Answer:
a) True
Question: Which of the following statements is CORRECT?
Answer Choices:
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: Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce
Answer Choices:
a. Higher depreciation charges in the early years of an asset’s life.
b. Larger cash flows in the earlier years of an asset’s life.
c. Larger total uncounted profits from the project over the project’s life.
d. Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes.
e. Lower tax payments in the earlier years of an asset’s life.
Answer:
c. Larger total uncounted profits from the project over the project’s life.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
b. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
c. A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices.
d. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.
e. If sunk costs are considered and reflected in a project’s cash flows, then the project’s calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored.
Answer:
d. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.
Question: The following are all examples of real options that are discussed in the text: (1) protection options, (2) flexibility options, (3) timing options, and (4) abandonment options. True False
Answer:
b. False
Question: 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. True False
Answer:
a) True
Question: The following are all examples of real options that are discussed in the text: (1) natural resource options, (2) flexibility options, (3) timing options, and (4) abandonment options. True False
Answer:
b. False
Question: 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. True False
Answer:
a) True
Question: The phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive projects that have different lives are being compared. True False
Answer:
b) False
Question: When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated. True False
Answer:
b) False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Projects with “normal” cash flows can have only one real IRR.
b. Projects with “normal” cash flows can have two or more real IRRs.
c. Projects with “normal” cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is “nonnormal.”
d. The “multiple IRR problem” can arise if a project’s cash flows are “normal.”
e. Projects with “nonnormal” cash flows are almost never encountered in the real world.
Answer:
a) Projects with “normal” cash flows can have only one real IRR.
Question: The relative risk of a proposed project is best accounted for by which of the following procedures?
Answer Choices:
a. Adjusting the discount rate upward if the project is judged to have above-average risk.
b. Adjusting the discount rate upward if the project is judged to have below-average risk.
c. Reducing the NPV by 10% for risky projects.
d. Picking a risk factor equal to the average discount rate.
e. Ignoring risk because project risk cannot be measured accurately.
Answer:
a. Adjusting the discount rate upward if the project is judged to have above-average risk.
Question: Any cash flows that can be classified as incremental to a particular project—i.e., results directly from the decision to undertake the project—should be reflected in the capital budgeting analysis. True False
Answer:
a) True
Question: The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault. True False
Answer:
b) False
Question: The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects’ IRRs are greater than their costs of capital. True False
Answer:
b) False
Question: Which of the following factors should be included in the cash flows used to estimate a project’s NPV?
Answer Choices:
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: Which of the following statements is CORRECT?
Answer Choices:
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 than sensitivity analysis.
Answer:
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.
Question: Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets. They then provide funds to their different divisions for investment in capital projects. The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects.
Answer Choices:
a. True
b. False
Answer:
a. True