Exam 13: Capital Budgeting: Cash Flows and Risk

Although it is difficult to make accurate forecasts, the initial outlays and subsequent costs of large projects are forecast with great accuracy, but revenues are more uncertain and large errors are not uncommon.

When calculating the cash flows for a project, you should include interest payments.

Risky projects can be evaluated by discounting expected cash flows using a risk-adjusted discount rate.

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000. The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000. Target's corporate tax rate is 40 percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing machine?

The truck's cost of capital is 10 percent. What is its NPV?

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

In theory, the decision maker should view market risk as being of primary importance. However, within-firm, or corporate, risk is relevant to a firm's

Risk in a revenue-producing project can best be adjusted for by

It is extremely difficult to estimate the revenues and costs associated with large complex projects that take several years to develop. This is why subjective judgement is recommended for such projects instead of cash flow analysis.

Which of the following statement completions is incorrect? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

Estimating project cash flows is considered the most important and the most difficult step in the capital budgeting process. Both the number of variables and the interdepartmental nature of the process contribute to the difficulty of estimating cash flows.

A firm which bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses MACRS accelerated depreciation than if it uses the optional straight-line alternative, other things being equal.

Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for $100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when the machine is retired at the end of Year 3. The machine will produce sales revenues of $900/year for 3 years; variable operating costs (excluding depreciation) will be 50 percent of sales. Operating cash inflows will begin 1 year from today (at Time 1). The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund from this project if the project's income is negative, and a 10 percent cost of capital. Inflation is zero. What is the project's NPV?

A company is considering a proposed expansion to its facilities. Which of the following statements is most correct?

Which of the following statements is most correct?

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not relevant in the analysis.

Superior analytical techniques, such as NPV, used in combination with cost of capital adjustments, can overcome the problem of poor cash flow estimation in decision making.

The primary advantage of accelerated depreciation over straight-line depreciation is that the total, undiscounted, depreciation tax savings over the life of the project are greater when an accelerated depreciation method is used.

Your company is considering a machine which will cost $50,000 at Time 0 and which can be sold after 3 years for $10,000. $12,000 must be invested at Time 0 in inventories and receivables; these funds will be recovered when the operation is closed at the end of Year 3. The facility will produce sales revenues of $50,000/year for 3 years; variable operating costs (excluding depreciation) will be 40 percent of sales. No fixed costs will be incurred. Operating cash inflows will begin 1 year from today (at t = 1). By an act of Congress, the machine will have depreciation expenses of $40,000, $5,000, and $5,000 in Years 1, 2, and 3 respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to get a tax refund on this project if the project's income is negative, and a 15 percent cost of capital. Inflation is zero. What is the project's NPV?

What is the project's NPV?