Question 1

Which of the following statements is correct?

Accepted Answer

A)  Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. 
B)  One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities. 
C)  Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions. 
A)  Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. 
B)  One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities. 
C)  Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

Question 2

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, what would it be reasonable for management to do?

Accepted Answer

A)  increase the estimated IRR of the project to reflect its greater risk 
B)  reject the project, since its acceptance would increase the firm's risk 
C)  ignore the risk differential if the project would amount to only a small fraction of the firm's total assets 
D)  increase the cost of capital used to evaluate the project to reflect the project's higher-than-average risk 
A)  increase the estimated IRR of the project to reflect its greater risk 
B)  reject the project, since its acceptance would increase the firm's risk 
C)  ignore the risk differential if the project would amount to only a small fraction of the firm's total assets 
D)  increase the cost of capital used to evaluate the project to reflect the project's higher-than-average risk

Question 3

You work for the Sing Oil Company, which is considering a new project whose data are shown below. What is the project's net operating cash flow for Year 1? Sales revenues, each year$55,000
Capital cost allowance$8,000
Cash operating costs$25,000
Interest expense$8,000
Tax rate35.0%

Accepted Answer

A)  $21,185 
B)  $22,300 
C)  $24,586 
D)  $25,815 
A)  $21,185 
B)  $22,300 
C)  $24,586 
D)  $25,815

Question 4

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 instead of a discounted cash flow analysis is recommended for such projects.

Accepted Answer

A) True 
 B)False

Question 5

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not relevant in a capital budgeting analysis.

Accepted Answer

A) True 
 B)False

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear-there is no mortgage on it. Which of the following statements is correct?

Accepted Answer

A)  Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project. 
B)  If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C)  This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D)  Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. 
A)  Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project. 
B)  If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it. 
C)  This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. 
D)  Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.

Question 8

Party Place is considering a new investment whose data are shown below. The equipment that would be used would have a constant annual capital cost allowance over the project's 3-year life and a zero salvage value. This project would require some additional working capital that would be recovered at the end of the project's life. Revenues and cash operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3. CCA is modified to smooth out the calculations.) WACC10.0%
Net investment in fixed assets (basis)$65,000
Required new working capital$10,000
Annual capital cost allowance$21,665
Sales revenues, each year$70,000
Cash operating costs, each year$25,000
Tax rate35.0%

Accepted Answer

A)  $24,112 
B)  $25,318 
C)  $26,584 
D)  $27,913 
A)  $24,112 
B)  $25,318 
C)  $26,584 
D)  $27,913

Question 9

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 are 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)  The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
C)  If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the new project were not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration. 
D)  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 are 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)  The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality. 
C)  If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the new project were not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration. 
D)  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 10

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, it would in effect be "double-counted." 
B)  Since depreciation is a noncash 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 any opportunity costs and sunk costs, but the firm should ignore 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. 
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, it would in effect be "double-counted." 
B)  Since depreciation is a noncash 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 any opportunity costs and sunk costs, but the firm should ignore 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.

Question 11

In capital budgeting terminology, an "externality" is defined as something that is outside, or external to, a proposed new project. Therefore, externalities are not considered in project cash flow estimates.

Accepted Answer

A) True 
 B)False

Question 12

What is the best approach to take into account the relative risk of a proposed project?

Accepted Answer

A)  adjusting the discount rate upward if the project is judged to have above-average risk 
B)  reducing the NPV by 10% for risky projects 
C)  picking a risk factor equal to the average discount rate 
D)  ignoring risk because project risk cannot be measured accurately 
A)  adjusting the discount rate upward if the project is judged to have above-average risk 
B)  reducing the NPV by 10% for risky projects 
C)  picking a risk factor equal to the average discount rate 
D)  ignoring risk because project risk cannot be measured accurately

Question 13

Which statement best describes sensitivity analysis?

Accepted Answer

A)  Straightforward sensitivity analysis, as it is generally employed, is incomplete in that it fails to consider the range of likely values for the key input variables and the probabilities of different input values. 
B)  Sensitivity analysis is a statistically based behavioural approach to project analysis that applies predetermined probability distributions is the scenario approach. 
C)  Sensitivity analysis is a method for evaluating a project that uses a number of possible values for a given variable, such as cash inflows, to assess its impact on the firm's return is simulation analysis. 
D)  Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key variables and the likely range of variable values. 
A)  Straightforward sensitivity analysis, as it is generally employed, is incomplete in that it fails to consider the range of likely values for the key input variables and the probabilities of different input values. 
B)  Sensitivity analysis is a statistically based behavioural approach to project analysis that applies predetermined probability distributions is the scenario approach. 
C)  Sensitivity analysis is a method for evaluating a project that uses a number of possible values for a given variable, such as cash inflows, to assess its impact on the firm's return is simulation analysis. 
D)  Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key variables and the likely range of variable values.

Question 14

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 one of the company's average projects. 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 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. 
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 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.

Question 15

Which of the following statements best describes a situation involving sunk costs?

Accepted Answer

A)  An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. 
B)  Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. 
C)  A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed those funds for tax purposes, and now is deciding whether to go forward with the project. 
D)  If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would be. 
A)  An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. 
B)  Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. 
C)  A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed those funds for tax purposes, and now is deciding whether to go forward with the project. 
D)  If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would be.

