Question 1

What is the effect on a firm's net working capital if a new project requires a $30,000 increase in inventory,a $10,000 increase in accounts receivable,a $35,000 expenditure on machinery,and a $20,000 increase in accounts payable?

Accepted Answer

Change in NWC = $30,000 + 10,000 − 20,000 = $20,000

Question 2

Which one of the following is least likely to influence the opportunity cost of an asset?

Accepted Answer

The current book value of an asset is based on its historical cost and accumulated amortization or depreciation, which do not directly affect its opportunity cost. The opportunity cost is determined by comparing the returns of the asset to the returns of other available investments or alternatives, which are influenced by factors such as its current market value, alternative uses, and demand.

Question 3

Assume your firm has an unused machine that originally cost $75,000,has a book value of $20,000,and a market value of $25,000.Ignoring taxes,what is the opportunity cost of using this machine?

Accepted Answer

The opportunity cost is the market value of the machine, which is $25,000, as it represents the amount you could receive if you sold the machine instead of using it.

Question 4

Cash flow from operations = (revenues − cash expenses)× (1 − tax rate)+ (depreciation × tax rate).

Accepted Answer

The formula for cash flow from operations is correct and includes adjustments for taxes and depreciation.

Question 5

Which one of the following changes in working capital is least likely if sales increase?

Accepted Answer

An increase in sales should lead to an increase in accounts receivable because more customers are buying on credit, which means they owe the company money. Increases in inventories (A) may occur as the company produces more to meet demand, and an increase in accounts payable (B) may occur as the company buys more materials or inventory on credit. However, a decrease in accounts receivable (C) would be unlikely in this scenario. An increase in notes payable (D) may occur if the company needs to borrow money to finance the growth in sales.

Question 6

Investments in working capital:

Accepted Answer

Investments in working capital reduce project NPV because they represent cash outflows that are not immediately recovered, thus reducing the present value of the project's cash flows.

Question 7

You are considering the introduction of a new product that will require an investment in new machinery.Which one of these will lower the net present value of that project?

Accepted Answer

The loss of sales of existing products due to the introduction of the new product will lower the net present value of the project because it will decrease the overall revenue of the firm. The other options will either reduce costs (A) or have no effect on the net present value (C, D).

Question 8

The opportunity cost of an asset:

Accepted Answer

The opportunity cost is the potential benefit that is foregone by choosing one option over another. In capital budgeting, it is important to consider the opportunity cost of an asset as it represents the potential return that could have been earned if the asset was invested in a different project or opportunity. Therefore, it should be included in the project cash flows to provide a comprehensive analysis of the potential returns of a capital investment.

Question 9

A project is expected to increase inventory by $17,000,increase accounts payable by $10,000,and decrease accounts receivable by $1,000.What is the project's cash flow from net working capital at time zero?

Accepted Answer

Cash flow₀ = −$17,000 + 10,000 + 1,000 = −$6,000

Question 10

Corporate income statements are designed primarily to show:

Accepted Answer

Corporate income statements are designed to show the performance of a company during a certain period, usually a quarter or a year. It shows the revenue earned, expenses incurred, and net profit or loss generated during that time. It does not show cash flows or account balances at the end of the period, nor does it show market values of assets and liabilities.

Question 11

In which of the following cases will a cash investment in net working capital be most likely?

Accepted Answer

An increase in inventory more than accounts payable will require additional cash investment in net working capital to fund the increase in inventory. The other choices do not necessarily require a cash investment in net working capital.

Question 12

Projects that have negative NPVs should be:

Accepted Answer

Projects that have negative NPVs should be rejected or abandoned as they are not expected to generate enough cash flows to cover the initial investment and provide returns to the investors. Continuing with such projects can lead to significant financial losses for the organization.

Question 13

If the adoption of a new product will reduce the sales of an existing product,then the project cash flows should:

Accepted Answer

The project cash flows should be reduced by the cash that would have been generated by the sales of the existing product that is expected to be cannibalized by the new product. This is because the new product's sales would come at the expense of the existing product's sales, resulting in a net loss for the company. Therefore, the cash flows should reflect the true impact on the company's overall revenue.

Question 14

The rationale for not including sunk costs in capital budgeting decisions is that they:

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered. Since they are not relevant to future cash flows or the incremental impact of a project, they should not be considered in capital budgeting decisions. Including sunk costs would reduce the project's net present value, which would be a mistake. Therefore, the best choice is C.

Question 15

When is it appropriate to include sunk costs in the evaluation of a project?

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, therefore they should not be considered in evaluating a project's potential profitability. Only future costs and benefits should be taken into account.

Question 16

The total depreciation tax shield equals the product of depreciation and the tax rate.

Accepted Answer

This statement is true. The depreciation tax shield refers to the tax savings that a company receives due to the tax deduction it receives for the depreciation expense on its assets. The amount of the tax shield is equal to the amount of depreciation multiplied by the company's tax rate.

Question 17

A proposed project requires an initial investment of $8,500 in current assets,75% of which will be financed with accounts payable.The project will have:

Accepted Answer

The initial investment in current assets is $8,500, but 75% is financed with accounts payable, meaning only 25% ($2,125) is the actual cash outflow at time zero. At the end of the project, the net working capital is recovered, resulting in a cash inflow.

Question 18

A firm invests in a 7-year project that requires the purchase of a $135,000 machine tool.This will be depreciated using 5-year MACRS and will have no salvage value.When will this equipment affect the project's tax payments?

Accepted Answer

The equipment will be depreciated using 5-year MACRS, so it will affect the project's tax payments for 6 years (the first year of depreciation is included in the year of purchase). Therefore, the correct answer is C – every year for 6 years.

Question 19

Net working capital is expected to increase by $25,000 in year 5 of a project.If this extra working capital is recovered when the project ends in year 6,what is the effect on the project's net present value,if the cost of capital is 15%?

Accepted Answer

ΔNPV = −$25,000 / 1.15⁵ + 25,000 / 1.15⁶ = $1,621.23

Question 20

Which one of these represents a cash outflow for a project?

Accepted Answer

Increase in accounts receivable represents a decrease in cash. When accounts receivable increase, it means the company has provided goods or services but has not yet received payment, resulting in a cash outflow. A sunk cost (A) is a cost that has already been incurred and cannot be recovered. Depreciation (C) is a non-cash expense that represents the decline in value of an asset over time. Accrued expenses (D) represent expenses that have been incurred but not yet paid, so they do not represent a cash outflow at the time they are accrued.

Quiz 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions