Question 1

Which of the following statements is CORRECT?

Accepted Answer

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

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)  An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
B)  Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
C)  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.
D)  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.
E)  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.F) A) and D)
G) C) and D)

Question 3

Clemson Software is considering a new project whose data are shown below.The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's Year 1 cash flow?
Equipment cost (depreciable basis)  $65,000
Straight-line depreciation rate 33.333%
Sales revenues, each year $60,000
Operating costs (excl. depr.)  $25,000
Tax rate 35.0%

Accepted Answer

A)  $28,115
B)  $28,836
C)  $29,575
D)  $30,333
E)  $31,092F) C) and E)
G) All of the above

Question 4

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 5

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

Accepted Answer

A)  The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.
B)  Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
C)  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.
D)  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.
E)  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.F) All of the above
G) C) and D)

Question 6

Foley Systems is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3.) 
 WACC                                                               10.0%
Net investment in fixed assets (basis)                            $75,000
Required net operating working capital                           $15,000
Straight-line depreciation rate                                  33.333%
Annual sales revenues                                            $75,000
Annual operating costs (excl. depreciation)                       $25,000
Tax rate                                                           35.0%

Accepted Answer

A)  $23,852
B)  $25,045
C)  $26,297
D)  $27,612
E)  $28,993F) A) and E)
G) B) and E)

Question 7

Dalrymple Inc.is considering production of 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 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.
B)  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.
C)  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.
D)  The new product will cut into sales of some of the firm's other products.
E)  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.F) A) and C)
G) B) and E)

Question 8

cash flows that can be classified as incremental to a particular project--i.e., results directly from the decision to undertake the project--should be reflected in the capital budgeting analysis.

Accepted Answer

A) True 
 B)False

Question 9

debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  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.
B)  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.
C)  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.
D)  Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified.However, the payback method does not.
E)  Identifying an externality can never lead to an increase in the calculated NPV.F) D) and E)
G) B) and C)

Question 11

Thomson Media is considering some new equipment whose data are shown below.The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down.Also, some new working capital would be required, but it would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV?
  WACC 10.0% Net investment in fixed assets (depreciable basis)  $70,000 Required net operating working capital $10,000 Straight-line depreciation rate 33.333% Annual sales revenues $57,000 Annual operating costs (excl. depreciation)  $30,000 Expected pre-tax salvage value $5,000 Tax rate 35.0%\begin{array} { | l | l | } \hline 	ext { WACC } & 10.0 \% \\hline 	ext { Net investment in fixed assets (depreciable basis)  } & \$ 70,000 \\hline 	ext { Required net operating working capital } & \$ 10,000 \\hline 	ext { Straight-line depreciation rate } & 33.333 \% \\hline 	ext { Annual sales revenues } & \$ 57,000 \\hline 	ext { Annual operating costs (excl. depreciation)  } & \$ 30,000 \\hline 	ext { Expected pre-tax salvage value } & \$ 5,000 \\hline 	ext { Tax rate } & 35.0 \% \\hline\end{array} WACC  Net investment in fixed assets (depreciable basis)   Required net operating working capital  Straight-line depreciation rate  Annual sales revenues  Annual operating costs (excl. depreciation)   Expected pre-tax salvage value  Tax rate ​10.0%$70,000$10,00033.333%$57,000$30,000$5,00035.0%​​

Accepted Answer

A)  $20,762
B)  $21,854
C)  $23,005
D)  $24,155
E)  $25,363 F) A) and B)
G) A) and C)

Question 12

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 13

Which of the following statements is CORRECT?

Accepted Answer

A)  Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.
B)  In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV.
C)  The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator.
D)  Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values.
E)  As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis.F) C) and D)
G) B) and D)

Exam 11: Cash Flow and Risk

Which of the following statements is CORRECT?

Correct Answer
verified

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
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Correct Answer
verified

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

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

cash flows that can be classified as incremental to a particular project--i.e., results directly from the decision to undertake the project--should be reflected in the capital budgeting analysis.

Correct Answer
verified

Dalrymple Inc.is considering production of 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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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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Exam 11: Cash Flow and Risk

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

cash flows that can be classified as incremental to a particular project--i.e., results directly from the decision to undertake the project--should be reflected in the capital budgeting analysis.

Correct AnswerverifiedShow Answer

Dalrymple Inc.is considering production of 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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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