If income tax considerations are ignored, how is depreciation handled by the following capital budgeting techniques?
Answer(s): A
If taxes are ignored, depreciation is not a consideration in any of the methods based on cash flows because it is a non-cash expense. Thus, the internal rate of return, net present value, and payback methods would not consider depreciation because these methods are based on cash flows. However, the accounting rate of return is based on net income as calculated on an income statement. Because depreciation is included in the determination of accrual accounting net income, it would affect the calculation of the accounting rate of return.
Which one of the following capital investment evaluation methods does not take the time value of money into consideration?
Answer(s): D
The accounting rate of return (unadjusted rate of return or rate of return on the carrying amount) equals accounting net income divided by the required initial or average investment. The accounting rate of return ignores the time value of money.
Which mutually exclusive project would you select if both are priced at $1,000 and your discount rate is 14%: Project A, with three annual cash flows of $1 .000, Project B, with three years of zero cash flow followed by three years of $1,500 annually?
Answer(s): B
Project A's VPV is calculated as follows:Since Project B has a slightly higher NPV , it should be selected.
Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming yearWhich project(s) should Maloney undertake during the upcoming year assuming it has no budget restrictions?
Answer(s): C
A company using the net present value (NPV) method should undertake all projects with positive NPVs that are not mutually exclusive. Given that Projects 1, 2, and 4 have positive NPVs, those projects should be undertaken. Furthermore, a company using the internal rate of return (IRR) as a decision rule ordinarily chooses projects with a return greater than the cost of capital. Given a 12% cost of capital. Projects 1, 2, and 4 should be chosen using an IRR criterion if they are not mutually exclusive. Use of the profitability index yields a similar decision because a project with an index greater than 100% should be undertaken.
Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming yearWhich projects should Maloney undertake during the upcoming year if it has only $12,000,000 of investment funds available?
With only $12,000,000 available and each project costing $4,000,000 or more, no more than two projects can be undertaken. Accordingly, projects should be selected because they have the greatest NPVs and profitability lily indexes.
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