Question 1

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? Seles revenues  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp; $\$ 22,250$
Depreciation  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp; $\$ 18,000 $
Other aperating casts  &emsp;  &emsp;  &emsp;  &emsp;  $\$ 12000$
Tax rate   &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  $35 \%$
A) $8,903
B) $9,179
C) $9,463
D) $9,746
E) $10,039

Accepted Answer

11ea42d0_c092_fab4_9abf_1b5e67635553_TB2090_00

Question 2

Which of the following statements is CORRECT?
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.

Accepted Answer

An externality refers to a situation where the actions of a firm or project have an impact on parties not directly involved in the transaction. The example given in choice A, where a bank's new office increases deposits in its other offices, is an example of a positive externality affecting the bank's other operations.

Question 3

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

Accepted Answer

Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. This means that any cash flows that would occur regardless of whether or not the project is accepted are not considered in the analysis. Only the additional or incremental cash flows that result from the project are relevant.

Question 4

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

Accepted Answer

Previous expenditures, such as costs associated with a market test that have already been expensed for tax purposes, are considered sunk costs and should not be included in the projected cash flows of a new project.

Question 5

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?
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.

Accepted Answer

Sunk costs, such as the $3 million already spent and expensed for tax purposes on research, should not be considered in the evaluation of future projects because these costs cannot be recovered and do not affect the future cash flows of the new project.

Question 6

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? Srles reyenues  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp; $\$ 13,000$
Depreciation &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  &emsp;$\$44,000$
Other aperating casts &emsp;&emsp;&emsp;&emsp;&emsp;&emsp; $\$6,000$
Tax rate &emsp;  &emsp;  &emsp;  &emsp;  &emsp; &emsp;  &emsp;  &emsp;  &emsp;  &emsp;  $350 \%$
A) $5,950
B) $6,099
C) $6,251
D) $6,407
E) $6,568

Accepted Answer

11ea42d0_c092_fab2_9abf_39783ddfd05d_TB2090_00

Question 7

To increase productive capacity,a company is considering a proposed new plant.Which of the following statements is CORRECT?
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 WACC 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 WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

Accepted Answer

Financing costs are accounted for in the discount rate (WACC), so they should not be deducted from operating cash flows to avoid double counting.

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 WACC of 8%,average-risk projects at 10%,and high-risk projects at 12%.The company is considering the following projects: 
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.

Accepted Answer

Statement b is true; the others are false.The following table shows the required return for each project on the basis of its risk level. 11ea42d0_c092_8580_9abf_05a1900b17dd_TB2090_00

Question 9

Wansley Enterprises is considering a new project.The company has a beta of 1.0,and its sales and profits are positively correlated with the overall economy.The company estimates that the proposed new project would have a higher standard deviation and coefficient of variation than an average company project.Also,the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.On the basis of this information,which of the following statements is CORRECT?
A) The proposed new project would increase the firm's corporate risk.
B) The proposed new project would increase the firm's market risk.
C) The proposed new project would not affect the firm's risk at all.
D) The proposed new project would have less stand-alone risk than the firm's typical project.
E) The proposed new project would have more stand-alone risk than the firm's typical project.

Accepted Answer

Statement e is true because the project has a relatively high standard deviation and thus more stand-alone risk than average.The project's revenues would be countercyclical to the rest of the firm's and to other firms' revenues,hence its within-firm and market risks would be relatively low.

Question 10

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?
A) 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.
B) The company has spent and expensed $1 million on R&D associated with the new project.
C) The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
D) 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.
E) The new project is expected to reduce sales of one of the company's existing products by 5%.

Accepted Answer

The answer of Which of the following should be considered...

Question 11

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: 
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?
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.

Accepted Answer

Statement b is true,while the other statements are false.Stand-alone risk is measured by standard deviation.Therefore,since Y's standard deviation is higher than X's,Y has higher stand-alone risk than X.Statement a is false because corporate risk is affected by the correlation of project cash flows with other company cash flows,and since Y's cash flows are more highly correlated with the cash flows of existing projects than X's,Y has more corporate risk than X.Market risk is measured by beta.Therefore,since X's beta is greater than Y's,statement b is true.

Question 12

Which of the following statements is CORRECT?
A) 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.
B) 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.
C) 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.
D) As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis.
E) Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Accepted Answer

Sensitivity analysis examines how changes in input variables affect the outcome (e.g., NPV) but does not typically account for the likelihood of these changes occurring, making it incomplete in terms of risk assessment.

