Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. 
B)  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. 
C)  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. 
D)  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. 
E)  As computer technology advances,simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis. 
A)  Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. 
B)  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. 
C)  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. 
D)  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. 
E)  As computer technology advances,simulation analysis becomes increasingly obsolete and thus less likely to be used than sensitivity analysis.

Question 2

Which of the following statement completions is NOT CORRECT? For a profitable firm,when MACRS accelerated depreciation is compared to straight-line depreciation,MACRS accelerated allowances produce

Accepted Answer

A)  Higher depreciation charges in the early years of an asset's life. 
B)  Larger cash flows in the earlier years of an asset's life. 
C)  Larger total undiscounted profits from the project over the project's life. 
D)  Smaller accounting profits in the early years,assuming the company uses the same depreciation method for tax and book purposes. 
E)  Lower tax payments in the earlier years of an asset's life. 
A)  Higher depreciation charges in the early years of an asset's life. 
B)  Larger cash flows in the earlier years of an asset's life. 
C)  Larger total undiscounted profits from the project over the project's life. 
D)  Smaller accounting profits in the early years,assuming the company uses the same depreciation method for tax and book purposes. 
E)  Lower tax payments in the earlier years of an asset's life.

Question 3

Foley Systems is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life,would have a zero salvage value,and would require additional net operating working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows from operations are constant in Years 1 to 3. )Do not round the intermediate calculations and round the final answer to the nearest whole number. $\begin{array}{lr}
\text { WACC } & 10.0 \% \
\text { Net investment in fixed assets (basis) } & \$ 75,000 \
\text { Required net operating working capital } & \$ 15,000 \
\text { Straight-line depreciation rate } & 33.333 \% \
\text { Annual sales revenues } & \$ 56,000 \
\text { Annual operating costs (excl. depr.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$
?

Accepted Answer

A)  -$6,860 
B)  -$7,615 
C)  -$6,380 
D)  -$7,683 
E)  -$6,106 
A)  -$6,860 
B)  -$7,615 
C)  -$6,380 
D)  -$7,683 
E)  -$6,106

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Mulroney Corp.is considering two mutually exclusive projects.Both require an initial investment of $10,800 at t = 0.Project X has an expected life of 2 years with after-tax cash inflows of $6,600 and $7,400 at the end of Years 1 and 2,respectively.In addition,Project X can be repeated at the end of Year 2 with no changes in its cash flows.Project Y has an expected life of 4 years with after-tax cash inflows of $4,300 at the end of each of the next 4 years.Each project has a WACC of 8%.Using the replacement chain approach,what is the NPV of the most profitable project? Do not round the intermediate calculations and round the final answer to the nearest whole number.

Accepted Answer

A)  $3,442 
B)  $3,718 
C)  $3,408 
D)  $3,339 
E)  $2,960 
A)  $3,442 
B)  $3,718 
C)  $3,408 
D)  $3,339 
E)  $2,960

Question 6

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 7

Temple Corp.is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life,would be depreciated by the straight-line method over its 3-year life,and would have a zero salvage value.No change in net operating working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number.
? $$\begin{array} { l r } 
\text { Risk-adjusted WACC } & 10.0 \% \
\text { Net investment cost (depreciable basis) } & \$ 65,000 \
\text { Straight-line depr. rate } & 33.3333 \% \
\text { Sales revenues, each year } & \$ 71,500 \
\text { Annual operating costs (excl. depr.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
?

Accepted Answer

A)  $25,831 
B)  $33,377 
C)  $34,828 
D)  $29,023 
E)  $22,928 
A)  $25,831 
B)  $33,377 
C)  $34,828 
D)  $29,023 
E)  $22,928

Question 8

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

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken,assuming the asset is used for its full tax life,is greater.

Accepted Answer

A) True 
 B)False

Question 11

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 12

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)  Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.This space could be used for other products if it is not used for the project under consideration. 
B)  Revenues from an existing product would be lost as a result of customers switching to the new product. 
C)  Shipping and installation costs associated with a machine that would be used to produce the new product. 
D)  The cost of a study relating to the market for the new product that was completed last year.The results of this research were positive,and they led to the tentative decision to go ahead with the new product.The cost of the research was incurred and expensed for tax purposes last year. 
E)  It is learned that land the company owns and would use for the new project,if it is accepted,could be sold to another firm. 
A)  Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.This space could be used for other products if it is not used for the project under consideration. 
B)  Revenues from an existing product would be lost as a result of customers switching to the new product. 
C)  Shipping and installation costs associated with a machine that would be used to produce the new product. 
D)  The cost of a study relating to the market for the new product that was completed last year.The results of this research were positive,and they led to the tentative decision to go ahead with the new product.The cost of the research was incurred and expensed for tax purposes last year. 
E)  It is learned that land the company owns and would use for the new project,if it is accepted,could be sold to another firm.

