Which of the following is the most difficult step in the capital budgeting proce

Question

Which of the following is the most difficult step in the capital budgeting process? a. Estimating cash flows b. Applying the capital budgeting techniques c. Interpreting the results d. Determining how to finance the project 18. If a proposed investment's payback period is 3 years, its initial cost is $50,000, and its useful life is 10 years, which of the follow ing must be true? a. cash inflows over the investment's useful life total $150,000. b. cash inflows over the first three years total $50,000. c. the accounting profits generated by the investment over the first three years total $50,000. d. none of the above 19. If a net present value analysis for a normal project gives an NPV greater than zero, an internal rate of return calculation on the same project would yield an internal rate of return the firm's cost of capital. a. greater than b. less than c. equal to d. cannot be determined from the information given 20. Which of the following is NOT true regarding an NPV profile? a. It slopes downward and to the right b. They slope upward and to the left c. It graphs NPV versus IRR d. It crosses the horizontal axis at IRR 21. You are evaluating two projects with unequal lives. Purchase of a high-quality machine will result in positive cash flows for nine years, while purchase of a medium-quality machine will result in positive cash flows for six years. At the end of each respective time period, the machine is expected to be worthless. How many times will the medium-quality machine project have to be linked in order to come up with a common time period? a. twice b. three times c. four times d. nine times

Explanation / Answer

17. Answer: (a) Estimating Cash Flows

Capital budgeting decisions involves the investment of substantial amount of funds. The capital budgeting decision has its effect over a long period of time. These decision not only affects the future benefits and costs of the firm but also influence the rate and direction of growth of the firm.

It is therefore necessary for a firm to make such decisions after a thoughtful consideration so as to result in the profitable use of its scarce resources.

18. Answer: (b) Cash inflows over the first three years total $ 50’000.

Payback Period – It is one of the simplest way to calculate the period within which the entire cost of a project will be completely recovered. It is the period within which the total cash inflows the project equals the cost of the project.

19. Answer: (c) Equal to zero

Internal rate of return (IRR) is the rate at which the sum total of cash inflows after discounting equals to the discounted cash outflows. The internal rate of return of a project is the discount rate which makes net present values of the project equal to zero.

20. Answer: (b) They slope upward and to the left

The NPV profile is a graph that illustrates a project's NPV against various discount rates, with the NPV on the y-axis and the cost of capital on the x-axis.

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