Question 1

Opportunity costs are evaluated for investment decisions at their historical (that is, book) cost.

Accepted Answer

Opportunity costs refer to the benefits that could have been gained by choosing an alternative option. They are not evaluated at historical cost, but rather by considering the potential benefits of the foregone alternative.

Question 2

What is the NPV of a project that costs $100,000, provides $23,000 in cash flows annually for six years, requires a $5,000 increase in net working capital, and depreciates the asset straight line over six years while ignoring the half-year convention? The discount rate is 14%.

Accepted Answer

The answer of What is the NPV of a project...

Question 3

If a project permits a reduction in the level of working capital, this reduction is assumed to increase cash flows.

Accepted Answer

A reduction in the level of working capital means that less money is tied up in current assets such as inventory, accounts receivable, and cash. This frees up more cash for the company to use for other purposes and can increase cash flows.

Question 4

Sunk costs do not affect project NPV.

Accepted Answer

Sunk costs have already been incurred and cannot be recovered regardless of whether the project is undertaken or not. Therefore, they should not be included in the analysis of a project's potential profitability (NPV). NPV only considers future cash flows, so sunk costs do not affect it.

Question 5

As a project comes to its end, there is a disinvestment in working capital, which also generates positive cash flow as inventories are sold off and accounts receivable are collected.

Accepted Answer

This is true. As a project nears its end, there tends to be a disinvestment in working capital as inventories are sold off and accounts receivable are collected. This generates positive cash flow for the project.

Question 6

When you finance a project partly with debt, you should still view the project as if it were all equity-financed, treating all cash outflows required for the project as coming from stockholders, and all cash inflows as going to them.

Accepted Answer

This statement is true. When financing a project partially with debt, it is important to evaluate the project as if it were all equity-financed to properly assess the impact on stockholders. This allows for a thorough analysis of the project's cash inflows and outflows and helps to determine the potential return on investment for shareholders.

Question 7

Capital budgeting analysis focuses on profits as opposed to cash flows.

Accepted Answer

Capital budgeting analysis focuses on cash flows rather than profits, as the ultimate goal is to maximize the value of the company by investing in projects that generate positive net cash flows. Profitability is certainly an important consideration, but it is not the sole focus of capital budgeting analysis.

Question 8

Which of the following statements regarding investment in working capital is incorrect?

Accepted Answer

Investment in working capital represents a negative cash flow, as it requires the use of cash to finance current assets such as inventory, accounts receivable, and prepaid expenses. The statement that investment in working capital represents a positive cash flow is incorrect.

Question 9

When an asset class is terminated, there will be recaptured depreciation when the adjusted cost of disposal from UCC of the asset class is a negative balance.

Accepted Answer

When an asset class is terminated, any undepreciated balance in the UCC is recaptured as income. If the adjusted cost of disposal (ACOD) of the asset class is a negative balance, it means that the total accumulated depreciation exceeds the asset's original cost, resulting in a recaptured depreciation.

Question 10

Accurate capital budgeting analysis depends on total cash flows as opposed to incremental cash flows.

Accepted Answer

Accurate capital budgeting analysis depends on incremental cash flows, which are the changes in cash flows that result from the investment project, rather than total cash flows which include all cash inflows and outflows. Incremental cash flows take into account the opportunity costs and externalities resulting from the investment project, which total cash flows may not adequately capture.

Question 11

Sunk costs remain the same whether or not you accept the project.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered. Therefore, they are irrelevant to the decision of whether or not to accept a project. Sunk costs will remain the same regardless of whether or not the project is accepted.

Question 12

Sunk costs influence capital budgeting decisions when the sunk costs exceed future cash inflows.

Accepted Answer

Sunk costs should not influence capital budgeting decisions as they are irretrievable and should be ignored in the decision-making process. Only future costs and cash inflows should be considered.

Question 13

Discounting real cash flows with real interest rates gives an overly optimistic idea of a project's value.

Accepted Answer

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Question 14

Suppose you finance a project partly with debt, you should neither subtract the debt proceeds from the required investment, nor would you recognize the interest and principal payments on the debt as cash outflows.

Accepted Answer

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Question 15

In project analysis, allocations of overhead should be limited to only those that represent additional expense.

Accepted Answer

Overhead costs should only be allocated to specific projects if they represent additional expenses that are directly related to the project. These costs should not include general overhead that would be incurred regardless of the project, such as rent or utilities.

Question 16

The method of financing a project affects the determination of its cash flows for capital budgeting purposes.

Accepted Answer

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Question 17

Which of the following statements is correct?

Accepted Answer

All statements are correct: A) Real cash flows should be discounted at a real discount rate to account for inflation. B) Nominal cash flows should be discounted at a nominal rate, which includes inflation. C) The relationship between real and nominal interest rates is given by the Fisher equation: (1 + real rate) = (1 + nominal rate)/(1 + inflation rate).

Question 18

Upon the sale of equipment at the end of its useful life, tax liability will be incurred whenever the book value of the equipment exceeds the sales price.

Accepted Answer

Tax liability will be incurred if the sales price exceeds the book value of the equipment. If the book value exceeds the sales price, it may result in a loss, but there will be no tax liability.

Question 19

An asset's CAA class number affects its CCA dollar deduction amount from taxable income.

Accepted Answer

The CAA class number determines the CCA rate and therefore the CCA deduction amount from taxable income for Canadian taxpayers.

Question 20

When additional funds must be committed to working capital, those funds are assumed to be recovered at the end of the project's life.

Accepted Answer

Working capital is the amount of money needed to cover the day-to-day operations of a business. When additional funds are committed to working capital for a project, it is assumed that these funds will be recovered at the end of the project's life because the project will generate revenue and profits that can cover the initial investment. This assumption is based on the idea that the project will be successful and generate cash inflows that can be used to pay back the working capital investment. However, this assumption is not guaranteed, and there is always a risk that the project may not generate enough cash flow to recover the initial investment.

Quiz 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions