Deck 9: Fundamentals of Capital Budgeting

Question 1

Joe preorders a nonrefundable movie ticket. He then reads a number of reviews of the movie in question that make him realise that he will not enjoy it. He goes to see it anyway, rationalising that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why?

A) No, because he incurred no further costs by going to see the movie.
B) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
C) No, because going to see the movie means that the product of his initial investment was realised as originally planned.
D) No, because the cost of the movie was not recoverable and would have been lost whatever action he took.

Answer 1

Yes, since he invested a valuable asset, his time, in a project based on its previous costs.

Question 2

A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,000,000. This in turn would cause inventory to increase by $150,000, accounts receivable to increase by $100,000, and accounts payable to increase by $75,000. What is the firm's expected change in net working capital?

A) $325,000
B) $250,000
C) $175,000
D) $1,175,000

Answer 2

$175,000

Question 3

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense?

A) the delivery and install cost only
B) the delivery and install cost and the cost of the depositor
C) the cost of the clean room only
D) the cost of the depositor only

Answer 3

the cost of the clean room only

Question 4

You are considering adding a microbrewery onto one of your firm's existing restaurants.

A) $5200
B) $2400
C) $26,000
D) $14,000

Question 5

The EBIT break-even point can be calculated using which of the following formulas?

A) (Units Sold × Sale Price) + (Units Sold × Cost per unit) + SG&A - Depreciation = 0
B) (Units Sold × Sale Price) - (Units Sold × Cost per unit) + SG&A + Depreciation = 0
C) (Units Sold × Sale Price) + (Units Sold × Cost per unit) - SG&A - Depreciation = 0
D) (Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0

Question 6

A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. How should the $20 million best be considered?

A) as a sunk cost
B) as a fixed overhead expense
C) as an opportunity cost
D) as a capital cost

Question 7

A company planning to market a new model of motor scooter analyses the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2480. What does this mean?

A) The predicted selling price of the motor scooter is $2480.
B) The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2480.
C) If the motor scooter is sold for $2480, then the project will make a profit.
D) If the motor scooter is sold for $2480, then the net present value (NPV) for the product will be zero.

Question 8

Which of the following would you NOT consider when making a capital budgeting decision?

A) the change in direct labour expense due to the purchase of a new machine
B) the cost of a marketing study completed last year
C) the opportunity to lease out a warehouse instead of using it to house a new production line
D) the additional taxes a firm would have to pay in the next year

Question 9

Luther Industries has outstanding tax loss carryforwards of $70 million from losses over the past four years. If Luther earns $15 million per year in pretax income from now on, in how many years will Luther first pay taxes?

A) 2 years
B) 7 years
C) 4 years
D) 5 years

Question 10

Which of the following statements is FALSE?

A) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pretax income.
B) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
C) We begin the capital budgeting process by determining the incremental earnings of a project.
D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.

Question 11

An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called

A) sensitivity analysis.
B) internal rate of return (IRR) analysis.
C) accounting break-even analysis.
D) scenario analysis.

Question 12

A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative (SG&A) expenses are $500,000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision?

A) Yes, since if the estimates for each parameter are correct, the EBIT will be positive.
B) Yes, since a positive EBIT ensures that the project will have a positive net present value (NPV).
C) No, since the cost per unit should be greater than the EBIT break-even point for cost of goods if the project is to have a positive EBIT.
D) It cannot be determined whether the decision was correct, since other factors contributing to the project's net present value (NPV), such as the upfront investment, have not been included in the analysis.

Question 13

An oil company is buying a semi-submersible oil rig for $20 million. Additionally, it will cost $1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the yearly depreciation expenses in this case?

