Question 1

When evaluating a new project, the firm should consider all of the following factors except:

Accepted Answer

A)  Changes in working capital attributable to the project. 
B)  Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes. 
C)  The current market value of any equipment to be replaced. 
D)  The resulting difference in depreciation expense if the project involves replacement. 
E)  All of the statements above should be considered. 
A)  Changes in working capital attributable to the project. 
B)  Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes. 
C)  The current market value of any equipment to be replaced. 
D)  The resulting difference in depreciation expense if the project involves replacement. 
E)  All of the statements above should be considered.

Question 2

Twin Hills Inc. is considering a proposed project. Given available information, it is currently estimated that the proposed project is risky but has a positive net present value. Which of the following factors would make the company less likely to adopt the current project?

Accepted Answer

A)  It is revealed that if the company proceeds with the proposed project, the company will lose two other accounts, both of which have positive NPVs. 
B)  It is revealed that the company has an option to back out of the project 2 years from now, if it is discovered to be unprofitable. 
C)  It is revealed that if the company proceeds with the project, it will have an option to repeat the project 4 years from now. 
D)  Answers a and b are correct. 
E)  Answers b and c are correct. 
A)  It is revealed that if the company proceeds with the proposed project, the company will lose two other accounts, both of which have positive NPVs. 
B)  It is revealed that the company has an option to back out of the project 2 years from now, if it is discovered to be unprofitable. 
C)  It is revealed that if the company proceeds with the project, it will have an option to repeat the project 4 years from now. 
D)  Answers a and b are correct. 
E)  Answers b and c are correct.

Question 3

The change in net operating working capital is always positive, meaning more working capital is required for projects considered in capital budgeting because all projects are either expansion projects or replacement projects which have expansion effects.

Accepted Answer

A) True 
 B)False

Question 4

Stanton Inc. is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually. Stanton will use the MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes. Stanton's marginal tax rate is 40 percent, and it uses a 9 percent cost of capital to evaluate projects of this type. If the machine's cost is $40,000, what is the project's NPV?

Accepted Answer

A)  $1,014 
B)  $2,292 
C)  $7,550 
D)  $ 817 
E)  $5,040 
A)  $1,014 
B)  $2,292 
C)  $7,550 
D)  $ 817 
E)  $5,040

Question 5

Monte Carlo simulation

Accepted Answer

A)  Can be useful for estimating a project's stand-alone risk. 
B)  Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable. 
C)  Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR. 
D)  All of the answers above. 
E)  Only answers a and b are correct. 
A)  Can be useful for estimating a project's stand-alone risk. 
B)  Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable. 
C)  Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR. 
D)  All of the answers above. 
E)  Only answers a and b are correct.

Question 6

Any cash flow that can be classified as incremental is relevant in a capital budgeting project analysis.

Accepted Answer

A) True 
 B)False

Question 7

Pickles Corp. is a company which sells bottled iced tea. The company is thinking about expanding its operations into the bottled lemonade business. Which of the following factors should the company incorporate into its capital budgeting decision as it decides whether or not to enter the lemonade business?

Accepted Answer

A)  If the company enters the lemonade business, its iced tea sales are expected to fall 5 percent as some consumers switch from iced tea to lemonade. 
B)  Two years ago the company spent $3 million to renovate a building for a proposed project which was never undertaken. If the project is adopted, the plan is to have the lemonade produced in this building. 
C)  If the company doesn't produce lemonade, it can lease the building to another company and receive after-tax cash flows of $500,000 a year. 
D)  All of the statements above are correct. 
E)  Answers a and c are correct. 
A)  If the company enters the lemonade business, its iced tea sales are expected to fall 5 percent as some consumers switch from iced tea to lemonade. 
B)  Two years ago the company spent $3 million to renovate a building for a proposed project which was never undertaken. If the project is adopted, the plan is to have the lemonade produced in this building. 
C)  If the company doesn't produce lemonade, it can lease the building to another company and receive after-tax cash flows of $500,000 a year. 
D)  All of the statements above are correct. 
E)  Answers a and c are correct.

Question 8

Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this, they should be excluded from the financial analyses.

Accepted Answer

A) True 
 B)False

Question 9

Regarding the net present value of a replacement decision, which of the following statements is false?

Accepted Answer

A)  The present value of the after tax cost reduction benefits resulting from the new investment is treated as an inflow. 
B)  The after-tax market value of the old equipment is treated as an inflow at t = 0. 
C)  The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. 
D)  Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0. 
E)  An increase in net operating working capital is treated as an outflow when the project begins and as an inflow when the project ends. 
A)  The present value of the after tax cost reduction benefits resulting from the new investment is treated as an inflow. 
B)  The after-tax market value of the old equipment is treated as an inflow at t = 0. 
C)  The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. 
D)  Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0. 
E)  An increase in net operating working capital is treated as an outflow when the project begins and as an inflow when the project ends.

