Question 1

When calculating the cash flows for a project, you should include interest payments.

Accepted Answer

A) True 
 B)False

Question 2

Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because

Accepted Answer

A) it represents a tax-deductible cash expense. 
B) the firm has a cash outflow equal to the depreciation expense each year. 
C) although it is a non-cash expense, depreciation has an impact on the taxes paid by the firm, which is a cash flow. 
D) depreciation is a sunk cost. 
E) None of the above is correct. 
A) it represents a tax-deductible cash expense. 
B) the firm has a cash outflow equal to the depreciation expense each year. 
C) although it is a non-cash expense, depreciation has an impact on the taxes paid by the firm, which is a cash flow. 
D) depreciation is a sunk cost. 
E) None of the above is correct.

Question 3

Mars Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually. Mars will use the MACRS accelerated method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000.The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 5 years.Mars' marginal tax rate is 40 percent, and it uses a 12 percent required rate of return to evaluate projects of this nature.If the machine costs $60,000, what is the NPV of the project?

Accepted Answer

A) −$15,394 
B) −$14,093 
C) −$58,512 
D) −$21,493 
E) −$46,901 
A) −$15,394 
B) −$14,093 
C) −$58,512 
D) −$21,493 
E) −$46,901

Question 4

A firm is evaluating a new machine to replace an existing, older machine.The old (existing) machine is being depreciated at $20,000 per year, whereas the new machine's depreciation will be $18,000.The firm's marginal tax rate is 30 percent.Everything else equal, if the new machine is purchased, what effect will the change in depreciation have on the firm's incremental operating cash flows?

Accepted Answer

A) There should be no effect on the firm's cash flows, because depreciation is a noncash expense. 
B) Operating cash flows will increase by $2,000. 
C) Operating cash flows will increase by $1,400. 
D) Operating cash flows will decrease by $600. 
E) None of the above is correct. 
A) There should be no effect on the firm's cash flows, because depreciation is a noncash expense. 
B) Operating cash flows will increase by $2,000. 
C) Operating cash flows will increase by $1,400. 
D) Operating cash flows will decrease by $600. 
E) None of the above is correct.

Question 5

The Oneonta Chemical Company is evaluating two mutually exclusive pollution control systems.Since the company's revenue stream will not be affected by the choice of control systems, the projects are being evaluated by finding the PV of each set of costs.The firm's required rate of return is 13 percent, and it adds or subtracts 3 percentage points to adjust for project risk differences.System A is judged to be a high-risk project (it might end up costing much more to operate than is expected).The appropriate risk-adjusted discount rate that should be used to evaluate System A is

Accepted Answer

A) 10%; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being discounted. 
B) 13%; the firm's cost of capital should not be adjusted when evaluating outflow only projects. 
C) 16%; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the project for its high risk. 
D) Somewhere between 10% and 16%, with the answer depending on the riskiness of the relevant inflows. 
E) Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the requirements with the lowest required investment. 
A) 10%; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being discounted. 
B) 13%; the firm's cost of capital should not be adjusted when evaluating outflow only projects. 
C) 16%; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the project for its high risk. 
D) Somewhere between 10% and 16%, with the answer depending on the riskiness of the relevant inflows. 
E) Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the requirements with the lowest required investment.

Question 6

Capital budgeting decisions must be based on the accounting income the project generates since stockholders are concerned with the reported net income the firm generates.

Accepted Answer

A) True 
 B)False

Question 7

Tech Engineering Company is considering the purchase of a new machine to replace an existing one.The old machine was purchased 5 years ago at a cost of $20,000, and it is being depreciated on a straight line basis to a zero salvage value over a 10-year life.The current market value of the old machine is $14,000.The new machine, which falls into the MACRS 5-year class, has an estimated life of 5 years, it costs $30,000, and Tech plans to sell the machine at the end of the 5th year for $1,000.The new machine is expected to generate before-tax cash savings of $3,000 per year.The company's tax rate is 40 percent.What is the IRR of the proposed project?

