Deck 10: Project Cash Flows and Risk

Question 1

In cash flow estimation,the presence of externalities has no direct cash flow effects.

Answer 1

False

Question 2

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Answer 2

False

Question 3

Replacement analysis involves the decision of whether to replace an existing asset that is still productive with a new asset.

Answer 3

True

Question 4

Quantification of risk is the easiest part of incorporating risk into capital budgeting; treatment of that calculated risk measure is more difficult.

Question 5

When calculating the cash flows for a project,you should include interest payments.

Question 6

With the current techniques available,estimating cash flows has become the easiest step in the analysis of a capital budgeting project.

Question 7

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 8

Net incremental operating cash flow is calculated by adding back the change in depreciation to the change in income after taxes.

Question 9

If an asset being considered for acquisition has beta of zero,its purchase will have no effect on the firm's market risk.

Question 10

The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR  k at the margin)is called capital rationing.

Question 11

One problem with Monte Carlo simulation analysis is that,while the simulation may provide some insights into the riskiness of a project,the analysis does not lead to a clear-cut accept versus reject decision.

Question 12

Capital budgeting decisions must be based on the accounting income the project generates since stockholders are concerned with the reported net income the firm generates.

Question 13

Although it is difficult to make accurate forecasts,the initial outlays and subsequent costs of large projects are forecast with great accuracy,but revenues are more uncertain and large errors are not uncommon.

Question 14

When risk is explicitly accounted for in capital budgeting,a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return.

Question 15

A particular project might have very uncertain cash flows,hence a highly uncertain NPV and IRR,yet it may not have high market risk.

Question 16

If a firm is considering purchasing an asset whose beta is greater than the current beta of the firm,it should use a discount rate greater than the firm's average required rate of return to evaluate the possible investment.

Question 17

Empirical studies of risk strongly support the contention that investors who are well diversified focus exclusively on market risk when they establish required returns.

Question 18

A key difference between replacement and expansion project analyses is that with replacement,the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

Question 19

A sunk is a cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected.These sunk costs are extremely important in capital budgeting decisions.

Question 20

Inflation does not need to be built into expected cash flows; the discount rate used in net present value calculations captures the effect of inflation.If you were to include expected inflation into cash flows,all net present value calculations would be incorrect.

Question 21

The change in net working capital associated with a capital project may actually result in a decrease in the firm's current funding requirement,which frees up cash flows for investment.

Question 22

The beta risk of a project is that part of the project's that cannot be eliminated by diversification.Investors are not concerned about this type of since it can not be diversified.

Question 23

Suppose a firm is considering production of a new product whose projected sales include sales that will be taken away from another product the firm also produces.The lost sales on the existing product are a sunk cost and are not a relevant cost to the new product.

Question 24

When evaluating a new project,the firm should consider all of the following factors except:

A) Changes in working capital attributable to the project.
B) Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes.
C) The current market value of any equipment to be replaced.
D) The resulting difference in depreciation expense if the project involves replacement.
E) All of the above should be considered.

Question 25

Expansion project analysis requires determining the amount of incremental cash as a result of the expansion relative to the cash flows if the expansion project was not accepted.The incremental cash flows will always be discounted at the same rate as the firm's original cash flows sine we are simply expanding the firm and not changing the risk of the firm.

Question 26

The stand-alone risk is the risk an asset would have if it were a firm's only asset and it is measured by the variability of the asset's expected returns.

Question 27

It is possible with a replacement project that the incremental depreciation cash flows will be negative even if the actual depreciation on the new asset is positive.

Question 28

Sensitivity analysis is a risk analysis technique in which key variables are changed and the resulting changes in the NPV and IRR are observed.

Question 29

When considering the risk of foreign investment,higher risk could arise from exchange rate risk and political risk while lower risk might result from international diversification.

Question 30

Superior analytical techniques,such as NPV,used in combination with adjustments to the average required rate of return,can overcome the problem of poor cash flow estimation in decision making.

Question 31

The two cardinal rules which financial analysts follow to avoid capital budgeting errors are: (1)capital budgeting decisions must be based on accounting income,and (2)only incremental cash flows are relevant to accept/reject decisions.

