Define Capital Budgeting

In essence, capital budgeting is the process of:
Deciding what to do with the firm’s money
Deciding how much capital the firm needs
Deciding where to get the money for capital investment projects
Deciding when to invest in a new project
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Question 2 2 pts
Which of the following cash flows is an “incremental cash flow” for the purposes of capital budgeting?
Expenditures on plant and equipment for a new project
R& D expenditures for a new project during the last three years
Dividend payments
Reduction of a competitor’s sales as a result of the your company’s introduction of a new product
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Question 3 2 pts
In capital budgeting, the payback period is the:
Amount of time it takes to receive all the future cash flows from a project
Amount of time it takes to pay back any money borrowed to finance the project
Amount of time it take for the project to be completed
Amount if time it takes to recoup the initial investment for the project
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Question 4 2 pts Skip to question text.
The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 10 percent. At what point will the initial investment be paid back?
at the end of the 4th year
at the end of the 5th year
at the end of the 6th year
at the end of the 7th year
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Question 5 2 pts Skip to question text.
Consider the following income statement and answer the question that follows: Sales (100 units)…………..$200 Variable costs ($.20 ea)……20 Fixed Costs…………………..80 EBIT…………………………..100 Interest Expense…………….30 EBT……………………………70 Income tax…………………..24 Net Income…………………..46 What is the firm’s Breakeven Point in units?
1
45
56
2,000
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Question 6 2 pts
The net present value of an investment is its present value minus its future value.
True
False
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Question 7 2 pts
If the NPV of a proposed project is positive, the NPV amount represents:
The amount of profit the firm will make if it adopts the project
The amount of cash that the project will produce if adopted
The amount of value that will be added to the firm if the project is adopted
The project’s expected rate of return
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Question 8 2 pts Skip to question text.
Joe the cut-rate bond dealer has offered to sell you a ten year zero-coupon bond for $300. (Remember, zero-coupon bonds pay their owners $1,000 at maturity and involve no other cash flows other than the purchase price.) If your required rate of return for cut-rate bonds is 20%, what is the NPV of Joe’s deal?
about $161
about -$138
about $700
about -$200
about $1096
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Question 9 2 pts
When using the IRR method to evaluate investments, those with positive IRRs are accepted and those with negative IRRs are rejected.
True
False
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Question 10 2 pts Skip to question text.
You’ve decided to give up playing the stock market and buy some zero-coupon bonds from Joe the cut-rate bond dealer instead. (Remember, zero-coupon bonds because they pay off a known amount, $1,000, at maturity and involve no other cash flows other than the purchase price.) Assume your required rate of return is 12%. If you buy some 10-year zero coupon bonds for $400 each today will the bonds meet your return requirements?
Yes
No
It depends
For Week 8, please turn in the answers to the following questions:
1. List the three steps that make up the general approach to capital budgeting.
2. Define an “Incremental cash flow” as the term is used in capital budgeting
3. Your firm is considering buying a new machine that costs $200,000, is expected to generate $110,000 in new revenue each year and will cost $45,000 a year to operate. If your firm’s marginal income tax rate is 35% what is the Net Cash Flow your firm will realize from the new machine during the first year? Assume the MACRS depreciation rate for the machine for year 1 is 20%. Note – do not include the cost of the machine in your answer.
4. Define the payback period method in capital budgeting and state the payback period decision rule.
5. What is the payback period of the following project?
Initial Investment: $50,000
Projected life: 8 years
Net cash flows each year: $10,000
6. Consider the following income statement and answer the questions that follow:
Sales (100 units) $200
Variable costs ($.80 ea) 80
Fixed Costs 20
EBIT 100
Interest Expense 30
EBT 70
Income tax 24
Net Income 46
a. What is the firm’s Breakeven Point in units?
b. Draw a breakeven chart for this firm.
7. Define the Net present Value (NPV) method in capital budgeting and state the NPV decision rule. In economic terms, what does the NPV amount represent?
8. Your firm is looking at a new investment opportunity, Project Alpha, with net cash flows as follows:
—- Net Cash Flows —-
Project Alpha
Initial Cost at T-0 (Now) ($10,000)
cash inflow at the end of year 1 6,000
cash inflow at the end of year 2 4,000
cash inflow at the end of year 3 2,000
Calculate project Alpha’s Net Present Value (NPV), assuming your firm’s required rate of return is 10%.
9. Define the Internal Rate of Return (IRR) method in capital budgeting and state the IRR Decision rule.
10. Calculate the IRR of the following project:
Year Cash Flow
0 -$30,000
1 $40,000
In essence, capital budgeting is the process of