True-False Indicate whether each statement is true (T) or false (F). ___ 1. The

ID: 2420595 • Letter: T

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True-False

Indicate whether each statement is true (T) or false (F).

___ 1. The planning and control tools used for year-to-year operating decisions are well suited for capital-budgeting decisions.

___ 2. The present value of $1 million to be received ten years from now is lower if computed at a discount rate of 10% rather than 14%.

___ 3. Assume a required rate of return of 12% is used to compute the NPV of a project. If NPV is negative, IRR is less than 12%.

___ 4. The payback method does not consider a project’s cash flows after the payback period.

___ 5. If the income tax rate for a profitable company is 30%, a depreciation deduction of $10,000 results in a tax savings of $7,000 (before considering time value of money).

___ 6. For a profitable company, the gain or loss on the recovery of working capital in a capital-budgeting project is subject to income tax.

____ 7. It is consistent to use NPV as best for capital-budgeting decisions and then use AARR to evaluate a manager’s performance over short time horizons.

Explanation / Answer

1. The planning and control tools used for year-to-year operating decisions are well suited for capital-budgeting decisions. False

For capital budgeting decisions we have to calculate the projected cash flows of the projects to be undertaken based on estimations

2. The present value of $1 million to be received ten years from now is lower if computed at a discount rate of 10% rather than 14%. False

PV of $1 million at 10% = 1000000 / (1.10)^10 = $385543.289

PV of $1 million at 14% = 1000000 / (1.14)^10 = $269743.809519

3. Assume a required rate of return of 12% is used to compute the NPV of a project. If NPV is negative, IRR is less than 12%. True

At IRR, the NPV of a project is zero, in calculations of IRR if the NPV comes negative, then we have to calculate NPV at a higher rate.

4. The payback method does not consider a project’s cash flows after the payback period. True

payback period is the period at which the cumulative cashflows are equal to the initial investments made.

5. If the income tax rate for a profitable company is 30%, a depreciation deduction of $10,000 results in a tax savings of $7,000 (before considering time value of money). False

The company has to pay tax on the whole amount of profits and no tax savings on depreciation are considered.

6. For a profitable company, the gain or loss on the recovery of working capital in a capital-budgeting project is subject to income tax.True

The addition in income generated from the gain on the recovery of working capital in a capital-budgeting project is a taxable income and tax has to be paid on it.

7. It is consistent to use NPV as best for capital-budgeting decisions and then use AARR to evaluate a manager’s performance over short time horizons. False

The methods can change given the circumstances

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