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)  Changes in net operating working capital. 
B)  Shipping and installation costs for machinery acquired. 
C)  Cannibalization effects. 
D)  Opportunity costs. 
E)  Sunk costs that have been expensed for tax purposes. 
A)  Changes in net operating working capital. 
B)  Shipping and installation costs for machinery acquired. 
C)  Cannibalization effects. 
D)  Opportunity costs. 
E)  Sunk costs that have been expensed for tax purposes.

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)  Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. 
B)  One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring,whereas scenario analysis cannot account for probabilities. 
C)  Well-diversified stockholders do not need to consider market risk when determining required rates of return. 
D)  Market risk is important,but it does not have a direct effect on stock prices because it only affects beta. 
E)  Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions. 
A)  Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. 
B)  One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring,whereas scenario analysis cannot account for probabilities. 
C)  Well-diversified stockholders do not need to consider market risk when determining required rates of return. 
D)  Market risk is important,but it does not have a direct effect on stock prices because it only affects beta. 
E)  Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

Question 3

The relative risk of a proposed project is best accounted for by which of the following procedures?

Accepted Answer

A)  Adjusting the discount rate upward if the project is judged to have above-average risk. 
B)  Adjusting the discount rate upward if the project is judged to have below-average risk. 
C)  Reducing the NPV by 10% for risky projects. 
D)  Picking a risk factor equal to the average discount rate. 
E)  Ignoring risk because project risk cannot be measured accurately. 
A)  Adjusting the discount rate upward if the project is judged to have above-average risk. 
B)  Adjusting the discount rate upward if the project is judged to have below-average risk. 
C)  Reducing the NPV by 10% for risky projects. 
D)  Picking a risk factor equal to the average discount rate. 
E)  Ignoring risk because project risk cannot be measured accurately.

Question 4

As assistant to the CFO of Boulder Inc. ,you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. $$\begin{array} { l r } 
\text { Sales revenues } & \$ 13,100 \
\text { Depreciation } & \$ 4,000 \
\text { Other operating costs } & \$ 6,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
?

Accepted Answer

A)  $6,015 
B)  $6,797 
C)  $6,436 
D)  $6,496 
E)  $5,414 
A)  $6,015 
B)  $6,797 
C)  $6,436 
D)  $6,496 
E)  $5,414

Question 5

Dalrymple Inc.is considering production of a new product.In evaluating whether to go ahead with the project,which of the following items should NOT be explicitly considered when cash flows are estimated?

Accepted Answer

A)  The company will produce the new product in a vacant building that was used to produce another product until last year.The building could be sold,leased to another company,or used in the future to produce another of the firm's products. 
B)  The project will utilize some equipment the company currently owns but is not now using.A used equipment dealer has offered to buy the equipment. 
C)  The company has spent and expensed for tax purposes $3 million on research related to the new product.These funds cannot be recovered,but the research may benefit other projects that might be proposed in the future. 
D)  The new product will cut into sales of some of the firm's other products. 
E)  If the project is accepted,the company must invest an additional $2 million in net operating working capital.However,all of these funds will be recovered at the end of the project's life. 
A)  The company will produce the new product in a vacant building that was used to produce another product until last year.The building could be sold,leased to another company,or used in the future to produce another of the firm's products. 
B)  The project will utilize some equipment the company currently owns but is not now using.A used equipment dealer has offered to buy the equipment. 
C)  The company has spent and expensed for tax purposes $3 million on research related to the new product.These funds cannot be recovered,but the research may benefit other projects that might be proposed in the future. 
D)  The new product will cut into sales of some of the firm's other products. 
E)  If the project is accepted,the company must invest an additional $2 million in net operating working capital.However,all of these funds will be recovered at the end of the project's life.

Question 6

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation,other things being equal.

Accepted Answer

A) True 
 B)False

Question 7

Your company,CSUS Inc. ,is considering a new project whose data are shown below.The required equipment has a 3-year tax life,and the accelerated rates for such property are 33%,45%,15%,and 7% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life.What is the project's Year 4 cash flow? $$\begin{array} { l r } 
\text { Equipment cost (depreciable basis) } & \$ 70,000 \
\text { Sales revenues, each year } & \$ 34,000 \
\text { Operating costs (excl. depr.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
?

Accepted Answer

A)  $8,700 
B)  $6,884 
C)  $7,565 
D)  $7,716 
E)  $8,473 
A)  $8,700 
B)  $6,884 
C)  $7,565 
D)  $7,716 
E)  $8,473

Question 8

Wilson Co.is considering two mutually exclusive projects.Both require an initial investment of $9,100 at t = 0.Project X has an expected life of 2 years with after-tax cash inflows of $5,500 and $8,200 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 $4,800 at the end of each of the next 4 years.Each project has a WACC of 11%.What is the equivalent annual annuity of the most profitable project? Do not round intermediate calculations.

