Question 1

Which of the following statements about the opportunity cost associated with a capital budgeting project is correct?

Accepted Answer

A) A project's opportunity cost is a cash outlay that the firm has already paid; therefore, it should not be included in a capital budgeting analysis. 
B) The terms sunk cost and opportunity cost generally are used interchangeably. 
C) A project's opportunity cost is the return (cash flow) that will not be earned (generated) if funds are invested in a particular capital budgeting project. 
D) A project's opportunity cost is not a relevant cash flow, therefore it should not be included in the capital budgeting analysis. 
E) A project's opportunity cost reflects the change in a firm's net cash flow that is attributable to purchasing the project.

Question 2

If a capital budgeting project has very uncertain cash flows, the Monte Carlo simulation technique can be used to measure its net present value (NPV) for a worst-case scenario, a best-case scenario, and a base-case scenario.

Accepted Answer

A) True 
 B)False

Question 3

Ziker Golf Company is evaluating a capital budgeting project that has a higher risk than the average risk of its existing assets. When evaluating projects that are riskier than average, Ziker normally adjusts its required rate of return by 4 percent. Ziker requires a 12 percent return on average-risk projects. What required rate of return should Ziker use to compute the net present value (NPV) of the risky project it is currently evaluating?

Accepted Answer

A) 8% 
B) 12% 
C) 16% 
D) 10% 
E) 48%

Question 4

Which of the following statements is correct concerning various techniques used for assessing a capital budgeting project's stand-alone risk?

Accepted Answer

A) Sensitivity analysis fails to consider the range of likely values for the key input variables that are used to evaluate a capital budgeting project. 
B) When using sensitivity analysis, the sensitivity of input variables can be compared by graphing their relationships with such measures as net present value (NPV) and internal rate of return (IRR). When comparing two of the variables, the variable that has the graph with the steeper line (slope) is considered less risky than the graph with the flatter line. 
C) The primary advantage of using simulation analysis to evaluate a capital budgeting project is that it provides an accurate point (single) estimate of the project's net present value (NPV). 
D) Compared to scenario analysis, one important benefit of using simulation analysis to evaluate a capital budgeting project is that once the analysis is complete, simulation provides a clear accept/reject decision rule. 
E) When using simulation analysis to evaluate a capital budgeting project, only a few discrete alternative scenarios are included.

Question 5

Topsider Inc. is evaluating whether to replace an existing leather-cutting machine with a new machine that has a five-year life. The old machine has current salvage value equal to $3,000; its salvage value in five years is expected to be zero. The net (after-tax) salvage value of the new machine in five years is expected to be $6,000. If the new machine is purchased, Topsider will have to invest $3,520 in its net working capital. Based on this information, what is the new machine's terminal cash?

Accepted Answer

A) $6,000 
B) $3,520 
C) $9,520 
D) $7,000 
E) $3,000

Question 6

According to the capital asset pricing model (CAPM), a capital budgeting project that has a beta equal to zero should be evaluated using a required rate of return equal to the risk-free rate.

Accepted Answer

A) True 
 B)False

Question 7

A major problem with Monte Carlo simulation analysis is that while the analysis provides insights into the riskiness of a project, it does not lead to a clear-cut accept/reject decision.

Accepted Answer

A) True 
 B)False

Question 8

Multinational companies can reduce the chance of a loss from expropriation by:

Accepted Answer

A) increasing the required rate of return a foreign subsidiary is expected to earn. 
B) establishing foreign subsidiaries in countries that have restrictive policies on repatriation of earnings. 
C) financing the foreign subsidiary using fund raised in the host country. 
D) obtaining insurance against economic losses associated with expropriation. 
E) investing all the funds in a single foreign subsidiary.

Question 9

Which of the following statements is correct?

Accepted Answer

A) Well-diversified stockholders do not consider a firm's corporate risk when establishing their required rates of return. 
B) Undiversified stockholders, including the owners of small businesses, probably are more concerned about the corporate risk associated with a particular firm than are diversified stockholders. 
C) Empirical studies to determine the factors that affect required rates of return (r) have concluded that only market risk affects stock prices; i.e., neither corporate risk nor stand-alone risk has any impact on required rates of return. 
D) A firm's market risk is important, but it does not directly affect stock prices because it only affects the firm's beta. 
E) A firm's market risk is not an important factor in determining its required rate of return.

Question 10

If the risk-free rate is 6 percent, the return on an average stock is 10 percent, and the beta of a capital budgeting project is 1.50, the project's required rate of return from the project is _____.

Accepted Answer

A) 12% 
B) 24% 
C) 4% 
D) 19% 
E) 21%

Question 11

Hill Top Lumber Company is considering building a sawmill in the state of Washington because the company doesn't have such a facility to service its growing customer base located on the west coast. When evaluating the acceptability of the project, which of the following would be considered a relevant cash flow that should be included when determining the sawmill's initial investment outlay?

Accepted Answer

A) Last year, Hill Top spent $75,000 preparing a feasibility study on whether the project should be pursued further; that is, whether the firm should conduct a complete capital budgeting analysis, which is extremely costly. 
B) Hill Top estimates that the new sawmill will generate $3 million of new business each year it operates. 
C) To raise the funds needed to build the sawmill, Hill Top must issue new bonds. 
D) It will cost Hill Top $3 million to clear the land on which the sawmill will be built. 
E) It is estimated that $20 million of business from Hill Top's current customers will transfer from existing sawmills to the new sawmill.

Question 12

Which of the following provides a measure of systematic risk?

