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


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.

F) All of the above
G) A) and E)

Correct Answer

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Liberty Services is now at the end of the final year of a project. 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.


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

F) D) and E)
G) B) and C)

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Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

A) True
B) False

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Langston Labs has an overall (composite) Which set of projects would maximize shareholder wealth?


A) A and B.
B) A, B, and C.
C) A, B, and D.
D) A, B, C, and D.
E) A, B, C, D, and E.

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

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Suppose Tapley Inc. 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 Tapley accept, assuming that the company uses the NPV method when choosing projects?


A) Project A, which has average risk and an IRR = 9%.
B) Project B, which has below-average risk and an IRR = 8.5%.
C) Project C, which has above-average risk and an IRR = 11%.
D) Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
E) All of these projects should be accepted as they will produce a positive NPV.

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

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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.

A) True
B) False

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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?


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

F) A) and D)
G) D) and E)

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Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

A) True
B) False

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Which of the following statements is CORRECT?


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 accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
E) Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV.

F) C) and D)
G) C) and E)

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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.

A) True
B) False

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


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.

F) A) and C)
G) All of the above

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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.

A) True
B) False

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Which of the following statements is CORRECT?


A) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV.
B) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV.
C) The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality.
D) If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.
E) If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.

F) C) and D)
G) B) and C)

Correct Answer

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