Deck 11: Cash Flow Estimation and Risk Analysis

Question 1

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.

Answer 1

True

Question 2

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.

Answer 2

False

Question 3

If a firm's projects differ in risk,then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

Answer 3

True

Question 4

Estimating project cash flows is generally the most important,but also the most difficult,step in the capital budgeting process.Methodology,such as the use of NPV versus IRR,is important,but less so than obtaining a reasonably accurate estimate of projects' cash flows.

Question 5

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.

Question 6

Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward,thus increasing their present value.On the other hand,using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses.However,the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

Question 7

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher,other things held constant.

Question 8

Any cash flows that can be classified as incremental to a particular project-i.e.,results directly from the decision to undertake the project-should be reflected in the capital budgeting analysis.

Question 9

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.

Question 10

Superior analytical techniques,such as NPV,used in combination with risk-adjusted cost of capital estimates,can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.

Question 11

The coefficient of variation,calculated as the standard deviation of expected returns divided by the expected return,is a standardized measure of the risk per unit of expected return.

Question 12

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation,other things being equal.

Question 13

Typically,a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used,other things held constant.

Question 14

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 included in a capital budgeting analysis.

Question 15

We can identify the cash costs and cash inflows to a company that will result from a project.These could be called "direct inflows and outflows," and the net difference is the direct net cash flow.If there are other costs and benefits that do not flow from or to the firm,but to other parties,these are called externalities,and they need not be considered as a part of the capital budgeting analysis.

Question 16

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

Question 17

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

Question 18

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

Question 19

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.

Question 20

If debt is to be used to finance a project,then when cash flows for a project are estimated,interest payments should be included in the analysis.

Question 21

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

A) Interest on funds borrowed to help finance the project.
B) The end-of-project recovery of any working capital required to operate the project.
C) Cannibalization effects, but only if those effects increase the project's projected cash flows.
D) Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.
E) All costs associated with the project that have been incurred prior to the time the analysis is being conducted.

Question 22

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.

Question 23

Which of the following statements is CORRECT?

A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
B) If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
C) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
D) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.
E) Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting.

Question 24

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

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 25

Which of the following procedures best accounts for the relative risk of a proposed project?

A) Adjusting the discount rate downward 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.
E) Adjusting the discount rate upward if the project is judged to have above-average risk.

Question 26

The CFO of Cicero Industries plans to calculate a new 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 flow),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?

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 investment in 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 27

Which of the following statements is CORRECT?

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 customers. Thus, cannibalization is dealt with by society through the antitrust laws.
B) 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.
C) 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.
D) 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.
E) 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.

Question 28

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.

Question 29

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.

Question 30

Which of the following statements is CORRECT?

A) 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.
B) 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.
C) Sunk costs were formerly hard to deal with but now that the NPV method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the PV of the project.
D) 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.
E) A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.

Question 31

Puckett Inc.risk-adjusts its WACC to account for project risk.It uses a WACC of 8% for below-average risk projects,10% for average-risk projects,and 12% for above-average risk projects.Which of the following independent projects should Puckett accept,assuming that the company uses the NPV method when choosing projects?

A) Project B, which has below-average risk and an IRR = 8.5%.
B) Project C, which has above-average risk and an IRR = 11%.
C) Without information about the projects' NPVs we cannot determine which project(s) should be accepted.
D) All of these projects should be accepted.
E) Project A, which has average risk and an IRR = 9%.

Question 32

Which of the following statements is CORRECT?

A) An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.
B) The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
C) Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
D) Identifying an externality can never lead to an increase in the calculated NPV.
E) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

Question 33

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.

Question 34

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.

Question 35

Which of the following statements is CORRECT?

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 36

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 is often used for such projects along with discounted cash flow analysis.

Question 37

Which of the following statements is CORRECT?

A) Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
B) A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices.
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 that cost 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.
E) An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.

Question 38

Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR)is affected by a small change in one of the input variables,say sales.Other things held constant,with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis,the steeper the graph of the relationship line,the more risky the project,other things held constant.

Question 39

Which of the following statements is CORRECT?

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 (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
C) Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
D) 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.
E) 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.

Question 40

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.

Question 41

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow?

A) $8,903
B) $9,179
C) $9,463
D) $9,746
E) $10,039

Question 42

Which of the following statements is CORRECT?

