Question 1

Which of the following statements is FALSE?

Accepted Answer

A) The firm deducts a fraction of the investments in plant,property,and equipment each year as depreciation. 
B) If securities are fairly priced,the net present value of a fixed set of cash flows is independent of how those cash flows are financed. 
C) Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in capital budgeting analysis. 
D) A good rule to remember is that if our decision does not affect a cash flow then the cash flow should not affect our decision. 
A) The firm deducts a fraction of the investments in plant,property,and equipment each year as depreciation. 
B) If securities are fairly priced,the net present value of a fixed set of cash flows is independent of how those cash flows are financed. 
C) Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in capital budgeting analysis. 
D) A good rule to remember is that if our decision does not affect a cash flow then the cash flow should not affect our decision.

Question 2

Use the information for the question(s)below.
Temporary Housing Services Incorporated (THSI)is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane.THSI will lease space in this facility to various agencies and groups providing relief services to the area.THSI estimates that this project will initially cost $5 million to set up and will generate $20 million in revenues during its first and only year in operation (paid in one year).Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million.THSI will require no working capital for this investment.THSI's marginal tax rate is 21%.
-Assume that THSI's cost of capital for this project is 15%.The NPV of this temporary housing project is closest to:

Accepted Answer

A) $1,043,500. 
B) -$650,000. 
C) $1,960,000. 
D) -$435,000. 
A) $1,043,500. 
B) -$650,000. 
C) $1,960,000. 
D) -$435,000.

Question 3

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million.If Sisyphean's corporate tax rate is 21%,then what is the value of the depreciation tax shield on their new project?

Accepted Answer

A) $750,000 
B) $525,000 
C) $1,500,000 
D) $1,750,000 
A) $750,000 
B) $525,000 
C) $1,500,000 
D) $1,750,000

Question 4

Which of the following statements is FALSE?

Accepted Answer

A) Because only the tax consequences of depreciation are relevant for free cash flow,we should use the depreciation expense that the firm will use for tax purposes in our free cash flow forecasts. 
B) A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into based on its overall level of pre-tax income,though C-corporations only have a single tax rate as a result of the Tax Cuts and Jobs Act of 2017. 
C) Free Cash Flow = (Revenues - Costs)× (1 - τc)- Capital Expenditures - ΔNWC + τc × Depreciation. 
D) Net working capital is found by subtracting current assets from current liabilities. 
A) Because only the tax consequences of depreciation are relevant for free cash flow,we should use the depreciation expense that the firm will use for tax purposes in our free cash flow forecasts. 
B) A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into based on its overall level of pre-tax income,though C-corporations only have a single tax rate as a result of the Tax Cuts and Jobs Act of 2017. 
C) Free Cash Flow = (Revenues - Costs)× (1 - τc)- Capital Expenditures - ΔNWC + τc × Depreciation. 
D) Net working capital is found by subtracting current assets from current liabilities.

Question 5

A decrease in the sales of a current project because of the launching of a new project is called:

Accepted Answer

A) cannibalization. 
B) a sunk cost. 
C) an overhead expense. 
D) an irrelevant aspect of the investment decision. 
A) cannibalization. 
B) a sunk cost. 
C) an overhead expense. 
D) an irrelevant aspect of the investment decision.

Question 6

Use the following information to answer the question(s)below.
(Include the MACRS Table from the Appendix. )
Casa Grande Farms is considering purchasing multiple tractors for a total purchase price of $540,000.These tractors are expected to generate EBITDA of $250,000 for each of the next three years.Casa Grande Farms has a 21% tax rate and has a cost of capital of 10%.
-Assume that Casa Grande Farms is planning to sell the tractors after two years,when their book value is $119,988,for a total price of $180,000.What is the effect on free cash flow in the year they are sold?

Accepted Answer

A) A cash inflow of $60,012 
B) A cash outflow of $60,012 
C) A cash inflow of $47,949 
D) A cash outflow of $47,949 
A) A cash inflow of $60,012 
B) A cash outflow of $60,012 
C) A cash inflow of $47,949 
D) A cash outflow of $47,949

Question 7

Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in?

