Question 1

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 2

Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product?

Accepted Answer

The cost of a product analysis completed in the previous tax year and specific to the new product is not considered a relevant concern in determining incremental cash flows for a new product as it is a sunk cost and cannot be recovered regardless of whether the new product is produced or not. The other options listed are all relevant concerns that would impact the incremental cash flows of a new product project.

Question 3

Project X has an up-front cost of $1 million, whereas Project Y has an up-front cost of only $200,000. Both projects last five years and provide positive cash flows in Years 1-5. Project X is riskier; its risk-adjusted WACC is 12 percent. Project Y is safer; its risk-adjusted WACC is 8 percent. After discounting each of the project's cash flows at the project's risk-adjusted WACC, you find that Project X has a NPV of $20,000, and Project Y has a NPV of $15,000. The projects are mutually exclusive and cannot be repeated. The firm is not capital constrained; it can raise as much capital as it needs, provided it has profitable projects in which to invest. Given this information, which of the following statements is most correct?

Accepted Answer

When considering mutually exclusive projects, the project with the higher NPV should be selected. In this case, Project X has a higher NPV of $20,000 compared to Project Y's NPV of $15,000. Therefore, the firm should select Project X. The return on investment (ROI) is not a relevant factor when choosing between mutually exclusive projects, as the absolute dollar amount of the NPV is what matters. The risk level of the projects is also not a decisive factor in this case, as both projects have positive NPVs and the firm is not capital constrained. The IRR is also not relevant when choosing between mutually exclusive projects.

Question 4

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000. The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000. Target's corporate tax rate is 40 percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing machine?

Accepted Answer

To find the initial after-tax outlay, we need to calculate the cash inflow from the sale of the old machine and the cash outflow for the purchase of the new machine.

Cash inflow from sale of old machine:

Market value of old machine = $24,000

Book value of old machine = $30,000

Taxable gain = Market value - Book value = $24,000 - $30,000 = -$6,000 (Since the market value is less than the book value, there is a loss)

Tax savings from loss = Tax rate * Taxable loss = 0.4 * (-$6,000) = -$2,400

Cash inflow = Market value + Tax savings = $24,000 - $2,400 = $21,600

Cash outflow for purchase of new machine = -$60,000

Initial after-tax outlay = Cash inflow - Cash outflow = $21,600 - $60,000 = -$33,600

Therefore, the best choice is C.

Question 5

Which of the following constitutes an example of a cost which is not incremental, and therefore not relevant in an accept/reject decision?

Accepted Answer

Incremental costs are additional costs that a company incurs when making a decision. In options A, B, and C, the costs or revenues are directly associated with the decision at hand, making them relevant and incremental.

Question 6

Risk in a revenue-producing project can best be adjusted for by

Accepted Answer

Adjusting the discount rate upward for increasing risk is the best way to account for risk in a revenue-producing project. This is because the discount rate is used to calculate the present value of future cash flows, and a higher discount rate reflects the higher risk associated with future cash flows. By adjusting the discount rate upward for increasing risk, the present value of future cash flows will be reduced, accounting for the potential negative impact of risk on the project's profitability.

Question 7

Which of the following statement completions is incorrect? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

Accepted Answer

MACRS accelerated depreciation does not change the total undiscounted profits over the project's life; it only affects the timing of depreciation charges.

Question 8

A company estimates that an average-risk project has a WACC of 10 percent, a below-average-risk project has a WACC of 8 percent, and an above-average-risk project has a WACC of 12 percent. Which of the following independent projects should the company accept?

Accepted Answer

The company should choose Project B because it has a below-average risk and its IRR of 8.5 percent is higher than its WACC of 8 percent. Projects A and C have IRRs that are below or equal to their respective WACCs, meaning that they would not generate enough return to cover the cost of capital. Therefore, these projects should not be accepted.

Question 9

Which of the following statements is correct?

Accepted Answer

When equipment is sold for more than its book value, it results in a gain, which increases taxable income. Despite the tax increase, the net cash flow is higher than if the asset were sold at book value due to the additional cash received from the sale.

Question 10

If a typical U.S. company uses the same discount rate to evaluate all projects, the firm will most likely become

Accepted Answer

If a company uses the same discount rate to evaluate all projects, it is not taking into account the varying levels of risk associated with each project. As a result, the company may be taking on riskier projects that have a lower present value (due to the higher risk) than it appears, or passing over less risky projects with higher present values (due to the lower discount rate). Over time, this can lead to the company gradually taking on more risk and becoming riskier overall, which will ultimately lead to a decline in its value.

