Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

Shultz Business Systems 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.This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects.What is the project's expected NPV?   Project cost of capital ( r )  10.0% Net investment cost (depreciable basis)  $200,000 Units sold 50,000 Average price per unit, Year 1$25.00 Fixed op cost excl. deprec. (constant)  $150,000 Variable op. cost ′ unit, Year 1$20.20 Annual depreciation rate 33.333% Expected inflation rate per year 5.00% Tax rate 25.0%\begin{array}{lr}	ext { Project cost of capital ( } \mathrm{r} 	ext { )  } & 10.0 \% \	ext { Net investment cost (depreciable basis)  } & \$ 200,000 \	ext { Units sold } & 50,000 \	ext { Average price per unit, Year } 1 & \$ 25.00\	ext { Fixed op cost excl. deprec. (constant)  } & \$ 150,000 \	ext { Variable op. cost }{ }^{\prime} 	ext { unit, Year } 1 & \$ 20.20 \	ext { Annual depreciation rate } & 33.333 \% \	ext { Expected inflation rate per year } & 5.00 \% \	ext { Tax rate } & 25.0 \%\end{array} Project cost of capital ( r )   Net investment cost (depreciable basis)   Units sold  Average price per unit, Year 1 Fixed op cost excl. deprec. (constant)   Variable op. cost ′ unit, Year 1 Annual depreciation rate  Expected inflation rate per year  Tax rate ​10.0%$200,00050,000$25.00$150,000$20.2033.333%5.00%25.0%​

Accepted Answer

A)   $27,625
B)   $29,079
C)   $30,610
D)   $32,140
E)   $33,747 F) C) and D)
G) C) and E)

Question 3

Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

Accepted Answer

A)   1.20
B)   1.26
C)   1.32
D)   1.39
E)   1.46F) C) and D)
G) All of the above

Question 4

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) C) and D)
G) A) and E)

Question 5

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 cost of capital 10.0% Net investment cost (depreciable basis)  $65,000 Straight-line deprec. rate 33.3333% Sal es revenues, each year $65,500 Operating costs (excl. deprec.) , each year $25,000 Tax rate 25.0%\begin{array} { l r } 	ext { Risk-adjusted cost of capital } & 10.0 \% \	ext { Net investment cost (depreciable basis)  } & \$ 65,000 \	ext { Straight-line deprec. rate } & 33.3333 \% \	ext { Sal es revenues, each year } & \$ 65,500 \	ext { Operating costs (excl. deprec.) , each year } & \$ 25,000 \	ext { Tax rate } & 25.0 \%\end{array} Risk-adjusted cost of capital  Net investment cost (depreciable basis)   Straight-line deprec. rate  Sal es revenues, each year  Operating costs (excl. deprec.) , each year  Tax rate ​10.0%$65,00033.3333%$65,500$25,00025.0%​

Accepted Answer

A)   $34,515
B)   $36,331
C)   $38,243
D)   $40,256
E)   $42,375 F) C) and D)
G) A) and B)

Question 6

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) C) and D)
G) A) and D)

Question 7

Which of the following rules is CORRECT for capital budgeting analysis?

Accepted Answer

A)   Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
B)   Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision.
C)   A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP) , is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted.
D)   If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows.However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis.
E)   The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.F) B) and C)
G) B) and E)

Question 8

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

Accepted Answer

A) True 
 B)False

Question 9

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 25%.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)   $5,611
B)   $5,906
C)   $6,202
D)   $6,512
E)   $6,837F) A) and D)
G) C) and D)

Question 10

Tallant Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data:   Froject X  Froject Y  Expected NPV $500,000$500,000 Standard deviation (oNPV)  $200,000$250,000 Project beta (vs. market)  1.40.8\begin{array} { l r r } & 	ext { Froject X } & 	ext { Froject Y } \	ext { Expected NPV } & \$ 500,000 & \$ 500,000 \	ext { Standard deviation (oNPV)  } & \$ 200,000 & \$ 250,000 \	ext { Project beta (vs. market)  } & 1.4 & 0.8\end{array} Expected NPV  Standard deviation (oNPV)   Project beta (vs. market)  ​ Froject X $500,000$200,0001.4​ Froject Y $500,000$250,0000.8​  Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?

Accepted Answer

A)   Project X has more corporate (or within-firm)  risk than Project Y.
B)   Project X has more market risk than Project Y.
C)   Project X has the same level of corporate risk as Project Y.
D)   Project X has less market risk than Project Y.
E)   Project X has more stand-alone risk than Project Y. F) B) and D)
G) A) and D)

Question 11

To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

Accepted Answer

A)   Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.
B)   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.
C)   Capital budgeting decisions should be based on before-tax cash flows.
D)   The cost of capital used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.
E)   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 cost of capital.If interest were deducted when estimating cash flows, this would, in effect, "double count" it.F) C) and D)
G) All of the above

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)   Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
B)   A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices.
C)   A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.
D)   If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would be.
E)   An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.F) All of the above
G) A) and C)

Question 13

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Accepted Answer

A) True 
 B)False

Question 14

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 15

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 16

Century Roofing is thinking of opening a new warehouse, and the key data are shown below.The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new warehouse.The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value.No new working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)    Project cost of capital (r)  10.0% Opportunity cost $100,000 Net equipment cost (depreciable basis)  $65,000 Straight-line deprec. rate for equipment 33.333% Sal es revenues, each year $123,000 Operating costs (excl. deprec.) , each year $25,000 Tax rate 25%\begin{array}{lr}	ext { Project cost of capital (r)  } & 10.0 \% \	ext { Opportunity cost } & \$ 100,000 \	ext { Net equipment cost (depreciable basis)  } & \$ 65,000 \	ext { Straight-line deprec. rate for equipment } & 33.333 \% \	ext { Sal es revenues, each year } & \$ 123,000 \	ext { Operating costs (excl. deprec.) , each year } & \$ 25,000 \	ext { Tax rate } & 25 \%\end{array} Project cost of capital (r)   Opportunity cost  Net equipment cost (depreciable basis)   Straight-line deprec. rate for equipment  Sal es revenues, each year  Operating costs (excl. deprec.) , each year  Tax rate ​10.0%$100,000$65,00033.333%$123,000$25,00025%​

Accepted Answer

A)   $26,796
B)   $28,207
C)   $29,691
D)   $31,254
E)   $32,817 F) D) and E)
G) A) and E)

Question 17

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) C) and E)
G) A) and C)

Question 18

The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

Accepted Answer

A)   Interest on funds borrowed to help finance the project.
B)   The end-of-project recovery of any working capital required to operate the project.
C)   Cannibalization effects, but only if those effects increase the project's projected cash flows.
D)   Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.
E)   All costs associated with the project that have been incurred prior to the time the analysis is being conducted.F) B) and D)
G) B) and C)

Question 20

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) B) and D)
G) A) and D)

Exam 11: Cash Flow Estimation and Risk Analysis

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Correct Answer
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Correct Answer
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Which of the following factors should be included in the cash flows used to estimate a project's NPV?

Correct Answer
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Which of the following statements is CORRECT?

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The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

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

Correct Answer
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Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

Correct Answer
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Correct Answer
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To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

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

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 of the following rules is CORRECT for capital budgeting analysis?

Correct Answer
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Exam 11: Cash Flow Estimation and Risk Analysis

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following rules is CORRECT for capital budgeting analysis?

Correct AnswerverifiedShow Answer

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