Question 32

The cash flows relevant for the analysis of a foreign investment should,from the parent company's perspective,include the financial cash flows that the subsidiary can legally send back to the parent company and the cash flows which must remain in the foreign country.

Question 33

As a practical matter,it is much easier to use market risk analysis at the project level than at the divisional level because it is easier to estimate the beta of a single project such as a machine tool die maker than the beta of an entire division (or subsidiary)such as Phillip Morris' Kraft foods unit.

Question 34

Sensitivity analysis measures the stand-alone risk of a project by showing how much the project's NPV is affected by a small change in one of the input variables,such as sales.Other things held constant,with the independent variable graphed on the horizontal axis,the steeper the graph of the relationship line,the less risky the project.

Question 35

Assume the following: (1)A firm is considering two projects,one with a 5-year life and the other with a 10-year life; (2)the cash flows of the two projects are equally risky by all definitions of the word "risky"; (3)the company uses 40 percent debt and 60 percent equity to finance the projects; (4)the debt used to finance any given project has a maturity equal to the life of the project; and (5)the term structure of interest rates has a sharp upward slope.This would suggest,other things held constant,that a lower discount rate should be used to find the NPV for the 5-year project than for the 10-year project.

Question 36

The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.

Question 37

Which of the following is not a cash flow that results from the decision to accept a project?

A) Changes in working capital.
B) Shipping and installation costs.
C) Sunk costs.
D) Opportunity costs.
E) Externalities.

Question 38

Corporate risk does not take into consideration the effects of stockholder's diversification; it is measured by a project's effect on the firm's earnings variability.

Question 39

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 recommended for such projects instead of cash flow analysis.

Question 40

If a project is small relative to the total firm,and if its returns are not highly correlated with the returns on the firm's other assets,then the project may not be very risky in either the within-firm (corporate)or the market risk sense,even if the returns on the project are highly uncertain and thus the project has a high degree of stand-alone risk.

Question 41

Which of the following methods involves calculating an average beta for firms in a similar business and then applying that beta to determine the beta of its own project?

A) Risk premium method.
B) Pure play method.
C) Accounting beta method.
D) CAPM method.
E) Answers b and c are both correct.

Question 42

Which of the following statements is correct?

A) If a firm's stockholders are well diversified, we know from theory and from studies of market behavior that corporate risk is not important.
B) Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk.
C) Empirical studies of the determinants of required rates of return (k) have found that only market risk affects stock prices.
D) Market risk is important but does not have a direct effect on stock price because it only affects beta.

Question 43

Which of the following statements is correct?

A) A relatively risky future cash outflow should be evaluated using a relatively low discount rate.
B) If a firm's managers want to maximize the value of the stock, they should concentrate exclusively on projects' market, or beta, risk.
C) If a firm evaluates all projects using the same required rate of return to determine NPVs, then the riskiness of the firm as measured by its beta will probably decline over time.
D) If a firm has a beta which is less than 1.0, say 0.9, this would suggest that its assets' returns are negatively correlated with the returns of most other firms' assets.
E) The above statements are all false.

Question 44

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm,based on any method for assessing risk.In evaluating this asset,the decision maker should

A) Increase the IRR of the asset to reflect the greater risk.
B) Increase the NPV of the asset to reflect the greater risk.
C) Reject the asset, since its acceptance would increase the risk of the firm.
D) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
E) Increase the required rate of return used to evaluate the project to reflect the higher risk of the project.

Question 45

Which of the following statements is most correct?

A) Sensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions.
B) 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.
C) The primary advantage of simulation is that it provides a very accurate point estimate of a project's NPV.
D) One important benefit of simulation analysis as compared to scenario analysis, is that once the analysis is complete, it provides a clear accept/reject decision rule.
E) Answers c and d are both correct.

Question 46

Which of the following statements is correct?

