Exam 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Your new employer, Freeman Software, is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected life. What is the Year 1 cash flow? Equipment cost (depreciable basis) Sales revenues, each year Operating costs (excl. deprec.) Tax rate \ 65,000 \ 60,000 \ 25,000 35.00\%

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.

Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other Weston's products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) Cost of capital 10.0\% Pre-tax cash flow reduction for other products (cannibalization) \ 5,000 Investment cost (depreciable basis) \ 80,000 Straight-line deprec. rate 33.333\% Sales revenues, each year for 3 years \ 67,500 Annual operating costs (excl. deprec.) \ 25,000 Tax rate 35,0\%

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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 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.

McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Collins Inc. is investigating whether to develop 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?

Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a risk-adjusted project cost of capital of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects: Project Pisk Expected Return A High 15\% B Average 12\% C High 11\% D Low 9\% E Low 6\% Which set of projects would maximize shareholder wealth?

The CFO of Cicero Industries plans to calculate a new project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

Which of the following statements is CORRECT?

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?

You have just landed an internship in the CFO's office of Hawkesworth Inc. Your first task is to estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow? Sales revenues Depreciation Other operating costs Tax rate \ 13,000 \ 4,000 \ 6,000 350\%

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

It 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.

Which of the following statements is CORRECT?

In cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows.

Which of the following statements is CORRECT?