Accepted Answer

A)  $2,502 
B)  $1,885.50 
C)  $1,553.77 
D)  $1,680.15 
E)  $1,465.82 
A)  $2,502 
B)  $1,885.50 
C)  $1,553.77 
D)  $1,680.15 
E)  $1,465.82

Question 9

Marshall-Miller & Company is considering the purchase of a new machine for $50,000,installed.The machine has a tax life of 5 years,and it can be depreciated according to the depreciation rates below.The firm expects to operate the machine for 4 years and then to sell it for $2,500.If the marginal tax rate is 40%,what will the after-tax salvage value be when the machine is sold at the end of Year 4? $$\begin{array} { c c } 
\text { Year } & \text { Depreciation Rate } \
\hline 1 & 0.20 \
2 & 0.32 \
3 & 0.19 \
4 & 0.12 \
5 & 0.11 \
6 & 0.06
\end{array}$$
?

Accepted Answer

A)  $4,508 
B)  $4,998 
C)  $5,488 
D)  $4,900 
E)  $4,655 
A)  $4,508 
B)  $4,998 
C)  $5,488 
D)  $4,900 
E)  $4,655

Question 10

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

Accepted Answer

A) True 
 B)False

Question 11

Fool Proof Software is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life,and the allowed depreciation rates for such property are 33%,45%,15%,and 7% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected life.What is the Year 1 cash flow? $$\begin{array} { l r } 
\text { Equipment cost (depreciable basis) } & \$ 48,000 \
\text { Sales revenues, each year } & \$ 60,000 \
\text { Operating costs (excl. depr.) } & \$ 25,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
?

Accepted Answer

A)  $29,426 
B)  $33,387 
C)  $28,294 
D)  $28,860 
E)  $29,709 
A)  $29,426 
B)  $33,387 
C)  $28,294 
D)  $28,860 
E)  $29,709

Question 12

Currently,Powell Products has a beta of 1.0,and its sales and profits are positively correlated with the overall economy.The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project.Also,the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.On the basis of this information,which of the following statements is CORRECT?

Accepted Answer

A)  The proposed new project would have more stand-alone risk than the firm's typical project. 
B)  The proposed new project would increase the firm's corporate risk. 
C)  The proposed new project would increase the firm's market risk. 
D)  The proposed new project would not affect the firm's risk at all. 
E)  The proposed new project would have less stand-alone risk than the firm's typical project. 
A)  The proposed new project would have more stand-alone risk than the firm's typical project. 
B)  The proposed new project would increase the firm's corporate risk. 
C)  The proposed new project would increase the firm's market risk. 
D)  The proposed new project would not affect the firm's risk at all. 
E)  The proposed new project would have less stand-alone risk than the firm's typical project.

Question 13

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

Accepted Answer

A)  The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows. 
B)  Only incremental cash flows,which are the cash flows that would result if a project is accepted,are relevant when making accept/reject decisions for capital budgeting projects. 
C)  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. 
D)  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. 
E)  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. 
A)  The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows. 
B)  Only incremental cash flows,which are the cash flows that would result if a project is accepted,are relevant when making accept/reject decisions for capital budgeting projects. 
C)  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. 
D)  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. 
E)  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.

Question 14

Typically,a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used,other things held constant.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)  If an asset is sold for less than its book value at the end of a project's life,it will generate a loss for the firm,hence its terminal cash flow will be negative. 
B)  Only incremental cash flows are relevant in project analysis,the proper incremental cash flows are the reported accounting profits,and thus reported accounting income should be used as the basis for investor and managerial decisions. 
C)  It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project's completion.Operating working capital like inventory is almost always used up in operations.Thus,cash flows associated with operating working capital should be included only at the start of a project's life. 
D)  If equipment is expected to be sold for more than its book value at the end of a project's life,this will result in a profit.In this case,despite taxes on the profit,the end-of-project cash flow will be greater than if the asset had been sold at book value,other things held constant. 
E)  Changes in net operating working capital refer to changes in current assets and current liabilities,not to changes in long-term assets and liabilities,hence they should not be considered in a capital budgeting analysis. 
A)  If an asset is sold for less than its book value at the end of a project's life,it will generate a loss for the firm,hence its terminal cash flow will be negative. 
B)  Only incremental cash flows are relevant in project analysis,the proper incremental cash flows are the reported accounting profits,and thus reported accounting income should be used as the basis for investor and managerial decisions. 
C)  It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project's completion.Operating working capital like inventory is almost always used up in operations.Thus,cash flows associated with operating working capital should be included only at the start of a project's life. 
D)  If equipment is expected to be sold for more than its book value at the end of a project's life,this will result in a profit.In this case,despite taxes on the profit,the end-of-project cash flow will be greater than if the asset had been sold at book value,other things held constant. 
E)  Changes in net operating working capital refer to changes in current assets and current liabilities,not to changes in long-term assets and liabilities,hence they should not be considered in a capital budgeting analysis.

