Question 1

By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.

Accepted Answer

A) True 
 B)False

Question 2

For the case of an electric car project, which of the following costs or cash flows should be categorized as incremental when analyzing whether to invest in the project?

Accepted Answer

A) The cost of research and development undertaken for developing the electric car during the past three years 
B) The annual depreciation charge 
C) Tax savings resulting from the depreciation charges 
D) Dividend payments 
A) The cost of research and development undertaken for developing the electric car during the past three years 
B) The annual depreciation charge 
C) Tax savings resulting from the depreciation charges 
D) Dividend payments

Question 3

A firm owns a building with a book value of $150,000 and a market value of $250,000.If the firm uses the building for a project, then its opportunity cost, ignoring taxes, is

Accepted Answer

A) $100,000. 
B) $150,000. 
C) $250,000. 
D) $400,000. 
A) $100,000. 
B) $150,000. 
C) $250,000. 
D) $400,000.

Question 4

You are considering the purchase of one of two machines required in your production process.Machine A has a life of two years.Machine A costs $50 initially and then $70 per year in maintenance.Machine B has an initial cost of $90.It requires $40 in maintenance for each year of its three-year life.Either machine must be replaced at the end of its life.Which is the better machine for the firm? The discount rate is 15 percent and the tax rate is zero.

Accepted Answer

A) Machine A, because EAC for machine A is $100.76 
B) Machine B, because EAC for machine B is $79.42 
C) Machine A, because PV of costs for machine A is $163.80 
D) Machine B, because PV of costs for machine B is $181.33 
A) Machine A, because EAC for machine A is $100.76 
B) Machine B, because EAC for machine B is $79.42 
C) Machine A, because PV of costs for machine A is $163.80 
D) Machine B, because PV of costs for machine B is $181.33

Question 5

You should replace a machine when the EAC of continuing to operate it exceeds the EAC of the new machine.

Accepted Answer

A) True 
 B)False

Question 6

The real cash flow occurring in year 2 is $60,000.If the inflation rate is 5 percent per year and the real rate of interest is 2 percent per year, calculate the nominal cash flow for year 2.

Accepted Answer

A) $60,000 
B) $62,424 
C) $66,150 
D) $63,654 
A) $60,000 
B) $62,424 
C) $66,150 
D) $63,654

Question 7

The current market value of a previously purchased machine proposed for use in a project is an example of a(n)

Accepted Answer

A) sunk cost. 
B) opportunity cost. 
C) fixed cost. 
D) inventoriable cost. 
A) sunk cost. 
B) opportunity cost. 
C) fixed cost. 
D) inventoriable cost.

Question 8

One should consider net working capital (NWC) in project cash flows because

Accepted Answer

A) typically firms must invest cash in short-term assets to produce finished goods. 
B) NWC represents sunk costs. 
C) firms need positive NPV projects for investment. 
D) inclusion of NWC typically increases calculated NPV. 
A) typically firms must invest cash in short-term assets to produce finished goods. 
B) NWC represents sunk costs. 
C) firms need positive NPV projects for investment. 
D) inclusion of NWC typically increases calculated NPV.

Question 9

If depreciation is $100,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is

Accepted Answer

A) $35,000. 
B) $100,000. 
C) $65,000. 
D) The answer cannot be determined from the information given. 
A) $35,000. 
B) $100,000. 
C) $65,000. 
D) The answer cannot be determined from the information given.

Question 10

RainMan Inc.is in the business of producing rain upon request.They must decide between two investment projects: a new airplane for seeding rain clouds or a new weather control machine built by Dr.Nutzbaum.The discount rate for the new airplane is 9 percent, while the discount rate for the weather machine is 39 percent (it happens to have higher market risk).Which investment should the company select and why? (Assume a 0 percent inflation rate and that projected costs do not change over time.) $\begin{array} { cc c } 
\text { Year } & \text { Airplane } & \text { Weather Machine } \
0 & - 900 & - 900 \
1 & 500 & 550 \
2 & 600 & 600 \
3 & & 685
\end{array}$

Accepted Answer

A) Airplane, because it has a higher NPV 
B) Weather machine, because it has a higher NPV 
C) Airplane, because it has a higher equivalent annual cash flow 
D) Weather machine, because it has a higher equivalent annual cash flow 
A) Airplane, because it has a higher NPV 
B) Weather machine, because it has a higher NPV 
C) Airplane, because it has a higher equivalent annual cash flow 
D) Weather machine, because it has a higher equivalent annual cash flow

Question 11

If the nominal interest rate is 7.5 percent and the inflation rate is 4.0 percent, what is the real interest rate?

Accepted Answer

A) 4.0 percent 
B) 9.5 percent 
C) 3.4 percent 
D) 11.5 percent 
A) 4.0 percent 
B) 9.5 percent 
C) 3.4 percent 
D) 11.5 percent

Question 12

A project requires an initial investment of $200,000 and expects to produce a cash flow before taxes of $120,000 per year for two years .The corporate tax rate is 30 percent.The assets will depreciate using the MACRS year 3 schedule: (t = 1: 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%).The company's tax situation is such that it can use all applicable tax shields.The opportunity cost of capital is 11 percent.Assume that the asset can sell for book value at the end of the project.Calculate the approximate IRR for the project.