Accepted Answer

A) 4.1% 
B) 2.2% 
C) 0.0% 
D) −1.5% 
E) −3.3% 
A) 4.1% 
B) 2.2% 
C) 0.0% 
D) −1.5% 
E) −3.3%

Question 8

According to the text, the financial staff's role in the forecasting process centers on

Accepted Answer

A) Developing the original assumptions used in estimating each project's cash flows. 
B) Making sure that no biases are inherent in the forecasts. 
C) Deciding which projects are strategically important to the firm. 
D) Setting the sales price and quantity estimates for use by other departments. 
E) All of the above. 
A) Developing the original assumptions used in estimating each project's cash flows. 
B) Making sure that no biases are inherent in the forecasts. 
C) Deciding which projects are strategically important to the firm. 
D) Setting the sales price and quantity estimates for use by other departments. 
E) All of the above.

Question 9

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Accepted Answer

A) True 
 B)False

Question 10

Regarding the net present value of a replacement decision, which of the following statements is false?

Accepted Answer

A) The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow. 
B) The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay). 
C) The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. 
D) Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay). 
E) An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow). 
A) The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow. 
B) The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay). 
C) The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. 
D) Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay). 
E) An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow).

Question 11

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

Accepted Answer

A) Accepting poor, high-risk projects. 
B) Rejecting good, low-risk projects. 
C) Accepting only good, low-risk projects. 
D) Accepting no projects. 
E) Answers a and b are both correct. 
A) Accepting poor, high-risk projects. 
B) Rejecting good, low-risk projects. 
C) Accepting only good, low-risk projects. 
D) Accepting no projects. 
E) Answers a and b are both correct.

Question 12

Risk in a revenue producing project can best be adjusted for by

Accepted Answer

A) Ignoring it. 
B) Adjusting the discount rate upward for increasing risk. 
C) Adjusting the discount rate downward for increasing risk. 
D) Picking a risk factor equal to the average discount rate. 
E) Reducing the NPV by 10 percent for risky projects. 
A) Ignoring it. 
B) Adjusting the discount rate upward for increasing risk. 
C) Adjusting the discount rate downward for increasing risk. 
D) Picking a risk factor equal to the average discount rate. 
E) Reducing the NPV by 10 percent for risky projects.

Question 13

Whitney Crane Inc.has the following independent investment opportunities for the coming year:  $\quad $ $\quad $$\quad $$\quad $$\quad $$\quad $$\quad $$\quad $$\text { Annual Cash }$
$\begin{array}{ccccc}
 \underline{\text { Project }} &  \underline{\text { Cost }}& \underline{\text { Inflows }} & \underline{ \text { Life(years) }}& \underline{ \text { IRR}}\
\mathrm{A} & \$ 10,000 & \$ 11,800&1& \
\mathrm{~B} & 5,000 & 3,075&2&15 \
\mathrm{C} & 12,000 & 5,696&3& \
\mathrm{D} & 3,000 & 1,009&4&13
\end{array}$ The IRRs for Project A and C, respectively, are:

Accepted Answer

A) 16% and 14% 
B) 18% and 10% 
C) 18% and 20% 
D) 18% and 13% 
E) 16% and 13% 
A) 16% and 14% 
B) 18% and 10% 
C) 18% and 20% 
D) 18% and 13% 
E) 16% and 13%

Question 14

The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects.The discount rate used for Project A is 12 percent.Further, Project A costs $15,000, and it would be depreciated using MACRS.It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years.Project B costs $14,815 and would also be depreciated using MACRS.B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years.The Unlimited's marginal tax rate is 40 percent.What risk-adjusted discount rate will equate the NPV of Project B to that of Project A?

Accepted Answer

A) 15% 
B) 16% 
C) 18% 
D) 20% 
E) 12% 
A) 15% 
B) 16% 
C) 18% 
D) 20% 
E) 12%

Question 15

Which of the following statements is correct?

Accepted Answer

A) Sensitivity analysis is used frequently in capital budgeting analysis.Its big advantage is that because it shows correlations between changes in input variables and NPV, it accounts for within-firm risk. 
B) Other things held constant, the lower the correlation between a project's returns and returns on the market, the less risky the project. 
C) In judging the relative stand-along risks of a set of projects, the projects' standard deviations of NPV are a better measure than their coefficients of variation. 
D) One can run a regression of returns on a project versus returns on the firm's other assets, get a beta coefficient, and use this beta as a measure of the project's market risk. 
E) One can run a regression of returns on a project versus returns on the stock market, get a beta coefficient, and use this beta as a measure of the project's within-firm risk. 
A) Sensitivity analysis is used frequently in capital budgeting analysis.Its big advantage is that because it shows correlations between changes in input variables and NPV, it accounts for within-firm risk. 
B) Other things held constant, the lower the correlation between a project's returns and returns on the market, the less risky the project. 
C) In judging the relative stand-along risks of a set of projects, the projects' standard deviations of NPV are a better measure than their coefficients of variation. 
D) One can run a regression of returns on a project versus returns on the firm's other assets, get a beta coefficient, and use this beta as a measure of the project's market risk. 
E) One can run a regression of returns on a project versus returns on the stock market, get a beta coefficient, and use this beta as a measure of the project's within-firm risk.