A) An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project.
B) Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions.
C) It is unrealistic to expect that increases in net working capital that are required at the start of an expansion project are simply recovered at the project's completion. Thus, these cash flows are included only at the start of a project.
D) Equipment sold for more than its book value at the end of a project's life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value.
E) All of the above are false.

Question 47

Risk in a revenue producing project can best be adjusted for by

A) Ignoring it.
B) Adjusting the discount rate upward for increasing risk.
C) Adjusting the discount rate downward for increasing risk.
D) Picking a risk factor equal to the average discount rate.
E) Reducing the NPV by 10 percent for risky projects.

Question 48

Which of the following is not discussed in the text as a method for analyzing risk in capital budgeting?

A) Sensitivity analysis.
B) Beta, or CAPM, analysis.
C) Monte Carlo simulation.
D) Scenario analysis.
E) All of the above are discussed in the text as methods of analyzing risk in capital budgeting.

Question 49

If a typical U.S.company uses the same discount rate to evaluate all projects,the firm will most likely become

A) Riskier over time, and its value will decline.
B) Riskier over time, and its value will rise.
C) Less risky over time, and its value will rise.
D) Less risky over time, and its value will decline.
E) There is no reason to expect its risk position or value to change over time as a result of its use of a single discount rate.

Question 50

If the firm is being operated so as to maximize shareholder wealth,and if our basic assumptions concerning the relationship between risk and return are true,then which of the following should be true?

A) If the beta of the asset is larger than the firm's beta, then the required return on the asset is less than the required return on the firm.
B) If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm.
C) If the beta of the asset is greater than the corporate beta prior to the addition of that asset, then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.
D) If the beta of an asset is larger than the corporate beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.
E) None of the above is a true statement.

Question 51

Which of the following is not considered a relevant concern in determining incremental cash flows for a new product?

A) The use of factory floor space which is currently unused but available for production of any product.
B) Revenues from the existing product that would be lost as a result of some customers switching to the new product.
C) Shipping and installation costs associated with preparing the machine to be used to produce the new product.
D) The cost of a product analysis completed in the previous tax year and specific to the new product.
E) None of the above (All are relevant concerns in estimating relevant cash flows attributable to a new product project.)

Question 52

In theory,the decision maker should view market risk as being of primary importance.However,within-firm,or corporate,risk is relevant to a firm's

A) Well-diversified stockholders, because it may affect debt capacity and operating income.
B) Management, because it affects job stability.
C) Creditors, because it affects the firm's credit worthiness.
D) All of the above are correct.
E) Only answers a and c are correct.

Question 53

Which of the following statements concerning cash flow evaluation in capital budgeting is incorrect?

A) When determining a project's terminal cash flows, it is generally assumed that the firm's operations return to the same level as they were before the project was purchased.
B) If a depreciable asset is sold at a price different than its book value, taxes will affect the net cash received from the disposal of the asset at the end of its life.
C) The relevant marginal cash flows associated with a project should always include depreciation, because depreciation is an annual operating expense that requires a cash payment.
D) If an asset is depreciated using the Modified Accelerated Cost Recovery System (MACRS), its depreciable basis is the amount that can be depreciated over the asset's useful life, which generally includes the purchase price plus any shipping and installation charges or other costs that are incurred in order to prepare the asset for use.
E) The sunk costs associated with an investment proposal are not relevant cash flows for capital budgeting analysis, so they should not be included in the computation of the marginal cash flows.

Question 54

Using the Security Market Line concept in capital budgeting,which of the following is correct?

A) If the expected rate of return on a given capital project lies above the SML, the project should be accepted even if its beta is above the beta of the firm's average project.
B) If a project's return lies below the SML, it should be rejected if it has a beta greater than the firm's existing beta but accepted if its beta is below the firm's beta.
C) If two mutually exclusive projects' expected returns are both above the SML, the project with the lower risk should be accepted.
D) If a project's expected rate of return is greater than the expected rate of return on an average project, it should be accepted.

Question 55

Regarding the net present value of a replacement decision,which of the following statements is false?

A) The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow.
B) The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay).
C) The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow.
D) Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay).
E) An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow).