Question 13

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 14

Any cash flows that can be classified as incremental to a particular project - i.e. ,results directly from the decision to undertake the project - should be reflected in the capital budgeting analysis.

Accepted Answer

A) True 
 B)False

Question 15

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

Accepted Answer

A)  All costs associated with the project that have been incurred prior to the time the analysis is being conducted. 
B)  Interest on funds borrowed to help finance the project. 
C)  The end-of-project recovery of any additional net operating working capital required to operate the project. 
D)  Cannibalization effects,but only if those effects increase the project's projected cash flows. 
E)  Expenditures to date on research and development related to the project,provided those costs have already been expensed for tax purposes. 
A)  All costs associated with the project that have been incurred prior to the time the analysis is being conducted. 
B)  Interest on funds borrowed to help finance the project. 
C)  The end-of-project recovery of any additional net operating working capital required to operate the project. 
D)  Cannibalization effects,but only if those effects increase the project's projected cash flows. 
E)  Expenditures to date on research and development related to the project,provided those costs have already been expensed for tax purposes.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. 
B)  A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. 
C)  A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. 
D)  Sunk costs were formerly hard to deal with,but once the NPV method came into wide use,it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV. 
E)  A good example of a sunk cost is a situation where Home Depot opens a new store,and that leads to a decline in sales of one of the firm's existing stores. 
A)  A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. 
B)  A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. 
C)  A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. 
D)  Sunk costs were formerly hard to deal with,but once the NPV method came into wide use,it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV. 
E)  A good example of a sunk cost is a situation where Home Depot opens a new store,and that leads to a decline in sales of one of the firm's existing stores.

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)  Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV. 
B)  Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C)  Corporations must use the same depreciation method (e.g. ,straight line or accelerated)for stockholder reporting and tax purposes. 
D)  Since depreciation is not a cash expense,it has no effect on cash flows and thus no effect on capital budgeting decisions. 
E)  Under accelerated depreciation,higher depreciation charges occur in the early years,and this reduces the early cash flows and thus lowers a project's projected NPV. 
A)  Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV. 
B)  Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C)  Corporations must use the same depreciation method (e.g. ,straight line or accelerated)for stockholder reporting and tax purposes. 
D)  Since depreciation is not a cash expense,it has no effect on cash flows and thus no effect on capital budgeting decisions. 
E)  Under accelerated depreciation,higher depreciation charges occur in the early years,and this reduces the early cash flows and thus lowers a project's projected NPV.

Question 18

Suppose Tapley Inc.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?

Accepted Answer

A)  Project A,which has average risk and an IRR = 9%. 
B)  Project B,which has below-average risk and an IRR = 8.5%. 
C)  Project C,which has above-average risk and an IRR = 11%. 
D)  Without information about the projects' NPVs we cannot determine which one or ones should be accepted. 
E)  All of these projects should be accepted as they will produce a positive NPV. 
A)  Project A,which has average risk and an IRR = 9%. 
B)  Project B,which has below-average risk and an IRR = 8.5%. 
C)  Project C,which has above-average risk and an IRR = 11%. 
D)  Without information about the projects' NPVs we cannot determine which one or ones should be accepted. 
E)  All of these projects should be accepted as they will produce a positive NPV.

Question 19

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 20

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

Accepted Answer

A) True 
 B)False

Which of the following statements is CORRECT?

Which of the following statement completions is NOT CORRECT? For a profitable firm,when MACRS accelerated depreciation is compared to straight-line depreciation,MACRS accelerated allowances produce

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.

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

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?

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.

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken,assuming the asset is used for its full tax life,is greater.

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?

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.

Any cash flows that can be classified as incremental to a particular project - i.e. ,results directly from the decision to undertake the project - should be reflected in the capital budgeting analysis.

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Suppose Tapley Inc.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?

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.

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

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements,cash Flow and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock,leasing,warrants,and Convertibles

Mergers and Acquisitions

Filters

Exam 12: Cash Flow Estimation and Risk Analysis

Which of the following statements is CORRECT?

Which of the following statement completions is NOT CORRECT? For a profitable firm,when MACRS accelerated depreciation is compared to straight-line depreciation,MACRS accelerated allowances produce

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.

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

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?

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.

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken,assuming the asset is used for its full tax life,is greater.

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?

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.

Any cash flows that can be classified as incremental to a particular project - i.e. ,results directly from the decision to undertake the project - should be reflected in the capital budgeting analysis.

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Suppose Tapley Inc.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?

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.

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

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements,cash Flow and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock,leasing,warrants,and Convertibles

Mergers and Acquisitions

Filters