Question 10

Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 12 percent to evaluate average-risk projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive projects are under consideration. Both have a cost of $200,000 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of $71,104. Project B, of less than average risk, will produce cash flows of $146,411 at the end of Years 3 and 4 only. Virus Stopper should accept

Accepted Answer

A)  B with a NPV of $10,001. 
B)  Both A and B because both have NPVs greater than zero. 
C)  B with a NPV of $8,042. 
D)  A with a NPV of $7,177. 
E)  A with a NPV of $15,968. 
A)  B with a NPV of $10,001. 
B)  Both A and B because both have NPVs greater than zero. 
C)  B with a NPV of $8,042. 
D)  A with a NPV of $7,177. 
E)  A with a NPV of $15,968.

Question 11

Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product?

Accepted Answer

A)  The use of factory floor space which is currently unused but available for production of any product. 
B)  Revenues from the existing product that would be lost as a result of some customers switching to the new product. 
C)  Shipping and installation costs associated with preparing the machine to be used to produce the new product. 
D)  The cost of a product analysis completed in the previous tax year and specific to the new product. 
E)  None of the above. (All are relevant concerns in estimating relevant cash flows attributable to a new-product project.) 
A)  The use of factory floor space which is currently unused but available for production of any product. 
B)  Revenues from the existing product that would be lost as a result of some customers switching to the new product. 
C)  Shipping and installation costs associated with preparing the machine to be used to produce the new product. 
D)  The cost of a product analysis completed in the previous tax year and specific to the new product. 
E)  None of the above. (All are relevant concerns in estimating relevant cash flows attributable to a new-product project.)

Question 12

Net incremental cash flow is calculated by adding back the change in depreciation to the change in net income.

Accepted Answer

A) True 
 B)False

Question 13

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net operating working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent.
-What is the net investment in the truck? (That is, what is the Year 0 net cash flow?)

Accepted Answer

A)  -$50,000 
B)  -$52,600 
C)  -$55,800 
D)  -$62,000 
E)  -$65,000 
A)  -$50,000 
B)  -$52,600 
C)  -$55,800 
D)  -$62,000 
E)  -$65,000

Question 14

If an asset being considered for acquisi¬tion has beta of zero, its purchase will have no effect on the firm's market risk.

Accepted Answer

A) True 
 B)False

Question 15

Other things held constant, which of the following would increase the NPV of a project being considered?

Accepted Answer

A)  A shift from MACRS to straight-line depreciation. 
B)  Making the initial investment in the first year rather than spreading it over the first 3 years. 
C)  A decrease in the discount rate associated with the project. 
D)  The sale of the old machine in a replacement decision at a capital loss rather than at book value. 
E)  An increase in required working capital. 
A)  A shift from MACRS to straight-line depreciation. 
B)  Making the initial investment in the first year rather than spreading it over the first 3 years. 
C)  A decrease in the discount rate associated with the project. 
D)  The sale of the old machine in a replacement decision at a capital loss rather than at book value. 
E)  An increase in required working capital.

Question 16

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in net operating working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent.
-What is the total terminal (non-operating) cash flow at the end of Year 3?

Accepted Answer

A)  $10,000 
B)  $12,000 
C)  $15,680 
D)  $16,000 
E)  $18,000 
A)  $10,000 
B)  $12,000 
C)  $15,680 
D)  $16,000 
E)  $18,000

Question 17

After a long drought, the manager of Long Branch Farm is considering the installation of an irrigation system which will cost $100,000. It is estimated that the irrigation system will increase revenues by $20,500 annually, although operating expenses other than depreciation will also increase by $5,000. The system will be depreciated using MACRS over its depreciable life (5 years) to a zero salvage value. If the tax rate on ordinary income is 40 percent, what is the project's IRR?

Accepted Answer

A)  12.6% 
B)  -1.3% 
C)  13.0% 
D)  10.2% 
E)  -4.8% 
A)  12.6% 
B)  -1.3% 
C)  13.0% 
D)  10.2% 
E)  -4.8%

Question 18

Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and provide positive cash flows in Years 1-5. Project X is riskier; its risk-adjusted WACC is 12 percent. Project Y is safer; its risk-adjusted WACC is 8 percent. After discounting each of the project's cash flows at the project's risk-adjusted WACC, you find that Project X has a NPV of $20,000, and Project Y has a NPV of $15,000. The projects are mutually exclusive and cannot be repeated. The firm is not capital constrained; it can raise as much capital as it needs, provided it has profitable projects in which to invest. Given this information, which of the following statements is most correct?

Accepted Answer

A)  The firm should select Project Y because it has a higher return; ($15,000/$200,000) is greater than ($20,000/$1,000,000). 
B)  The firm should select Project X because it has a higher NPV. 
C)  The firm should select Project Y because it is less risky. 
D)  The firm should reject both projects because their IRRs are less than the risk-adjusted WACC. 
E)  Statements a and c are correct.
Medium 
A)  The firm should select Project Y because it has a higher return; ($15,000/$200,000) is greater than ($20,000/$1,000,000). 
B)  The firm should select Project X because it has a higher NPV. 
C)  The firm should select Project Y because it is less risky. 
D)  The firm should reject both projects because their IRRs are less than the risk-adjusted WACC. 
E)  Statements a and c are correct.
Medium

Question 19

Which of the following statements is correct?