A) $4.3 million
B) $5.0 million
C) $4.0 million
D) $3.8 million

Question 14

Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three
years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a
residual value of $0.
The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year for
each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The
canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net
working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its
annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The
firm is in the 30% tax bracket and has a cost of capital of 10%.
The change in net working capital from year 1 to year 2 is closest to:

A) an increase of $360
B) a decrease of $360
C) an increase of $396
D) a decrease of $396

Question 15

Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:
$\begin{array}{lrrr}\hline\text { Year }&0&1&2&3\\\hline \text { Sales (Revenues) } && 100,000 & 100,000 & 100,000 \\\hline \text { - Cost of Goods Sold (50\% of Sales) } && 50,000 & 50,000 & 50,000 \\\hline \text { - Depreciation } && 30,000 & 30,000 & 30,000 \\\hline \text { = EBIT } && 20,000 & 20,000 & 20,000 \\\hline \text { - Taxes }(30 \%) && 6000 & 6000 & 6000 \\\hline \text { = unlevered net income } && 14,000 & 14,000 & 14,000 \\\hline \text { + Depreciation } && 30,000 & 30,000 & 30,000 \\\hline+ \text { changes to working capital } && -5000 & -5000 & 10,000 \\\hline \text { - capital expenditures } & -90,000\\\hline\end{array}$

-The free cash flow for the last year of Epiphany's project is closest to:

A) $54,000
B) $35,000
C) $43,000
D) $39,000

Question 16

Which of the following will increase the EBIT break-even for sales?

A) a decrease in the number of units sold
B) a decrease in depreciation expense
C) a decrease in the sales price
D) a decrease in selling, general, and administrative expenses

Question 17

$\begin{array}{lrrr}&\text { Year 0 } &\text { Year 1 } & \text { Year 2 } & \text { Year 3 } \\\text { Revenues } && 800,000 & 800,000 & 800,000 \\\text { Costs of Coods Sold } && -320,000 & -320,000 & -320,000\\\hline\text { Gross Profit } && 480,000 & 480,000 & 480,000 \\\text { Selling. General and Admin } & &-105,000 & -105,000 & -105,000 \\\text { Depreciation } && -200,000 & -200,000 & -200,000\\\hline\text { EBIT } && 175,000 & 175,000 & 175,000 \\\text { Income tax }(30 \%) && -52,500 & -52,500 & -52,500\\\hline\text { Incremental Earnings } && 122,500 & 122,500 & 122,500\\\\\text { Capital Purchases } &-600,000\\\text { Changes to NWC }&&-12,000 &-12,000 &-12,000\\\end{array}$ Cromwell Industries is considering a new project which will have costs, revenues, etc. as shown by the data above. If the cost of capital is 8.5%, what is the net present value (NPV) of this project?

A) -$278,832
B) -$153,046
C) $300,691
D) $254,320

Question 18

The difference between scenario analysis and sensitivity analysis is

A) only sensitivity analysis allows us to change our estimated inputs of our net present value (NPV) analysis.
B) scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters.
C) only scenario analysis breaks the net present value (NPV) calculation into its component assumptions.
D) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is based upon net present value (NPV).

Question 19

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's marginal corporate tax rate is 30%, what is the value of the depreciation tax shield on the company's new project?

A) $1,750,000
B) $1,500,000
C) $1,000,000
D) $750,000

Question 20

$\begin{array}{lrrrr}&\text { Year 0 } &\text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } \\\text { Revenues }&&120,000 & 400,000 & 400,000 & 300,000\\\text { Costs of Goods Sold } && -60,000 & -200,000 & -200,000 & -150,000\\\\text { Gross Profit } && 60,000 & 200,000 & 200,000 & 150,000 \\\text { Selling, General and Admin } && -6,000 & -6,000 & -6,000 & -6,000 \\\text { Depreciation } && -70,000 & -70,000 & -70,000 & -70,000\\\hline \text { EBIT } && -16,000 & 124,000 & 124,000 & 74,000 \\\text { Income } \operatorname{tax}(30 \%) & &4,800 & -37,200 & -37,200 & -22,200 \\\hline \text { Incremental Earnings } && -11,200 & 86,800 & 86,800 & 51,800\\\\\text { Capital Purchases } &-280,000\\\text { Changes to NWC }&&-5,000 &-5,000 &-5,000 &-5,000\\\end{array}$ A garage is installing a new "bubble-wash" car wash. It will promote the car wash as a fun activity for the family, and it is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 10%, what is the net present value (NPV) of this project?

