Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

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.

Accepted Answer

A) True 
 B)False

Question 3

Real Time Inc.
The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's required rate of return is 14 percent.
-Refer to Real Time Inc.What is the terminal cash flow ?

Accepted Answer

A)  $18,120 
B)  $19,000 
C)  $21,000 
D)  $25,000 
E)  $27,000 
A)  $18,120 
B)  $19,000 
C)  $21,000 
D)  $25,000 
E)  $27,000

Question 4

As a practical matter,it is much easier to use market risk analysis at the project level than at the divisional level because it is easier to estimate the beta of a single project such as a machine tool die maker than the beta of an entire division (or subsidiary)such as Phillip Morris' Kraft foods unit.

Accepted Answer

A) True 
 B)False

Question 5

Truck Acquisition
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 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.
-Refer to Truck Acquisition.What is the initial investment outlay for 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 6

Truck Acquisition
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 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.
-Refer to Truck Acquisition.What is the supplemental operating cash flow in Year 1?

Accepted Answer

A)  $17,820 
B)  $18,254 
C)  $19,920 
D)  $20,121 
E)  $21,737 
A)  $17,820 
B)  $18,254 
C)  $19,920 
D)  $20,121 
E)  $21,737

Question 7

Which of the following statements is correct?

Accepted Answer

A)  Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same. 
B)  In estimating supplemental operating cash flows for the purpose of capital budgeting,interest payments should not be included since the effects of these payments are already included in the rate of return the firm is required to earn from its investments. 
C)  When equipment is sold,companies receive a tax credit as long as the salvage value is less than the initial cost of the equipment. 
D)  All of the above answers are correct. 
E)  None of the above answers is correct. 
A)  Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same. 
B)  In estimating supplemental operating cash flows for the purpose of capital budgeting,interest payments should not be included since the effects of these payments are already included in the rate of return the firm is required to earn from its investments. 
C)  When equipment is sold,companies receive a tax credit as long as the salvage value is less than the initial cost of the equipment. 
D)  All of the above answers are correct. 
E)  None of the above answers is correct.

Question 8

Which of the following constitutes an example of a cost which is not incremental,and therefore not relevant in an accept/reject decision?

Accepted Answer

A)  A firm has a parcel of land that can be used for a new plant site or,alternatively,can be used to grow watermelons. 
B)  A firm can produce a new cleaning product that will generate new sales,but some of the new sales will be from customers who switch from another product the company currently produces. 
C)  A firm orders and receives a piece of new equipment which is shipped across the country and requires $25,000 in installation and set-up costs. 
D)  All of the above are not examples of incremental cash flows. 
E)  Answers a,b,and c are examples of incremental,and therefore relevant,cash flows. 
A)  A firm has a parcel of land that can be used for a new plant site or,alternatively,can be used to grow watermelons. 
B)  A firm can produce a new cleaning product that will generate new sales,but some of the new sales will be from customers who switch from another product the company currently produces. 
C)  A firm orders and receives a piece of new equipment which is shipped across the country and requires $25,000 in installation and set-up costs. 
D)  All of the above are not examples of incremental cash flows. 
E)  Answers a,b,and c are examples of incremental,and therefore relevant,cash flows.

Question 9

Under certain conditions,a particular project may have more than one IRR.One condition under which this situation can occur is if,in addition to the initial investment at time = 0,a negative cash flow occurs at the end of the project's life.

Accepted Answer

A) True 
 B)False

Question 10

____ projects are projects whose cash flows are not affected by the acceptance or non-acceptance of other projects.

Accepted Answer

A)  Independent 
B)  Replacement 
C)  Expansion 
D)  Mutually exclusive 
A)  Independent 
B)  Replacement 
C)  Expansion 
D)  Mutually exclusive

Question 11

If a particular project would increase a firm's beta coefficient if it is accepted,then we can conclude that the firm's required rate of return also would increase,other things held constant.

Accepted Answer

A) True 
 B)False

Question 12

One problem with Monte Carlo simulation analysis is that,while the simulation may provide some insights into the riskiness of a project,the analysis does not lead to a clear-cut accept versus reject decision.

Accepted Answer

A) True 
 B)False

Question 13

The depreciable base of an asset includes the purchase price and any additional expenditures required to make the asset operational,including shipping and installation.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following statements is correct?

Accepted Answer

A)  Neither "stand-alone" nor "within-firm" risk takes account of diversification,either by stockholders or by the firm. 
B)  If a project's expected returns are highly correlated with returns on the market,this will tend to reduce the project's market risk. 
C)  Monte Carlo simulation analysis and sensitivity analysis are similar,but sensitivity analysis is generally harder to use because it requires knowledge of the probability distributions associated with the input variables. 
D)  Sensitivity analysis requires a project's beta coefficient,which can be obtained by either the "pure play" or the "accounting beta" method. 
E)  If we are choosing between two mutually exclusive projects which have only costs (no revenues),the riskier one should be evaluated with a lower required rate of return. 
A)  Neither "stand-alone" nor "within-firm" risk takes account of diversification,either by stockholders or by the firm. 
B)  If a project's expected returns are highly correlated with returns on the market,this will tend to reduce the project's market risk. 
C)  Monte Carlo simulation analysis and sensitivity analysis are similar,but sensitivity analysis is generally harder to use because it requires knowledge of the probability distributions associated with the input variables. 
D)  Sensitivity analysis requires a project's beta coefficient,which can be obtained by either the "pure play" or the "accounting beta" method. 
E)  If we are choosing between two mutually exclusive projects which have only costs (no revenues),the riskier one should be evaluated with a lower required rate of return.

Question 15

The post-audit is used to

Accepted Answer

A)  Improve cash flow forecasts. 
B)  Stimulate management to improve operations and bring results into line with forecasts. 
C)  Eliminate potentially profitable but risky projects. 
D)  All of the above are correct. 
E)  Only answers a and b are correct. 
A)  Improve cash flow forecasts. 
B)  Stimulate management to improve operations and bring results into line with forecasts. 
C)  Eliminate potentially profitable but risky projects. 
D)  All of the above are correct. 
E)  Only answers a and b are correct.

Question 16

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 17

If a project is small relative to the total firm,and if its returns are not highly correlated with the returns on the firm's other assets,then the project may not be very risky in either the within-firm (corporate)or the market risk sense,even if the returns on the project are highly uncertain and thus the project has a high degree of stand-alone risk.

Accepted Answer

A) True 
 B)False

Question 18

A firm should never undertake an investment if accepting the project would cause an increase in the firm's required rate of return.

Accepted Answer

A) True 
 B)False

Question 19

When risk is explicitly accounted for in capital budgeting,a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return.

Accepted Answer

A) True 
 B)False

Question 20

The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR ≥ r at the margin)is called capital rationing.

Accepted Answer

A) True 
 B)False

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

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.

Which of the following statements is correct?

Which of the following constitutes an example of a cost which is not incremental,and therefore not relevant in an accept/reject decision?

Under certain conditions,a particular project may have more than one IRR.One condition under which this situation can occur is if,in addition to the initial investment at time = 0,a negative cash flow occurs at the end of the project's life.

____ projects are projects whose cash flows are not affected by the acceptance or non-acceptance of other projects.

If a particular project would increase a firm's beta coefficient if it is accepted,then we can conclude that the firm's required rate of return also would increase,other things held constant.

One problem with Monte Carlo simulation analysis is that,while the simulation may provide some insights into the riskiness of a project,the analysis does not lead to a clear-cut accept versus reject decision.

The depreciable base of an asset includes the purchase price and any additional expenditures required to make the asset operational,including shipping and installation.

Which of the following statements is correct?

The post-audit is used to

A firm should never undertake an investment if accepting the project would cause an increase in the firm's required rate of return.

When risk is explicitly accounted for in capital budgeting,a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return.

The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR ≥ r at the margin)is called capital rationing.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Structure and Dividend Policy Decisions

Working Capital Management

Investment and Securities

Investment Analysis and Valuation Techniques

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Exam 13: Capital Budgeting

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

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.

Which of the following statements is correct?

Which of the following constitutes an example of a cost which is not incremental,and therefore not relevant in an accept/reject decision?

Under certain conditions,a particular project may have more than one IRR.One condition under which this situation can occur is if,in addition to the initial investment at time = 0,a negative cash flow occurs at the end of the project's life.

____ projects are projects whose cash flows are not affected by the acceptance or non-acceptance of other projects.

If a particular project would increase a firm's beta coefficient if it is accepted,then we can conclude that the firm's required rate of return also would increase,other things held constant.

One problem with Monte Carlo simulation analysis is that,while the simulation may provide some insights into the riskiness of a project,the analysis does not lead to a clear-cut accept versus reject decision.

The depreciable base of an asset includes the purchase price and any additional expenditures required to make the asset operational,including shipping and installation.

Which of the following statements is correct?

The post-audit is used to

A firm should never undertake an investment if accepting the project would cause an increase in the firm's required rate of return.

When risk is explicitly accounted for in capital budgeting,a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return.

The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR ≥ r at the margin)is called capital rationing.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Structure and Dividend Policy Decisions

Working Capital Management

Investment and Securities

Investment Analysis and Valuation Techniques

Filters