Question 1

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

Accepted Answer

A) Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
B) When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. 
C) Capital budgeting decisions should be based on before-tax cash flows. 
D) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. 
E) In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it. 
A) Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
B) When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. 
C) Capital budgeting decisions should be based on before-tax cash flows. 
D) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. 
E) In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

Question 2

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?

Accepted Answer

A) The proposed new project would increase the firm's corporate risk. 
B) The proposed new project would increase the firm's market risk. 
C) The proposed new project would not affect the firm's risk at all. 
D) The proposed new project would have less stand-alone risk than the firm's typical project. 
E) The proposed new project would have more stand-alone risk than the firm's typical project. 
A) The proposed new project would increase the firm's corporate risk. 
B) The proposed new project would increase the firm's market risk. 
C) The proposed new project would not affect the firm's risk at all. 
D) The proposed new project would have less stand-alone risk than the firm's typical project. 
E) The proposed new project would have more stand-alone risk than the firm's typical project.

Question 3

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

Accepted Answer

A) Shipping and installation costs. 
B) Cannibalization effects. 
C) Opportunity costs. 
D) Sunk costs that have been expensed for tax purposes. 
E) Changes in net working capital. 
A) Shipping and installation costs. 
B) Cannibalization effects. 
C) Opportunity costs. 
D) Sunk costs that have been expensed for tax purposes. 
E) Changes in net working capital.

Question 4

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?

Accepted Answer

A) 0.67 
B) 0.73 
C) 0.81 
D) 0.89 
E) 0.98 
A) 0.67 
B) 0.73 
C) 0.81 
D) 0.89 
E) 0.98

Question 5

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.

Accepted Answer

A) True 
 B)False

Question 6

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 7

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.) $$\begin{array} { l r } 
 \text { WACC } & 10.0 \% \
\text { Opportunity cost } & \$ 100,000 \
\text { Net equipment cost (depreciable basis) } & \$ 65,000 \
\text { Straight-line deprec. rate for equipment } & 33.333 \% \
\text { Sales revenues, each year } & \$ 123,000 \
\text { Operating costs (excl. deprec.), each year } & \$ 25,000 \
\text { Tax rate } & 35 \%
\end{array}$$

Accepted Answer

A) $10,521 
B) $11,075 
C) $11,658 
D) $12,271 
E) $12,885 
A) $10,521 
B) $11,075 
C) $11,658 
D) $12,271 
E) $12,885

Question 8

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) Revenues from an existing product would be lost as a result of customers switching to the new product. 
B) Shipping and installation costs associated with a machine that would be used to produce the new product. 
C) 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. 
D) 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. 
E) 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. 
A) Revenues from an existing product would be lost as a result of customers switching to the new product. 
B) Shipping and installation costs associated with a machine that would be used to produce the new product. 
C) 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. 
D) 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. 
E) 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.

Question 9

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) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
B) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
C) A firm has spent $2 million on R&D associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
D) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
E) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
A) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products. 
B) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
C) A firm has spent $2 million on R&D associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. 
D) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
E) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.

Question 10

VR Corporation has the opportunity to invest in a new project,the details of which are shown below.What is the Year 1 cash flow for the project? $$\begin{array} { l r } 
\text { Sales revenues, each year) } & \$ 42,000 \
\text { Depreciation} & \$10,000\
\text { Other operating costs } & \$ 17,000 \
\text { Interest expense } & \$4,000 \
\text { Tax rate } & 35.0 \%
\end{array}$$

Accepted Answer

A) $16,351 
B) $17,212 
C) $18,118 
D) $19,071 
E) $20,075 
A) $16,351 
B) $17,212 
C) $18,118 
D) $19,071 
E) $20,075

Question 11

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.

Accepted Answer

A) True 
 B)False

Question 12

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: $\begin{array}{c}
\begin{array}{lll}
\
\text {Expected NPV}\
\text {Standard deviation (oNPV)}\
\text {Project beta (vs. market)}
\end{array}
\begin{array}{lll}
\text {Project $ X $ }\
\$ 500,000 \
\$ 200,000 \
1.4 
\end{array}
\begin{array}{lll}
\text {Project $ Y $ }\
\$ 500,000 \
\$ 250,000 \
0.8
\end{array}
\end{array}$
 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?

Accepted Answer

A) Project X has more corporate (or within-firm) risk than Project Y. 
B) Project X has more market risk than Project Y. 
C) Project X has the same level of corporate risk as Project Y. 
D) Project X has less market risk than Project Y. 
E) Project X has more stand-alone risk than Project Y. 
A) Project X has more corporate (or within-firm) risk than Project Y. 
B) Project X has more market risk than Project Y. 
C) Project X has the same level of corporate risk as Project Y. 
D) Project X has less market risk than Project Y. 
E) Project X has more stand-alone risk than Project Y.

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

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

Accepted Answer

A) Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
B) The value of a building owned by the firm that will be used for this project. 
C) A decline in the sales of an existing product, provided that decline is directly attributable to this project. 
D) The salvage value of assets used for the project that will be recovered at the end of the project's life. 
E) Changes in net working capital attributable to the project. 
A) Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. 
B) The value of a building owned by the firm that will be used for this project. 
C) A decline in the sales of an existing product, provided that decline is directly attributable to this project. 
D) The salvage value of assets used for the project that will be recovered at the end of the project's life. 
E) Changes in net working capital attributable to the project.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
B) Corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
C) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
D) Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project. 
E) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset. 
A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
B) Corporations must use the same depreciation method for both stockholder reporting and tax purposes. 
C) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. 
D) Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project. 
E) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.

Question 17

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.

Accepted Answer

A) True 
 B)False

Question 18

The two cardinal rules that financial analysts should follow to avoid capital budgeting errors are: (1)in the NPV equation,the numerator should use income calculated in accordance with generally accepted accounting principles,and (2)all incremental cash flows should be considered when making accept/reject decisions.

Accepted Answer

A) True 
 B)False

Question 19

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? $\begin{array}{c}
\begin{array}{lll}
\text {Sales revenues}\
\text {Depteciation}\
\text {Other operating costs}\
\text {Tax rate}
\end{array}
\begin{array}{r}
\$ 13,000 \
\$ 4,000 \
\$ 6,000 \
35.0 \%
\end{array}
\end{array}$

Accepted Answer

A) $5,950 
B) $6,099 
C) $6,251 
D) $6,407 
E) $6,568 
A) $5,950 
B) $6,099 
C) $6,251 
D) $6,407 
E) $6,568

Question 20

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.

Accepted Answer

A) True 
 B)False

Exam 13: Cash Flow Estimation and Risk Analysis

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?

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?

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.

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.

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?

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?

VR Corporation has the opportunity to invest in a new project,the details of which are shown below.What is the Year 1 cash flow for the project? Sales revenues, each year) \ 42,000 Depreciation \1 0,000 Other operating costs \ 17,000 Interest expense \4 ,000 Tax rate 35.0\%

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.

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.

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

Which of the following statements is CORRECT?

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.

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? Sales revenues Depteciation Other operating costs Tax rate \ 13,000 \ 4,000 \ 6,000 35.0\%

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.

An Overview of Financial Management and the Financial Environment

Risk and Return: Part I

Risk and Return: Part Ii

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Rules

Real Options

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings, investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: a Review

Pension Plan Management

Financial Management in Not-For-Profit Businesses

a Values of the Areas Under the Standard Normal

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