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VR Corporation has the opportunity to invest in a new project, the details of which are shown below.What is the Year 1 cash flow for the project? VR Corporation has the opportunity to invest in a new project, the details of which are shown below.What is the Year 1 cash flow for the project? 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) None of the above
G) A) and D)

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Garden-Grow Products is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3.) Garden-Grow Products is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3.) A) $23, 852 B) $25, 045 C) $26, 297 D) $27, 612 E) $28, 993


A) $23, 852
B) $25, 045
C) $26, 297
D) $27, 612
E) $28, 993

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

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

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

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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 D)
G) A) and C)

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

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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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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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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 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.
B) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery.
C) A firm has spent $2 million on R&D 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.
D) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.
E) 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.

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

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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 precision¾estimates of its effect would really just be guesses.In this case, the externality should be ignored¾i.e., not considered at all¾because if it were considered it would make the analysis appear more precise than it really is.

A) True
B) False

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

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Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process.Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

A) True
B) False

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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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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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McPherson Company must purchase a new milling machine.The purchase price is $50, 000, including installation.The 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? McPherson Company must purchase a new milling machine.The purchase price is $50, 000, including installation.The 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


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

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

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Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?


A) 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.
B) 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.
C) 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.
D) DCF techniques were originally developed to value passive investments (stocks and bonds) .However, capital budgeting projects are not passive investments¾managers 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.
E) 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.

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

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Spot-Free 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.) Spot-Free 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) B) and C)
G) A) and D)

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We can identify the cash costs and cash inflows to a company that will result from a project.These could be called "direct inflows and outflows, " and the net difference is the direct net cash flow.If there are other costs and benefits that do not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of the capital budgeting analysis.

A) True
B) False

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The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

A) True
B) False

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Erickson Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?


A) 1.20
B) 1.26
C) 1.32
D) 1.39
E) 1.46

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

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The two cardinal rules that financial analysts should follow to avoid capital budgeting errors are: (1)in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2)all incremental cash flows should be considered when making accept/reject decisions.

A) True
B) False

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