Which of the Following Rules Is Correct for Capital Budgeting

Question 44

Multiple Choice

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

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Q 45

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

Q 46

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 firm has a parcel of land that can be used for a new plant site or be sold,rented,or used for agricultural purposes. B) 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. C) A firm must obtain new equipment for the project,and $1 million is required for shipping and installing the new machinery. D) A firm has spent $2 million on research and development 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. E) A firm can produce a new product,and the existence of that product will stimulate sales of some of the firm's other products.

Q 47

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) 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. B) Revenues from an existing product would be lost as a result of customers switching to the new product. C) Shipping and installation costs associated with a machine that would be used to produce the new product. D) 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. E) 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.