Deck 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions

Question 1

When is it appropriate to include sunk costs in the evaluation of a project?

A)Include sunk costs when they are relatively large
B)Include sunk costs if it improves the project's NPV
C)Include sunk costs if they are considered to be overhead costs
D)It is never appropriate to include sunk costs

Answer 1

It is never appropriate to include sunk costs

Question 2

Allocations of overhead should not affect a project's incremental cash flows unless the:

A)Project actually increased overhead expenses
B)Overhead cannot be recovered at the end of the project
C)Overhead cannot be allocated to other projects
D)Accountant is required to allocate costs to this project

Answer 2

Project actually increased overhead expenses

Question 3

Which of the following is least likely to influence the opportunity cost of an asset?

A)Its current market value
B)Alternative uses for the asset
C)The current demand for the asset
D)Its current book value

Answer 3

Its current book value

Question 4

If a project is expected to increase inventory by $15,000, increase accounts payable by $10,000, and decrease accounts receivable by $1,000, what effect does working capital have during the life of the project?

A)Increases investment by $4,000
B)Increases investment by $5,000
C)Increases investment by $6,000
D)Working capital has no effect during the life of the project

Question 5

The rationale for not including sunk costs in capital budgeting decisions is that they:

A)Are usually small in magnitude
B)Revert at the end of the investment
C)Have no incremental effect
D)Reduce the estimated NPV

Question 6

Working capital will affect incremental cash flows if:

A)Current liabilities change more than current assets
B)Current assets change more than current liabilities
C)Inventory changes from previous levels
D)Net working capital changes from previous levels

Question 7

If the adoption of a new product will reduce the sales of an existing product, then the:

A)New product should not be undertaken
B)Old product should be abandoned
C)Incremental benefits of the new product may be overestimated
D)Incremental benefits of the new product may be underestimated

Question 8

Corporate income statements are designed primarily to show:

A)cash flows during a period
B)Account balances at the end of a period
C)Performance during a period
D)Market values of assets and liabilities

Question 9

If a project's cash flows include those triggered outside the project's incremental cash flows, it is likely that the:

A)Project interacts with other aspects of the firm
B)Project must have high depreciation expense
C)Opportunity cost of capital must be high
D)Project will have a negative NPV

Question 10

Changes in net working capital can occur at:

A)The beginning of a project
B)The end of a project
C)Any time during the life of a project
D)The beginning of any accounting period

Question 11

The opportunity cost of an asset:

A)Should be depreciated annually
B)Can differ depending on market conditions
C)Is typically ignored in capital budgeting
D)is important only for parcels of land

Question 12

What is the net effect on a firm's working capital if a new project requires: $30,000 increase in inventory, $10,000 increase in accounts receivable, $25,000 increase in machinery, and a $20,000 increase in accounts payable?

A)- $5,000
B)+ $10,000
C)+ $20,000
D)+ $45,000 change in net working capital =

Question 13

Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and is currently worth $25,000.Ignoring taxes, the correct opportunity cost for this machine in capital budgeting decisions is:

A)$75,000
B)$25,000
C)$20,000
D)$5,000

Question 14

A cost should be considered sunk when it:

A)Is fully depreciated
B)Produces no additional sales revenues
C)Has no effect on future flows
D)Is replaced by costs that are not yet sunk

Question 15

Which of the following changes in working capital is least likely, given an increase in the overall level of sales?

A)An increase in inventories
B)An increase in accounts payable
C)A decrease in accounts receivable
D)A decrease in accruals

Question 16

What effect is expected at the end of the life of a project that initially required a $20,000 increase in net working capital?

A)The $20,000 must now be paid by the firm
B)The firm receives a $20,000 cash inflow
C)Taxable income is reduced by $20,000
D)No effects are expected from sunk costs

Question 17

In capital budgeting analysis, an increase in working capital can be shown as:

A)A cash inflow at the beginning of the project
B)An outflow at the beginning and an equal inflow at the end of the project
C)An inflow at the beginning and an equal outflow at the end of the project
D)A decrease in the initial amount invested

Question 18

Which of the following represents a common reason for increases in net working capital with new projects?

A)Inventory can now be held at lower levels
B)Accounts receivable are often not paid on time
C)Inventory increases more than accounts payable increase
D)Accounts payable must be increased

Question 19

Projects that are calculated as having negative NPVs should be:

A)Depreciated over a longer time period
B)Charged less in overhead costs
C)Discounted using lower rates
D)Rejected or abandoned

Question 20

The value of a proposed capital budgeting project depends upon the:

A)Total cash flows produced
B)Incremental cash flows produced
C)Accounting profits produced
D)Increase in total sales produced

Question 21

Firms favour assets with high CCA rates because:

A)They have longer economic lives
B)It reduces the total amount of taxes paid over the project's life
C)They increase net accounting profits over the project's life
D)Their choice impacts project net present value favourably

Question 22

Which of the following changes would be likely to increase the NPV of a project?

A)Increasing the firm's opportunity cost of capital
B)Permitting a net decrease in working capital
C)Spreading the total cash inflows over a longer interval
D)Increasing the project's estimated expenses

Question 23

A tax shield is equal to the reduction in:

A)Tax liability resulting from a deductible expense
B)Taxable income resulting from a deductible expense
C)Cash flow from an expense
D)Net income

Question 24

The likely effect of discounting nominal cash flows with real interest rates will be to:

A)Make an investment's NPV appear more attractive
B)Make an investment's NPV appear less attractive
C)Correctly calculate an investment's NPV if inflation is expected
D)Correctly calculate an investment's NPV, regardless of expected inflation

Question 25

What is the amount of the operating cash flow for a firm with $500,000 profit before tax, $100,000 depreciation expense, and a 35 percent marginal tax rate?

A)$260,000
B)$325,000
C)$360,000
D)$425,000

Question 26

Which of the following would be more likely to make an unacceptable project appear acceptable?

A)Discounting real cash flows with real rates
B)Discounting nominal cash flows with real rates
C)Discounting real cash flows with nominal rates
D)Discounting nominal cash flows with nominal rates

Question 27

Which of the following would not be expected to affect the decision of whether to undertake an investment?

A)Income tax rates
B)Estimates of inflation rates
C)Sales reductions in other products caused by this investment
D)Cost of the feasibility study which was conducted for this project

Question 28

Higher depreciation rates:

A)Allow more depreciation over the asset's life
B)Decrease the depreciation tax shield
C)Increase the depreciation tax shield
D)Allow assets to be depreciated more rapidly

Question 29

Your forecast shows $500,000 annually in sales for each of the next three years.If your second and third year predictions have failed to incorporate 5 percent expected annual inflation, how far off in total dollars is your three-year forecast?

A)$25,000
B)$50,000
C)$52,550
D)$76,250

Question 30

Which of the following categories would be least likely to require annual adjustments in a capital budgeting analysis due to the effects of inflation?

A)Sales
B)Expenses
C)Working capital
D)Depreciation expense

Question 31

The NPV of an investment proposal becomes negative as a result of allocating a portion of the corporation president's salary.It is most likely the case that:

A)The project should be accepted
B)Rejecting the project is the correct decision
C)The allocation should be postponed until the project is accepted
D)The salary should be considered an opportunity cost of the project

Question 32

In what manner does depreciation expense affect investment projects?

A)It reduces cash flows by the amount of the depreciation expense
B)It increases cash flows by the amount of the depreciation expense
C)It reduces taxable income by the amount of the depreciation expense
D)It reduces taxes by the amount of the depreciation expense

Question 33

Which of the following methods will provide a correct analysis for capital budgeting purposes?

