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Liberty Services is now at the end of the final year of a project. The equipment originally cost $22,500, of which 75% has been depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale.


A) $5,558
B) $5,850
C) $6,143
D) $6,450
E) $6,772

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

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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.
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.

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

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Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? Clemson Software is considering a new project whose data are shown below. The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year 1 cash flow? A) $28,115 B) $28,836 C) $29,575 D) $30,333 E) $31,092


A) $28,115
B) $28,836
C) $29,575
D) $30,333
E) $31,092

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

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

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

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Which of the following statements is CORRECT?


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.

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

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Rowell 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. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT?


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.

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

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Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. No new working capital would be required. Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV decline? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.) Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. No new working capital would be required. Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV decline? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.) A) $28,939 B) $30,462 C) $32,066 D) $33,753 E) $35,530


A) $28,939
B) $30,462
C) $32,066
D) $33,753
E) $35,530

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

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Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward, thus increasing their present value. On the other hand, using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses. However, the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

A) True
B) False

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As assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow? As assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow? A) $5,950 B) $6,099 C) $6,251 D) $6,407 E) $6,568


A) $5,950
B) $6,099
C) $6,251
D) $6,407
E) $6,568

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

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Dalrymple Inc. is considering production of 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 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.
B) 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.
C) 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.
D) The new product will cut into sales of some of the firm's other products.
E) 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.

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

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If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

A) True
B) False

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In 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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Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? A) $15,740 B) $16,569 C) $17,441 D) $18,359 E) $19,325


A) $15,740
B) $16,569
C) $17,441
D) $18,359
E) $19,325

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

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As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data. What is the Year 1 cash flow? As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data. What is the Year 1 cash flow? A) $16,351 B) $17,212 C) $18,118 D) $19,071 E) $20,075


A) $16,351
B) $17,212
C) $18,118
D) $19,071
E) $20,075

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

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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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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 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.

F) All of the above
G) B) and D)

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The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant.

A) True
B) False

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Which of the following statements is CORRECT?


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

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

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Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?


A) Project A, which has average risk and an IRR = 9%.
B) Project B, which has below-average risk and an IRR = 8.5%.
C) Project C, which has above-average risk and an IRR = 11%.
D) Without information about the projects' NPVs we cannot determine which project(s) should be accepted.
E) All of these projects should be accepted.

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

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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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