Question 56

If a company uses the same discount rate for evaluating all projects,which of the following results is likely?

A) Accepting poor, high-risk projects.
B) Rejecting good, low-risk projects.
C) Accepting only good, low-risk projects.
D) Accepting no projects.
E) Answers a and b are both correct.

Question 57

Suppose the firm's required rate of return is stated in nominal terms,but the project's expected cash flows are expressed in real dollars.In this situation,other things held constant,the calculated NPV would

A) Be correct.
B) Be biased downward.
C) Be biased upward.
D) Possibly have a bias, but it could be upward or downward.
E) More information is needed; otherwise, we can make no reasonable statement.

Question 58

According to the text,the financial staff's role in the forecasting process centers on

A) Developing the original assumptions used in estimating each project's cash flows.
B) Making sure that no biases are inherent in the forecasts.
C) Deciding which projects are strategically important to the firm.
D) Setting the sales price and quantity estimates for use by other departments.
E) All of the above.

Question 59

Which of the following rules are essential to successful cash flow estimates,and ultimately,to successful capital budgeting?

A) The return on invested capital is the only relevant cash flow.
B) Only incremental cash flows are relevant to the accept/reject decision.
C) Total cash flows are relevant to capital budgeting analysis and the accept/reject decision.
D) All of the above are correct.
E) Only answers a and b are correct.

Question 60

Monte Carlo simulation

A) Can be useful for estimating a project's stand-alone risk.
B) Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable.
C) Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR.
D) All of the above.
E) Only answers a and b are correct.

Question 61

Given the following information,calculate the NPV of a proposed project: Cost = $4,000; estimated life = 3 years; initial decrease in accounts receivable = $1000,which must be restored at the end of the project's life; estimated salvage value = $1,000; net income before taxes and depreciation = $2,000 per year; method of depreciation = MACRS; tax rate = 40 percent; required rate of return = 18 percent.

A) $1,137
B) -$151
C) $137
D) $804
E) $544

Question 62

Which of the following items should not be considered when computing the terminal cash flow for an expansion project?

A) a change in net working capital associated with the purchase of the project
B) the selling price of the asset at the end of its life
C) increases in cash sales that occur because the project is purchased
D) taxes on the sale of the asset at the end of its life
E) none of the above

Question 63

Express Press evaluates many different capital budgeting projects each year.The risks of the projects often differ significantly,from very little risk to risks that are substantially greater than the average risk associated with the firm.If Express Press always uses its weighted average cost of capital,or average required rate of return,to evaluate all of these capital budgeting projects,then the company might make an incorrect decision,or a mistake,by

A) accepting projects that actually should be rejected.
B) accepting projects with internal rates of return that are too high.
C) rejecting projects that actually should be rejected.
D) rejecting projects with internal rates of return that are lower than the appropriate risk-adjusted required rate of return.
E) accepting project that actually should be accepted.

Question 64

Which of the following statements is correct?

A) Sensitivity analysis is used frequently in capital budgeting analysis. Its big advantage is that because it shows correlations between changes in input variables and NPV, it accounts for within-firm risk.
B) Other things held constant, the lower the correlation between a project's returns and returns on the market, the less risky the project.
C) In judging the relative stand-along risks of a set of projects, the projects' standard deviations of NPV are a better measure than their coefficients of variation.
D) One can run a regression of returns on a project versus returns on the firm's other assets, get a beta coefficient, and use this beta as a measure of the project's market risk.
E) One can run a regression of returns on a project versus returns on the stock market, get a beta coefficient, and use this beta as a measure of the project's within-firm risk.

Question 65

Carolina Insurance Company,an all-equity life insurance firm,is considering the purchase of a fire insurance company.If the purchase is made,Carolina will be 50 percent larger than before.Currently,Carolina's stock has a beta of 1.2 and the return required is 15.2 percent.The fire insurance company is expected to generate a return of 20 percent with a beta of 2.5.If the risk-free rate is 8 percent and the market risk premium is 6 percent,should Carolina make the investment?