A) $119,888
B) $76,607
C) -$214,525
D) -$145,283

Question 21

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case?

A) $1,501,667
B) $1,000,000
C) $1,001,667
D) $1,500,000

Question 22

After research into where to place a new restaurant, Burger Billies, a small fast-food chain, plans to open a new store near a TAFE. The anticipated customer base is students attending the TAFE. They learn that a major fast-food chain will be opening a franchise within the TAFE, which leads the owners of Burger Billies to revise their estimate of sales to one below the break-even point. Which of the following is most likely the best real option for Burger Billies to take with regard to the proposed restaurant site?

A) option to delay
B) option to expand
C) option to abandon
D) option to switch

Question 23

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colours. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?

A) option to delay
B) option to expand
C) option to abandon
D) option to switch

Question 24

Bubba Ho-Tep Ltd reported net income of $300 million for the most recent fiscal year. The firm had depreciation expenses of $125 million and capital expenditures of $150 million. Although it had no interest expense, the firm did have an increase in net working capital of $20 million. What is Bubba Ho-Tep's free cash flow?

A) $5 million
B) $170 million
C) $255 million
D) $150 million

Question 25

Use the table for the question(s) below
$\begin{array} { l c c } & \text { Year 0 } & \text { Years 1 to } 10 \\\text { Revenues } & & 3.50 \\\text {-Manufacturing Expenses } && - 0.5 \\\text {-Marketing Expenses } && - 0.25 \\\text {-Depreciation } && - 0.8 \\\hline \text { =EBIT } && 1.95 \\\text { - Taxes (40\%) } && - 0.78 \\\hline \text { =Unlevered net income } && 1.17 \\\text { +Depreciation } && + 0.8 \\\text { - Additions to Net Working Capital } && - 0.2 \\\text { - Capital Expenditures } & - 8.00 & \\\hline \text { =Free Cash Flow } & & 1.77\end{array}$

-Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision. There are concerns of the sensitivity of this project to changes in the cost of capital. For what cost of capital does this project break even?

A) 14%
B) 18%
C) 16%
D) 12%

Question 26

Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars). It is thought that if marketing expenses are increased by 40%, then revenues will rise. By how much will revenues have to rise for the net present value (NPV) of the project to increase?

A) at least 3.8%
B) at least 3.2%
C) at least 2.9%
D) at least 2.0%

Question 27

Which of the following statements is FALSE?

A) When evaluating a capital budgeting project, financial managers should make the decision that maximises net present value (NPV).
B) Sensitivity analysis reveals which aspects of the project are most critical when we are actually managing the project.
C) The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital.
D) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero.

Question 28

How does the capital budgeting process begin?

A) by forecasting the future consequences for the firm of each potential project
B) by evaluating the net present value (NPV) of each project's cash flows
C) by analysing alternate projects
D) by compiling a list of potential projects

Question 29

Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:
$\begin{array}{lrrr}\hline\text { Year }&0&1&2&3\\\hline \text { Sales (Revenues) } && 100,000 & 100,000 & 100,000 \\\hline \text { - Cost of Goods Sold (50\% of Sales) } && 50,000 & 50,000 & 50,000 \\\hline \text { - Depreciation } && 30,000 & 30,000 & 30,000 \\\hline \text { = EBIT } && 20,000 & 20,000 & 20,000 \\\hline \text { - Taxes }(30 \%) && 6000 & 6000 & 6000 \\\hline \text { = unlevered net income } && 14,000 & 14,000 & 14,000 \\\hline \text { + Depreciation } && 30,000 & 30,000 & 30,000 \\\hline+ \text { changes to working capital } && -5000 & -5000 & 10,000 \\\hline \text { - capital expenditures } & -90,000\\\hline\end{array}$

-The net present value (NPV) for Epiphany's Project is closest to:

A) $14,348
B) $4825
C) $29,400
D) $39,000

Question 30

The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project's net present value (NPV). Which of the following best describes what type of analysis the manager is performing?

