Question 1

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 2

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 3

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

Question 4

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 5

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

Accepted Answer

A) True 
 B)False

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

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? $\begin{array}{lr}
\text { Sales revenues } & \$ 13,000 \
\text { Depreciation } & \$ 4,000 \
\text { Other operating costs } & \$ 6,000 \
\text { Tax rate } & 35.0 \%
\end{array}$

a. $\$ 5,950$
b. $\$ 6,099$
c. $\$ 6,251$
d. $\$ 6,407$
e. $\$ 6,568$

Accepted Answer

The answer of As assistant to the CFO of Boulder...

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV. 
B)  In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV. 
C)  The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
D)  If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. 
E)  If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored. 
A)  In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV. 
B)  In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV. 
C)  The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
D)  If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. 
E)  If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. 
B)  Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. 
C)  A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices. 
D)  A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. 
E)  If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored. 
A)  An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. 
B)  Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. 
C)  A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices. 
D)  A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. 
E)  If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored.

Question 10

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 11

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: $$\begin{array} { l l l } 
& \underline { \text { Project X } } & \underline { \text { Project } \mathrm { Y } } \
\text { Expected NPV } & \$ 350,000 & \$ 350,000 \
\text { Standard deviation } \left( \sigma _ { \mathrm { NPV } } \right) & \$ 100,000 & \$ 150,000 \
\text { Project beta (vs. market) } & 1.4 & 0.8 \
\text { Correlation of the project cash } & \text { Cash flows are not correlated } & \text { Cash flows are highly } \
\text { flows with cash flows from } & \text { with the cash flows from } & \text { correlated with the cash flows } \
\text { currently existing projects } & \text { existing projects } & \text { from existing projects }
\end{array}$$ 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.

Question 12

Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

Accepted Answer

A) True 
 B)False

Question 13

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 14

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 15

Aggarwal Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the following simple decision tree to show its three most-likely scenarios. The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties. How much is the option to abandon worth to the firm? $\text { WACC }=11.5 \% \quad \quad \quad \text { Dollars in Thousands }  \quad \quad \quad \quad\quad  \quad \quad\text { NPV This } \quad \text { Prob. } \times$
$\begin{array}{c}
\begin{array}{lll}
 \text {Prob. \( =20 \% $}\
 \text {Prob. $ =60 \% $}\
 \text {Prob. $ =20 \% $} 
\end{array}
\begin{array}{c}
\
t=0 \
\hline-\$ 1,000 \
-\$ 1,000 \
-\$ 1,000\
\
\end{array}
\begin{array}{c}
\
t=1 \ 
\hline\$ 800.0 \
\$ 520.0 \
-\$ 200.0\
\
\end{array}
\begin{array}{c}
\
t=2 \
\hline\$ 800.0 \
\$ 520.0 \
-\$ 200.0\
\
\end{array}
\begin{array}{c}
\
t=3 \
\hline \$ 800.0 \
\$ 520.0 \
-\$ 200.0\
\
\end{array}
\begin{array}{c}
\
\text { State } \
\hline\$ \$ 938.1 \
\$ 259.8 \
-\$ 1,454.5 \
\text { Exp. NPV }=
\end{array}
\begin{array}{c}
\
\mathrm{NPV} \
\hline \$ 187.6 \
\$ 155.9 \
\underline{-\$ 296.9} \
\underline{\underline{ \$ 46.6}} \

\end{array}

\end{array}\)

a. $\$ 55.0$
b. $\$ 58.0$
c. $\$ 61.0$
d. $\$ 64.1$
e. $\$ 67.3$

Accepted Answer

The answer of Aggarwal Enterprises is considering a new project...

Question 16

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 17

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 $12,500. 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)  $ 8,878 
B)  $ 9,345 
C)  $ 9,837 
D)  $10,355 
E)  $10,900 
A)  $ 8,878 
B)  $ 9,345 
C)  $ 9,837 
D)  $10,355 
E)  $10,900

Question 18

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

Accepted Answer

A) True 
 B)False

Question 19

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 20

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 (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

Accepted Answer

A)  All sunk costs that have been incurred relating to the project. 
B)  All interest expenses on debt used to help finance the project. 
C)  The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. 
D)  Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. 
E)  Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows. 
A)  All sunk costs that have been incurred relating to the project. 
B)  All interest expenses on debt used to help finance the project. 
C)  The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. 
D)  Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. 
E)  Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.

Which of the following statements is CORRECT?

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?

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.

Which of the following statements is CORRECT?

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

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.

Which of the following statements is CORRECT?

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

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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Exam 12: Cash Flow Estimation and Risk Analysis

Which of the following statements is CORRECT?

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?

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.

Which of the following statements is CORRECT?

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

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.

Which of the following statements is CORRECT?

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

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

Filters