A) An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
B) The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
C) Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
D) Identifying an externality can never lead to an increase in the calculated NPV.
E) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

Question 43

Which of the following rules is CORRECT for capital budgeting analysis?

A) Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
B) Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision.
C) A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted.
D) If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis.
E) The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.

Question 44

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

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 45

Collins Inc.is investigating whether to develop a new product.In evaluating whether to go ahead with the project,which of the following items should NOT be explicitly considered when cash flows are estimated?

A) The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment.
B) The company has spent and expensed for tax purposes $3 million on research related to the new detergent. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future.
C) The new product will cut into sales of some of the firm's other products.
D) If the project is accepted, the company must invest $2 million in working capital. However, all of these funds will be recovered at the end of the project's life.
E) The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm's products.

Question 46

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?

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

Question 47

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

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 48

Laramie Labs uses a risk-adjustment when evaluating projects of different risk.Its overall (composite)WACC is 10%,which reflects the cost of capital for its average asset.Its assets vary widely in risk,and Laramie evaluates low-risk projects with a WACC of 8%,average-risk projects at 10%,and high-risk projects at 12%.The company is considering the following projects:
Which set of projects would maximize shareholder wealth?

A) A and B.
B) A, B, and C.
C) A, B, and D.
D) A, B, C, and D.
E) A, B, C, D, and E.

Question 49

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?

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 50

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

A) 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.
B) The company has spent and expensed $1 million on R&D associated with the new project.
C) The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
D) 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.
E) The new project is expected to reduce sales of one of the company's existing products by 5%.

Question 51

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:
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?

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 52

Which of the following statements is CORRECT?

A) In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV.
B) The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator.
C) Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values.
D) As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis.
E) Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Question 53

While developing a new product line,Cook 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.Cook owns the building free and clear-there is no mortgage on it.Which of the following statements is CORRECT?

A) 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.
B) 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.
C) 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.
D) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
E) 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.

Question 54

Which of the following statements is CORRECT?

A) 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.
B) Well-diversified stockholders do not need to consider market risk when determining required rates of return.
C) Market risk is important, but it does not have a direct effect on stock prices because it only affects beta.
D) Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.
E) Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.

Question 55

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?

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 56

Which of the following statements is CORRECT?

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 a downward 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 sold or leased to another firm if the new project were not undertaken, then the net after-tax proceeds 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.
E) 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.

Question 57

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,it would be reasonable for management to do which of the following?

A) Increase the estimated NPV 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 its higher-than-average risk.
E) Increase the estimated IRR of the project to reflect its greater risk.

Question 58

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

A) Differential project risk cannot be accounted for by using "risk-adjusted discount rates" because it is highly subjective and difficult to justify. It is better to not risk adjust at all.
B) Other things held constant, if returns on a project are thought to be positively correlated with the returns on other firms in the economy, then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated.
C) Monte Carlo simulation uses a computer to generate random sets of inputs, those inputs are then used to determine a trial NPV, and a number of trial NPVs are averaged to find the project's expected NPV. Sensitivity and scenario analyses, on the other hand, require much more information regarding the input variables, including probability distributions and correlations among those variables. This makes it easier to implement a simulation analysis than a scenario or a sensitivity analysis, hence simulation is the most frequently used procedure.
D) DCF techniques were originally developed to value passive investments (stocks and bonds). However, capital budgeting projects are not passive investments-managers can often take positive actions after the investment has been made that alter the cash flow stream. Opportunities for such actions are called real options. Real options are valuable, but this value is not captured by conventional NPV analysis. Therefore, a project's real options must be considered separately.
E) The firm's corporate, or overall, WACC is used to discount all project cash flows to find the projects' NPVs. Then, depending on how risky different projects are judged to be, the calculated NPVs are scaled up or down to adjust for differential risk.

Question 59

Which of the following statements is CORRECT?

A) Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
B) It is unrealistic to believe that any increases in net working capital required at the start of an expansion project can be recovered at the project's completion. Working capital like inventory is almost always used up in operations. Thus, cash flows associated with working capital should be included only at the start of a project's life.
C) If equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.
D) Changes in net working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities. Therefore, changes in net working capital should not be considered in a capital budgeting analysis.
E) If an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm, hence its terminal cash flow will be negative.

Question 60

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?

