Answer Choices:
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.
Answer:
e
Question: Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: A company is considering a new project. The CFO plans to calculate the 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 flows), 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?
Answer Choices:
a. All sunk costs that have been incurred relating to the project.
b. All interest expenses on debt used to help finance the project.
c. The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project’s life.
d. Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year.
e. Effects of the project on other divisions of the firm, but only if those effects lower the project’s own direct cash flows.
Answer:
c
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer:
e
Question: 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?
Answer Choices:
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.
Answer:
d
Question: Which of the following rules is CORRECT for capital budgeting analysis?
Answer Choices:
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 for capital budgeting projects.
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.
Answer:
b
Question: Which of the following statements is CORRECT?
Answer Choices:
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 they use accelerated depreciation, firms 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.
Answer:
e
Question: If 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.
Answer Choices:
a. True
b. False
Answer:
a. True
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.
Answer Choices:
a. True
b. False
Answer:
b. False
Question: Traditionally, an NPV analysis assumes that projects will be accepted or rejected, which implies that they will be undertaken now or never. However, in practice, companies sometimes have at least one additional year from the original analysis, it is unlikely that the firm would ever delay a project—particularly given the loss of the “first mover advantage.”
Answer Choices:
a. True
b. False
Answer:
b. False
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
Question: When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:
Answer Choices:
a. Changes in net operating working capital attributable to the project.
b. Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.
c. The value of a building owned by the firm that will be used for this project.
d. A decline in the sales of an existing product, provided that decline is directly attributable to this project.
e. The salvage value of assets used for the project that will be recovered at the end of the project’s life.
Answer:
b
Question: Weisbach Electronics is considering investing in India. Which of the following factors would make the company less likely to proceed with the investment?
Answer Choices:
a. The company would have the option to withdraw from the investment after 2 years if it turns out to be unprofitable.
b. The investment would increase the odds of the company being able to subsequently make a successful entry into China.
c. The investment would preclude the company from being able to make a profitable investment in China.
d. Competitors are considering similar investments in India, and the firm can discourage them from trying by entering now.
e. The new plant could be easily retrofitted to manufacture many of the firm’s other products.
Answer:
c