Question 1

When evaluating a new project, which statement should firms NOT include in the projected cash flows?

Accepted Answer

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 at the end of the project's life A

Question 2

Sometimes analysts think that an externality is present in a project, but they recognize that the particular externality cannot be quantified with any precision-estimates of its effect would really just be guesses. In such a situation, 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 actually is.

Accepted Answer

A) True 
 B)False  False

Question 3

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected sales include sales that will be taken away from another of Walker's books. The lost sales on the existing book are a sunk cost and as such should not be considered in the analysis of the new book.

Accepted Answer

A) True 
 B)False  False

Question 4

Which of the following statements is correct?

Accepted Answer

A)   Only incremental cash flows are relevant in project analysis, and the proper incremental cash flows are the reported accounting profits, which form the best basis for investor and managerial decisions.
B)   It is unrealistic to believe that increases in net operating 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 are included only at the start of a project's life.
C)   If a terminal loss or CCA recapture could occur at the conclusion of the business, no subsequent cash flows would be received.
D)   Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities, hence they are not considered in a capital budgeting analysis.

Question 5

Laurier Inc., a household products firm, is considering production of a new detergent. In evaluating whether to go ahead with the project, which item should NOT be explicitly considered when cash flows are estimated?

Accepted Answer

A)   The company will produce the detergent 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 other Laurier products.
B)   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.
C)   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 is expected to benefit other projects that might be proposed in the future.
D)   The new detergent will cut into sales of the firm's other detergents.

Question 6

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, the project's initial outlays and subsequent costs for large projects can be forecasted with great accuracy.

Accepted Answer

A) True 
 B)False

Question 7

When the cash flows for a project are estimated, interest payments should be included if debt is to be used to help finance the project.

Accepted Answer

A) True 
 B)False

Question 8

California Hideaways is considering a new project whose data are shown below. The equipment has a 4-year project life. This equipment falls into class 43 with a CCA rate of 30% and would have zero salvage value. No new working capital would be required. Revenues and cash operating costs are expected to be constant over the project's 4-year life. What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 4.) WACC10.0%
Net investment cost$65,000
Sales revenues, each year$60,000
Cash operating costs$25,000
Tax rate35.0%

Accepted Answer

A)   $28,499
B)   $23,402
C)   $19,417
D)   $16,284

Question 9

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 more risky the project.

Accepted Answer

A) True 
 B)False

Question 10

Rocky Top Car Wash 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 the project's 3-year life, and would have 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. This is just one project for the firm, so any losses can be used to offset gains on other firm projects. If the number of cars washed declined by 50% from the expected level, by how much would the project's NPV change? (Hint: Cash flows are constant in Years 1 to 3.) WACC10.0%
Net capital investment cost$60,000
Number of cars washed2,800
Average price per car$25.00
Fixed cash operating cost$10,000
Variable op. cost/unit (i.e., per car washed)$5.357
Annual capital cost allowance$20,000
Tax rate35.0%

Accepted Answer

A)   $38,113
B)   $40,119
C)   $42,230
D)   $44,453

Question 11

Your company, Q4 Inc., is considering a new project whose data are shown below. The required equipment has an economic year of 5 years, and has a CCA rate of 30% in class 10. Revenues and cash operating costs are expected to be constant over the project's 5-year operating life. What is the project's net operating cash flow during Year 2? Equipment cost$70,000
Sales revenues (each year)$50,000
Cash operating costs (each year)$25,000
Tax rate35.0%

Accepted Answer

A)   $16,213.00
B)   $20,067.50
C)   $22,497.50
D)   $18,863.50

Question 12

Suppose Tapley Corporation uses a WACC of 8% for below-average risk projects, 10% for average risk projects, and 12% for above-average risk projects. Which independent project should Tapley accept, assuming that the company uses the NPV method when choosing projects?

Accepted Answer

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

Question 13

Which factor is NOT relevant when determining incremental cash flows for a new product?

Accepted Answer

A)   the land that would be used for the new project and could be sold to another firm
B)   revenues from an existing product that would be lost as a result of customers switching to the new product
C)   shipping and installation costs associated with preparing a machine that would be used to produce the new product
D)   the cost of a marketing study that was completed last year related to the new product (This research led to the tentative decision to go ahead with the new product, and the cost of the research was expensed for tax purposes last year.)

Question 14

Bing Services is now in the final year of a project. The equipment originally cost $20,000. The existing UCC is $5,000. Bing can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment's net after-tax salvage value for use in a capital budgeting analysis? Note that the recapture is fully taxable.

Accepted Answer

A)   $5,320
B)   $5,600
C)   $5,880
D)   $6,174

Question 15

Any cash flow that can be classified as incremental to a particular project is relevant in a capital budgeting analysis.

Accepted Answer

A) True 
 B)False

Question 16

Which of the following statements best describes a sunk cost?

Accepted Answer

A)   A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.
B)   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.
C)   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.
D)   A sunk cost is any cost not directly related to the physical work required to complete the project.

Question 17

As a member of Midwest Corporation's financial staff, you must estimate the Year 1 operating cash flow for a proposed project with the following data. What is the Year 1 net operating cash flow? Sales revenues, each year$35,000
Capital cost allowance$10,000
Cash operating costs$17,000
Interest expense$4,000
Tax rate35.0%

Accepted Answer

A)   $12,380
B)   $13,032
C)   $14,440
D)   $15,200

Question 18

Which of the following statements regarding CCA is true?

Accepted Answer

A)   Since CCA deduction is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.
B)   When corporations use CCA depreciation method, the stockholder report financially looks better.
C)   CCA is a pool concept calculating values for the entire asset class, not individual assets.
D)   Using CCA declining-balance depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV.

Question 19

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

Accepted Answer

A)   The new project is expected to reduce sales of one of the company's existing products by 5%.
B)   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.
C)   The company has spent and expensed $1 million on R&D associated with the new 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.

Question 20

In cash flow estimation, the existence of externalities must be taken into account if those externalities have any effects on the firm's cash flows.

Accepted Answer

A) True 
 B)False

Exam 11: Cash Flow Estimation and Risk Analysis

When evaluating a new project, which statement should firms NOT include in the projected cash flows?

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected sales include sales that will be taken away from another of Walker's books. The lost sales on the existing book are a sunk cost and as such should not be considered in the analysis of the new book.

Which of the following statements is correct?

Laurier Inc., a household products firm, is considering production of a new detergent. In evaluating whether to go ahead with the project, which item should NOT be explicitly considered when cash flows are estimated?

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, the project's initial outlays and subsequent costs for large projects can be forecasted with great accuracy.

When the cash flows for a project are estimated, interest payments should be included if debt is to be used to help finance the project.

Suppose Tapley Corporation uses a WACC of 8% for below-average risk projects, 10% for average risk projects, and 12% for above-average risk projects. Which independent project should Tapley accept, assuming that the company uses the NPV method when choosing projects?

Which factor is NOT relevant when determining incremental cash flows for a new product?

Any cash flow that can be classified as incremental to a particular project is relevant in a capital budgeting analysis.

Which of the following statements best describes a sunk cost?

Which of the following statements regarding CCA is true?

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

In cash flow estimation, the existence of externalities must be taken into account if those externalities have any effects on the firm's cash flows.