Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 9 Fundamentals of Capital Budgeting
9.1 The Capital Budgeting Process
1) A capital budget lists the potential projects a company may undertake in future years.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Capital budgeting decisions use the Net Present Value rule so that those decisions
maximize net present value (NPV).
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) The capital budgeting process begins by ________.
A) analyzing alternate projects
B) evaluating the net present value (NPV) of each project's cash flows
C) compiling a list of potential projects
D) forecasting the future consequences for the firm of each potential project
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4) The ultimate goal of the capital budgeting process is to ________.
A) determine how the consequences of making a particular decision affects the firm's
revenues and costs
B) list the projects and investments that a company plans to undertake in the future
C) forecast the consequences of a list of future projects for the firm
D) determine the effect of the decision to accept or reject a project on the firm's cash flows
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
1
Copyright © 2015 Pearson Education, Inc.
,5) Which of the following best defines incremental earnings?
A) cash flows arising from a particular investment decision
B) the amount by which a firm's earnings are expected to change as a result of an
investment decision
C) the earnings arising from all projects that a company plans to undertake in a fixed time
span
D) the net present value (NPV) of earnings that a firm is expected to receive as the result of
an investment decision
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) Which of the following best describes why the predicted incremental earnings arising
from a given decision are not sufficient in and of themselves to determine whether that
decision is worthwhile?
A) They do not tell how the decision affects the firm's reported profits from an accounting
perspective.
B) They are not easily predicted from historical financial statements of a firm and its
competitors.
C) These earnings are not actual cash flows.
D) They do not show how the firm's earnings are expected to change as the result of a
particular decision.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7) What is the correct tax rate that should be used for capital budgeting decisions?
Answer: The correct tax rate that should be used is the firm's marginal tax rate, which is
the tax rate paid on the last dollar earned by the firm.
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
8) How do we handle interest expense when making a capital budgeting decision?
Answer: We do not generally include interest expense when making capital budgeting
decisions.
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
2
Copyright © 2015 Pearson Education, Inc.
,9.2 Forecasting Incremental Earnings
1) When evaluating the effectiveness of an improved manufacturing process we should
evaluate the total sales and costs generated by this process.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Interest and other financing-related expenses are excluded when determining a project's
unlevered net income.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and
installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to have a working life of six years. Which of these
activities will be reported as an operating expense?
A) the delivery and install cost only
B) the cost of the depositor only
C) the redesign of the plant only
D) the delivery and install cost and the cost of the depositor
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3
Copyright © 2015 Pearson Education, Inc.
, 4) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $4 million to buy the machine and $12,000 to have it delivered and
installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to have a working life of six years. If straight-line
depreciation is used, what are the yearly depreciation expenses in this case?
A) $666,667
B) $668,667
C) $1,166,667
D) $1,168,667
Answer: B
Explanation: B) ($4 million + $12,000) / 6 = $668,667
Diff: 1 Var: 27
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
5) An oil company is buying a semi-submersible oil rig for $15 million. Additionally, it will
cost
$1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is
depreciated over five years using straight-line depreciation, what are the yearly
depreciation expenses in this case?
A) $2.7 million
B) $3.0 million
C) $3.3 million
D) $3.8 million
Answer: C
Explanation: B) $(15 + 1.5) / 5 = $3.3 million
Diff: 1 Var: 12
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) Which of the following is usually NOT a factor that must be considered when estimating
the revenues and costs arising from a new product?
A) the fluctuations in the cost of capital over the period in question
B) the sales of a new product will typically accelerate, plateau, and ultimately decline over
time
C) the prices of technology products generally fall over time
D) competition tends to reduce profit margins over time in most industries
Answer: A
Diff: 1 Var: 1
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4
Copyright © 2015 Pearson Education, Inc.
Chapter 9 Fundamentals of Capital Budgeting
9.1 The Capital Budgeting Process
1) A capital budget lists the potential projects a company may undertake in future years.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Capital budgeting decisions use the Net Present Value rule so that those decisions
maximize net present value (NPV).
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) The capital budgeting process begins by ________.
A) analyzing alternate projects
B) evaluating the net present value (NPV) of each project's cash flows
C) compiling a list of potential projects
D) forecasting the future consequences for the firm of each potential project
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4) The ultimate goal of the capital budgeting process is to ________.
A) determine how the consequences of making a particular decision affects the firm's
revenues and costs
B) list the projects and investments that a company plans to undertake in the future
C) forecast the consequences of a list of future projects for the firm
D) determine the effect of the decision to accept or reject a project on the firm's cash flows
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
1
Copyright © 2015 Pearson Education, Inc.
,5) Which of the following best defines incremental earnings?
A) cash flows arising from a particular investment decision
B) the amount by which a firm's earnings are expected to change as a result of an
investment decision
C) the earnings arising from all projects that a company plans to undertake in a fixed time
span
D) the net present value (NPV) of earnings that a firm is expected to receive as the result of
an investment decision
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) Which of the following best describes why the predicted incremental earnings arising
from a given decision are not sufficient in and of themselves to determine whether that
decision is worthwhile?
A) They do not tell how the decision affects the firm's reported profits from an accounting
perspective.
B) They are not easily predicted from historical financial statements of a firm and its
competitors.
C) These earnings are not actual cash flows.
D) They do not show how the firm's earnings are expected to change as the result of a
particular decision.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7) What is the correct tax rate that should be used for capital budgeting decisions?
Answer: The correct tax rate that should be used is the firm's marginal tax rate, which is
the tax rate paid on the last dollar earned by the firm.
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
8) How do we handle interest expense when making a capital budgeting decision?
Answer: We do not generally include interest expense when making capital budgeting
decisions.
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
2
Copyright © 2015 Pearson Education, Inc.
,9.2 Forecasting Incremental Earnings
1) When evaluating the effectiveness of an improved manufacturing process we should
evaluate the total sales and costs generated by this process.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Interest and other financing-related expenses are excluded when determining a project's
unlevered net income.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and
installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to have a working life of six years. Which of these
activities will be reported as an operating expense?
A) the delivery and install cost only
B) the cost of the depositor only
C) the redesign of the plant only
D) the delivery and install cost and the cost of the depositor
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3
Copyright © 2015 Pearson Education, Inc.
, 4) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $4 million to buy the machine and $12,000 to have it delivered and
installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to have a working life of six years. If straight-line
depreciation is used, what are the yearly depreciation expenses in this case?
A) $666,667
B) $668,667
C) $1,166,667
D) $1,168,667
Answer: B
Explanation: B) ($4 million + $12,000) / 6 = $668,667
Diff: 1 Var: 27
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
5) An oil company is buying a semi-submersible oil rig for $15 million. Additionally, it will
cost
$1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is
depreciated over five years using straight-line depreciation, what are the yearly
depreciation expenses in this case?
A) $2.7 million
B) $3.0 million
C) $3.3 million
D) $3.8 million
Answer: C
Explanation: B) $(15 + 1.5) / 5 = $3.3 million
Diff: 1 Var: 12
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
6) Which of the following is usually NOT a factor that must be considered when estimating
the revenues and costs arising from a new product?
A) the fluctuations in the cost of capital over the period in question
B) the sales of a new product will typically accelerate, plateau, and ultimately decline over
time
C) the prices of technology products generally fall over time
D) competition tends to reduce profit margins over time in most industries
Answer: A
Diff: 1 Var: 1
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4
Copyright © 2015 Pearson Education, Inc.
