Multiple Choice Answers

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Question 1
Cash flow can be said to equal operating income:
A. less taxes plus depreciation.
B. less taxes.
C. before depreciation and taxes plus depreciation.
D. after taxes minus depreciation.

Question 2
There are several disadvantages to the payback method; among them is that payback:
A. ignores the time value of money.
B. emphasizes receiving money back as fast as possible for reinvestment.
C. is easy to use and to understand.
D. can be used in conjunction with time adjusted methods of evaluation.

Question 3
The Dammon Corp. has the following investment opportunities. Year Machine A Inflows ($15,000 investment) Machine B Inflows ($22,500 investment) Machine C Inflows ($37,500 investment) 1 $6,000 $12,000 $-0- 2 9,000 12,000 30,000 3 3,000 10,500 30,000 4 -0- 10,500 15,000 5 -0- -0- 15,000 Under the payback method and assuming these machines are mutually exclusive, which machine(s) would Dammon Corp. choose?
A. Machine A
B. Machine B
C. Machine C
D. Machine A and B

Question 4
You buy a new piece of equipment for $5,535, and you receive a cash inflow of $1,000 per year for 8 years. What is the internal rate of return?
A. Less than 10%
B. Between 10% and 11%
C. Between 11% and 12%
D. More than 12%

Question 5
Assuming that a firm has no capital rationing constraint and that a firm’s investment alternatives are not mutually exclusive, the firm should accept all investment proposals:
A. for which it can obtain financing.
B. that have a positive net present value.
C. that have positive cash flows.
D. that provide returns greater than the after-tax cost of debt.

Question 6
The internal rate of return and net present value methods:
A. always give the same investment decision answer.
B. never give the same investment decision answer.
C. usually give the same investment decision answer.
D. always give answers different from the payback method.

Question 7
The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method:
A. assumes that cash flows are reinvested at the project’s internal rate of return.
B. concentrates on the liquidity aspects of investment projects.
C. assumes that cash flows are reinvested at the firm’s weighted average cost of capital.
D. None of the above

Question 8
Capital rationing:
A. is a way of preserving the assets of the firm over the long term.
B. is a less than optimal way to arrive at capital budgeting decisions.
C. assures stockholder wealth maximization.
D. assures maximum potential profitability.

Question 9
An asset fitting into the 5-year MACRS category was purchased 2 years ago for $60,000. The book value of this asset is now:
A. $28,800.
B. $31,200.
C. $48,000.
D. $60,000.

Question 10
In a replacement decision, if an old asset sells below book value, from a tax standpoint there is:
A. a decrease in cash flow.
B. an increase in cash flow.
C. no effect on cash flow.
D. a decrease in net present value.

Question 11
The term “risk averse” means that:
A. an individual refuses to take risks.
B. most investors and businessmen seek risk.
C. an individual will seek to avoid risk or be compensated with a higher return.
D. only investment proposals with no risk should be accepted.

Question 12
If one project has a higher standard deviation than another it:
A. has a greater risk.
B. has a higher expected value.
C. has more possible outcomes.
D. may be riskier, but this can only be determined by the coefficient of variation.

Question 13
A project has the following projected outcomes in dollars: $250, $350, and $500. The probabilities of their outcomes are 25%, 50%, and 25% respectively. What is the expected value of these outcomes?
A. $362.50
B. $89.40
C. $94.50
D. $178.30

Question 14
Risk may be integrated into capital budgeting decisions by:
A. adjusting the standard deviation of possible outcomes.
B. determining the expected value.
C. adjusting the discount rate.
D. adjusting the time horizon.

Question 15
Using the risk-adjusted discount rate approach, the cost of capital is applied to projects with __________ risk.
A. normal
B. high
C. no
D. low

Question 16
A Monte Carlo simulation model uses:
A. random variables as inputs.
B. a point estimate.
C. the cost of capital.
D. portfolio risk.

Question 17
In order to reduce risk in a firm, the firm would seek to enter a business that has:
A. high positive correlation with its present business.
B. zero correlation with its present business.
C. high negative correlation with its present business.
D. high negative variation with its present business.

Question 18
A correlation coefficient of __________ provides the greatest risk reduction.
A. 0
B. 1
C. +1
D. +.5

Question 19
A project that carries a normal amount of risk and does not affect the risk exposure of the firm should be discounted back at the:
A. coefficient of variation.
B. beta.
C. risk-free rate.
D. weighted average cost of capital.

Question 20
The “efficient frontier” indicates alternatives with:
A. neutral combinations of risk and return.
B. the highest returns.
C. the best combination of risk and return.
D. no risk.