A) EBIT break-even analysis
B) sensitivity analysis
C) scenario analysis
D) break-even analysis

Question 31

Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows for the first two years (in millions).
$\begin{array} { l c c } \hline \text { Year } & \mathbf { 1 } & \mathbf { 2 } \\\hline \text { Revenues } & 1200 & 1400 \\\hline \text { Operating expense } & 450 & 525 \\\hline \text { Depreciation } & 240 & 280 \\\hline \text { Increase in working capital } & 60 & 70 \\\hline \text { Capital expenditures } & 300 & 350 \\\hline \text { Marginal corporate tax rate } & 30 \% & 30 \% \\\hline\end{array}$

-The depreciation tax shield for Shepard Industries project in year 2 is closest to:

A) $96
B) $84
C) $196
D) $72

Question 32

Which of the following statements is FALSE?

A) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.
B) Many projects use a resource that the company already owns.
C) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
D) When evaluating a capital budgeting decision, we generally include interest expense.

Question 33

An insurance office owns a large building. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?

A) the cost of refurbishing the new space to be occupied by the Human Resources Department
B) the cost of the research into the feasibility of renting the sixth floor
C) the amount obtained by renting the sixth floor
D) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces

Question 34

Which of the following is NOT a factor that a manager should bear in mind when estimating a project's revenues and costs?

A) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline.
B) Sales of a product will typically accelerate, stabilise, and then decline as the product becomes outdated or faces increased competition.
C) Prices and costs tend to rise with the general level of inflation in the economy.
D) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product.

Question 35

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product?

A) The sales of a new product will typically accelerate, plateau, and ultimately decline over time.
B) Competition tends to reduce profit margins over time in most industries.
C) The cost of capital tends to fluctuate over the period in question.
D) The prices of technology products generally fall over time.

Question 36

A brewer is launching a new product-brewed ginger beer with a low alcohol content. The brewer plans to spend $4 million promoting this product this year, which is expected to expand its sales of this product to $10 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year and next year in their other products as customers switch to drinking the new ginger beer. The gross profit margin for the new ginger beer is 40%, the gross profit margin of all of the brewer's other products is 30%, and the brewer's marginal corporate tax rate is 30%. What are incremental earnings arising from the promotional campaign this year?

A) $5.28 million
B) $3.29 million
C) $4.68 million
D) $2.10 million

Question 37

Which of the following formulas will correctly calculate Net Working Capital?

A) Cash - Inventory + Receivables + Payables
B) Cash + Inventory - Receivables + Payables
C) Cash + Inventory + Receivables + Payables
D) Cash + Inventory + Receivables - Payables

Question 38

A decrease in the sales of a current project because of the launching of a new project is

A) a sunk cost.
B) cannibalisation.
C) an overhead expense.
D) irrelevant to the investment decision.

Question 39

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 2?

A) $1,001,667
B) $3,247,834
C) $2,400,500
D) $1,298,917

Question 40

Use the figure for the question(s) below.

A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. Which parameter should be scrutinised most carefully in the estimation process?

A) units sold
B) sales price
C) cost of capital
D) cost of goods

Question 41

CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental free cash flows in the second year of this project?

A) $2.415 million
B) $2.500 million
C) $2.015 million
D) $1.870 million

Question 42

A firm is considering a new project that will generate cash revenue of $1,000,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $200,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 30%?

A) $245,000
B) $195,000
C) $162,500
D) $225,000

Question 43

Which of the following statements is FALSE?

