Exam 11: Cash Flow Estimation and Risk Analysis

Kasper Film Co.is selling off some old equipment it no longer needs because its associated project has come to an end.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 25%.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.

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.

Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

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

Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

Tallant Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data: Froject X Froject Y Expected NPV \ 500,000 \ 500,000 Standard deviation (oNPV) \ 200,000 \ 250,000 Project beta (vs. market) 1.4 0.8 Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Century Roofing is thinking of opening a new warehouse, and the key data are shown below.The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new warehouse.The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value.No new working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Project cost of capital (r) 10.0\% Opportunity cost \ 100,000 Net equipment cost (depreciable basis) \ 65,000 Straight-line deprec. rate for equipment 33.333\% Sal es revenues, each year \ 123,000 Operating costs (excl. deprec.), each year \ 25,000 Tax rate 25\%

Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision⎯estimates of its effect would really just be guesses.In this case, the externality should be ignored⎯i.e., not considered at all⎯because if it were considered it would make the analysis appear more precise than it really is.

The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

DeVault Services recently hired you as a consultant to help with its capital budgeting process.The company 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 cost of capital 10.0\% Net investment cost (depreciable basis) \ 65,000 Straight-line deprec. rate 33.3333\% Sal es revenues, each year \ 65,500 Operating costs (excl. deprec.), each year \ 25,000 Tax rate 25.0\%

Shultz Business Systems 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.What is the project's expected NPV? Project cost of capital ( ) 10.0\% Net investment cost (depreciable basis) \ 200,000 Units sold 50,000 Average price per unit, Year 1 \ 25.00 Fixed op cost excl. deprec. (constant) \ 150,000 Variable op. cost unit, Year 1 \ 20.20 Annual depreciation rate 33.333\% Expected inflation rate per year 5.00\% Tax rate 25.0\%

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

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.