Exam 11: Cash Flow Estimation and Risk Analysis

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.

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

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

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.

McLeod Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?

We can identify the cash costs and cash inflows to a company that will result from a project.These could be called "direct inflows and outflows," and the net difference is the direct net cash flow.If there are other costs and benefits that do not flow from or to the firm,but to other parties,these are called externalities,and they need not be considered as a part of the capital budgeting analysis.

Which of the following statements is CORRECT?

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

Tallant 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: Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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?

You have just landed an internship in the CFO's office of Hawkesworth Inc.Your first task is to estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow? Srles reyenues               $\$ 13,000$ Depreciation                 $\$44,000$ Other aperating casts        $\$6,000$ Tax rate                     $350 \%$

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

Spot-Free 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 new 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 decline? (Hint: Note that cash flows are constant at the Year 1 level,whatever that level is.) WACC 10.0\% Net investment cost (depreciable basis) \ 60,000 Number of cars washed 2,800 Average price per car \ 25.00 Fixed op. cost (excl. deprec.) \ 10,000 Variable op. cost/unit (i.e., VC per car washed) \ 5.375 Annual depreciation \ 20,000 Taxrate 35.0\%

Because of differences in the expected returns on different investments,the standard deviation is not always an adequate measure of risk.However,the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

While developing a new product line,Cook 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.Cook owns the building free and clear-there is no mortgage on it.Which of the following statements is CORRECT?

Sheridan Films 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,some new 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? WACC 10.0\% Net investment in fixed assets (depreciable basis) \ 70,000 Required new working capital \ 10,000 Straight-line deprec. rate 33.333\% Sales revenues, each year \ 75,000 Operating costs (excl. deprec.), each year \ 30,000 Expected pretax salvage value \ 5,000 Taxrate 35.0\%

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

Taylor Inc.,the company you work for,is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Sales revenues, each year \ 62,500 Depreciation \ 8,000 Other operating costs \ 25,000 Interest expense \ 8,000 Tax rate 35,0\%