A)Discounting real cash flows with real rates
B)Discounting real cash flows with nominal rates
C)Discounting nominal cash flows with real rates
D)All of the above methods will provide similar results

Question 34

For a profitable firm in the 35 percent marginal tax bracket with $100,000 of annual depreciation expense, the depreciation tax shield would be:

A)$10,500
B)$30,000
C)$35,000
D)$65,000

Question 35

The correct method to handle overhead costs in capital budgeting is to:

A)Allocate a portion to each project
B)Allocate them to projects with the highest NPVs
C)Ignore all except identifiable incremental amounts
D)Ignore them in all cases

Question 36

Adding depreciation expense to net profit equals:

A)Profit before tax
B)Total revenues
C)The depreciation tax shield
D)cash flows from operations

Question 37

Capital budgeting proposals should be evaluated as if the project were financed:

A)Entirely by debt
B)Entirely by equity
C)Half by debt and half by equity
D)With the highest cost source of funds, to be safe

Question 38

What is the amount of the annual depreciation tax shield for a firm with $200,000 in net income, $75,000 in depreciation expense and a 35 percent marginal tax rate?

A)$26,250
B)$43,750
C)$70,000
D)$75,000

Question 39

When assets are sold from a CCA pool:

A)Other assets' values increase
B)The assets sold continue in the pool
C)A new rate is used in the pool
D)The remaining pool is subject to the net acquisitions rule

Question 40

The "recovery" of an additional investment in working capital is assumed to:

A)Occur at the end of the project's life
B)Occur at the beginning of the project's life
C)Occur whenever the project first shows a profit
D)Be a sunk cost.

Question 41

A new, more efficient machine will last four years and allow inventory levels to decrease by $100,000 during its life.At a cost of capital of 13 percent, how does the net working capital change affect the project's NPV?

A)NPV increases by $38,668
B)NPV increases by $61,330
C)NPV increases by $100,000
D)NPV increases by $138,668

Question 42

An investment today of $25,000 promises to return $10,000 annually for the next three years.What is the approximate real rate of return on this investment if inflation averages 6 percent annually during the period?

A)3.5 percent
B)9.7 percent
C)14.0 percent
D)20.0 percent Solving with financial calculator, the IRR = 9.701%.

Question 43

Recaptured depreciation and terminal loss occur when:

A)All assets are depreciated over five years
B)Depreciable percentages decline throughout the asset's class life
C)Straight-line depreciation percentages are doubled
D)A business terminates an asset pool

Question 44

The statement "We've got too much invested in that project to pull out now" possibly illustrates the need to:

A)Switch to another CCA method
B)Be reacquainted with the concept of sunk costs
C)Reduce net working capital assigned to the project
D)Reduce discount rates to improve NPV

Question 45

At current prices and a 13 percent cost of capital, a project's NPV is $100,000.By what minimum amount must the initial cost of the project decrease (revenues will be unchanged) before you would prefer to wait two years before investing?

A)$21,685
B)$26,000
C)$27,690
D)$29,380

Question 46

Assume that sales revenues are increasing more rapidly than product costs, but that a project's cash flows have been represented as an annuity when calculating NPV.Which of the following problems may occur?

A)Nominal cash flows are possibly being discounted with a real rate
B)Real cash flows are possibly being discounted with a nominal rate
C)Nominal cash flows are possibly being discounted with a nominal rate
D)Real cash flows are possibly being discounted with a real rate

Question 47

Which of the following statements is most likely to be correct for a project in which the NPV is negative when based on flows from net income?

A)NPV may turn positive after adjusting for depreciation expense
B)NPV should be calculated with pretax cash flows
C)NPV has probably been overestimated
D)The project should be rejected or abandoned

Question 48

What is the NPV of a project that costs $100,000, provides $23,000 in cash flows annually for six years, requires a $5,000 increase in net working capital, and depreciates the asset at 15 percent declining balance over six years and sold at zero salvage value? The discount rate is 14 percent.The tax rate is 40 percent.

A)-$23,460
B)-$13,283
C)$13,283
D)$44,866

Question 49

What is the present value at a 10 percent discount rate of the depreciation tax shield for a firm in the 35 percent tax bracket that purchases a $50,000 asset being depreciated at 15 percent declining balance with a half-year rule, disposed from the existing asset pool at zero?

A)$10,866
B)$10,023
C)$17,500
D)$37,908

Question 50

A firm generates sales of $250,000, depreciation expense of $50,000, taxable income of $50,000, and has a 35 percent tax rate.By how much does net cash flow deviate from net income?