Question 16

Fool Proof Software is considering a new project whose data are shown below. The equipment has an economic life of 3 years, and is in the CCA class 10 (30%). Revenues and cash operating costs are expected to be constant over the project's 3-year life. What is the net operating cash flow for Year 1? Equipment cost$65,000
Annual sales revenues$60,000
Annual cash operating costs$25,000
Tax rate35.0%

Accepted Answer

A)  $26,162.50 
B)  $28,770.00 
C)  $30,359.25 
D)  $25,275.50 
A)  $26,162.50 
B)  $28,770.00 
C)  $30,359.25 
D)  $25,275.50

Question 17

Which of the following does NOT have incremental cash flow effects and thus should NOT be considered in capital budgeting decisions?

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 of costs for shipping and installing the new machinery will be required. 
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 if the new project is 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. 
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 of costs for shipping and installing the new machinery will be required. 
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 if the new project is 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.

Question 18

The primary advantage of declining-balance depreciation over straight-line depreciation is that, while the total amount of depreciation and thus tax savings is unchanged, charges are taken sooner. This means that the firm gets the benefits of the tax savings sooner, which increases their present value.

Accepted Answer

A) True 
 B)False

Question 19

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets were not used for the project being evaluated.

Accepted Answer

A) True 
 B)False

Question 20

When determining the present value of the tax shield for assets being replaced rather than bought new, the calculation must reflect the cash flow difference (incremental cash flow) generated by the new and old assets.

Accepted Answer

A) True 
 B)False

Which of the following statements is correct?

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, what would it be reasonable for management to do?

You work for the Sing Oil Company, which is considering a new project whose data are shown below. What is the project's net operating cash flow for Year 1? Sales revenues, each year$55,000 Capital cost allowance$8,000 Cash operating costs$25,000 Interest expense$8,000 Tax rate35.0%

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 instead of a discounted cash flow analysis is recommended for such projects.

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not relevant in a capital budgeting analysis.

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

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?

In capital budgeting terminology, an "externality" is defined as something that is outside, or external to, a proposed new project. Therefore, externalities are not considered in project cash flow estimates.

What is the best approach to take into account the relative risk of a proposed project?

Which statement best describes sensitivity analysis?

Which of the following statements best describes a situation involving sunk costs?

Which of the following does NOT have incremental cash flow effects and thus should NOT be considered in capital budgeting decisions?

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets were not used for the project being evaluated.

When determining the present value of the tax shield for assets being replaced rather than bought new, the calculation must reflect the cash flow difference (incremental cash flow) generated by the new and old assets.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Financial Planning and Forecasting Financial Statements

Bonds, Bond Valuation, and Interest Rates

Risk, Return, and the Capital Asset Pricing Model

Stocks, Stock Valuation, and Stock Market Equilibrium

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Capital Structure Decisions

Distributions to Shareholders: Dividends and Repurchases

Initial Public Offerings, Investment Banking, and Financial Restructuring

Lease Financing

Capital Market Financing: Hybrid and Other Securities

Working Capital Management and Short-Term Financing

Current Asset Management

Financial Options and Applications in Corporate Finance

Decision Trees, Real Options, and Other Capital Budgeting Topics

Derivatives and Risk Management

International Financial Management

Corporate Valuation, Value-Based Management, and Corporate Governance

Mergers, Acquisitions, and Restructuring

Filters

Exam 11: Cash Flow Estimation and Risk Analysis

Which of the following statements is correct?

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, what would it be reasonable for management to do?

You work for the Sing Oil Company, which is considering a new project whose data are shown below. What is the project's net operating cash flow for Year 1? Sales revenues, each year$55,000 Capital cost allowance$8,000 Cash operating costs$25,000 Interest expense$8,000 Tax rate35.0%

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 instead of a discounted cash flow analysis is recommended for such projects.

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not relevant in a capital budgeting analysis.

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

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?

In capital budgeting terminology, an "externality" is defined as something that is outside, or external to, a proposed new project. Therefore, externalities are not considered in project cash flow estimates.

What is the best approach to take into account the relative risk of a proposed project?

Which statement best describes sensitivity analysis?

Which of the following statements best describes a situation involving sunk costs?

Which of the following does NOT have incremental cash flow effects and thus should NOT be considered in capital budgeting decisions?

Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets were not used for the project being evaluated.

When determining the present value of the tax shield for assets being replaced rather than bought new, the calculation must reflect the cash flow difference (incremental cash flow) generated by the new and old assets.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Financial Planning and Forecasting Financial Statements

Bonds, Bond Valuation, and Interest Rates

Risk, Return, and the Capital Asset Pricing Model

Stocks, Stock Valuation, and Stock Market Equilibrium

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Capital Structure Decisions

Distributions to Shareholders: Dividends and Repurchases

Initial Public Offerings, Investment Banking, and Financial Restructuring

Lease Financing

Capital Market Financing: Hybrid and Other Securities

Working Capital Management and Short-Term Financing

Current Asset Management

Financial Options and Applications in Corporate Finance

Decision Trees, Real Options, and Other Capital Budgeting Topics

Derivatives and Risk Management

International Financial Management

Corporate Valuation, Value-Based Management, and Corporate Governance

Mergers, Acquisitions, and Restructuring

Filters