Exam 13: Cash Flows and Risk

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.

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.

cash flows that can be classified as incremental to a particular project--i.e., results directly from the decision to undertake the project--should be reflected in the capital budgeting analysis.

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

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

Which of the following statements is CORRECT?

Puckett Incrisk-adjusts its WACC to account for project riskIt uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects Which of the following independent projects should Puckett accept, assuming that the company uses the NPV method when choosing projects?

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.

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.

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.

is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

While developing a new product line, Cook 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 Cook owns the building free and clear--there is no mortgage on it Which of the following statements is CORRECT?

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 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?

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.

Which of the following statements is CORRECT?

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.