A)$17,500
B)$50,000
C)$67,500
D)$82,500

Question 51

When the real rate of interest is less than the nominal rate of interest, then:

A)Inflation must be added to the nominal rate
B)Investment returns do not increase purchasing power
C)Nominal flows should be discounted with real rates
D)Inflation is expected to occur

Question 52

A project anticipates net cash flows of $10,000 at the end of year one, with such amount growing at the expected 5 percent rate of inflation over the subsequent four years.Calculate the real present value of this five-year cash stream if the firm employs a nominal discount rate of 15 percent.

A)$33,522
B)$38,377
C)$43,294
D)$55,000

Question 53

A new project requires an increase in both current assets and current liabilities of $125,000 each.What is the overall impact on net working capital investment?

A)An increase of zero
B)An increase of $125,000
C)An increase of $250,000
D)An increase of $62,500, when averaged over the life of the project

Question 54

A tax shield loss is created upon the sale of an asset from a pool will occur whenever:

A)Salvage is greater than zero
B)The asset has been partially depreciated
C)The corporation keeps two sets of books
D)The asset's market value exceeds its book value

Question 55

The opportunity cost of a resource should be considered in project analysis, unless:

A)No cash flows result from its use
B)The resource was purchased in a prior time period
C)The resource has been fully depreciated
D)The resource has no identifiable market value

Question 56

One can continue to earn CCA tax shields from an asset sold from an existing pool if:

A)UCC is positive and greater than salvage
B)Salvage is positive
C)The present value of the tax shields is negative
D)The tax bracket is greater than 50 percent

Question 57

What is the undiscounted cash flow in the final year of an investment, assuming: 10,000 after-tax cash flows from operations, the fully depreciated machine, the sole asset in the pool, is sold for $1,000, the project had required $2,000 in additional working capital, and a 35 percent tax rate?

A)$8,450
B)$12,600
C)$12,650
D)$14,000

Question 58

What nominal annual return is required on an investment in order that an investor experiences a 12 percent gain in purchasing power? Assume inflation to be 4 percent.

A)7.69 percent
B)9.29 percent
C)12.00 percent
D)16.48 percent (1 + real rate) x (1 + inflation rate) = 1 + nominal rate

Question 59

The primary difficulty in the allocation of overhead costs to prospective projects is that the:

A)Allocation will reduce the project's NPV
B)Discount rate is unknown
C)Costs may not represent an incremental expense
D)Expenses may have been previously allocated

Question 60

The present value at any given discount rate of the depreciation tax shield is:

A)Equal for all depreciation methods
B)Higher with MACRS than straight-line depreciation
C)Higher for the tenth year than the seven-year recovery period class
D)Likely to increase annually due to inflation

Question 61

A parcel of corporate land was recently dedicated as the new plant site.What cost allocation should the land receive, based on the following: original cost of $200,000, market value of $300,000, net book value of $200,000, a recent offer to purchase for $250,000?

A)$200,000
B)$250,000
C)$275,000
D)$300,000

Question 62

New projects or products can provide positive indirect effects as well as negative effects.Which of the following appears to be a positive indirect effect?

A)The new, efficient machine uses less electricity
B)Orders of your complementary products increase
C)The project has a positive NPV
D)Accelerated methods of depreciation can be used

Question 63

Which of the following typically results from using straight-line depreciation in the set of books for shareholders?

A)Net income appears higher during the early periods of depreciation
B)Less money is paid to the Canada Revenue Agency
C)Financial managers have more funds from operations available
D)Depreciable assets last for a longer period of time

Question 64

Why is it likely that firms would use straight-line depreciation methods for depicting project analysis to shareholders or lenders, if such choice were possible?

A)It increases the NPV of the project
B)It decreases the tax liability of the project
C)It mirrors the market value of the assets
D)It allows asset balances to decline more slowly

Question 65

Which of the following costs probably should not be allocated to the investment needed for a new project?

A)Increase in accounts receivable
B)New warehouse, built for this project
C)25 percent of the vice president's salary
D)Labour expense for employees in new warehouse

Question 66

Your forecast shows $500,000 annually in sales for each of the next three years.If your second and third year predictions have failed to incorporate 2.5% expected annual inflation, how far off in total dollars is your three-year forecast?