Accepted Answer

A) 12.00 percent 
B) 11.00 percent 
C) 17.73 percent 
D) 14.06 percent 
A) 12.00 percent 
B) 11.00 percent 
C) 17.73 percent 
D) 14.06 percent

Question 13

For the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project except

Accepted Answer

A) the consequent reduction in sales of the company's existing gasoline models (i.e., incidental effects). 
B) interest payments on debt incurred to finance the project. 
C) the value of tools that will be transferred to the project from the company's existing plants instead of being sold. 
D) the expenditure on new plants and equipment. 
A) the consequent reduction in sales of the company's existing gasoline models (i.e., incidental effects). 
B) interest payments on debt incurred to finance the project. 
C) the value of tools that will be transferred to the project from the company's existing plants instead of being sold. 
D) the expenditure on new plants and equipment.

Question 14

A reduction in the sales of existing products caused by the introduction of a new product is an example of

Accepted Answer

A) incidental effects. 
B) opportunity costs. 
C) sunk costs. 
D) allocated overhead costs. 
A) incidental effects. 
B) opportunity costs. 
C) sunk costs. 
D) allocated overhead costs.

Question 15

What are some of the important points to remember while estimating the cash flows of a project?
Estimate after-tax cash flows on an incremental basis.
Include all incidental effects.
Include working capital requirements.
Include opportunity costs.
Do not include sunk costs.
Take inflation into consideration in a consistent manner.

Accepted Answer

Estimate after-tax cash flows on an incr

Question 16

Opportunity costs should not be included in project analysis, as they are missed opportunities.

Accepted Answer

A) True 
 B)False

Question 17

Briefly explain how inflation is treated consistently while estimating a project's NPV.

Accepted Answer

There are two ways to treat inflation co

Question 18

Suppose that a project has a depreciable investment of $600,000 and falls under the following MACRS year 5 class depreciation schedule: year 1: 20 percent; year 2: 32 percent; year 3: 19.2 percent; year 4: 11.5 percent; year 5: 11.5 percent; and year 6: 5.8 percent.
Calculate depreciation for year 2.

Accepted Answer

A) $120,000 
B) $192,000 
C) $96,000 
D) $115,200 
A) $120,000 
B) $192,000 
C) $96,000 
D) $115,200

Question 19

A firm has a general-purpose machine, which has a book value of $300,000 and is worth $500,000 in the market.If the tax rate is 35 percent, what is the opportunity cost of using the machine in a project?

Accepted Answer

A) $500,000 
B) $430,000 
C) $300,000 
D) $200,000 
A) $500,000 
B) $430,000 
C) $300,000 
D) $200,000

Question 20

OM Construction Company must choose between two types of cranes.Crane A costs $600,000, will last for five years, and will require $60,000 in maintenance each year.Crane B costs $750,000, will last for seven years, and will require $30,000 in maintenance each year.Maintenance costs for cranes A and B occur at the end of each year.The appropriate discount rate is 12 percent per year.Which machine should OM Construction purchase?

Accepted Answer

A) Crane A, because EAC is $226,444 
B) Crane B, because EAC is $194,336 
C) Crane A, because its PV is $816,286 (i.e., less than the PV of Project 
B)  
D) The answer cannot be calculated because the revenues for the project are not given. 
A) Crane A, because EAC is $226,444 
B) Crane B, because EAC is $194,336 
C) Crane A, because its PV is $816,286 (i.e., less than the PV of Project 
B)  
D) The answer cannot be calculated because the revenues for the project are not given.

Exam 6: Making Investment Decisions With the Net Present Value Rule

By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.

For the case of an electric car project, which of the following costs or cash flows should be categorized as incremental when analyzing whether to invest in the project?

A firm owns a building with a book value of $150,000 and a market value of $250,000.If the firm uses the building for a project, then its opportunity cost, ignoring taxes, is

You should replace a machine when the EAC of continuing to operate it exceeds the EAC of the new machine.

The real cash flow occurring in year 2 is $60,000.If the inflation rate is 5 percent per year and the real rate of interest is 2 percent per year, calculate the nominal cash flow for year 2.

The current market value of a previously purchased machine proposed for use in a project is an example of a(n)

One should consider net working capital (NWC) in project cash flows because

If depreciation is $100,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is

If the nominal interest rate is 7.5 percent and the inflation rate is 4.0 percent, what is the real interest rate?

For the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project except

A reduction in the sales of existing products caused by the introduction of a new product is an example of

Opportunity costs should not be included in project analysis, as they are missed opportunities.

Briefly explain how inflation is treated consistently while estimating a project's NPV.

A firm has a general-purpose machine, which has a book value of $300,000 and is worth $500,000 in the market.If the tax rate is 35 percent, what is the opportunity cost of using the machine in a project?

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

Investment Strategy and Economic Rents

Agency Problems Compensation and Performance Measurement

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing Risk

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

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