Cma-P3-Su19

Front 1

Flex Corporation is studying a capital acquisition proposal in which newly acquired assets will be depreciated using the straight-line method.
Which one of the following statements about the proposal would be if a switch is made to the modified accelerated cost recovery system
(MACRS)?


A- The net present value will increase.

B- The internal rate of return will increase.

C- The payback period will be shortened.

D- The profitability index will decrease.

Back 1

D is correct.


A switch from straight-line depreciation to MACRS depreciation will have the following effects:



* Depreciation expense in the early life of the project will be increased.

* Because of the increased depreciation expense in the early life of the project, income taxes will be deferred and will be paid off in the later years.

* When the cash flows are discounted the present value of net cash flows will be greater than they would have been using straight-line
depreciation.

* Increasing the present value of cash flows increases net present value. And, because profitability index is present value of inflows divided by present value of the initial net investment,

Front 2

The profitability index approach to investment analysis:


A- considers only the project's contribution to net income and does not consider cash flow effects.

B- always yields the same accept/reject decisions for independent projects as the net present value method.

C- may yield different accept/reject decisions for mutually exclusive projects than the net present value method.

D- always yields the same accept/reject decisions for dependent projects as the net present value method.

Back 2

B is correct.

Since the profitability index is a variation of the NPV method, the two methods will always rank investment choices in the same order.

Front 3

The profitability index is the ratio of:


A- net present value to net investment.

B- net investment to net present value.

C- present value of future net cash flows to net investment.

D- net investment to present value of future net cash flows.

Back 3

C is correct.

The profitability index is a ratio obtained by calculating the total present value of all future net cash inflows and dividing that by the total cash
outflow (or net investment).

Front 4

If income tax considerations are ignored, how is depreciation handled by the following capital budgeting techniques?

Internal Accounting
ROR ROR Payback

A. Excluded Included Excluded
B. Included Excluded Included
C- Excluded Excluded Included
D Included Included Included

Back 4

A is correct



If taxes are ignored, depreciation is not a consideration in any of the methods based on cash flows because it is a non-cash expense.
Thus, the internal rate of return, net present value, and payback methods would not consider depreciation because these methods are based on cash flows.
However, the accounting rate of return is based on net income as calculated on an income statement. Because depreciation is included in the determination
of accrual accounting net income, it would affect the calculation of the accounting rate of return.

Front 5

MS Trucking is considering the purchase of a new piece of equipment that has a net initial investment with a present value of $300,000. The equipment has an
estimated useful life of 3 years. For tax purposes, the equipment will be fully depreciated at rates of 30%, 40%, and 30% in years one, two, and three, respectively.

The new machine is expected to have a $20,000 salvage value. The machine is expected to save the company $170,000 per year in operating expenses. MS
Trucking has a 40% marginal income tax rate and a 16% cost of capital. Discount rates for a 16% rate are:

PV of an
Annuity  PV of $1

Year 1 .862 .862
Year 2 1.605 .743
Year 3 2.246 .641






The payback period for this investment is

A. 2.08 years.
B. 2.84 years.
C. 3.00 years.
D. 1.76 years.

Back 5

A is correct.

The payback period is the time required to recover the original investment. The annual net after-tax cash inflows for Year 1 through

Year 3 are $138,000, $150,000, and $150,000, respectively, as determined by the following: 
In Year 1, the after-tax cash inflow is $170,000 minus taxes of $32,000 {[$170,000 – ($300,000 × 30%) depreciation] × 40%}, or $138,000.
In Year 2, the after-tax cash inflow is $170,000 minus taxes of $20,000 {[$170,000 – ($300,000 × 40%) depreciation] × 40%}, or $150,000.
In Year 3, the after-tax cash inflow (excluding salvage value) is again $138,000.
After 2 years, $288,000 ($138,000 + $150,000) will have been recovered. Consequently, the first $12,000 received in Year 3 will recoup the initial investment.
Because $12,000 represents .08 of Year 3 net after-tax cash inflows ($12,000 ÷ $150,000), the payback period is 2.09 years.

Front 6

The profitability index (present value index)

A. Is the relationship between the net discounted cash inflows less the discounted cash outflows divided by the discounted cash outflows.

B. Is calculated by dividing the discounted profits by the cash outflows.

C. Is the ratio of the discounted net cash inflows to discounted cash outflows.

D. Represents the ratio of the discounted net cash outflows to cash inflows.

Back 6

C is correct.

The profitability index, also known as the excess present value index, is the ratio of the present value of future net cash inflows to the
initial net cash investment (discounted cash outflows). This tool is a variation of the NPV method that facilitates comparison of different-sized investments.