Question 1

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?

Accepted Answer

A) Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.This space could be used for other products if it is not used for the project under consideration. 
B) Revenues from an existing product would be lost as a result of customers switching to the new product. 
C) Shipping and installation costs associated with a machine that would be used to produce the new product. 
D) The cost of a study relating to the market for the new product that was completed last year.The results of this research were positive, and they led to the tentative decision to go ahead with the new product.The cost of the research was incurred and expensed for tax purposes last year. 
E) It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm. 
A) Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.This space could be used for other products if it is not used for the project under consideration. 
B) Revenues from an existing product would be lost as a result of customers switching to the new product. 
C) Shipping and installation costs associated with a machine that would be used to produce the new product. 
D) The cost of a study relating to the market for the new product that was completed last year.The results of this research were positive, and they led to the tentative decision to go ahead with the new product.The cost of the research was incurred and expensed for tax purposes last year. 
E) It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm.

Question 2

Rowell Company spent $3 million two years ago to build a plant for a new product.It then decided not to go forward with the project, so the building is available for sale or for a new product.Rowell owns the building free and clear--there is no mortgage on it.Which of the following statements is CORRECT?

Accepted Answer

A) Since the building has been paid for, it can be used by another project with no additional cost.Therefore, it should not be reflected in the cash flows for any new project. 
B) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. 
E) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building. 
A) Since the building has been paid for, it can be used by another project with no additional cost.Therefore, it should not be reflected in the cash flows for any new project. 
B) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. 
E) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C) Corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
D) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
E) Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project. 
A) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C) Corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
D) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
E) Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project.

Question 4

Poulsen 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.The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an adjustment is required.What is the difference in the expected NPV if the inflation adjustment is made vs.if it is not made?

Accepted Answer

A) $13,286 
B) $13,985 
C) $14,721 
D) $15,457 
E) $16,230 
A) $13,286 
B) $13,985 
C) $14,721 
D) $15,457 
E) $16,230

Question 5

Aggarwal Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the following simple decision tree to show its three most likely scenarios.The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties.How much is the option to abandon worth to the firm?

Accepted Answer

A) $55.08 
B) $57.98 
C) $61.03 
D) $64.08 
E) $67.29 
A) $55.08 
B) $57.98 
C) $61.03 
D) $64.08 
E) $67.29

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A) Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer. 
C) If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
D) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
E) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes. 
A) Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer. 
C) If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
D) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
E) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations.If the project would have a favorable effect on other operations, then this is not an externality. 
B) An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline. 
C) The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not.This is another reason to favor the NPV. 
D) Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified.However, the payback method does not. 
E) Identifying an externality can never lead to an increase in the calculated NPV. 
A) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations.If the project would have a favorable effect on other operations, then this is not an externality. 
B) An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline. 
C) The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not.This is another reason to favor the NPV. 
D) Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified.However, the payback method does not. 
E) Identifying an externality can never lead to an increase in the calculated NPV.

Question 8

company, CSUS Inc., is considering a new project whose data are shown below.The required equipment has a 3-year tax life, and the accelerated 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 operating life.What is the project's Year 4 cash flow?

Equipment cost (depreciable basis) $70,000
Sales revenues, each year $30,500
Operating costs (excl. deprec.) $25,000
Tax rate 35%

Accepted Answer

A) $11,814 
B) $12,436 
C) $13,090 
D) $13,745 
E) $14,432 
A) $11,814 
B) $12,436 
C) $13,090 
D) $13,745 
E) $14,432

Question 9

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

Accepted Answer

A) True 
 B)False

Question 10

assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

Accepted Answer

A) $5,950 
B) $6,099 
C) $6,251 
D) $6,407 
E) $6,568 
A) $5,950 
B) $6,099 
C) $6,251 
D) $6,407 
E) $6,568

Question 11

a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow?

Accepted Answer

A) $16,351 
B) $17,212 
C) $18,118 
D) $19,071 
E) $20,075 
A) $16,351 
B) $17,212 
C) $18,118 
D) $19,071 
E) $20,075

Question 12

Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward, thus increasing their present value.On the other hand, using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses.However, the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

Accepted Answer

A) True 
 B)False

Question 13

firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?

Accepted Answer

A) Increase the estimated IRR of the project to reflect its greater risk. 
B) Increase the estimated NPV of the project to reflect its greater risk. 
C) Reject the project, since its acceptance would increase the firm's risk. 
D) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets. 
E) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. 
A) Increase the estimated IRR of the project to reflect its greater risk. 
B) Increase the estimated NPV of the project to reflect its greater risk. 
C) Reject the project, since its acceptance would increase the firm's risk. 
D) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets. 
E) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.