Question 11

In theory, the decision maker should view market risk as being of primary importance. However, within-firm, or corporate, risk is relevant to a firm's

Accepted Answer

Corporate risk is relevant to stockholders, management, and creditors as it affects debt capacity, operating income, job stability, and creditworthiness.

Question 12

Which of the following statements is most correct?

Accepted Answer

Interest and dividend payments should not be included in estimating net cash flows for capital budgeting because their effects are already considered in the weighted average cost of capital (WACC). Including them again would result in double-counting.

Question 13

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should

Accepted Answer

When considering an asset with greater risk than the current risk of the firm, the decision maker should increase the cost of capital used to evaluate the project to reflect the higher risk of the project. This is because a higher cost of capital would decrease the NPV of the project, which would provide a more conservative analysis of the potential return on investment. This would ensure that the firm is adequately compensated for taking on the higher risk, and would also allow for a more accurate comparison of the potential returns of the project with other projects under consideration. The other options are not as effective in addressing the higher risk associated with the asset.

Question 14

Regarding the net present value of a replacement decision, which of the following statements is false?

Accepted Answer

A loss on the sale of old equipment would result in a tax shield, which is treated as an inflow, not an outflow.

Question 15

Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?

Accepted Answer

Statement b should be included in the analysis since it will affect the overall profitability of Sanford & Son Inc. Both shops will be competing for customers, and profits at the existing shop will decline. Statement c should also be included since leasing the property to another company can provide an alternative source of income if the new shop venture does not succeed. Statement a is not relevant to the analysis since the cost of clearing the property happened 5 years ago and is a sunk cost.

Question 16

Monte Carlo simulation

Accepted Answer

All of the statements (A, B, and C) are accurate descriptions of Monte Carlo simulation. It is useful for estimating a project's stand-alone risk by simulating thousands of possible scenarios based on input variables and their assigned probability distributions. This allows for a more comprehensive understanding of risk than using a single numerical estimate for each variable. The simulation produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR, typically expressed as a range, probability distribution, or other statistical measure.

Question 17

(3)2). Which of the following statements is correct?

Accepted Answer

The opportunity cost of using an asset that could otherwise be leased out should be included as a cost in the project's cash flow analysis.

Question 18

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

Accepted Answer

Using the same discount rate for all projects can lead to accepting poor, high-risk projects because they may have high potential returns that could be overlooked with a uniform discount rate, and rejecting good, low-risk projects because they may have lower potential returns that are not worth pursuing with the same discount rate. Therefore, both answers A and B are correct.

Question 19

Pickles Corp. is a company which sells bottled iced tea. The company is thinking about expanding its operations into the bottled lemonade business. Which of the following factors should the company incorporate into its capital budgeting decision as it decides whether or not to enter the lemonade business?

Accepted Answer

Option A is important because it considers the impact of introducing a new product on existing sales, which is a key factor in determining the potential profitability of a new project. Option C is important because it presents an alternative use for the building, which could be a financially viable option for the company if it decides not to enter the lemonade business. Option B, while providing information about the building, is not directly relevant to the decision of whether or not to enter the lemonade business. Therefore, options A and C are the best choices to incorporate into the capital budgeting decision.

Question 20

Suppose the firm's WACC is stated in nominal terms, but the project's expected cash flows are expressed in real dollars. In this situation, other things held constant, the calculated NPV would

Accepted Answer

When the WACC is stated in nominal terms (which includes a premium for inflation), but the cash flows are in real dollars (which do not account for inflation), the calculated NPV may be biased downward because the cash flows are being discounted at a rate that is too high (due to the inflation premium). This can lead to an underestimate of the project's true value.

Quiz 13: Capital Budgeting: Cash Flows and Risk

Which of the following statements is correct?

Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product?

Which of the following constitutes an example of a cost which is not incremental, and therefore not relevant in an accept/reject decision?

Risk in a revenue-producing project can best be adjusted for by

Which of the following statement completions is incorrect? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

A company estimates that an average-risk project has a WACC of 10 percent, a below-average-risk project has a WACC of 8 percent, and an above-average-risk project has a WACC of 12 percent. Which of the following independent projects should the company accept?

Which of the following statements is correct?

If a typical U.S. company uses the same discount rate to evaluate all projects, the firm will most likely become

In theory, the decision maker should view market risk as being of primary importance. However, within-firm, or corporate, risk is relevant to a firm's

Which of the following statements is most correct?

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should

Regarding the net present value of a replacement decision, which of the following statements is false?

Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?

Monte Carlo simulation

(3) 2) . Which of the following statements is correct?

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

Suppose the firm's WACC is stated in nominal terms, but the project's expected cash flows are expressed in real dollars. In this situation, other things held constant, the calculated NPV would