Question 1

If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

Accepted Answer

A) True 
 B)False  True

Question 2

The change in net operating working capital associated with new projects is always positive, because new projects mean that more operating working capital will be required.

Accepted Answer

A) True 
 B)False  False

Question 3

A 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. E

Question 4

If 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.

Accepted Answer

A) True 
 B)False

Question 5

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 for capital budgeting projects.

Accepted Answer

A) True 
 B)False

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Accepted Answer

A)  The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm's products. 
B)  The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. 
C)  The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future. 
D)  The new product will cut into sales of some of the firm's other products. 
E)  If the project is accepted, the company must invest an additional $2 million in net operating working capital. However, all of these funds will be recovered at the end of the project's life. 
A)  The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm's products. 
B)  The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. 
C)  The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future. 
D)  The new product will cut into sales of some of the firm's other products. 
E)  If the project is accepted, the company must invest an additional $2 million in net operating working capital. However, all of these funds will be recovered at the end of the project's life.

Question 8

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.

Accepted Answer

A)  $5,558 
B)  $5,850 
C)  $6,143 
D)  $6,450 
E)  $6,772 
A)  $5,558 
B)  $5,850 
C)  $6,143 
D)  $6,450 
E)  $6,772

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. 
B)  In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV. 
C)  The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator. 
D)  Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values. 
E)  As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis. 
A)  Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. 
B)  In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV. 
C)  The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator. 
D)  Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values. 
E)  As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis.

Question 10

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

Accepted Answer

A) True 
 B)False

Question 11

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)  A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
B)  A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
C)  A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D)  A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
E)  A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
A)  A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
B)  A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
C)  A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D)  A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
E)  A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.

Question 12

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Accepted Answer

A) True 
 B)False

Question 13

If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Accepted Answer

A) True 
 B)False

Question 14

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 15

Which of the following rules is CORRECT for capital budgeting analysis?

Accepted Answer

A)  The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows. 
B)  Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions for capital budgeting projects. 
C)  Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision. 
D)  A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted. 
E)  If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis. 
A)  The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows. 
B)  Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions for capital budgeting projects. 
C)  Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision. 
D)  A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted. 
E)  If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis.

Question 16

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

Accepted Answer

A)  All costs associated with the project that have been incurred prior to the time the analysis is being conducted. 
B)  Interest on funds borrowed to help finance the project. 
C)  The end-of-project recovery of any additional net operating working capital required to operate the project. 
D)  Cannibalization effects, but only if those effects increase the project's projected cash flows. 
E)  Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes. 
A)  All costs associated with the project that have been incurred prior to the time the analysis is being conducted. 
B)  Interest on funds borrowed to help finance the project. 
C)  The end-of-project recovery of any additional net operating working capital required to operate the project. 
D)  Cannibalization effects, but only if those effects increase the project's projected cash flows. 
E)  Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.

Question 17

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 18

(12A). Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

Accepted Answer

A)  Higher depreciation charges in the early years of an asset's life. 
B)  Larger cash flows in the earlier years of an asset's life. 
C)  Larger total undiscounted profits from the project over the project's life. 
D)  Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes. 
E)  Lower tax payments in the earlier years of an asset's life. 
A)  Higher depreciation charges in the early years of an asset's life. 
B)  Larger cash flows in the earlier years of an asset's life. 
C)  Larger total undiscounted profits from the project over the project's life. 
D)  Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes. 
E)  Lower tax payments in the earlier years of an asset's life.

Question 19

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

Accepted Answer

A)  The new project is expected to reduce sales of one of the company's existing products by 5%. 
B)  Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. 
C)  The company has spent and expensed $1 million on research and development costs associated with the new project. 
D)  The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. 
E)  The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year. 
A)  The new project is expected to reduce sales of one of the company's existing products by 5%. 
B)  Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. 
C)  The company has spent and expensed $1 million on research and development costs associated with the new project. 
D)  The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. 
E)  The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.

Question 20

The 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

If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

The change in net operating working capital associated with new projects is always positive, because new projects mean that more operating working capital will be required.

A 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?

If 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.

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 for capital budgeting projects.

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.

Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Which of the following statements is CORRECT?

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

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?

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Which of the following statements is CORRECT?

Which of the following rules is CORRECT for capital budgeting analysis?

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

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

(12A). Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

The 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.

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters

Exam 12: Cash Flow and Risk

If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

The change in net operating working capital associated with new projects is always positive, because new projects mean that more operating working capital will be required.

A 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?

If 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.

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 for capital budgeting projects.

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.

Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Which of the following statements is CORRECT?

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

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?

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Which of the following statements is CORRECT?

Which of the following rules is CORRECT for capital budgeting analysis?

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

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

(12A). Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

The 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.

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters