Question 1

The primary difficulty in the allocation of overhead costs to prospective projects is that the:

Accepted Answer

A)  allocation will reduce the project's NPV. 
B)  discount rate is unknown. 
C)  costs may not represent an incremental expense. 
D) expenses may have been previously allocated. 
A)  allocation will reduce the project's NPV. 
B)  discount rate is unknown. 
C)  costs may not represent an incremental expense. 
D) expenses may have been previously allocated.

Question 2

Capital budgeting projects typically assume that all cash flows transpire at the end of the year. The reason for this is that:

Accepted Answer

A)  less tax liability results from this practice. 
B)  balance sheets are prepared at the end of the year. 
C)  it makes forecasting easier for the analyst. 
D) most corporations collect their cash at the end of the year. 
A)  less tax liability results from this practice. 
B)  balance sheets are prepared at the end of the year. 
C)  it makes forecasting easier for the analyst. 
D) most corporations collect their cash at the end of the year.

Question 3

The net cash flow from the sale of an asset will exceed the asset's sale price when a firm has positive taxable income and the asset's book value exceeds its market value.

Accepted Answer

A) True 
 B)False

Question 4

Cash flow from operations = (revenues - cash expenses) × (1 - tax rate) + (depreciation × tax rate).

Accepted Answer

A) True 
 B)False

Question 5

Which one of the following is representative of how depreciation expense is handled in the face of inflation?

Accepted Answer

A)  It increases annually with the rate of inflation. 
B)  It decreases annually in nominal terms. 
C)  The depreciable base is not altered by inflation. 
D) The real value of the depreciation is fixed. 
A)  It increases annually with the rate of inflation. 
B)  It decreases annually in nominal terms. 
C)  The depreciable base is not altered by inflation. 
D) The real value of the depreciation is fixed.

Question 6

Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and a market value of $25,000. Ignoring taxes, what is the opportunity cost of this machine?

Accepted Answer

A)  $75,000 
B)  $25,000 
C)  $20,000 
D) $5,000 
A)  $75,000 
B)  $25,000 
C)  $20,000 
D) $5,000

Question 7

A new, more efficient machine will last 4 years and allow inventory levels to decrease by $100,000 over its life. At a cost of capital of 13%, how does the net working capital change affect the project's NPV?

Accepted Answer

A)  NPV increases by $38,668.13. 
B)  NPV increases by $61,330.09. 
C)  NPV will not change. 
D) NPV increases by $100,000. 
A)  NPV increases by $38,668.13. 
B)  NPV increases by $61,330.09. 
C)  NPV will not change. 
D) NPV increases by $100,000.

Question 8

The modified accelerated cost recovery system (MACRS) allows an increase:

Accepted Answer

A)  in total depreciation over the asset's life. 
B)  in annual depreciation during earlier years. 
C)  in real but not nominal depreciation expense. 
D) in the asset's depreciable cost basis. 
A)  in total depreciation over the asset's life. 
B)  in annual depreciation during earlier years. 
C)  in real but not nominal depreciation expense. 
D) in the asset's depreciable cost basis.

Question 9

The correct method to handle overhead costs in capital budgeting is to:

Accepted Answer

A)  allocate a portion to each project. 
B)  allocate them to projects with the highest NPVs. 
C)  ignore all except identifiable incremental amounts. 
D) ignore them in all cases. 
A)  allocate a portion to each project. 
B)  allocate them to projects with the highest NPVs. 
C)  ignore all except identifiable incremental amounts. 
D) ignore them in all cases.

Question 10

Describe how adding depreciation expense to net income can approximate cash flow from operations. Does depreciation expense really reflect a cash flow?

Accepted Answer

Depreciation is a noncash expense that i

Question 11

Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost for equipment, straight-line depreciation over 5 years to a zero book value, $5,000 pre-tax salvage value of equipment, 35% tax rate, $45,000 additional annual revenues, $15,000 additional annual cash expenses, $8,000 initial investment in working capital to be recouped at project end, and a cost of capital of 11%. Should the project be accepted or rejected? (Show your work computing the NPV.)

Accepted Answer

OCF = ($45,000 - 15,000)(1 - .

Question 12

If a project permits a reduction in the level of working capital, this reduction is assumed to increase cash flows.

Accepted Answer

A) True 
 B)False

Question 13

Capital budgeting proposals should be evaluated as if the project were financed:

Accepted Answer

A)  entirely by debt. 
B)  entirely by equity. 
C)  half by debt and half by equity. 
D) with the highest cost source of funds, to be safe. 
A)  entirely by debt. 
B)  entirely by equity. 
C)  half by debt and half by equity. 
D) with the highest cost source of funds, to be safe.

Question 14

What is the amount of the operating cash flow for a firm with $500,000 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

Accepted Answer

A)  $260,000 
B)  $325,000 
C)  $360,000 
D) $425,000 
A)  $260,000 
B)  $325,000 
C)  $360,000 
D) $425,000

Question 15

What effect is expected at the end of the life of a project that initially required a $20,000 increase in net working capital?

Accepted Answer

A)  The $20,000 must now be paid by the firm. 
B)  The firm receives a $20,000 cash inflow. 
C)  Taxable income is reduced by $20,000. 
D) No effects are expected because the $20,000 is now a sunk cost. 
A)  The $20,000 must now be paid by the firm. 
B)  The firm receives a $20,000 cash inflow. 
C)  Taxable income is reduced by $20,000. 
D) No effects are expected because the $20,000 is now a sunk cost.

Question 16

A project anticipates net cash inflows of $10,000 at the end of year 1, with that amount increasing at the expected 4% rate of inflation over the subsequent 4 years. The initial project cost is $12,800. Calculate the real present value of this 5-year cash stream if the firm employs a nominal discount rate of 10.76%.

Accepted Answer

A)  $33,522.30 
B)  $28,756.79 
C)  $33,294.07 
D) $26,311.15 
A)  $33,522.30 
B)  $28,756.79 
C)  $33,294.07 
D) $26,311.15

Question 17

Which one of the following methods will provide a correct analysis for capital budgeting purposes?

Accepted Answer

A)  Discounting real cash flows with real rates. 
B)  Discounting real cash flows with nominal rates. 
C)  Discounting nominal cash flows with real rates. 
D) Discounting nominal cash flows with either real or nominal rates. 
A)  Discounting real cash flows with real rates. 
B)  Discounting real cash flows with nominal rates. 
C)  Discounting nominal cash flows with real rates. 
D) Discounting nominal cash flows with either real or nominal rates.

Question 18

Which one of the following changes in working capital is least likely, given an increase in the overall level of sales?

Accepted Answer

A)  An increase in inventories 
B)  An increase in accounts payable 
C)  A decrease in accounts receivable 
D) An increase in notes payable 
A)  An increase in inventories 
B)  An increase in accounts payable 
C)  A decrease in accounts receivable 
D) An increase in notes payable

Question 19

What nominal annual return is required on an investment for an investor to experience a 12% gain in purchasing power? Assume inflation is 4%.

Accepted Answer

A)  7.69% 
B)  9.29% 
C)  12.00% 
D) 16.48% 
A)  7.69% 
B)  9.29% 
C)  12.00% 
D) 16.48%

Question 20

The total depreciation tax shield equals the product of depreciation and the tax rate.

Accepted Answer

A) True 
 B)False

Exam 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions

The primary difficulty in the allocation of overhead costs to prospective projects is that the:

Capital budgeting projects typically assume that all cash flows transpire at the end of the year. The reason for this is that:

The net cash flow from the sale of an asset will exceed the asset's sale price when a firm has positive taxable income and the asset's book value exceeds its market value.

Cash flow from operations = (revenues - cash expenses) × (1 - tax rate) + (depreciation × tax rate).

Which one of the following is representative of how depreciation expense is handled in the face of inflation?

Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and a market value of $25,000. Ignoring taxes, what is the opportunity cost of this machine?

A new, more efficient machine will last 4 years and allow inventory levels to decrease by $100,000 over its life. At a cost of capital of 13%, how does the net working capital change affect the project's NPV?

The modified accelerated cost recovery system (MACRS) allows an increase:

The correct method to handle overhead costs in capital budgeting is to:

Describe how adding depreciation expense to net income can approximate cash flow from operations. Does depreciation expense really reflect a cash flow?

If a project permits a reduction in the level of working capital, this reduction is assumed to increase cash flows.

Capital budgeting proposals should be evaluated as if the project were financed:

What is the amount of the operating cash flow for a firm with $500,000 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

What effect is expected at the end of the life of a project that initially required a $20,000 increase in net working capital?

Which one of the following methods will provide a correct analysis for capital budgeting purposes?

Which one of the following changes in working capital is least likely, given an increase in the overall level of sales?

What nominal annual return is required on an investment for an investor to experience a 12% gain in purchasing power? Assume inflation is 4%.

The total depreciation tax shield equals the product of depreciation and the tax rate.

Goals and Governance of the Corporation

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing

How Corporations Raise Venture Capital and Issue Securities

Debt Policy

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers, Acquisitions, and Corporate Control

International Financial Management

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