A) No; the expected return is less than the required return.
B) No; the IRR is less than the appropriate required rate of return.
C) Yes; the IRR is greater than the appropriate required rate of return.
D) Yes; the expected return is greater than the required return.
E) Yes; the project's risk/return combination lies above the SML.

Question 66

Hill Top Lumber Company is considering building a sawmill in the state of Washington because the company doesn't have such a facility to service its growing customer base that is located on the west coast.Hill Top's executives believe that future growth in west coast customers will make the sawmill project a good investment.When evaluating the acceptability of the project,which of the following would not be considered a relevant cash flow that should be included when determining its initial investment outlay?

A) Hill Top owns acreage that is large enough and would be an ideal location for the sawmill. The land, which was purchased five years ago, has a current value of $3 million.
B) It is estimated that the cost of building the sawmill will be $175 million.
C) It will cost $3 million to clear the land on which Hill Top wants to build the sawmill.
D) It is estimated that $20 million of business from existing customers will move to the new sawmill.
E) All of these cash flows should be included in the computation of the sawmill's initial investment outlay.

Question 67

The Oneonta Chemical Company is evaluating two mutually exclusive pollution control systems.Since the company's revenue stream will not be affected by the choice of control systems,the projects are being evaluated by finding the PV of each set of costs.The firm's required rate of return is 13 percent,and it adds or subtracts 3 percentage points to adjust for project risk differences.System A is judged to be a high-risk project (it might end up costing much more to operate than is expected).The appropriate risk-adjusted discount rate that should be used to evaluate System A is

A) 10%; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being discounted.
B) 13%; the firm's cost of capital should not be adjusted when evaluating outflow only projects.
C) 16%; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the project for its high risk.
D) Somewhere between 10% and 16%, with the answer depending on the riskiness of the relevant inflows.
E) Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the requirements with the lowest required investment.

Question 68

Which of the following cash flows are incremental cash flows that need to be considered when evaluating a capital project?

A) Interest expenses on the financing of the project.
B) Sunk costs of engineering study to determine the feasibility of the project.
C) Opportunity cost of land being used for project that the firm already owns.
D) Both a and b are correct.
E) None of the above.

Question 69

If a firm uses its weighted average cost of capital (WACC)to evaluate all capital budgeting projects,which of the following could occur?

A) Projects with little or no risk might be rejected when they actually should be accepted.
B) Projects with significant risks might be accepted when the actually should be rejected.
C) Projects with average risk will always be rejected when they actually should be rejected.
D) All of the above could occur.
E) None of the above could occur.

Question 70

When determining the marginal cash flows associated with an expansion capital budgeting project,which of the following would be included as an incremental operating cash flow?

A) depreciation
B) shipping and installation
C) increase in working capital
D) salvage value
E) decrease in sales

Question 71

Dick Boe Enterprises,an all-equity firm,has a corporate beta coefficient of 1.5.The financial manager is evaluating a project with an IRR of 21 percent,before any risk adjustment.The risk-free rate is 10 percent,and the required rate of return on the market is 16 percent.The project being evaluated is riskier than Boe's average project,in terms of both beta risk and total risk.Which of the following statements is correct?

A) The project should be accepted because its IRR (before risk adjustment) is greater than its required return.
B) The project should be rejected because its IRR (before risk adjustment) is less than its required return.
C) The accept/reject decision depends on the risk-adjustment policy of the firm. If the firm's policy were to reduce a riskier-than-average project's IRR by 1 percentage point, then the project should be accepted.
D) Riskier-than-average projects should have their IRRs increased to reflect their added riskiness. Clearly, this would make the project acceptable regardless of the amount of the adjustment.
E) Projects should be evaluated on the basis of their total risk alone. Thus, there is insufficient information in the problem to make an accept/reject decision.

Question 72

The financial staff's role in the forecasting process includes all of the following except

A) coordinating the efforts of other departments, such as engineering and marketing.
B) ensuring that everyone involved in the forecasts uses a consistent set of economic assumptions.
C) making sure that no biases are inherent in the forecasts.
D) determine the appropriate discount rate for cash flows.
E) none of the above.

