A) The firm's corporate,or overall,WACC is used to discount all project cash flows to find the projects' NPVs.Then,depending on how risky different projects are judged to be,the calculated NPVs are scaled up or down to adjust for differential risk.
B) Differential project risk cannot be accounted for by using "risk-adjusted discount rates" because it is highly subjective and difficult to justify.It is better to not risk adjust at all.
C) Other things held constant,if returns on a project are thought to be positively correlated with the returns on other firms in the economy,then the project's NPV will be found using a lower discount rate than would be appropriate if the project's returns were negatively correlated.
D) Monte Carlo simulation uses a computer to generate random sets of inputs,those inputs are then used to determine a trial NPV,and a number of trial NPVs are averaged to find the project's expected NPV.Sensitivity and scenario analyses,on the other hand,require much more information regarding the input variables,including probability distributions and correlations among those variables.This makes it easier to implement a simulation analysis than a scenario or sensitivity analysis,hence simulation is the most frequently used procedure.
E) DCF techniques were originally developed to value passive investments (stocks and bonds) .However,capital budgeting projects are not passive investments - managers can often take positive actions after the investment has been made that alter the cash flow stream.Opportunities for such actions are called real options.Real options are valuable,but this value is not captured by conventional NPV analysis.Therefore,a project's real options must be considered separately.
G) B) and C)
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A
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B) False
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A) All costs associated with the project that have been incurred prior to the time the analysis is being conducted.
B) Interest on funds borrowed to help finance the project.
C) The end-of-project recovery of any additional net operating working capital required to operate the project.
D) Cannibalization effects,but only if those effects increase the project's projected cash flows.
E) Expenditures to date on research and development related to the project,provided those costs have already been expensed for tax purposes.
G) A) and B)
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B) False
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A) $5,750
B) $5,060
C) $5,335
D) $4,180
E) $6,380
G) A) and E)
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B) False
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A) $20,978
B) $36,761
C) $18,450
D) $34,900
E) $12,543
G) C) and D)
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A) Project X has more stand-alone risk than Project Y.
B) Project X has more corporate (or within-firm) risk than Project Y.
C) Project X has more market risk than Project Y.
D) Project X has the same level of corporate risk as Project Y.
E) Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects.
G) D) and E)
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A) Increase the estimated IRR of the project to reflect its greater risk.
B) Increase the estimated NPV of the project to reflect its greater risk.
C) Reject the project,since its acceptance would increase the firm's risk.
D) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets.
E) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
G) A) and E)
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B) False
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A) $22,849
B) $26,149
C) $32,063
D) $20,818
E) $30,211
G) C) and D)
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B) False
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False
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A) Since depreciation is a cash expense,the faster an asset is depreciated,the lower the projected NPV from investing in the asset.
B) Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
C) Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
D) Using bonus depreciation rather than straight line normally has the effect of receiving depreciation cash flows immediately and thus increasing a project's forecasted NPV.
E) Using bonus depreciation rather than straight line normally has the effect of delaying the receipt of depreciation cash flows and thus reducing a project's forecasted NPV.
G) A) and C)
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B) False
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A) $33,040
B) $32,008
C) $29,598
D) $28,222
E) $26,250
G) C) and D)
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E
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A) In calculating the project's operating cash flows,the firm should not deduct financing costs such as interest expense,because financing costs are accounted for by discounting at the WACC.If interest were deducted when estimating cash flows,this would,in effect,"double count" it.
B) Since depreciation is a non-cash expense,it has no impact on a project's calculated NPV..
C) When estimating the project's operating cash flows,it is important to include both opportunity costs and sunk costs,but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.
D) Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis.
E) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.To do otherwise would bias the NPV upward.
G) A) and C)
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A) Changes in net operating working capital.
B) Shipping and installation costs for machinery acquired.
C) Cannibalization effects.
D) Opportunity costs.
E) Sunk costs that have been expensed for tax purposes.
G) A) and B)
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A) $22,922
B) $17,677
C) $20,785
D) $21,375
E) $17,871
G) A) and B)
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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 firms use bonus depreciation,they will write off assets slower than they would under straight-line depreciation,and as a result projects' forecasted NPVswould normally be lower than they would be if straight-line depreciation were required for tax purposes..
D) If firms use bonus depreciation,they can write off assets faster than they could under straight-line depreciation,and as a result projects' forecasted NPVs would normally be lower than they would be if straight-line depreciation were required for tax purposes.
E) If firms use bonus depreciation,they can write off assets faster than they could under straight-line depreciation,and as a result projects' forecasted NPVs would normally be higher than they would be if straight-line depreciation were required for tax purposes.
G) A) and D)
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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 research and development costs associated with the new project.
D) The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
E) 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.
G) B) and D)
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