Exam 11: Cash Flow Estimation and Risk Analysis

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?

In cash flow estimation,the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows.

To increase productive capacity,a company is considering a proposed new plant.Which of the following statements is CORRECT?

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?

Century Roofing is thinking of opening a new warehouse,and the key data are shown below.The company owns the building that would be used,and it could sell it for $100,000 after taxes if it decides not to open the new warehouse.The equipment for the project would be depreciated by the straight-line method over the project's 3-year life,after which it would be worth nothing and thus it would have a zero salvage value.No new working capital would be required,and revenues and other operating costs would be constant over the project's 3-year life.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) WACC 10.0\% Opportunity cost \ 100,000 Net equipment cost (depreciable basis) \ 65,000 Straight-line deprec. rate for equipment 33.333\% Sales revenues, each year \ 123,000 Operating costs (excl. deprec.), each year \ 25,000 Tax rate 35\%

Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets,not working capital.

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.

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Which of the following statements is CORRECT?

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? Seles revenues             $\$ 22,250$ Depreciation             $\$ 18,000$ Other aperating casts         $\$ 12000$ Tax rate                   $35 \%$

Your new employer,Freeman 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 33.33%,44.45%,14.81%,and 7.41% 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? Equipment cost (depreciable basis) \ 65,000 Sales revenues, each year \ 60,000 Operating costs (excl. deprec.) \ 25,000 Tax rate 35,0\%

If debt is to be used to finance a project,then when cash flows for a project are estimated,interest payments should be included in the analysis.

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.

The change in net working capital associated with new projects is always positive,because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Shultz Business Systems is analyzing an average-risk project,and the following data have been developed.Unit sales will be constant,but the sales price should increase with inflation.Fixed costs will also be constant,but variable costs should rise with inflation.The project should last for 3 years,it will be depreciated on a straight-line basis,and there will be no salvage value.This is just one of many projects for the firm,so any losses can be used to offset gains on other firm projects.What is the project's expected NPV? WACC 10.0\% Net investment cost (depreciable basis) \ 200,000 Units sold 50,000 Average price per unit, Year 1 \ 25.00 Fixed op. cost excl. deprec. (constant) \ 150,000 Variable op. cost/unit, Year 1 \ 20.20 Annual depreciation rate 33.333\% Expected inflation rate per year 5.00\% Tax rate 40.0\%

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?