Answer Options:
a. The proposed new project would have more stand-alone risk than the firm’s typical project.
b. The proposed new project would increase the firm’s corporate risk.
c. The proposed new project would increase the firm’s market risk.
d. The proposed new project would not affect the firm’s risk at all.
e. The proposed new project would have less stand-alone risk than the firm’s typical project.
Answer: A. The proposed new project would have more stand-alone risk than the firm’s typical project.
Question: A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.
Answer Options:
a. True
b. False
Answer: A. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. For a project to have more than one IRR, then both IRRs must be greater than the WACC.
b. If two projects are mutually exclusive, then they are likely to have multiple IRRs.
c. If a project is independent, then it cannot have multiple IRRs.
d. Multiple IRRs can only occur if the signs of the cash flows change more than once.
e. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.
Answer: D. Multiple IRRs can only occur if the signs of the cash flows change more than once.
Question: Which of the following statements is CORRECT?
Answer Options:
a. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
b. To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.
Answer: A. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
Question: Other things held constant, which of the following would increase the NPV of a project being considered?
Answer Options:
a. A shift from straight-line to MACRS depreciation.
b. Making the initial investment in the first year rather than spreading it over the first three years.
c. An increase in the discount rate associated with the project.
d. An increase in required net operating working capital.
e. The project would decrease sales of another product line.
Answer: A. A shift from straight-line to MACRS depreciation.
Question: Which of the following factors should be included in the cash flows used to estimate a project’s NPV?
Answer Options:
a. All costs associated with the project that have been incurred prior to the time the analysis is being conducted.
b. Interest on funds borrowed to help finance the project.
c. The end-of-project recovery of any additional net operating working capital required to operate the project.
d. Cannibalization effects, but only if those effects increase the project’s projected cash flows.
e. Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.
Answer: C. The end-of-project recovery of any additional net operating working capital required to operate the project.
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 Options:
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. 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.
Question: Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.
Answer Options:
a. True
b. False
Answer: B. False
Question: 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.
Answer Options:
a. True
b. False
Answer: B. False
Question: Which of the following statements is CORRECT?
Answer Options:
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. 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.
Question: Which of the following statements is CORRECT?
Answer Options:
a. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.
b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
c. Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
d. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project’s forecasted NPV.
e. Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project’s forecasted NPV.
Answer: D. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project’s forecasted NPV.
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:
a. True
b. False
Answer: B. False
Question: 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?
Answer Options:
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 one or ones should be accepted.
Answer: D. Without information about the projects’ NPVs we cannot determine which one or ones should be accepted.
Question: If a firm practices capital rationing, this means that it is accepting fewer projects than would be theoretically optimal; hence, it is not maximizing its theoretical value.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. The MIRR and NPV decision criteria can never conflict.
b. The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
c. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
d. The higher the WACC, the shorter the discounted payback period.
e. The MIRR method assumes that cash flows are reinvested at the crossover rate.
Answer: C. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
Question: The true expected value of a project with a growth option is the expected NPV of the project (including the value of the option) less the cost of obtaining that option.
Answer Options:
a. True
b. False
Answer: A. True