A) 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.
B) 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.
C) 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.
D) 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.
E) 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.
G) C) and E)
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A) $16,351
B) $17,212
C) $18,118
D) $19,071
E) $20,075
G) All of the above
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B) False
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A) 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.
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
C) 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.
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 lower than they would be if straight-line depreciation were required for tax purposes.
E) 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.
G) B) and C)
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A) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.
B) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
C) Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
D) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
E) Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project.
G) C) and E)
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A) $5,950
B) $6,099
C) $6,251
D) $6,407
E) $6,568
G) A) and B)
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B) False
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A) Increase the estimated IRR of the project to reflect its greater risk.
B) Increase the estimated NPV of the project to reflect its greater risk.
C) Reject the project, since its acceptance would increase the firm's risk.
D) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets.
E) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
G) D) and E)
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A) $3,636
B) $3,828
C) $4,019
D) $4,220
E) $4,431
G) A) and C)
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A) 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.
B) 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.
C) 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.
D) 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.
E) 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.
G) C) and E)
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A) $13,286
B) $13,985
C) $14,721
D) $15,457
E) $16,230
G) B) and E)
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B) False
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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.
G) C) and D)
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A) $11,814
B) $12,436
C) $13,090
D) $13,745
E) $14,432
G) C) and D)
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A) $15,740
B) $16,569
C) $17,441
D) $18,359
E) $19,325
G) C) and D)
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B) False
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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 decline.
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.
G) B) and E)
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A) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors.Thus, cannibalization is dealt with by society through the antitrust laws.
B) If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers.Thus, cannibalization is dealt with by society through the antitrust laws.
C) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects.Otherwise, the calculated NPV will be biased downward.
D) If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized.
E) Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.
G) A) and B)
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A) Adjusting the discount rate upward if the project is judged to have above-average risk.
B) Adjusting the discount rate downward if the project is judged to have above-average risk.
C) Reducing the NPV by 10% for risky projects.
D) Picking a risk factor equal to the average discount rate.
E) Ignoring risk because project risk cannot be measured accurately.
G) D) and E)
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A) $55.08
B) $57.98
C) $61.03
D) $64.08
E) $67.29
G) B) and E)
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