Question 1

​Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

Accepted Answer

A) True 
 B)False  True

Question 2

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.

Accepted Answer

A) True 
 B)False  True

Question 3

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.

Accepted Answer

A) True 
 B)False  True

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

The change in net operating working capital associated with new projects is always positive,because new projects mean that more operating working capital will be required.

Accepted Answer

A) True 
 B)False

Question 6

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

Accepted Answer

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

Question 7

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.​

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  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.
B)  Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
C)  If they use accelerated depreciation, firms 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.
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 lower than they would be if straight-line depreciation were required for tax purposes.
E)  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.

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

Desai Industries 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.No change in net operating working capital would be required.This is just one of many projects for the firm,so any losses on this project can be used to offset gains on other firm projects.What is the project's expected NPV?

Accepted Answer

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

Question 11

Clemson Software 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?

Accepted Answer

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

Question 12

The relative risk of a proposed project is best accounted for by which of the following procedures?

Accepted Answer

A)  Adjusting the discount rate upward if the project is judged to have above-average risk.
B)  Adjusting the discount rate upward if the project is judged to have below-average risk.
C)  Reducing the NPV by 10% for risky projects.
D)  Picking a risk factor equal to the average discount rate.
E)  Ignoring risk because project risk cannot be measured accurately.

Question 13

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?

Accepted Answer

A)  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.
B)  Revenues from an existing product would be lost as a result of customers switching to the new product.
C)  Shipping and installation costs associated with a machine that would be used to produce the new product.
D)  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.
E)  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.

Question 14

Foley Systems 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 additional net operating 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 from operations are constant in Years 1 to 3.)

Accepted Answer

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

Question 15

As a member of UA Corporation's financial staff,you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow?

Accepted Answer

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

Question 16

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.

Accepted Answer

A) True 
 B)False

Question 17

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.

Accepted Answer

A) True 
 B)False

Question 18

​Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)  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.
B)  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.
C)  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.
D)  Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
E)  Identifying an externality can never lead to an increase in the calculated NPV.

Question 20

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.

Accepted Answer

A) True 
 B)False

Exam 12: Cash Flow Estimation and Risk Analysis

​Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

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.

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.

The change in net operating working capital associated with new projects is always positive,because new projects mean that more operating working capital will be required.

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.​

Which of the following statements is CORRECT?

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.

The relative risk of a proposed project is best accounted for by which of the following procedures?

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?

As a member of UA Corporation's financial staff,you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow?

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.

​Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.

Which of the following statements is CORRECT?

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.

Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.