Question 1

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?

Accepted Answer

A)  shipping and installation costs. 
B)  cannibalization effects. 
C)  opportunity costs. 
D)  sunk costs that have been expensed for tax purposes. 
E)  changes in net working capital. 
A)  shipping and installation costs. 
B)  cannibalization effects. 
C)  opportunity costs. 
D)  sunk costs that have been expensed for tax purposes. 
E)  changes in net working capital.

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)  sunk costs must be considered if the irr method is used but not if the firm relies on the npv method. 
B)  a good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices. 
C)  a good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. 
D)  if sunk costs are considered and reflected in a project's cash flows, then the project's calculated npv will be higher than it otherwise would be. 
E)  an example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. 
A)  sunk costs must be considered if the irr method is used but not if the firm relies on the npv method. 
B)  a good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices. 
C)  a good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. 
D)  if sunk costs are considered and reflected in a project's cash flows, then the project's calculated npv will be higher than it otherwise would be. 
E)  an example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR) is affected by a small change in one of the input variables, say sales. Other things held constant, with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the more risky the project, other things held constant.

Accepted Answer

A) True 
 B)False

Question 5

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 included in a capital budgeting analysis.

Accepted Answer

A) True 
 B)False

Question 6

A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following?

Accepted Answer

A)  increase the estimated npv of the project to reflect its greater risk. 
B)  reject the project, since its acceptance would increase the firm's risk. 
C)  ignore the risk differential if the project would amount to only a small fraction of the firm's total assets. 
D)  increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. 
E)  increase the estimated irr of the project to reflect its greater risk. 
A)  increase the estimated npv of the project to reflect its greater risk. 
B)  reject the project, since its acceptance would increase the firm's risk. 
C)  ignore the risk differential if the project would amount to only a small fraction of the firm's total assets. 
D)  increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. 
E)  increase the estimated irr of the project to reflect its greater risk.

Question 7

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

Accepted Answer

A)  previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
B)  the value of a building owned by the firm that will be used for this project. 
C)  a decline in the sales of an existing product, provided that decline is directly attributable to this project. 
D)  the salvage value of assets used for the project that will be recovered at the end of the project's life. 
E)  changes in net working capital attributable to the project. 
A)  previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
B)  the value of a building owned by the firm that will be used for this project. 
C)  a decline in the sales of an existing product, provided that decline is directly attributable to this project. 
D)  the salvage value of assets used for the project that will be recovered at the end of the project's life. 
E)  changes in net working capital attributable to the project.

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
B)  corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
C)  using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted npv. 
D)  using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting npv of the project. 
E)  since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected npv from investing in the asset. 
A)  under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
B)  corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
C)  using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted npv. 
D)  using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting npv of the project. 
E)  since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected npv from investing in the asset.

Question 9

If 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.

Accepted Answer

A) True 
 B)False

Question 10

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

Accepted Answer

A) True 
 B)False

Question 11

The two cardinal rules that financial analysts should follow to avoid capital budgeting errors are: (1) in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash flows should be considered when making accept/reject decisions.

Accepted Answer

A) True 
 B)False

Question 12

Taylor Inc., the company you work for, is considering a new project whose data are shown below. What is the project's Year 1 cash flow?

$\begin{array}{l}
\begin{array} { l } 
\text { Sales revenues } \
\text { Depreciation}\
\text { Other operating costs}\
\text { Interest expense }\
\text { Tax rate}
\end{array}
\begin{array} { l } 
\$ 62,500 \
\$ 8,000 \
\$ 25,000 \
\$ 8,000\
35.0\%
\end{array}
\end{array}$

Accepted Answer

A)  $25,816 
B)  $27,175 
C)  $28,534 
D)  $29,960 
E)  $31,458 
A)  $25,816 
B)  $27,175 
C)  $28,534 
D)  $29,960 
E)  $31,458

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

The 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.

Accepted Answer

A) True 
 B)False

Question 15

VR Corporation has the opportunity to invest in a new project, the details of which are shown below. What is the Year 1 cash flow for the project?