A)$37,813
B)$50,000
C)$52,550
D)$76,250

Question 67

How does net working capital affect the NPV of a five-year project if working capital is expected to increase by $25,000 and the firm has a 15% cost of capital?

A)NPV will increase by $9,322
B)NPV will increase by $12,571
C)NPV will decrease by $25,000
D)NPV will decrease by $12,571 t_o-$25,000 outflow
T₅-inflow, which has a present value of $12,429.42 (25,000/1.15⁵)

Question 68

Which of the following is representative of how depreciation expense is handled in the face of inflation?

A)It increases annually with the rate of inflation
B)It decreases annually in nominal terms
C)The depreciable base is not altered by inflation
D)The real value of the depreciation is fixed

Question 69

New projects or products can have an indirect effect on the firm as well as a direct effect.Which of the following appears to be an indirect effect of launching a new product?

A)Additional working capital is required
B)The sales force will need to be increased
C)Sales of our similar product will decline
D)Additional machinery must be purchased

Question 70

Which of the following is not accurate in depicting cash flows from operations?

A)(Revenues - expenses) (1 - tax rate) + (depreciation x tax rate)
B)(Revenues - expenses - taxes paid)
C)(Net profit + depreciation)
D)(Revenues - cash expenses - taxes paid)

Question 71

Opportunity costs for organizational resources:

A)are limited to the explicit cash flows involved
B)Are determined according to the marginal tax rate
C)Can involve no cash flows
D)Should not be determined for existing products

Question 72

Why is it fairly easy to fall into the trap of discounting real cash flows with nominal rates?

A)It is difficult to determine real discount rates
B)Increases in nominal cash flows are often not forecast
C)Inflation does not impact cash flows, but it does impact discount rates
D)Increases in revenues are offset by increases in costs

Question 73

Capital budgeting projects typically assume that all cash flows transpire at the end of the year.The reason for this is that:

A)Less tax liability results from this practice
B)Balance sheets are prepared at the end of the year
C)It is easier for the analyst in this manner
D)Most corporations collect their cash at the end of the year

Question 74

The additional inventory investment that is often required for new projects can be partially funded by:

A)Switching to accelerated depreciation methods
B)Reducing accounts receivable
C)Decreasing equipment purchases
D)Increasing accounts payable

Question 75

A five-year project requires an additional commitment of $100,000 in net working capital.What is the present value opportunity cost associated with this investment?

A)$100,000
B)The present value of $100,000, discounted at the firm's cost of capital
C)The value of $100,000, netted against the discounted present value of the $100,000 of working capital returned at the end of the project
D)No opportunity cost is involved

Question 76

With the half-year rule, the depreciation percentage is lower in the first year than in the second year.This is due to the fact that:

A)The depreciation percentage increases in each year
B)Assets are assumed to be acquired at mid-year
C)Depreciation expense increases at the rate of inflation
D)Declining balance depreciation is less attractive than straight-line depreciation

Question 77

Assuming that an asset has been fully depreciated according to its straight line CCA class, which of the following statements is correct concerning the value of the asset:

A)Its market value is zero
B)Its UCC value is zero
C)Its book value is the current market value
D)It has neither book value nor market value

Question 78

What rate of nominal growth is expected in sales if they are currently $1,000,000 and expected to reach $1,600,000 in five years?

A)3.20 percent
B)9.86 percent
C)12.00 percent
D)16.00 percent

Question 79

A project that increased sales was accompanied by a $50,000 increase in inventory, a $20,000 increase in accounts receivable, and a $25,000 increase in accounts payable.Assuming these amounts remain constant, by how much has net working capital increased?

A)$5,000
B)$25,000
C)$30,000
D)$45,000

Question 80

For a profitable firm in the 30% marginal tax bracket with $100,000 of annual depreciation expense, the depreciation tax shield would be:

A)$10,500
B)$30,000
C)$35,000
D)$65,000 Depreciation tax shield = depreciation x tax rate
= $100,000 x .30