A) To compute the net present value (NPV) for a project, you need to estimate the incremental cash flows and choose a discount rate.
B) Estimates of the cash flows and cost of capital are often subject to significant uncertainty.
C) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our net present value (NPV) analysis for the project.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.

Question 44

A firm reports that in a certain year it had a net income of $4.5 million, depreciation expenses of $2.8 million, capital expenditures of $2.3 million, and Net Working Capital decreased by $1.5 million. What is the firm's free cash flow for that year?

A) $2.4 million
B) $6.5 million
C) $11.1 million
D) $8.1 million

Question 45

Use the figure for the question(s) below.

A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. If the best-case assumptions for Net Working Capital are met, what will the net present value (NPV) of this project be?

A) $2 million
B) $3 million
C) $0.65 million
D) $1.7 million

Question 46

A small manufacturer that makes clothes-pegs and other household products buys new injection moulding equipment for a cost of $500,000. This will allow the manufacturer to make more pegs in the same amount of time with an estimated increase in sales of 15%. If the manufacturer currently makes 75 tonnes of pegs per year, which sell at $18,000 per tonne, what will be the increase in revenue next year from the new equipment?

A) $80,500
B) $20,700
C) $857,000
D) $202,500

Question 47

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

A) adding depreciation
B) subtracting increases in Net Working Capital
C) subtracting all noncash expenses
D) subtracting depreciation expenses from taxable earnings

Question 48

CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the lollies will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new product line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental earnings in the second year of this project?

A) $2.11 million
B) $1.75 million
C) $1.47 million
D) $1.54 million

Question 49

A stationery company plans to launch a new type of permanent marker. Advertising for the new product will be heavy and will cost the company $10 million, although the company expects general revenues of $280 million next year from sources other than sales of the new pen. If the company has a corporate tax rate of 30% on its pretax income, what effect will the advertising for the new pen have on its taxes?

A) increase taxes by $3 million
B) no effect on taxes
C) reduce taxes by $3 million
D) increase taxes by $10 million

Question 50

Which of the following is an example of cannibalisation?

A) A football manufacturer adds football boots to its product line.
B) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
C) A newsagent begins selling prepaid mobile phones.
D) A grocery store begins selling T-shirts featuring the local university's logo.

Question 51

Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:
$\begin{array}{lrrr}\hline\text { Year }&0&1&2&3\\\hline \text { Sales (Revenues) } && 100,000 & 100,000 & 100,000 \\\hline \text { - Cost of Goods Sold (50\% of Sales) } && 50,000 & 50,000 & 50,000 \\\hline \text { - Depreciation } && 30,000 & 30,000 & 30,000 \\\hline \text { = EBIT } && 20,000 & 20,000 & 20,000 \\\hline \text { - Taxes }(30 \%) && 6000 & 6000 & 6000 \\\hline \text { = unlevered net income } && 14,000 & 14,000 & 14,000 \\\hline \text { + Depreciation } && 30,000 & 30,000 & 30,000 \\\hline+ \text { changes to working capital } && -5000 & -5000 & 10,000 \\\hline \text { - capital expenditures } & -90,000\\\hline\end{array}$

-The free cash flow for the first year of Epiphany's project is closest to?

A) $39,000
B) $25,000
C) $43,000
D) $45,000

Question 52

An exploration of the effect of changing multiple project parameters on net present value (NPV) is called

A) sensitivity analysis.
B) scenario analysis.
C) internal rate of return (IRR) analysis.
D) accounting break-even analysis.

Question 53

Which of the following costs would you consider when making a capital budgeting decision?

A) sunk cost
B) interest expense
C) fixed overhead cost
D) opportunity cost

Question 54

Which of the following best explains why it is sensible for a firm to use an accelerated depreciation schedule rather than straight-line depreciation?

A) The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).
B) The firm can decide over how many years an item may be depreciated, thus allowing it full control of its depreciation expenses.
C) The firm will have substantially fewer depreciation expenses later in the depreciation timeline.
D) The firm will substantially decrease its depreciation tax shield across all of the depreciation timeline.