$\begin{array}{l}
\begin{array} { l } 
\text { Sales revenues } \
\text { Depreciation}\
\text { Other operating costs}\
\text { Interest expense }\
\text { Tax rate}
\end{array}
\begin{array} { l } 
\$ 42,500 \
\$ 10,000 \
\$ 17,000 \
\$ 4,000\
35.0\%
\end{array}
\end{array}$

Accepted Answer

A)  $16,351 
B)  $17,212 
C)  $18,118 
D)  $19,071 
E)  $20,075 
A)  $16,351 
B)  $17,212 
C)  $18,118 
D)  $19,071 
E)  $20,075

Question 16

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

Accepted Answer

A)  only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. 
B)  sunk costs are not included in the annual cash flows, but they must be deducted from the pv of the project's other costs when reaching the accept/reject decision. 
C)  a proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (gaap), is discounted at the wacc, and if the pv of this income stream exceeds the project's cost, the project should be accepted. 
D)  if a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. however, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis. 
E)  the interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows. 
A)  only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. 
B)  sunk costs are not included in the annual cash flows, but they must be deducted from the pv of the project's other costs when reaching the accept/reject decision. 
C)  a proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (gaap), is discounted at the wacc, and if the pv of this income stream exceeds the project's cost, the project should be accepted. 
D)  if a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. however, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis. 
E)  the interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)  in comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's npv. 
B)  the primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a pc with a spreadsheet program or even with just a calculator. 
C)  sensitivity analysis is a type of risk analysis that considers both the sensitivity of npv to changes in key input variables and the probability of occurrence of these variables' values. 
D)  as computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis. 
E)  sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. 
A)  in comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's npv. 
B)  the primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a pc with a spreadsheet program or even with just a calculator. 
C)  sensitivity analysis is a type of risk analysis that considers both the sensitivity of npv to changes in key input variables and the probability of occurrence of these variables' values. 
D)  as computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis. 
E)  sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)  if a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. thus, cannibalization is dealt with by society through the antitrust laws. 
B)  if cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. otherwise, the calculated npv will be biased downward. 
C)  if cannibalization is determined to exist, then this means that the calculated npv if cannibalization is considered will be higher than the npv if this effect is not recognized. 
D)  cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself. 
E)  if a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. thus, cannibalization is dealt with by society through the antitrust laws. 
A)  if a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. thus, cannibalization is dealt with by society through the antitrust laws. 
B)  if cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. otherwise, the calculated npv will be biased downward. 
C)  if cannibalization is determined to exist, then this means that the calculated npv if cannibalization is considered will be higher than the npv if this effect is not recognized. 
D)  cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself. 
E)  if a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. thus, cannibalization is dealt with by society through the antitrust laws.

Question 19

Which of the following procedures best accounts for the relative risk of a proposed project?

Accepted Answer

A)  adjusting the discount rate downward if the project is judged to have above-average risk. 
B)  reducing the npv by 10% for risky projects. 
C)  picking a risk factor equal to the average discount rate. 
D)  ignoring risk because project risk cannot be measured accurately. 
E)  adjusting the discount rate upward if the project is judged to have above-average risk. 
A)  adjusting the discount rate downward if the project is judged to have above-average risk. 
B)  reducing the npv by 10% for risky projects. 
C)  picking a risk factor equal to the average discount rate. 
D)  ignoring risk because project risk cannot be measured accurately. 
E)  adjusting the discount rate upward if the project is judged to have above-average risk.

Question 20

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?

Accepted Answer

A)  a new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
B)  a firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
C)  a firm has spent $2 million on r&d associated with a new product. these costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
D)  a firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
E)  a firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
A)  a new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
B)  a firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
C)  a firm has spent $2 million on r&d associated with a new product. these costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
D)  a firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
E)  a firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.

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

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?

Which of the following statements is CORRECT?

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 included in a capital budgeting analysis.

A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following?

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?

If 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.

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

Taylor Inc., the company you work for, is considering a new project whose data are shown below. What is the project's Year 1 cash flow? Sales revenues Depreciation Other operating costs Interest expense Tax rate \ 62,500 \ 8,000 \ 25,000 \ 8,000 35.0\%

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.

The 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.

VR Corporation has the opportunity to invest in a new project, the details of which are shown below. What is the Year 1 cash flow for the project? Sales revenues Depreciation Other operating costs Interest expense Tax rate \ 42,500 \ 10,000 \ 17,000 \ 4,000 35.0\%

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following procedures best accounts for the relative risk of a proposed project?

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?

An Overview of Financial Management and the Financial Environment

Risk and Return-Part I

Risk and Return-Part II

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Criteria

Real Options

Distributions to Shareholders-Dividends and Repurchases

Capital Structure Decisions

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings-Investment Banking: and Financial Restructuring

Lease Financing

Hybrid Financing Preferred Stock-Warrants and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Enterprise Risk Management

Bankruptcy-Reorganization and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: A review

Pension Plan Management

Financial Management in Not for Profit Businesses

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