Accepted Answer

A) The tax savings brought about by the project's depreciation expense 
B) The cost of a marketing survey you conducted to determine demand for the proposed project 
C) Interest payments on debt used to finance the project 
D) Research and Development expenditures you have made 
A) The tax savings brought about by the project's depreciation expense 
B) The cost of a marketing survey you conducted to determine demand for the proposed project 
C) Interest payments on debt used to finance the project 
D) Research and Development expenditures you have made

Question 8

Which of the following statements is FALSE?

Accepted Answer

A) We can use scenario analysis to evaluate alternative pricing strategies for our project. 
B) Scenario analysis considers the effect on NPV of changing multiple project parameters. 
C) The difference between the IRR of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. 
D) Scenario analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each one of the underlying assumptions change. 
A) We can use scenario analysis to evaluate alternative pricing strategies for our project. 
B) Scenario analysis considers the effect on NPV of changing multiple project parameters. 
C) The difference between the IRR of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. 
D) Scenario analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each one of the underlying assumptions change.

Question 9

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years.Epiphany plans on using a cost of capital of 12% to evaluate this project.Based on extensive research,it has prepared the following incremental cash flow projections:  
-Epiphany is worried about the reliability of the sales forecast.How sensitive is the project's NPV to a 10% change in sales?

Accepted Answer

Base Case @#IMG-DLM& 10% Decrease in Sal

Question 10

Use the information for the question(s)below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities.Management has projected the project will produce the following cash flows for the first two years (in millions).  
-The incremental EBIT for the Shepard Industries project in year one is closest to:

Accepted Answer

A) $360 million. 
B) $750 million. 
C) $595 million. 
D) $510 million. 
A) $360 million. 
B) $750 million. 
C) $595 million. 
D) $510 million.

Question 11

You are considering investing $600,000 in a new automated inventory system that will provide after-tax cost savings of $50,000 next year.These cost savings are expected to grow at the same rate as sales.If sales are expected to grow at 5% per year and your cost of capital is 10%,then what is the NPV of the automated inventory system?

Accepted Answer

A) $400,000 
B) $500,000 
C) -$100,000 
D) $1,000,000 
A) $400,000 
B) $500,000 
C) -$100,000 
D) $1,000,000

Question 12

Use the information for the question(s)below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities.Management has projected the project will produce the following cash flows for the first two years (in millions).  
-The free cash flow from the Shepard Industries project in year one is closest to:

Accepted Answer

A) $283 million. 
B) $300 million. 
C) -$5 million. 
D) $390 million. 
A) $283 million. 
B) $300 million. 
C) -$5 million. 
D) $390 million.

Question 13

You are considering adding a microbrewery on to one of your firm's existing restaurants.This will entail an increase in inventory of $8000,an increase in accounts payable of $2500,and an increase in property,plant,and equipment of $40,000.All other accounts will remain unchanged.The change in net working capital resulting from the addition of the microbrewery is:

Accepted Answer

A) $45,500. 
B) $10,500. 
C) $6500. 
D) $5500. 
A) $45,500. 
B) $10,500. 
C) $6500. 
D) $5500.

Question 14

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years.The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2000 canes in year 1.Sales are estimated to grow by 10% per year each year through year three.The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant.The canes have a manufacturing cost of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash,4% of its annual sales in accounts receivable,9% of its annual sales in inventory,and 6% of its annual sales in accounts payable.The firm is in the 21% tax bracket,and has a cost of capital of 10%.
-The amount of incremental income taxes that the Sisyphean Company will pay in the first year on this new project is closest to:

Accepted Answer

A) $6300. 
B) $5200. 
C) $3500. 
D) $1680. 
A) $6300. 
B) $5200. 
C) $3500. 
D) $1680.

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) A capital budget lists the projects and investments that a company plans to undertake during the coming year. 
B) Income Tax = EBIT × (1 - τc). 
C) When sales of a new product displace sales of an existing product,the situation is often referred to as cannibalization. 
D) Overhead expenses are often allocated to the different business activities for accounting purposes. 
A) A capital budget lists the projects and investments that a company plans to undertake during the coming year. 
B) Income Tax = EBIT × (1 - τc). 
C) When sales of a new product displace sales of an existing product,the situation is often referred to as cannibalization. 
D) Overhead expenses are often allocated to the different business activities for accounting purposes.

