Question 1

Which of the following statements is CORRECT?

Accepted Answer

A) A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. 
B) A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. 
C) A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. 
D) Sunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV. 
E) A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores. 
A) A sunk cost is any cost that must be expended in order to complete a project and bring it into operation. 
B) A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. 
C) A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. 
D) Sunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV. 
E) A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.

Question 2

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 firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. 
B) 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. 
C) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D) A firm has spent $2 million on research and development 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. 
E) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products. 
A) 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. 
B) 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. 
C) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. 
D) A firm has spent $2 million on research and development 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. 
E) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A) Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C) Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes. 
D) Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions. 
E) Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV. 
A) Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV. 
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. 
C) Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes. 
D) Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions. 
E) Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.

Question 4

A company is considering a proposed new plant that would increase productive capacity.Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
C) 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. 
D) Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. 
E) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward. 
A) 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. 
B) Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows. 
C) 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. 
D) Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. 
E) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward.

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. Thus, cannibalization is dealt with by society through the antitrust laws. 
B) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. Thus, cannibalization is dealt with by society through the antitrust laws. 
C) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward. 
D) If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized. 
E) Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself. 
A) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. Thus, cannibalization is dealt with by society through the antitrust laws. 
B) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. Thus, cannibalization is dealt with by society through the antitrust laws. 
C) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward. 
D) If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized. 
E) Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.

Question 6

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

Accepted Answer

A) The new project is expected to reduce sales of one of the company's existing products by 5%. 
B) Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. 
C) The company has spent and expensed $1 million on research and development costs associated with the new project. 
D) The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. 
E) The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year. 
A) The new project is expected to reduce sales of one of the company's existing products by 5%. 
B) Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. 
C) The company has spent and expensed $1 million on research and development costs associated with the new project. 
D) The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. 
E) The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.

Question 7

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.

Accepted Answer

A) True 
 B)False

Question 8

Florida 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 change in net operating 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 change? (Hint: Note that cash flows are constant at the Year 1 level,whatever that level is.)

Accepted Answer

A) −$28,939 
B) −$30,462 
C) −$32,066 
D) −$33,753 
E) −$35,530 
A) −$28,939 
B) −$30,462 
C) −$32,066 
D) −$33,753 
E) −$35,530

Question 9

Sub-Prime Loan Company is thinking of opening a new office,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 office.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 change in net operating 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.)

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 10

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.

Accepted Answer

A) True 
 B)False

Question 11

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

Question 12

You work for Whittenerg Inc.,which is considering a new project whose data are shown below.What is the project's Year 1 cash flow?

Accepted Answer

A) $25,816 
B) $27,175 
C) $28,534 
D) $29,960 
E) $31,458 
A) $25,816 
B) $27,175 
C) $28,534 
D) $29,960 
E) $31,458

Question 13

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

Accepted Answer

A) True 
 B)False

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Other things held constant,which of the following would increase the NPV of a project being considered?

Accepted Answer

A) A shift from straight-line to MACRS depreciation. 
B) Making the initial investment in the first year rather than spreading it over the first three years. 
C) An increase in the discount rate associated with the project. 
D) An increase in required net operating working capital. 
E) The project would decrease sales of another product line. 
A) A shift from straight-line to MACRS depreciation. 
B) Making the initial investment in the first year rather than spreading it over the first three years. 
C) An increase in the discount rate associated with the project. 
D) An increase in required net operating working capital. 
E) The project would decrease sales of another product line.

Question 16

Because of improvements in forecasting techniques,estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV. 
B) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV. 
C) The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
D) If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. 
E) If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored. 
A) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV. 
B) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV. 
C) The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
D) If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. 
E) If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.

Question 18

A company is considering a new project.The CFO plans to calculate the 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 flows),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?

Accepted Answer

A) All sunk costs that have been incurred relating to the project. 
B) All interest expenses on debt used to help finance the project. 
C) The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. 
D) Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. 
E) Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows. 
A) All sunk costs that have been incurred relating to the project. 
B) All interest expenses on debt used to help finance the project. 
C) The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. 
D) Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year. 
E) Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.

Question 19

As assistant to the CFO of Boulder Inc.,you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

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

Currently,Powell Products has a beta of 1.0,and its sales and profits are positively correlated with the overall economy.The company estimates that a 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 have more stand-alone risk than the firm's typical project. 
B) The proposed new project would increase the firm's corporate risk. 
C) The proposed new project would increase the firm's market risk. 
D) The proposed new project would not affect the firm's risk at all. 
E) The proposed new project would have less stand-alone risk than the firm's typical project. 
A) The proposed new project would have more stand-alone risk than the firm's typical project. 
B) The proposed new project would increase the firm's corporate risk. 
C) The proposed new project would increase the firm's market risk. 
D) The proposed new project would not affect the firm's risk at all. 
E) The proposed new project would have less stand-alone risk than the firm's typical project.

Exam 12: Cash Flow Estimation and Risk Analysis

Which of the following statements is CORRECT?

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 of the following statements is CORRECT?

A company is considering a proposed new plant that would increase productive capacity.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

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.

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

You work for Whittenerg Inc.,which is considering a new project whose data are shown below.What is the project's Year 1 cash flow?

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

Other things held constant,which of the following would increase the NPV of a project being considered?

Because of improvements in forecasting techniques,estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

Which of the following statements is CORRECT?

As assistant to the CFO of Boulder Inc.,you must estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, leasing, warrants, and Convertibles

Mergers and Acquisitions

Continuous Compounding and Discounting

Zero Coupon Bonds

Bankruptcy and Reorganization

Calculating Beta Coefficients

Using the Capm to Estimate the Risk-Adjusted Cost of Capital

Techniques for Measuring Beta Risk

Degree of Leverage

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