Answer: b
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 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 undiscounted 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
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. a. True b. False
Answer: b
Question: Which of the following statements is CORRECT? 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. Constructing a NPV sensitivity analysis involves the one with the steeper lines would be considered less risky, because two 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
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. a. True b. False
Answer: a
Question: Which of the following statements is CORRECT? 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, hence its terminal cash flow will be negative. b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions. c. It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project’s completion. Operating working capital like inventory is almost always used up in operations. Thus, cash flows associated with operating working capital should be included only at the start of a project’s life. d. If equipment is expected to be sold for more than its book value at the end of a project’s life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant. e. Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities, hence they should not be considered in a capital budgeting analysis.
Answer: d
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.
Answer Options:
a. True
b. False
Answer: a. True
Question: A conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects’ cost of capital is less than the rate at which the projects’ NPV profiles cross.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT? a. If a project has “normal” cash flows, then its IRR must be positive. b. If a project has “normal” cash flows, then its MIRR must be positive. c. If a project has “normal” cash flows, then it will have exactly two real IRRs. d. The definition of “normal” cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project’s life. e. If a project has “normal” cash flows, then it can have only one real IRR, whereas a project with “nonnormal” cash flows might have more than one real IRR.
Answer: e
Question: It is not possible for abandonment options to decrease a project’s risk as measured by the project’s coefficient of variation. a. True b. False
Answer: b
Question: Replacement chain or EAA analysis is required when analyzing projects that have different lives. This is true regardless of whether the projects are mutually exclusive or independent of one another. a. True b. False
Answer: b
Question: The NPV method’s assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.
Answer Options:
a. True
b. False
Answer: a. True
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. a. True b. False
Answer: b
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. a. True b. False
Answer: a
Question: Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.
Answer Options:
a. True
b. False
Answer: a. True
Question: Real options are valuable, and that value is correctly captured by a traditional NPV analysis. Therefore, there is no reason to consider real options separately from the NPV analysis. a. True b. False
Answer: b
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.
Answer Options:
a. True
b. False
Answer: b. False
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. a. True b. False
Answer: b
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 a third choice—delay the decision until later, when more information will be available. a. True b. False
Answer: b
Question: Which of the following statements is CORRECT? 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
Question: Real options exist whenever managers have the opportunity, after a project has been implemented, to make operating changes in response to changed conditions that modify the project’s cash flows. a. True b. False
Answer: a
Question: Because “present value” refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.
Answer Options:
a. True
b. False
Answer: b. False
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. a. True b. False
Answer: b
Question: Sensitivity analysis measures a project’s stand-alone risk by showing how much the project’s NPV (or IRR) is affected by a small change in one of the input variables, say sales. Other things held constant, with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the more risky the project, other things held constant. a. True b. False
Answer: a
Question: One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.
Answer Options:
a. True
b. False
Answer: b