A. TRUE / FALSE QUESTIONS

Enter True or False on the blank preceding each question.

_T_____ 1. The purchase of additional physical facilities, such as additional equipment or a new factory, is an

example of a capital expenditure.

_F_____ 2. The following three projects are mutually exclusive relative to one another: (1) installing air

conditioning in the plant; (2) acquiring a small supplier firm; (3) purchasing a new computer system.

_T____ 3. Mutually exclusive projects are those whose cash flows are unrelated to one another. The acceptance

of a mutually exclusive project does not eliminate the other projects from further consideration.

_T_____ 4. The Net Present Value (NPV) of a capital budgeting project is found by subtracting a projects

initial investment cost from the present value of the projects cash flows, with the cash flows

being discounted back to the present (t = 0) at an interest rate equal to the projects Internal Rate

of Return (IRR).

_T_____ 5. On a purely theoretical basis, NPV is the better approach to capital budgeting than Internal Rate of

Return (IRR) because IRR implicitly assumes that any intermediate cash inflows generated by an

investment are re-invested at the firms cost of capital.

______ 6. If the payback period on a given project is less than the maximum acceptable payback period,

the project should be rejected.

_F_____ 7. On a purely theoretical basis, IRR is a better approach when selecting among two mutually

exclusive projects.

_T_____ 8. Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could

actually re-invest cash inflows, the use of NPV is, in theory, preferable to IRR.

_T_____ 9. The target capital structure is the desired optimal mix of debt and equity financing that most

firms attempt to achieve and maintain.

______ 10. The cost of capital can be thought of as the rate of return required by the market suppliers of

capital (i.e., lenders and stock investors) in order to attract their funds to the firm.

_T_____ 11. The cost of preferred stock is typically lower than the cost of long-term debt (i.e., bonds) because

the preferred stock dividend payments are tax deductible.

______ 12. The break point is the level of new financing at which the cost of one of the financing

components rises, causing an upward shift in the weighted marginal cost of capital.

_T_____ 13. Generally, increases in leverage result in increased return and risk.

______ 14. Earnings Before Interest and Taxes (EBIT) are negative above the operating breakeven point,

and show a positive value or profit below the operating breakeven point.

_T_____ 15. An increase in cost (fixed cost or variable cost) tends to decrease the operating breakeven

point, whereas an increase in sales price per unit will increase the operating breakeven point.