honeycfa

The process of evaluating and selecting profitable long-term investments consistent with the firm’s goal of shareholder wealth maximization is known as:

A) financial restructuring.

B) capital budgeting.

C) monitoring.

---

In the process of capital budgeting, a manager is making decisions about a firm’s earning assets, which provide the basis for the firm’s profit and value. Capital budgeting refers to investments expected to produce benefits for a period of time greater than one year. Financial restructuring is done as a result of bankruptcy and monitoring is a critical assessment aspect of capital budgeting.

honeycfa

A company is considering the purchase of a copier that costs $5,000. Assume a cost of capital of 10 percent and the following cash flow schedule:

• Year 1: $3,000
• Year 2: $2,000
• Year 3: $2,000

Determine the project's NPV and IRR.

NPV

IRR

A) $243 20%

B) $883 15%

C) $883 20%

---

To determine the NPV, enter the following:
PV of $3,000 in year 1 = $2,727, PV of $2,000 in year 2 = $1,653, PV of $2,000 in year 3 = $1,503. NPV = ($2,727 + $1,653 + $1,503) ? $5,000 = 883.

You know the NPV is positive, so the IRR must be greater than 10%. You only have two choices, 15% and 20%. Pick one and solve the NPV. If it is not close to zero, then you guessed wrong; select the other one.

[3000 ÷ (1 + 0.2)1 + 2000 ÷ (1 + 0.2)2 + 2000 ÷ (1 + 0.2)3] ? 5000 = 46 This result is closer to zero (approximation) than the $436 result at 15%. Therefore, the approximate IRR is 20%.

honeycfa

Which of the following statements about the payback period is FALSE?

A) The payback period provides a rough measure of a project's liquidity and risk.

B) The payback method considers all cash flows throughout the entire life of a project.

C) The payback period is the number of years it takes to recover the original cost of the investment.

---

The payback period does not take any cash flows after the payback point into consideration.

honeycfa

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%. The payback period for this investment is closest to:

A) 5.23 years.

B) 6.12 years.

C) 4.86 years.

---

Years	0	1	2	3	4	5
Cash Flows	-$150,000	$30,000	$30,000	$30,000	$30,000	$35,000

$150,000
120,000	(4 years)(30,000/year)
$30,000

With $30,000 unrecovered cost in year 5, and $35,000 cash flow in year 5; $30,000 / $35,000 = 0.86 years

4 + 0.86 = 4.86 years

honeycfa

Landen, Inc. uses several methods to evaluate capital projects. An appropriate decision rule for Landen would be to invest in a project if it has a positive:

A) profitability index (PI).

B) net present value (NPV).

C) internal rate of return (IRR).

---

The decision rules for net present value, profitability index, and internal rate of return are to invest in a project if NPV > 0, IRR > required rate of return, or PI > 1.