Question 16

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

Question 17

When determining the marginal cash flows associated with an expansion capital budgeting project, which of the following would be included as an incremental operating cash flow?

Accepted Answer

A) depreciation 
B) shipping and installation 
C) increase in working capital 
D) salvage value 
E) decrease in sales 
A) depreciation 
B) shipping and installation 
C) increase in working capital 
D) salvage value 
E) decrease in sales

Question 18

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk.In evaluating this asset, the decision maker should

Accepted Answer

A) Increase the IRR of the asset to reflect the greater risk. 
B) Increase the NPV of the asset to reflect the greater risk. 
C) Reject the asset, since its acceptance would increase the risk of the firm. 
D) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm. 
E) Increase the required rate of return used to evaluate the project to reflect the higher risk of the project. 
A) Increase the IRR of the asset to reflect the greater risk. 
B) Increase the NPV of the asset to reflect the greater risk. 
C) Reject the asset, since its acceptance would increase the risk of the firm. 
D) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm. 
E) Increase the required rate of return used to evaluate the project to reflect the higher risk of the project.

Question 19

Inflation does not need to be built into expected cash flows; the discount rate used in net present value calculations captures the effect of inflation.If you were to include expected inflation into cash flows, all net present value calculations would be incorrect.

Accepted Answer

A) True 
 B)False

Question 20

In cash flow estimation, the presence of externalities has no direct cash flow effects.

Accepted Answer

A) True 
 B)False

When calculating the cash flows for a project, you should include interest payments.

Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because

Capital budgeting decisions must be based on the accounting income the project generates since stockholders are concerned with the reported net income the firm generates.

According to the text, the financial staff's role in the forecasting process centers on

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Regarding the net present value of a replacement decision, which of the following statements is false?

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

Risk in a revenue producing project can best be adjusted for by

Whitney Crane Inc.has the following independent investment opportunities for the coming year: $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\text { Annual Cash }$ \ 10,000 \ 11,800 1 5,000 3,075 2 15 12,000 5,696 3 3,000 1,009 4 13 The IRRs for Project A and C, respectively, are:

Which of the following statements is correct?

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.

When determining the marginal cash flows associated with an expansion capital budgeting project, which of the following would be included as an incremental operating cash flow?

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk.In evaluating this asset, the decision maker should

Inflation does not need to be built into expected cash flows; the discount rate used in net present value calculations captures the effect of inflation.If you were to include expected inflation into cash flows, all net present value calculations would be incorrect.

In cash flow estimation, the presence of externalities has no direct cash flow effects.

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debt Characteristics and Valuation

Socks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk Appendix

Capital Structure

Distribution of Retained Earrings: Dividends and Stock Repurchases

Working Capital Policy

Managing Short- Term Assets

Managing Short-Term Liabilities Financing

Financial Planning and Control

Filters

Exam 11: The Cost of Capital

When calculating the cash flows for a project, you should include interest payments.

Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because

Capital budgeting decisions must be based on the accounting income the project generates since stockholders are concerned with the reported net income the firm generates.

According to the text, the financial staff's role in the forecasting process centers on

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Regarding the net present value of a replacement decision, which of the following statements is false?

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

Risk in a revenue producing project can best be adjusted for by

Which of the following statements is correct?

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.

When determining the marginal cash flows associated with an expansion capital budgeting project, which of the following would be included as an incremental operating cash flow?

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk.In evaluating this asset, the decision maker should

Inflation does not need to be built into expected cash flows; the discount rate used in net present value calculations captures the effect of inflation.If you were to include expected inflation into cash flows, all net present value calculations would be incorrect.

In cash flow estimation, the presence of externalities has no direct cash flow effects.

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debt Characteristics and Valuation

Socks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk Appendix

Capital Structure

Distribution of Retained Earrings: Dividends and Stock Repurchases

Working Capital Policy

Managing Short- Term Assets

Managing Short-Term Liabilities Financing

Financial Planning and Control

Filters