Question 1

Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Accepted Answer

A)   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.
B)   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 may benefit other projects that might be proposed in the future.
C)   the new product will cut into sales of some of the firm's other products.
D)   if the project is accepted, the company must invest $2 million in working capital. however, all of these funds will be recovered at the end of the project's life.
E)   the company will produce the new product 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 another of the firm's products.F) B) and D)
G) C) and D)

Question 2

Your new employer, Freeman Software, is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected life. What is the Year 1 cash flow?

Equipment cost (depreciable basis)   Sales revenues, each year Operating costs (excl. deprec.)  Tax rate$65,000$60,000$25,00035.00%\begin{array}{l}\begin{array} { l } 	ext { Equipment cost (depreciable basis)  } \	ext { Sales revenues, each year }\	ext {Operating costs (excl. deprec.) }\	ext { Tax rate}\end{array}\begin{array} { l } \$ 65,000 \\$ 60,000 \\$ 25,000 \35.00\%\end{array}\end{array} Equipment cost (depreciable basis)   Sales revenues, each year Operating costs (excl. deprec.)  Tax rate​$65,000$60,000$25,00035.00%​​

Accepted Answer

A)   $30,333
B)   $31,849
C)   $33,442
D)   $35,114
E)   $36,869 F) C) and D)
G) D) and E)

Question 3

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)   one advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities.
B)   well-diversified stockholders do not need to consider market risk when determining required rates of return.
C)   market risk is important, but it does not have a direct effect on stock prices because it only affects beta.
D)   simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.
E)   sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.F) A) and B)
G) None of the above

Question 5

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

Question 6

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 7

You have just landed an internship in the CFO's office of Hawkesworth Inc. Your first task is to estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow?   Sales revenues  Depreciation  Other operating costs  Tax rate $13,000$4,000$6,000350%\begin{array}{l}\begin{array}{l}	ext { Sales revenues } \	ext { Depreciation } \	ext { Other operating costs } \	ext { Tax rate }\end{array}\begin{array}{r}\$ 13,000 \\$ 4,000 \\$ 6,000 \350 \%\end{array}\end{array} Sales revenues  Depreciation  Other operating costs  Tax rate ​$13,000$4,000$6,000350%​​

Accepted Answer

A)   $5,950
B)   $6,099
C)   $6,251
D)   $6,407
E)   $6,568 F) B) and D)
G) B) and C)

Question 8

Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite)  WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a risk-adjusted project cost of capital of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:
   Project  Pisk  Expected Return  A  High 15% B  Average 12% C  High 11% D  Low 9% E  Low 6%\begin{array}{ccc}	ext { Project } & 	ext { Pisk } & 	ext { Expected Return } \	ext { A } & 	ext { High } & 15 \% \	ext { B }& 	ext { Average } & 12 \% \	ext { C }  & 	ext { High } & 11 \% \	ext { D } & 	ext { Low } & 9 \% \	ext { E }& 	ext { Low } & 6 \%\end{array} Project  A  B  C  D  E ​ Pisk  High  Average  High  Low  Low ​ Expected Return 15%12%11%9%6%​ 
Which set of projects would maximize shareholder wealth?

Accepted Answer

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) None of the above
G) C) and D)

Question 9

It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

Accepted Answer

A) True 
 B)False

Question 10

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

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)   an example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
B)   the npv method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the irr method does not. this is another reason to favor the npv.
C)   both the npv and irr methods deal correctly with externalities, even if the externalities are not specifically identified. however, the payback method does not.
D)   identifying an externality can never lead to an increase in the calculated npv.
E)   an externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. if the project would have a favorable effect on other operations, then this is not an externality.F) B) and D)
G) B) and C)

Question 12

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.)    Cost of capital 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}{lr}	ext { Cost of capital } & 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} Cost of capital  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) A) and B)
G) None of the above

Question 13

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)   revenues from an existing product would be lost as a result of customers switching to the new product.
B)   shipping and installation costs associated with a machine that would be used to produce the new product.
C)   the cost of a study relating to the market for the new product that was completed last year. the results of this research were positive, and they led to the tentative decision to go ahead with the new product. the cost of the research was incurred and expensed for tax purposes last year.
D)   it is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm.
E)   using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. this space could be used for other products if it is not used for the project under consideration.F) A) and B)
G) B) and E)

Question 14

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 15

McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Accepted Answer

A)   0.67
B)   0.73
C)   0.81
D)   0.89
E)   0.98F) A) and E)
G) B) and E)

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)   only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
B)   it is unrealistic to believe that any increases in net 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 should be included only at the start of a project's life.
C)   if equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit. in this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.
D)   changes in net working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities. therefore, changes in net working capital should not be considered in a capital budgeting analysis.
E)   if an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm, hence its terminal cash flow will be negative.F) A) and C)
G) All of the above

Question 18

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

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)   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.
B)   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.
C)   sunk costs were formerly hard to deal with but now that the npv method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the pv of the project.
D)   a good example of a sunk cost is a situation where home depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.
E)   a sunk cost is any cost that must be expended in order to complete a project and bring it into operation.F) C) and D)
G) A) and E)

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

Exam 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk

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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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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The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
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McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Correct Answer
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Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

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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Correct Answer
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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
verified

It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

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

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

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
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Exam 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Correct AnswerverifiedShow Answer

Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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