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Which of the following statements is CORRECT?


A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
B) Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
C) Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
D) Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.
E) Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV.

F) A) and B)
G) A) and C)

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Which of the following procedures best accounts for the relative risk of a proposed project?


A) Adjusting the discount rate downward if the project is judged to have above-average risk.
B) Reducing the NPV by 10% for risky projects.
C) Picking a risk factor equal to the average discount rate.
D) Ignoring risk because project risk cannot be measured accurately.
E) Adjusting the discount rate upward if the project is judged to have above-average risk.

F) B) and E)
G) A) and E)

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McPherson Company must purchase a new milling machineThe purchase price is $50,000, including installationThe machine has a tax life of 5 years, and it can be depreciated according to the following rates The firm expects to operate the machine for 4 years and then to sell it for $12,500 If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4?


A) $ 8,878
B) $ 9,345
C) $ 9,837
D) $10,355
E) $10,900

F) A) and E)
G) A) and D)

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Collins Incis 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.

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

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Wansley Enterprises is considering a new projectThe 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.

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

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change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required This situation is especially true for replacement projects.

A) True
B) False

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CFO of Cicero Industries plans to calculate a new project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow) , then discounting those cash flows at the company's overall WACC Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?


A) All interest expenses on debt used to help finance the project.
B) The investment in working capital required to operate the project, even if that investment will be recovered at the end of the project's life.
C) Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year.
D) Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.
E) All sunk costs that have been incurred relating to the project.

F) A) and D)
G) A) and E)

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cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows.

A) True
B) False

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Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

A) True
B) False

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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.

F) B) and E)
G) None of the above

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Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?


A) Shipping and installation costs.
B) Cannibalization effects.
C) Opportunity costs.
D) Sunk costs that have been expensed for tax purposes.
E) Changes in net working capital.

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

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Which of the following statements is CORRECT?


A) A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.
B) A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.
C) Sunk costs were formerly hard to deal with but now that the NPV method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the PV of the project.
D) A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.
E) A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.

F) All of the above
G) A) and C)

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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.

A) True
B) False

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Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

A) True
B) False

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Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision--estimates of its effect would really just be guesses In this case, the externality should be ignored--i.e., not considered at all--because if it were considered it would make the analysis appear more precise than it really is.

A) True
B) False

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Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

A) True
B) False

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Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

A) True
B) False

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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.

F) None of the above
G) D) and E)

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an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.

A) True
B) False

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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%.

F) B) and E)
G) B) and D)

Correct Answer

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