Question 16

Rowell Company spent $3 million two years ago to build a plant for a new product.It then decided not to go forward with the project,so the building is available for sale or for a new product.Rowell owns the building free and clear - there is no mortgage on it.Which of the following statements is CORRECT?

Accepted Answer

A)  Since the building has been paid for,it can be used by another project with no additional cost.Therefore,it should not be reflected in the cash flows of the capital budgeting analysis for any new project. 
B)  If the building could be sold,then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C)  This is an example of an externality,because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D)  Since the building was built in the past,its cost is a sunk cost and thus need not be considered when new projects are being evaluated,even if it would be used by those new projects. 
E)  If there is a mortgage loan on the building,then the interest on that loan would have to be charged to any new project that used the building. 
A)  Since the building has been paid for,it can be used by another project with no additional cost.Therefore,it should not be reflected in the cash flows of the capital budgeting analysis for any new project. 
B)  If the building could be sold,then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C)  This is an example of an externality,because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D)  Since the building was built in the past,its cost is a sunk cost and thus need not be considered when new projects are being evaluated,even if it would be used by those new projects. 
E)  If there is a mortgage loan on the building,then the interest on that loan would have to be charged to any new project that used the building.

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)  Since depreciation is a cash expense,the faster an asset is depreciated,the lower the projected NPV from investing in the asset. 
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 for both stockholder reporting and tax purposes. 
D)  Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
E)  Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV. 
A)  Since depreciation is a cash expense,the faster an asset is depreciated,the lower the projected NPV from investing in the asset. 
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 for both stockholder reporting and tax purposes. 
D)  Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
E)  Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV.

Question 18

Thomson Media is considering some new equipment whose data are shown below.The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years,but it would have a positive pre-tax salvage value at the end of Year 3,when the project would be closed down.Also,additional net operating working capital would be required,but it 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 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. $$\begin{array} { l r } 
\text { WACC } & 10.0 \% \
\text { Net investment in fixed assets (depreciable basis) } & \$ 70,000 \
\text { Required net operating working capital } & \$ 10,000 \
\text { Straight-line depreciation rate } & 33.333 \% \
\text { Annual sales revenues } & \$ 70,000 \
\text { Annual operating costs (excl. depreciation) } & \$ 30,000 \
\text { Expected pre-tax salvage value } & \$ 5,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$
?

Accepted Answer

A)  0$14,922 
B)  0$17,011 
C)  0$12,982 
D)  0$15,668 
E)  0$14,773 
A)  0$14,922 
B)  0$17,011 
C)  0$12,982 
D)  0$15,668 
E)  0$14,773

Question 19

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the present value approach.

Accepted Answer

A) True 
 B)False

Question 20

Taussig Technologies is considering two potential projects,X and Y.In assessing the projects' risks,the company estimated the beta of each project versus both the company's other assets and the stock market,and it also conducted thorough scenario and simulation analyses.This research produced the following data: $\begin{array}{lll}&\text { Project } \mathrm{X}&\text { Project } \mathrm{Y}\
\text { Expected NPV } & \$ 350,000 & \$ 350,000 \
\text { Standard deviation (oNPV) } & \$ 100,000 & \$ 150,000 \
\text { Project beta (vs. market) } & 1.4 & 0.8\
\text { Correlation of the project cash flows }&\text { Cash flows are not correlated }&\text { Cash flows are highly correl ated }\
\text { with cash flows from currently }&\text { with the cash flows from }&\text { with the cash flows from }\
\text { existing projects. }&\text { existing projects. }&\text { existing projects. }\
\end{array}$
?
Which of the following statements is CORRECT?

Accepted Answer

A)  Project X has more stand-alone risk than Project Y. 
B)  Project X has more corporate (or within-firm)risk than Project Y. 
C)  Project X has more market risk than Project Y. 
D)  Project X has the same level of corporate risk as Project Y. 
E)  Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects. 
A)  Project X has more stand-alone risk than Project Y. 
B)  Project X has more corporate (or within-firm)risk than Project Y. 
C)  Project X has more market risk than Project Y. 
D)  Project X has the same level of corporate risk as Project Y. 
E)  Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects.

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?

The relative risk of a proposed project is best accounted for by which of the following procedures?

Dalrymple Inc.is considering production of a new product.In evaluating whether to go ahead with the project,which of the following items should NOT be explicitly considered when cash flows are estimated?

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation,other things being equal.

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

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

Typically,a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used,other things held constant.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the present value approach.

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 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?

The relative risk of a proposed project is best accounted for by which of the following procedures?

Dalrymple Inc.is considering production of a new product.In evaluating whether to go ahead with the project,which of the following items should NOT be explicitly considered when cash flows are estimated?

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation,other things being equal.

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

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

Typically,a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used,other things held constant.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the present value approach.

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