Exam 11: Cash Flow Estimation and Risk Analysis

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?

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.

If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.

Puckett Inc.risk-adjusts its WACC to account for project risk.It 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 Puckett accept,assuming that the company uses the NPV method when choosing projects?

A firm is considering a new project whose risk is greater than the risk of the firm's average project,based on all methods for assessing risk.In evaluating this project,it would be reasonable for management to do which of the following?

The CFO of Cicero Industries plans to calculate a new 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 flow),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?

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.

The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower,and cash flows higher,during every year of a project's life,other things held constant.

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

Suppose a firm's CFO thinks that an externality is present in a project,but that it cannot be quantified with any precision-estimates of its effect would really just be guesses.In this case,the externality should be ignored-i.e.,not considered at all-because if it were considered it would make the analysis appear more precise than it really is.

Wansley Enterprises is considering a new project.The company has a beta of 1.0,and its sales and profits are positively correlated with the overall economy.The company estimates that the 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?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

DeVault Services recently hired you as a consultant to help with its capital budgeting process.The company is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life,would be depreciated by the straight-line method over its 3-year life,and would have a zero salvage value.No new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? Risk-adjusted WACC 10.0\% Net investment cost (depreciable basis) \ 65,000 Straight-line deprec. rate 33.3333\% Sales revenues, each year \ 65,500 Operating costs (excl. deprec.), each year \ 25,000 Tax rate 35.0\%

Which of the following statements is CORRECT?

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.

Kasper Film Co.is selling off some old equipment it no longer needs because its associated project has come to an end.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.

Weston Clothing Company is considering manufacturing a new style of shirt,whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value,and no new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However,this project would compete with other Weston's products and would reduce their pre-tax annual cash flows.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) WACC 10.0\% Pre-tax cash flow reduction for other products (cannibalization) \ 5,000 Investment cost (depreciable basis) \ 80,000 Straight-line deprec. rate 33.333\% Sales revenues, each year for 3 years \ 67,500 Annual operating costs (excl. deprec.) \ 25,000 Tax rate 35,0\%

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.