Question 55

Use the table for the question(s) below
$\text { Balance Sheet }$
\begin{array} { l } \text {Assets }& \text {Liabilities }\\\begin{array} { l } \text { Current Assets}\\\hline \text { Cash } & 50 \\\text { Accounts receivable } & 22 \\\text { Inventories } & 17 \\\text { Total current assets } & 89\end{array}&\begin{array}{l}\text { Current Liabilities }\\\hline \text { Accounts payable } & 42 \\\text { Total current liabilities } & 42\\\\\\\end{array}\\\\\text { Long-Term Assets }&\text { Long-Term Liabilities }\\\begin{array}{lc}\hline\text { Net property, plant, }\\\text { and equipment } & 121 \\\text { Total long-term assets } & 121 \\\\\text { Total Assets } & 210\\\\\\\end{array}&\begin{array}{ll}\hline\text { Long-term debt } & 128 \\\text { Total long-term liabilities } & 128\\\\\text { Total Liabilities } & 170 \\\text { Shareholders' Equity } & 40 \\\text { Total Liabilities and } & 210 \\\text { Shareholders' Equity } &\\end{array}\end{array}


-The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is this firm's Net Working Capital?

A) $89,000
B) $30,000
C) $40,000
D) $47,000

Question 56

Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%
The required net working capital in the first year for the Sisyphean Corporation's project is closest
to:

A) $3600
B) $5400
C) $3960
D) $2880

Question 57

Which of the following best defines incremental earnings?

A) the earnings arising from all projects that a company plans to undertake in a fixed timespan
B) the amount by which a firm's earnings are expected to change as the result of an investment decision
C) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision
D) cash flows arising from a particular investment decision

Question 58

Which of the following statements regarding real options is NOT correct?

A) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.
B) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date.
C) Real options build greater flexibility into a project and thus increase its net present value (NPV).
D) Real options should only be exercised when they increase the NPV of a project.

Question 59

The depreciation tax shield for Shepard Industries project in year 1 is closest to?

A) $84
B) $96
C) $72
D) $168

Question 60

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 1?

A) $1,001,667
B) -$6,000,000
C) -$6,010,000
D) -$3,709,417

Question 61

Why does the option to abandon a project have value?

Question 62

Capital budgeting decisions use the Net Present Value rule so that those decisions maximise net present value (NPV).

Question 63

A real option is the obligation to take a particular business action?

Question 64

The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

Question 65

Use the figure for the question(s) below.

The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true?

A) The net present value (NPV) of the project increases with increased cost of goods sold.
B) The net present value (NPV) of the project will be positive if the cost of good sold is greater than $110.
C) If the good costs $110 to make, the net present value (NPV) of the project will be zero.
D) The project should not be undertaken if the predicted cost of goods sold is less than $110.

Question 66

What are sunk costs?

Question 67

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings.

Question 68

What is the correct tax rate that should be used for capital budgeting decisions?

Question 69

Firms should use the most accelerated depreciation scheme allowable?

Question 70

What is break-even analysis?

Question 71

When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process.

Question 72

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?

A) These earnings are not actual cash flows.
B) They are not easily predicted from historical financial statements of a firm and its competitors.
C) They do not show how the firm's earnings are expected to change as the result of a particular decision.
D) They do not tell how the decision affects the firm's reported profits from an accounting perspective.

Question 73

The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital.

Question 74

How do we handle interest expense when making a capital budgeting decision?

Question 75

An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of the diminishing value method of depreciation.

Question 76

What is the most important function of sensitivity analysis?

Question 77

Interest and other financing-related expenses are excluded when determining a project's unlevered net income.

Question 78

A capital budget lists the potential projects a company may undertake in future years?

Question 79

What are the most difficult parts of capital budgeting?

Question 80

What is the major difference between scenario analysis and sensitivity analysis?