Question 73

How do most firms deal with the risks of projects when making capital budgeting decisions?

A) Projects risks are not considered directly because the weighted average cost of capital (WACC) that is used as the required rate of return for capital budgeting decisions is based on the riskiness of the firm. As a result, all projects, no matter their risks, can be evaluated using WACC.
B) Evaluating risk is important only when the projects are similar to the firm's existing assets.
C) Most firms adjust the discount rates used to evaluate new projects that have significantly different risks than the risk associated with the firm's existing assets.
D) Firms generally increase the required rate of return used to evaluate projects that have significantly different risks than the risk associated with the firm's existing assets, regardless of whether the new projects' risks are higher or lower.
E) None of the above is a correct answer.

Question 74

Stanton Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually.Stanton will use the MACRS method to depreciate the machine,and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes.Stanton's marginal tax rate is 40 percent,and it uses a 9 percent required rate of return to evaluate projects of this type.If the machine's cost is $40,000,what is the project's NPV?

A) $1,014
B) $2,292
C) $7,550
D) $817
E) $5,040

Question 75

Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because

A) it represents a tax-deductible cash expense.
B) the firm has a cash outflow equal to the depreciation expense each year.
C) although it is a non-cash expense, depreciation has an impact on the taxes paid by the firm, which is a cash flow.
D) depreciation is a sunk cost.
E) None of the above is correct.

Question 76

A firm is evaluating a new machine to replace an existing,older machine.The old (existing)machine is being depreciated at $20,000 per year,whereas the new machine's depreciation will be $18,000.The firm's marginal tax rate is 30 percent.Everything else equal,if the new machine is purchased,what effect will the change in depreciation have on the firm's incremental operating cash flows?

A) There should be no effect on the firm's cash flows, because depreciation is a noncash expense.
B) Operating cash flows will increase by $2,000.
C) Operating cash flows will increase by $1,400.
D) Operating cash flows will decrease by $600.
E) None of the above is correct.

Question 77

Cyrus Cypress evaluates all capital budgeting projects with its normal,or average,required rate of return (k),regardless of the risk associated with the projects.If Cyrus is currently examining projects that are significantly riskier than the existing assets of the firm,the capital budgeting decisions that the firm makes could be

A) correct.
B) incorrect because acceptable projects might be rejected when they should be accepted.
C) incorrect because unacceptable projects might be accepted when they should be rejected.
D) Both a and b are correct answers.
E) Both a and c are correct answers.

Question 78

An evaluation of four independent capital budgeting projects by the director of capital budgeting for Ziker Golf Company yielded the following results: The firm's weighted average cost of capital is 12 percent.Ziker Golf generally evaluates projects that are riskier than average by adjusting its required rate of return by 4 percent,whereas projects with less-than-average risk are evaluated by adjusting the required rate of return by 2 percent.Which project(s)should the firm purchase?

A) Project L
B) Projects L and E
C) Projects L and M
D) Projects L, E, and M
E) None of the above is a correct answer.

Question 79

Mars Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually.Mars will use the MACRS accelerated method to depreciate the machine,and it expects to sell the machine at the end of its 5-year operating life for $10,000.The firm expects to be able to reduce net working capital by $15,000 when the machine is installed,but required working capital will return to the original level when the machine is sold after 5 years.Mars' marginal tax rate is 40 percent,and it uses a 12 percent required rate of return to evaluate projects of this nature.If the machine costs $60,000,what is the NPV of the project?

A) -$15,394
B) -$14,093
C) -$58,512
D) -$21,493
E) -$46,901

Question 80

When evaluating the cash flows associated with a capital budgeting project,shipping and installation costs associated with the purchase of an asset,such as a lathe,are considered part of the

A) initial investment outlay because these expenses effectively are part of the asset's purchase price.
B) incremental operating cash flows because shipping and installation costs represent expenses that have to be written off over the life of the asset.
C) terminal cash flows, because these expenses aren't paid until the end of the asset's life.
D) sunk costs because these expenses do not affect any current or future cash flows associated with investing in the asset.
E) None of the above is a correct answer.