be altered in the foreseeable future. The equipment was expected to have five years of useful life with no salvage value. The company employed straight-line depreciation. The net cash inflow was expected to be $180,000 each year for five years. Olsen uses a rate of 9% in evaluating its capital investments. Required: Round all answers to 2 decimal places (e.g., 12.34%). 1. Calculate the payback period for this proposed investment. (Assume that cash inflows occur evenly throughout the year.) 2. Calculate the project's accounting rate of return (ARR) based on the initial investment. 3. Calculate the accounting rate of return (ARR) based on average investment, where the latter is defined as a simple average of beginning-of-project net book value and end-of-project net book value 4. Calculate the internal rate of return (IRR) of this proposed investment. (Note: To answer this question, students need access either to Appendix C, Table 2 or to Excel.)

In making capital budgeting decisions, the principal focus is on:

For a capital investment project, a net present value (NPV) of $500 indicates that the:

The internal rate of return (IRR) for a project can be determined

Assume that cash inflows occur evenly throughout the year. The estimated payback period for this proposed investment, in years, is (rounded to two decimal places) :

Which of the following items has no after-tax consequences in the analysis of a capital investment proposal?

For dealing with uncertainty in the capital budgeting process, all of the following techniques can be used except which one?

What is the present value payback period, rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791.)

HHR Construction, Inc. is currently considering developing, on a piece of land currently held by the company, a new courtyard motel. This project would provide a single payoff from a buyer in one year (after construction was completed). The concept of a courtyard motel is relatively new, so there is a certain amount of risk associated with this project. The company's management feels that new information regarding potential consumer demand would be revealed, that is, whether in the chosen geographic location a courtyard motel would be popular ("good news") or unpopular ("bad news"). In the former case, you anticipate a selling price of $13 million, while in the latter case only $9 million. At the present, these two outcomes are considered equally likely. For projects of this sort, the company uses a WACC (discount rate) of 10% after tax. The company estimates that total construction costs for this project would, in today's dollars, be approximately $9.7 million. Required: 1. Based on the given probabilities for the two possible outcomes (states of nature), what is the expected NPV of the proposed investment? 2. What is the primary deficiency of the traditional DCF analysis you conducted above in (1)? 3. Suppose now that management has an option to wait a year before deciding whether to construct the motel in question. The question the company is grappling with is whether it should delay the investment decision for one year. Given the information above, what do you recommend, and why? (For simplicity, assume that one year from now the investment cost would be $9.7 million and that the return one year later would be $13 million.) 4. Define the term "real option." Compare real options with financial options. 5. This problem deals with what is called an investment-timing option, one of four general classes of real options. What other types of real options can be embedded in a capital investment proposal? How do these classes relate to put options and call options?

In capital budgeting, the accounting rate of return (ARR) decision model:

Research has shown that in framing capital investment decisions, sunk costs tend to:

For a typical capital investment project, the bulk of the investment-related cash outflow occurs:

The estimated net present value (NPV) of this proposed investment (rounded to the nearest thousand) is: (Note: the PV annuity factor from Table 2, Appendix C, 10%, 10 years is 6.145.)

Which of the following methods can be used to deal formally with uncertainty in the capital-budgeting process?

When the internal rate of return (IRR) method and the net present value (NPV) method do not yield the same recommendation for the same investment project, the technique normally selected is:

If an existing asset is sold at a gain, and the gain is taxable, then the after-tax proceeds from this transaction would be equal to: