Answer Options:
a. If an asset is sold for less than its book value at the end of a project’s life, it will generate a loss for the firm, thus reducing its taxable income and resulting in a tax credit.
b. If an asset is sold for more than its book value at the end of a project’s life, it will generate a gain for the firm, thus increasing its taxable income and resulting in a tax payment.
c. If an asset is sold for its book value at the end of a project’s life, it will be a tax-neutral event for the firm.
d. Taxes should be ignored when calculating the terminal year cash flow of an asset at the end of a project’s life because they are considered to be a sunk cost.
e. Taxes on a gain from the sale of an asset are paid in the year following the sale.
Answer: B. If an asset is sold for more than its book value at the end of a project’s life, it will generate a gain for the firm, thus increasing its taxable income and resulting in a tax payment.
Question: Which of the following statements is CORRECT?
Answer Options:
a. An NPV profile graph shows how a project’s payback varies as the cost of capital changes.
b. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
c. An NPV profile graph is designed to give decision makers an idea about how a project’s risk varies with its life.
d. An NPV profile graph is designed to give decision makers an idea about how a project’s contribution to the firm’s value varies with the cost of capital.
e. We cannot draw a project’s NPV profile unless we know the appropriate WACC for use in evaluating the project’s NPV.
Answer: D. An NPV profile graph is designed to give decision makers an idea about how a project’s contribution to the firm’s value varies with the cost of capital.
Question: The phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive projects that have different lives are being compared.
Answer Options:
a. True
b. False
Answer: False
Question: The NPV method is based on the assumption that projects’ cash flows are reinvested at the project’s risk-adjusted cost of capital.
Answer Options:
a. True
b. False
Answer: True
Question: Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives, it is not used in practice because not projects meet the assumptions the method requires.
Answer Options:
a. True
b. False
Answer: A. True
Question: 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.
Answer Options:
a. True
b. False
Answer: A. True
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.
Answer Options:
a. True
b. False
Answer: A. True
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.
Answer Options:
a. True
b. False
Answer: B. False
Question: Which of the following statements is CORRECT?
Answer Options:
a. The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project’s profitability.
b. If the cost of capital declines, this lowers a project’s NPV.
c. The NPV method is regarded by most academics as being the best indicator of a project’s profitability, hence most academics recommend that firms use only this one method and disregard other methods.
d. A project’s NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project’s life.
e. The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.
Answer: E. The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.
Question: Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital budgeting projects.
Answer Options:
a. True
b. False
Answer: B. False
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: Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?
Answer Options:
a. Lacks an objective, market-determined benchmark for making decisions.
b. Ignores cash flows beyond the payback period.
c. Does not directly account for the time value of money.
d. Does not provide any indication regarding a project’s liquidity or risk.
e. Does not take account of differences in size among projects.
Answer: D. Does not provide any indication regarding a project’s liquidity or risk.