Question 1

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 2

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects.

Accepted Answer

A) True 
 B)False

Question 3

Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. No change in net operating working capital would be required. Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV change? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.) $\begin{array}{lr}
  \text { WACC } &10.0\%\
 \text {  Net investment cost (depreciable basis)} &\$60,000\
 \text {Number of cars washed  } &2,800\
\
\text { Average price per car } & \$ 25.00 \
\text { Fixed oper. costs (excl. depreciation) } & \$ 10,000 \
\text { Variable oper. cost/unit (i.e., VC per car washed) } & \$ 5.375 \
\text { Annual depreciation } & \$ 20,000 \
\text { Tax rate } & 35.0 \%
\end{array}$

a. $- \$ 28,939$
b. $- \$ 30,462$
c. $- \$ 32,066$
d. $- \$ 33,753$
e. $- \$ 35,530$

Accepted Answer

The answer of Florida Car Wash is considering a new...

Question 4

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 5

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 6

Liberty Services is now at the end of the final year of a project. The equipment originally cost $22,500, of which 75% has been depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale.

Accepted Answer

A)  $5,558 
B)  $5,850 
C)  $6,143 
D)  $6,450 
E)  $6,772 
A)  $5,558 
B)  $5,850 
C)  $6,143 
D)  $6,450 
E)  $6,772

Question 7

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Accepted Answer

A)  The firm's corporate, or overall, WACC is used to discount all project cash flows to find the projects' NPVs. Then, depending on how risky different projects are judged to be, the calculated NPVs are scaled up or down to adjust for differential risk. 
B)  Differential project risk cannot be accounted for by using "risk­adjusted discount rates" because it is highly subjective and difficult to justify. It is better to not risk adjust at all. 
C)  Other things held constant, if returns on a project are thought to be positively correlated with the returns on other firms in the economy, then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated. 
D)  Monte Carlo simulation uses a computer to generate random sets of inputs, those inputs are then used to determine a trial NPV, and a number of trial NPVs are averaged to find the project's expected NPV. Sensitivity and scenario analyses, on the other hand, require much more information regarding the input variables, including probability distributions and correlations among those variables. This makes it easier to implement a simulation analysis than a scenario or sensitivity analysis, hence simulation is the most frequently used procedure. 
E)  DCF techniques were originally developed to value passive investments (stocks and bonds). However, capital budgeting projects are not passive investments-managers can often take positive actions after the investment has been made that alter the cash flow stream. Opportunities for such actions are called real options. Real options are valuable, but this value is not captured by conventional NPV analysis. Therefore, a project's real options must be considered separately. 
A)  The firm's corporate, or overall, WACC is used to discount all project cash flows to find the projects' NPVs. Then, depending on how risky different projects are judged to be, the calculated NPVs are scaled up or down to adjust for differential risk. 
B)  Differential project risk cannot be accounted for by using "risk­adjusted discount rates" because it is highly subjective and difficult to justify. It is better to not risk adjust at all. 
C)  Other things held constant, if returns on a project are thought to be positively correlated with the returns on other firms in the economy, then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated. 
D)  Monte Carlo simulation uses a computer to generate random sets of inputs, those inputs are then used to determine a trial NPV, and a number of trial NPVs are averaged to find the project's expected NPV. Sensitivity and scenario analyses, on the other hand, require much more information regarding the input variables, including probability distributions and correlations among those variables. This makes it easier to implement a simulation analysis than a scenario or sensitivity analysis, hence simulation is the most frequently used procedure. 
E)  DCF techniques were originally developed to value passive investments (stocks and bonds). However, capital budgeting projects are not passive investments-managers can often take positive actions after the investment has been made that alter the cash flow stream. Opportunities for such actions are called real options. Real options are valuable, but this value is not captured by conventional NPV analysis. Therefore, a project's real options must be considered separately.

Question 8

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 9

Other things held constant, which of the following would increase the NPV of a project being considered?

Accepted Answer

A)  A shift from straight-line to MACRS depreciation. 
B)  Making the initial investment in the first year rather than spreading it over the first three years. 
C)  An increase in the discount rate associated with the project. 
D)  An increase in required net operating working capital. 
E)  The project would decrease sales of another product line. 
A)  A shift from straight-line to MACRS depreciation. 
B)  Making the initial investment in the first year rather than spreading it over the first three years. 
C)  An increase in the discount rate associated with the project. 
D)  An increase in required net operating working capital. 
E)  The project would decrease sales of another product line.

Question 10

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)  A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
B)  A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
C)  A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D)  A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
E)  A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
A)  A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
B)  A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
C)  A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D)  A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
E)  A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.

Question 11

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 12

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

Accepted Answer

A)  Changes in net operating working capital attributable to the project. 
B)  Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
C)  The value of a building owned by the firm that will be used for this project. 
D)  A decline in the sales of an existing product, provided that decline is directly attributable to this project. 
E)  The salvage value of assets used for the project that will be recovered at the end of the project's life. 
A)  Changes in net operating working capital attributable to the project. 
B)  Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
C)  The value of a building owned by the firm that will be used for this project. 
D)  A decline in the sales of an existing product, provided that decline is directly attributable to this project. 
E)  The salvage value of assets used for the project that will be recovered at the end of the project's life.

Question 13

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 14

Which of the following statements is CORRECT?

Accepted Answer

A)  Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting. 
B)  Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer. 
C)  If they use accelerated depreciation, firms will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
D)  If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
E)  If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes. 
A)  Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting. 
B)  Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer. 
C)  If they use accelerated depreciation, firms will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
D)  If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes. 
E)  If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.

Question 15

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 16

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 17

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

Accepted Answer

A) True 
 B)False

Question 18

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

Accepted Answer

A)  In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it. 
B)  Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
C)  When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. 
D)  Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. 
E)  The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward. 
A)  In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it. 
B)  Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
C)  When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. 
D)  Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. 
E)  The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward.

Question 19

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 20

Which of the following statements is CORRECT?

Accepted Answer

A)  An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality. 
B)  An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase. 
C)  The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV. 
D)  Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not. 
E)  Identifying an externality can never lead to an increase in the calculated NPV. 
A)  An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality. 
B)  An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase. 
C)  The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV. 
D)  Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not. 
E)  Identifying an externality can never lead to an increase in the calculated NPV.

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

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects.

Which of the following statements is CORRECT?

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 procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

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

Other things held constant, which of the following would increase the NPV of a project being considered?

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 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.

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

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

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

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?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The 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

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

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Exam 12: Cash Flow Estimation and Risk Analysis

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

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects.

Which of the following statements is CORRECT?

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 procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

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

Other things held constant, which of the following would increase the NPV of a project being considered?

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 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.

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

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

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

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?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The 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

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Financial and Operating Leverage: Analysis and Calculation

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