Question 16

Which of the following costs would you consider when making a capital budgeting decision?

Accepted Answer

A) Sunk cost 
B) Opportunity cost 
C) Interest expense 
D) Fixed overhead cost 
A) Sunk cost 
B) Opportunity cost 
C) Interest expense 
D) Fixed overhead cost

Question 17

Which of the following statements is FALSE?

Accepted Answer

A) Sales will ultimately decline as the product nears obsolescence or faces increased competition. 
B) Managers sometimes continue to invest in a project that has a negative NPV because they have already invested a large amount in the project and feel that by not continuing it,the prior investment will be wasted. 
C) With straight-line depreciation the asset's cost is divided equally over its life. 
D) A project's unlevered net income is equal to its incremental revenues less costs and depreciation,evaluated on a pre-tax basis. 
A) Sales will ultimately decline as the product nears obsolescence or faces increased competition. 
B) Managers sometimes continue to invest in a project that has a negative NPV because they have already invested a large amount in the project and feel that by not continuing it,the prior investment will be wasted. 
C) With straight-line depreciation the asset's cost is divided equally over its life. 
D) A project's unlevered net income is equal to its incremental revenues less costs and depreciation,evaluated on a pre-tax basis.

Question 18

Use the following information to answer the question(s)below.
(Include the MACRS Table from the Appendix. )
Casa Grande Farms is considering purchasing multiple tractors for a total purchase price of $540,000.These tractors are expected to generate EBITDA of $250,000 for each of the next three years.Casa Grande Farms has a 21% tax rate and has a cost of capital of 10%.
-Assuming that Casa Grande Farms depreciates these tractors straight line over the three-year life,then the annual depreciation tax shield in year 2 is closest to:

Accepted Answer

A) $37,800. 
B) $80,000. 
C) $84,000. 
D) $117,000. 
A) $37,800. 
B) $80,000. 
C) $84,000. 
D) $117,000.

Question 19

Use the following information to answer the question(s)below.
Galt Motors currently produces 500,000 electric motors a year and expects output levels to remain steady in the future.It buys armatures from an outside supplier at a price of $2.50 each.The plant manager believes that it would be cheaper to make these armatures rather than buy them.Direct in-house production costs are estimated to be only $1.80 per armature.The necessary machinery would cost $700,000 and would be obsolete in 10 years.This investment would be depreciated to zero for tax purposes using a 10-year straight line depreciation.The plant manager estimates that the operation would require additional working capital of $40,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years.The expected proceeds from scrapping the machinery after 10 years are estimated to be $10,000.Galt Motors pays tax at a rate of 21% and has an opportunity cost of capital of 14%.
-The IRR of manufacturing the armatures in-house is closest to:

Accepted Answer

A) 48%. 
B) 49%. 
C) 50%. 
D) 53%. 
A) 48%. 
B) 49%. 
C) 50%. 
D) 53%.

Question 20

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years.The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2000 canes in year 1.Sales are estimated to grow by 10% per year each year through year three.The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant.The canes have a manufacturing cost of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash,4% of its annual sales in accounts receivable,9% of its annual sales in inventory,and 5% of its annual sales in accounts payable.The firm is in the 21% tax bracket,and has a cost of capital of 10%.
-The required net working capital in the first year for the Sisyphean Corporation's project is closest to:

Accepted Answer

A) $3600. 
B) $3960. 
C) $2880. 
D) $5400. 
A) $3600. 
B) $3960. 
C) $2880. 
D) $5400.

Which of the following statements is FALSE?

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million.If Sisyphean's corporate tax rate is 21%,then what is the value of the depreciation tax shield on their new project?

Which of the following statements is FALSE?

A decrease in the sales of a current project because of the launching of a new project is called:

Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following costs would you consider when making a capital budgeting decision?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Exam 8: Fundamentals of Capital Budgeting

Which of the following statements is FALSE?

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million.If Sisyphean's corporate tax rate is 21%,then what is the value of the depreciation tax shield on their new project?

Which of the following statements is FALSE?

A decrease in the sales of a current project because of the launching of a new project is called:

Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following costs would you consider when making a capital budgeting decision?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters