Exam 11: Cash Flow and Risk

Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy.The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project.Also, the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.On the basis of this information, which of the following statements is CORRECT?

Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

Proof Software is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected life.What is the Year 1 cash flow? Equipment cost (depreciable basis)$65,000 Sales revenues, each year$60,000 Operating costs (excl. depreciation)$25,000 Tax rate35.0%

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

work for Whittenerg Inc., which is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Project Data Sales revenues, each year \ 62,500 Depreciation \ 8,000 Other operating costs \ 25,000 Interest expense \ 8,000 Tax rate 35.0\%

use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant.

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR) is affected by a small change in one of the input variables, say sales.Other things held constant, with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the more risky the project, other things held constant.

Liberty Services is now at the end of the final year of a project.The equipment originally cost $22,500, of which 75% has been depreciated.The firm can sell the used equipment today for $6,000, and its tax rate is 40%.What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale.

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy.This is especially true for large product development projects.

company is considering a new project.The CFO plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow), then discounting those cash flows at the company's overall WACC.Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

can identify the cash costs and cash inflows to a company that will result from a project.These could be called "direct inflows and outflows," and the net difference is the direct net cash flow.If there are other costs and benefits that do not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of the capital budgeting analysis.

company, RMU Inc., is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Sales revenues………………$22,250 Depreciation ………………..$ 8,000 Other operating costs ……….$12,000 Tax rate …………………….. 35.0%

cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows.

Taussig Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data: Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?

primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater.

Desai Industries is analyzing an average-risk project, and the following data have been developed.Unit sales will be constant, but the sales price should increase with inflation.Fixed costs will also be constant, but variable costs should rise with inflation.The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value.This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects.What is the project's expected NPV?

Which of the following statements is CORRECT?

an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.