Answer Choices:
a. The new project is expected to capture sales of one of the company’s existing products by 5%.
b. Since the firm’s director of capital budgeting spent some of their 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.
c. The company has spent and expensed $1 million on research and development costs associated with the new project.
d. The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
e. 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.
Answer:
a. The new project is expected to capture sales of one of the company’s existing products by 5%.
Question: Which of the following statements is CORRECT?
Answer Choices:
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 increase.
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.
Answer:
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 increase.
Question: Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher NPV. True False
Answer:
a) True
Question: The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater. True False
Answer:
b) False
Question: Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project’s life. True False
Answer:
a) True
Question: 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.
Answer:
Options
Question: 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. True False
Answer:
a) True
Question: Extending the lives of projects with different lives out to a common life for comparison purposes, while theoretically appealing, is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.
Answer:
Options
Question: 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?
Answer Choices:
a. The following item is not provided in the images supplied. However, if it is a sunk cost, it should not be considered.
Answer:
a. The following item is not provided in the images supplied. However, if it is a sunk cost, it should not be considered.
Question: Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects’ initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects. True False
Answer:
b) False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Answer:
d) The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Question: The two cardinal rules that financial analysts should follow to avoid 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 for capital budgeting projects.
Answer:
Options
Question: Real options can affect the size of a project’s expected NPV but not project’s risk as measured by the standard deviation or coefficient of variation of the NPV. True False
Answer:
b. False