Accepted Answer

A)  Well diversified stockholders do not consider corporate risk when determining required rates of return. 
B)  Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk. 
C)  Managers care only about market risk. 
D)  Market risk is important but does not have a direct effect on stock price because it only affects beta. 
E)  All of the statements above are false. 
A)  Well diversified stockholders do not consider corporate risk when determining required rates of return. 
B)  Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk. 
C)  Managers care only about market risk. 
D)  Market risk is important but does not have a direct effect on stock price because it only affects beta. 
E)  All of the statements above are false.

Question 20

Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?

Accepted Answer

A)  The property was cleared of trees and brush 5 years ago at a cost of $5,000. 
B)  The new shop is expected to affect the profitability of the existing shop since some current customers will transfer their business to the new shop. Sanford and Son estimate that profits at the existing shop will decrease by 10 percent. 
C)  Sanford & Son can lease the entire property to another company (that wants to grow flowers on the lot) for $5,000 per year. 
D)  Both statements b and c should be included in the analysis. 
E)  All of the statements above should be included in the analysis. 
A)  The property was cleared of trees and brush 5 years ago at a cost of $5,000. 
B)  The new shop is expected to affect the profitability of the existing shop since some current customers will transfer their business to the new shop. Sanford and Son estimate that profits at the existing shop will decrease by 10 percent. 
C)  Sanford & Son can lease the entire property to another company (that wants to grow flowers on the lot) for $5,000 per year. 
D)  Both statements b and c should be included in the analysis. 
E)  All of the statements above should be included in the analysis.

When evaluating a new project, the firm should consider all of the following factors except:

Twin Hills Inc. is considering a proposed project. Given available information, it is currently estimated that the proposed project is risky but has a positive net present value. Which of the following factors would make the company less likely to adopt the current project?

The change in net operating working capital is always positive, meaning more working capital is required for projects considered in capital budgeting because all projects are either expansion projects or replacement projects which have expansion effects.

Monte Carlo simulation

Any cash flow that can be classified as incremental is relevant in a capital budgeting project analysis.

Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this, they should be excluded from the financial analyses.

Regarding the net present value of a replacement decision, which of the following statements is false?

Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product?

Net incremental cash flow is calculated by adding back the change in depreciation to the change in net income.

If an asset being considered for acquisi¬tion has beta of zero, its purchase will have no effect on the firm's market risk.

Other things held constant, which of the following would increase the NPV of a project being considered?

Which of the following statements is correct?

Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?

An Overview of Financial Management

Risk and Return: Part I

Risk and Return: Part II

Bond Valuation

Basic Stock Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Financial Planning and Forecasting Financial Statements

Determining the Cost of Capital

Corporate Valuation and Value-Based Management

Capital Budgeting: Decision Criteria

Real Options

Capital Structure Decisions: Part I

Capital Structure Decisions: Part II

Distributions to Shareholders

Ipos, Investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing

Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Derivatives and Risk Management

Bankruptcy, Reorganization, and Liquidation

Mergers, Lbos, Divestitures, and Holding Companies

Multinational Financial Management

Filters

Exam 13: Capital Budgeting: Cash Flows and Risk

When evaluating a new project, the firm should consider all of the following factors except:

Twin Hills Inc. is considering a proposed project. Given available information, it is currently estimated that the proposed project is risky but has a positive net present value. Which of the following factors would make the company less likely to adopt the current project?

The change in net operating working capital is always positive, meaning more working capital is required for projects considered in capital budgeting because all projects are either expansion projects or replacement projects which have expansion effects.

Monte Carlo simulation

Any cash flow that can be classified as incremental is relevant in a capital budgeting project analysis.

Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this, they should be excluded from the financial analyses.

Regarding the net present value of a replacement decision, which of the following statements is false?

Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product?

Net incremental cash flow is calculated by adding back the change in depreciation to the change in net income.

If an asset being considered for acquisi¬tion has beta of zero, its purchase will have no effect on the firm's market risk.

Other things held constant, which of the following would increase the NPV of a project being considered?

Which of the following statements is correct?

Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?

An Overview of Financial Management

Risk and Return: Part I

Risk and Return: Part II

Bond Valuation

Basic Stock Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Financial Planning and Forecasting Financial Statements

Determining the Cost of Capital

Corporate Valuation and Value-Based Management

Capital Budgeting: Decision Criteria

Real Options

Capital Structure Decisions: Part I

Capital Structure Decisions: Part II

Distributions to Shareholders

Ipos, Investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing

Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Derivatives and Risk Management

Bankruptcy, Reorganization, and Liquidation

Mergers, Lbos, Divestitures, and Holding Companies

Multinational Financial Management

Filters