Exam 11: Cash Flow Estimation and Risk 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?

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected sales include sales that will be taken away from another of Walker's books. The lost sales on the existing book are a sunk cost and as such should not be considered in the analysis of the new book.

Which of the following statements best describes sunk costs?

The two cardinal rules that financial analysts follow to avoid capital budgeting errors are (1) capital budgeting decisions must be based on accounting income, and (2) all incremental cash flows should be considered when making accept/reject decisions.

Which of the following statements is correct?

Your company, Omega Corporation, is considering a new project that you must analyze. Based on the following data, what is the project's Year 1 operating cash flow?

Which of the following is NOT a relevant factor when determining incremental cash flows for a new product?

Suppose Tapley Corporation uses a WACC of 8% for below-average risk projects, 10% for average- risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?

Your company, Q4 Inc., is considering a new project whose data are shown below. The required equipment has an economic year of 5 years, and has a CCA rate of 30% in class 10. Revenues and cash operating costs are expected to be constant over the project's 5-year operating life. What is the project's net operating cash flow during Year 2?

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

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

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is correct?

Which of the following statements best describes CCA?

In capital budgeting terminology, an "externality" is defined as something that is outside, or external to, a proposed new project. Therefore, externalities are not considered in project cash flow estimates.

Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average projects at 10%, and high-risk projects at 12%. The company is considering the following projects: Which set of projects would maximize shareholder wealth?

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

Superior analytical techniques, such as NPV, used in combination with cost of capital adjustments, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.

As a member of Midwest Corporation's financial staff, you must estimate the Year 1 operating cash flow for a proposed project with the following data. What is the Year 1 net operating cash flow?

When the cash flows for a project are estimated, interest payments should be included if debt is to be used to help finance the project.