Question 1

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)   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.F) All of the above
G) C) and D)

Question 2

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?   Risk-adjusted WACC 10.0% Net investment cost (depreciable basis)  $65,000 Straight-line deprec. rate 33.3333% Sales revenues, each year $65,500 Operating costs (excl. deprec.) , each year $25,000 Tax rate 35.0%\begin{array}{lr}	ext { Risk-adjusted WACC } & 10.0 \% \	ext { Net investment cost (depreciable basis)  } & \$ 65,000 \	ext { Straight-line deprec. rate } & 33.3333 \% \	ext { Sales revenues, each year } & \$ 65,500 \	ext { Operating costs (excl. deprec.) , each year } & \$ 25,000 \	ext { Tax rate } &  35.0 \% \end{array} Risk-adjusted WACC  Net investment cost (depreciable basis)   Straight-line deprec. rate  Sales revenues, each year  Operating costs (excl. deprec.) , each year  Tax rate ​10.0%$65,00033.3333%$65,500$25,00035.0%​

Accepted Answer

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

Question 3

Which of the following statements is CORRECT?

Accepted Answer

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.F) D) and E)
G) A) and C)

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.

Accepted Answer

A) True 
 B)False

Question 5

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.

Accepted Answer

A) True 
 B)False

Question 6

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.

Accepted Answer

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

Question 7

Which of the following statements is CORRECT?

Accepted Answer

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.F) None of the above
G) B) and D)

Question 8

Which of the following statements is CORRECT?

Accepted Answer

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.F) B) and E)
G) B) and D)

Question 9

Which of the following statements is CORRECT?

Accepted Answer

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.F) A) and E)
G) B) and D)

Question 10

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.

Accepted Answer

A) True 
 B)False

Question 11

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

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 that will be recovered at the end of the project's life.
E)   Changes in net working capital attributable to the project.F) A) and E)
G) None of the above

Question 12

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.

Accepted Answer

A) True 
 B)False

Question 13

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?

Accepted Answer

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.F) A) and B)
G) A) and E)

Question 14

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?

Accepted Answer

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.F) B) and C)
G) A) and B)

Question 15

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?

Accepted Answer

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.F) B) and C)
G) A) and B)

Question 16

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.

Accepted Answer

A) True 
 B)False

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.

Accepted Answer

A) True 
 B)False

Question 18

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.

Accepted Answer

A) True 
 B)False

Question 19

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.)    WACC 10.0% Pre-tax cash flow reduction for other products (cannibalization)  $5,000 Investment cost (depreciable basis)  $80,000 Straight-line deprec. rate 33.333% Sales revenues, each year for 3 years $67,500 Annual operating costs (excl. deprec.)  $25,000 Tax rate 35,0%\begin{array}{lrr}	ext { WACC } & 10.0 \% \	ext { Pre-tax cash flow reduction for other products (cannibalization)  } & \$ 5,000 \	ext { Investment cost (depreciable basis)  } & \$ 80,000 \	ext { Straight-line deprec. rate } & 33.333 \% \	ext { Sales revenues, each year for } 3 	ext { years } & \$ 67,500 \	ext { Annual operating costs (excl. deprec.)  } & \$ 25,000 \	ext { Tax rate } & 35,0 \%\end{array} WACC  Pre-tax cash flow reduction for other products (cannibalization)   Investment cost (depreciable basis)   Straight-line deprec. rate  Sales revenues, each year for 3 years  Annual operating costs (excl. deprec.)   Tax rate ​10.0%$5,000$80,00033.333%$67,500$25,00035,0%​

Accepted Answer

A)   $3,636
B)   $3,828
C)   $4,019
D)   $4,220
E)   $4,431 F) None of the above
G) B) and C)

Question 20

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?

Accepted Answer

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%.F) A) and E)
G) D) and E)

Exam 11: Cash Flow Estimation and Risk Analysis

Correct Answer
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Correct Answer
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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.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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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.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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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.

Correct Answer
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Correct Answer
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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?

Correct Answer
verified

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.

Correct Answer
verified

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

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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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?

Correct Answer
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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.

Correct Answer
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Exam 11: Cash Flow Estimation and Risk Analysis

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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