Accepted Answer

A) Sensitivity analysis 
B) Net present value analysis 
C) Beta coefficient 
D) Monte Carlo simulation 
E) Accumulated depreciation

Question 13

Chovita Sports Company is evaluating a project that has lower-than-average risk. When evaluating projects that have different risks than its existing assets, Chovita normally adjusts its average required rate of return, which is 12 percent, by 2 percent. What required rate of return should Chovita use to compute the net present value (NPV) of the project it is currently evaluating?

Accepted Answer

A) 14% 
B) 12% 
C) 6% 
D) 10% 
E) 24%

Question 14

Because stockholders are very concerned with the "bottom-line" net income that the firm generates, capital budgeting decisions should be based on the accounting income a project generates.

Accepted Answer

A) True 
 B)False

Question 15

A firm that is considering purchasing a capital budgeting project with a beta coefficient greater than the firm's current beta coefficient should evaluate the project using a risk-adjusted required rate of return that is greater than the firm's existing (average) required rate of return.

Accepted Answer

A) True 
 B)False

Question 16

Sensitivity analysis is a technique in which:

Accepted Answer

A) all key input variables are changed to their most likely values to compute a project's net present value (NPV). 
B) all of the input variables are set at their most reasonably expected values to computes a project's internal rate of return (IRR). 
C) the values of key input variables are changed to observe the resulting changes in a project's net present value (NPV) and its internal rate of return (IRR). 
D) a "bad" set and "good" set of financial circumstances are compared with a most likely, or base case, situation. 
E) key input variables are set at their worst reasonably forecasted values to compute a project's net present value (NPV).

Question 17

Which of the following statements is correct?

Accepted Answer

A) Capital budgeting projects with fairly risky cash flows should be evaluated using relatively high discount rates (required rates of return). 
B) If managers want to maximize the firm's stock value, they should not be concerned with risk when making capital budgeting decisions. 
C) If a firm evaluates all capital budgeting projects using its existing required rate of return, its overall risk, as measured by its beta coefficient, probably will decline over time. 
D) If a firm has a beta coefficient that is less than 1.0, its existing required rate of return will be negatively correlated with the returns on most of the capital budgeting projects it evaluates in the future. 
E) A firm should use a different approach to estimate the riskiness of mutually exclusive projects than it uses to estimate the riskiness of independent projects.

Question 18

Using the capital asset pricing model (CAPM), Sun State determined that the required rate of return for a capital budgeting project it is evaluating is equal to 18 percent. If U.S. Treasury bonds yield 7 percent and the market risk premium is 5 percent, what is the project's beta coefficient?

Accepted Answer

A) 5.50 
B) 2.20 
C) 5.00 
D) 12.50 
E) 0.45

Question 19

Which of the following statements concerning cash flow evaluation in capital budgeting is correct?

Accepted Answer

A) When determining a project's terminal cash flows, it is generally assumed that the firm's operations do not return to the same level as they were before the project was purchased. 
B) Even though it is a noncash expense, a capital budgeting project's depreciation expense must be computed because it affects the after-tax cash flows of the project. 
C) The relevant marginal cash flows associated with a project include depreciation, because it is an annual operating expense that requires a cash payment. 
D) Shipping and installation charges are deducted from the purchase price of an asset to compute its depreciable basis. 
E) The sunk costs associated with an investment proposal are relevant cash flows for capital budgeting analysis that should be included in the computation of the project's initial investment outlay.

Question 20

Chovita Motors Corp. is evaluating a machine that costs $100,000. The machine is expected to generate net income equal to $30,000, $90,000, and $50,000, respectively, during the next three years. The machine's annual depreciation expense will be $5,000, $3,000, and $2,000, respectively. In three years, the machine will have a salvage value equal to zero. What is the machine's net present value (NPV) if the Chovita's required rate of return is 10 percent?

Accepted Answer

A) $63,550 
B) $80,000 
C) $247,746 
D) $47,746 
E) $186,135

Exam 10: Project Cash Flows and Risk

Which of the following statements about the opportunity cost associated with a capital budgeting project is correct?

If a capital budgeting project has very uncertain cash flows, the Monte Carlo simulation technique can be used to measure its net present value (NPV) for a worst-case scenario, a best-case scenario, and a base-case scenario.

Which of the following statements is correct concerning various techniques used for assessing a capital budgeting project's stand-alone risk?

According to the capital asset pricing model (CAPM), a capital budgeting project that has a beta equal to zero should be evaluated using a required rate of return equal to the risk-free rate.

A major problem with Monte Carlo simulation analysis is that while the analysis provides insights into the riskiness of a project, it does not lead to a clear-cut accept/reject decision.

Multinational companies can reduce the chance of a loss from expropriation by:

Which of the following statements is correct?

If the risk-free rate is 6 percent, the return on an average stock is 10 percent, and the beta of a capital budgeting project is 1.50, the project's required rate of return from the project is _____.

Which of the following provides a measure of systematic risk?

Because stockholders are very concerned with the "bottom-line" net income that the firm generates, capital budgeting decisions should be based on the accounting income a project generates.

A firm that is considering purchasing a capital budgeting project with a beta coefficient greater than the firm's current beta coefficient should evaluate the project using a risk-adjusted required rate of return that is greater than the firm's existing (average) required rate of return.

Sensitivity analysis is a technique in which:

Which of the following statements is correct?

Using the capital asset pricing model (CAPM) , Sun State determined that the required rate of return for a capital budgeting project it is evaluating is equal to 18 percent. If U.S. Treasury bonds yield 7 percent and the market risk premium is 5 percent, what is the project's beta coefficient?

Which of the following statements concerning cash flow evaluation in capital budgeting is correct?