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 61

Shultz Business Systems is analyzing an average-risk project,and the following data have been developed.Unit sales will be constant,but the sales price should increase with inflation.Fixed costs will also be constant,but variable costs should rise with inflation.The project should last for 3 years,it will be depreciated on a straight-line basis,and there will be no salvage value.This is just one of many projects for the firm,so any losses can be used to offset gains on other firm projects.What is the project's expected NPV?

A) $15,925
B) $16,764
C) $17,646
D) $18,528
E) $19,455

Question 62

DeVault Services recently hired you as a consultant to help with its capital budgeting process.The company is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life,would be depreciated by the straight-line method over its 3-year life,and would have a zero salvage value.No new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV?

A) $15,740
B) $16,569
C) $17,441
D) $18,359
E) $19,325

Question 63

Garden-Grow Products is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life,would have a zero salvage value,and would require some additional working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3.)

A) $23,852
B) $25,045
C) $26,297
D) $27,612
E) $28,993

Question 64

Kasper Film Co.is selling off some old equipment it no longer needs because its associated project has come to an end.The equipment originally cost $22,500,of which 75% has been depreciated.The firm can sell the used equipment today for $6,000,and its tax rate is 40%.What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value,the firm will receive a tax credit as a result of the sale.

A) $5,558
B) $5,850
C) $6,143
D) $6,450
E) $6,772

Question 65

Whitestone Products is considering a new project whose data are shown below.The required equipment has a 3-year tax life,and the accelerated rates for such property are 33.33%,44.45%,14.81%,and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life.What is the project's Year 4 cash flow?

A) $11,904
B) $12,531
C) $13,190
D) $13,850
E) $14,542

Question 66

Brandt Enterprises is considering a new project that has a cost of $1,000,000,and the CFO set up the following simple decision tree to show its three most likely scenarios.The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so,but to obtain this abandonment option,it would have to make a payment to those parties.How much is the option to abandon worth to the firm?

A) $55.08
B) $57.98
C) $61.03
D) $64.08
E) $67.29

Question 67

Your new employer,Freeman Software,is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life,and the allowed depreciation rates for such property are 33.33%,44.45%,14.81%,and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected life.What is the Year 1 cash flow?

A) $30,333
B) $31,849
C) $33,442
D) $35,114
E) $36,869

Question 68

Fitzgerald Computers is considering a new project whose data are shown below.The required equipment has a 3-year tax life,after which it will be worthless,and it will be depreciated by the straight-line method over 3 years.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's Year 1 cash flow?

A) $28,115
B) $28,836
C) $29,575
D) $30,333
E) $31,092

Question 69

Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

A) 1.20
B) 1.26
C) 1.32
D) 1.39
E) 1.46

Question 70

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.)

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

Question 71

Weston Clothing Company is considering manufacturing a new style of shirt,whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value,and no new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However,this project would compete with other Weston's products and would reduce their pre-tax annual cash flows.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)

A) $3,636
B) $3,828
C) $4,019
D) $4,220
E) $4,431

Question 72

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

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

Question 73

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?

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

Question 74

Spot-Free 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 new 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 decline? (Hint: Note that cash flows are constant at the Year 1 level,whatever that level is.)

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

Question 75

Sylvester Media is analyzing an average-risk project,and the following data have been developed.Unit sales will be constant,but the sales price should increase with inflation.Fixed costs will also be constant,but variable costs should rise with inflation.The project should last for 3 years,it will be depreciated on a straight-line basis,and there will be no salvage value.This is just one of many projects for the firm,so any losses can be used to offset gains on other firm projects.The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate,but the CFO thinks an adjustment is required.What is the difference in the expected NPV if the inflation adjustment is made vs.if it is not made?

A) $13,286
B) $13,985
C) $14,721
D) $15,457
E) $16,230

Question 76

Sheridan Films is considering some new equipment whose data are shown below.The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years,but it would have a positive pre-tax salvage value at the end of Year 3,when the project would be closed down.Also,some new working capital would be required,but it would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV?

A) $20,762
B) $21,854
C) $23,005
D) $24,155
E) $25,363

Question 77

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?

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

Question 78

McPherson Company must purchase a new milling machine.The purchase price is $50,000,including installation.The machine has a tax life of 5 years,and it can be depreciated according to the following rates.The firm expects to operate the machine for 4 years and then to sell it for $12,500.If the marginal tax rate is 40%,what will the after-tax salvage value be when the machine is sold at the end of Year 4?

A) $8,878
B) $9,345
C) $9,837
D) $10,355
E) $10,900