Question 13

While developing a new product line,Cook Company spent $3 million two years ago to build a plant for a new product.It then decided not to go forward with the project,so the building is available for sale or for a new product.Cook owns the building free and clear-there is no mortgage on it.Which of the following statements is CORRECT?
A) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.
B) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.
C) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.
D) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
E) Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project.

Accepted Answer

The opportunity cost of using the building for a new project is the after-tax proceeds from selling it, which should be considered in the project's evaluation.

Question 14

Which of the following statements is CORRECT?
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.

Accepted Answer

Simulation analysis is a computerized version of scenario analysis where input variables are randomly selected based on their probability distributions, making it more accurate and realistic compared to scenario analysis. The other statements are incorrect.

Question 15

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?
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.

Accepted Answer

The cost of the study was already incurred and expensed for tax purposes last year, so it does not result in any incremental cash flows for the current project. A, B, D, and E all involve real cash flows that need to be considered in the capital budgeting analysis.

Question 16

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 a downward bias in the NPV.
B) The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality.
C) 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 after-tax proceeds that could be obtained should be charged as a cost to the project under consideration.
D) 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.
E) 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.

Accepted Answer

Regarding e and a,note that since interest should not be considered,exclusion will not lead to any type of bias,positive or negative.

Question 17

A firm is considering a new project whose risk is greater than the risk of the firm's average project,based on all methods for assessing risk.In evaluating this project,it would be reasonable for management to do which of the following?
A) Increase the estimated NPV of the project to reflect its greater risk.
B) Reject the project, since its acceptance would increase the firm's risk.
C) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets.
D) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
E) Increase the estimated IRR of the project to reflect its greater risk.

Accepted Answer

To account for the higher-than-average risk of the new project, the cost of capital used to evaluate the project should be increased. This reflects the fact that investors would require a higher return to compensate for the higher risk. Option A is not appropriate, as increasing the estimated NPV would not reflect the higher risk, and option E is incorrect as increasing the estimated IRR would not necessarily reflect the higher risk. Option B is not necessarily the best choice, as rejecting the project solely based on its higher risk may result in missed opportunities for growth and higher returns. Option C is also not appropriate, as the relative size of the project is not the only factor to consider when assessing risk.

Question 18

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?
A) 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.
B) 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.
C) 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 a sensitivity analysis, hence simulation is the most frequently used procedure.
D) 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.
E) 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.

Accepted Answer

DCF techniques do not account for real options, which are valuable opportunities that can alter cash flows after an investment is made. Real options must be considered separately in capital budgeting analyses.

Question 19

Which of the following statements is CORRECT?
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.

Accepted Answer

This statement is correct because selling an asset for more than its book value at the end of a project's life will result in a profit, which will increase the end-of-project cash flow despite taxes on the profit. Therefore, it should be considered in a capital budgeting analysis.

Question 20

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?
A) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products.
B) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery.
C) A firm has spent $2 million on R&D associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.
D) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.
E) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.

Accepted Answer

R&D expenses have already been expensed and cannot be recovered, therefore they do not represent incremental cash flows and should not be included in the capital budgeting analysis. A, B, D, and E all represent potential incremental cash flows that would need to be considered in the analysis.

Quiz 11: Cash Flow Estimation and Risk Analysis

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? Seles revenues $\$ 22,250$ Depreciation $\$ 18,000$ Other aperating casts $\$ 12000$ Tax rate $35 \%$

Which of the following statements is CORRECT?

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

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

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?

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? Srles reyenues $\$ 13,000$ Depreciation $\$44,000$ Other aperating casts $\$6,000$ Tax rate $350 \%$

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

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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?

Which of the following statements is CORRECT?

A firm is considering a new project whose risk is greater than the risk of the firm's average project,based on all methods for assessing risk.In evaluating this project,it would be reasonable for management to do which of the following?

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Which of the following statements is CORRECT?

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?

Quiz 11: Cash Flow Estimation and Risk Analysis

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? Seles revenues $22,250\$ 22,250$22,250 Depreciation $18,000\$ 18,000 $18,000 Other aperating casts $12000\$ 12000$12000 Tax rate 35%35 \%35%

Which of the following statements is CORRECT?

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

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

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?

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

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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?

Which of the following statements is CORRECT?

A firm is considering a new project whose risk is greater than the risk of the firm's average project,based on all methods for assessing risk.In evaluating this project,it would be reasonable for management to do which of the following?

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Which of the following statements is CORRECT?

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?

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? Seles revenues $\$ 22,250$ Depreciation $\$ 18,000$ Other aperating casts $\$ 12000$ Tax rate $35 \%$