Question 14

Temple Corp.is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value.No new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV?
Risk-adjusted WACC 10.0%
Net investment cost (depreciable basis) $65,000
Straight-line deprec. rate 33.3333%
Sales revenues, each year $65,500
Operating costs (excl. deprec.), each year $25,000

Accepted Answer

A) $15,740 
B) $16,569 
C) $17,441 
D) $18,359 
E) $19,325 
A) $15,740 
B) $16,569 
C) $17,441 
D) $18,359 
E) $19,325

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors.Thus, cannibalization is dealt with by society through the antitrust laws. 
B) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers.Thus, cannibalization is dealt with by society through the antitrust laws. 
C) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects.Otherwise, the calculated NPV will be biased downward. 
D) If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized. 
E) Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself. 
A) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors.Thus, cannibalization is dealt with by society through the antitrust laws. 
B) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers.Thus, cannibalization is dealt with by society through the antitrust laws. 
C) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects.Otherwise, the calculated NPV will be biased downward. 
D) If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized. 
E) Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.

Question 16

primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

Accepted Answer

A) True 
 B)False

Question 17

relative risk of a proposed project is best accounted for by which of the following procedures?

Accepted Answer

A) Adjusting the discount rate upward if the project is judged to have above-average risk. 
B) Adjusting the discount rate downward if the project is judged to have above-average risk. 
C) Reducing the NPV by 10% for risky projects. 
D) Picking a risk factor equal to the average discount rate. 
E) Ignoring risk because project risk cannot be measured accurately. 
A) Adjusting the discount rate upward if the project is judged to have above-average risk. 
B) Adjusting the discount rate downward if the project is judged to have above-average risk. 
C) Reducing the NPV by 10% for risky projects. 
D) Picking a risk factor equal to the average discount rate. 
E) Ignoring risk because project risk cannot be measured accurately.

Question 18

Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Accepted Answer

A) The firm's corporate, or overall, WACC is used to discount all project cash flows to find the projects' NPVs.Then, depending on how risky different projects are judged to be, the calculated NPVs are scaled up or down to adjust for differential risk. 
B) Differential project risk cannot be accounted for by using "risk-adjusted discount rates" because it is highly subjective and difficult to justify.It is better to not risk adjust at all. 
C) Other things held constant, if returns on a project are thought to be positively correlated with the returns on other firms in the economy, then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated. 
D) Monte Carlo simulation uses a computer to generate random sets of inputs, those inputs are then used to determine a trial NPV, and a number of trial NPVs are averaged to find the project's expected NPV.Sensitivity and scenario analyses, on the other hand, require much more information regarding the input variables, including probability distributions and correlations among those variables.This makes it easier to implement a simulation analysis than a scenario or a sensitivity analysis, hence simulation is the most frequently used procedure. 
E) DCF techniques were originally developed to value passive investments (stocks and bonds).However, capital budgeting projects are not passive investments--managers can often take positive actions after the investment has been made that alter the cash flow stream.Opportunities for such actions are called real options.Real options are valuable, but this value is not captured by conventional NPV analysis.Therefore, a project's real options must be considered separately. 
A) The firm's corporate, or overall, WACC is used to discount all project cash flows to find the projects' NPVs.Then, depending on how risky different projects are judged to be, the calculated NPVs are scaled up or down to adjust for differential risk. 
B) Differential project risk cannot be accounted for by using "risk-adjusted discount rates" because it is highly subjective and difficult to justify.It is better to not risk adjust at all. 
C) Other things held constant, if returns on a project are thought to be positively correlated with the returns on other firms in the economy, then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated. 
D) Monte Carlo simulation uses a computer to generate random sets of inputs, those inputs are then used to determine a trial NPV, and a number of trial NPVs are averaged to find the project's expected NPV.Sensitivity and scenario analyses, on the other hand, require much more information regarding the input variables, including probability distributions and correlations among those variables.This makes it easier to implement a simulation analysis than a scenario or a sensitivity analysis, hence simulation is the most frequently used procedure. 
E) DCF techniques were originally developed to value passive investments (stocks and bonds).However, capital budgeting projects are not passive investments--managers can often take positive actions after the investment has been made that alter the cash flow stream.Opportunities for such actions are called real options.Real options are valuable, but this value is not captured by conventional NPV analysis.Therefore, a project's real options must be considered separately.

Question 20

TexMex Food Company is considering a new salsa whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)
WAAC = 10%
Pre tax cash flow reduction for other products(cannibalization) = $5,000
Investment costs(depreciable basis) = $80,000
Straight line depr rate = 33.333%
Sales revenues, each for 3 years = $67,500
Annual operating costs (excl deprec) = $25,000
Tax rate = 35.0%

Accepted Answer

A) $3,636 
B) $3,828 
C) $4,019 
D) $4,220 
E) $4,431 
A) $3,636 
B) $3,828 
C) $4,019 
D) $4,220 
E) $4,431

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?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow?

firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?

Which of the following statements is CORRECT?

primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

relative risk of a proposed project is best accounted for by which of the following procedures?

Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Cost of Capital

Capital Budgeting

Forecasting

Valuation, Governanc

Dividends

CAP Structure

Working Capital

Multinational

Filters

Exam 11: Cash Flow and Risk

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?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow?

firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?

Which of the following statements is CORRECT?

primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

relative risk of a proposed project is best accounted for by which of the following procedures?

Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Overview

Statements, CF, Taxes

Financial Analysis

Time Value of Money

Bonds

Risk and Return

Stocks

Financial Options

Cost of Capital

Capital Budgeting

Forecasting

Valuation, Governanc

Dividends

CAP Structure

Working Capital

Multinational

Filters