Question 1

A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?

Accepted Answer

The most appropriate action in this situation would be to increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. This is because the project's increased risk will likely require a higher return to compensate investors for accepting the risk. Option A is not appropriate because arbitrarily increasing the estimated NPV would not reflect the project's true level of risk. Option B is not appropriate because rejecting a project on the basis of increased risk alone is not a sound decision-making approach. Option C is not appropriate because the percentage of the firm's total assets that a project represents is irrelevant to the level of risk it poses. Option E is not appropriate because arbitrarily increasing the estimated IRR would not reflect the project's true level of risk.

Question 2

Collins Inc.is investigating whether to develop a new product.In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Accepted Answer

The $3 million spent on research is a sunk cost, which means it has already been incurred and cannot be recovered or changed by the decision to go ahead with the new project. Therefore, it should not be considered in the cash flow estimation for the new project.

Question 3

Which of the following rules is CORRECT for capital budgeting analysis?

Accepted Answer

Only incremental cash flows are relevant for capital budgeting analysis because they are the cash flows that would result if the project is accepted. Sunk costs and accounting net income are irrelevant, and competitive and complementary products should be considered when estimating the relevant cash flows. Interest paid on funds borrowed to finance a project is included in the project's cash flow as a cost.

Question 4

While developing a new product line, Cook Company spent $3 million two years ago to build a plant for a new product.It then decided not to go forward with the project, so the building is available for sale or for a new product.Cook owns the building free and clear¾there is no mortgage on it.Which of the following statements is CORRECT?

Accepted Answer

The opportunity cost of using the building for a new project is the after-tax proceeds from selling it, which should be considered in the project's evaluation.

Question 5

Which of the following statements is CORRECT?

Accepted Answer

Simulation analysis is a modeling technique that allows for the evaluation of the implications of a range of possible outcomes under different conditions. Input variables are chosen randomly according to their probability distributions, and the resulting output is used to assess the potential impact of different scenarios. This is similar to scenario analysis but more precise as it considers probabilities. The other statements are incorrect.

Question 6

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Accepted Answer

The answer of Which of the following procedures does the...

Question 7

Laramie Labs uses a risk-adjustment when evaluating projects of different risk.Its overall (composite)WACC is 10%, which reflects the cost of capital for its average asset.Its assets vary widely in risk, and Laramie evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%.The company is considering the following projects:

Which set of projects would maximize shareholder wealth?

Accepted Answer

Statement b is t; the others are f.The following table shows the required return for each project on the basis of its risk level. 11ea1b84_8bb9_e4d3_a54a_9f82b464d962_TB3581_00

Question 8

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

Accepted Answer

The cost of a study completed last year is a sunk cost, meaning that it has already been incurred and cannot be recovered. Therefore, it should not be included in the capital budgeting analysis for a new project. The other options (A, B, D, and E) are all relevant to the analysis and would result in incremental cash flows that should be considered.

Question 9

To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

Accepted Answer

Depreciation affects tax payments and thus cash flows, opportunity costs are relevant while sunk costs are not, cash flows should be considered on an after-tax basis, and the WACC is calculated after taxes. Financing costs are indeed accounted for in the WACC, avoiding double counting.

Question 10

You have just landed an internship in the CFO's office of Hawkesworth Inc.Your first task is to estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

Accepted Answer

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Question 11

Which of the following statements is CORRECT?

Accepted Answer

An externality can be positive or negative and affects parties not directly involved in the transaction. The example given in choice A, where a bank's new office increases deposits in its other offices, is a positive externality affecting the bank's overall operations.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

The statement in option C is correct. If equipment is sold for a price higher than its book value, it will generate a profit which will increase the end-of-project cash flow. However, if it is sold for less than its book value, it will generate a loss which will decrease the terminal cash flow. Options A, B, D, and E are incorrect statements. Option A states that reported accounting profits should be used as the basis for investor and managerial decisions, which is incorrect since accounting profits may not represent the actual cash flows of a project. Option B states that working capital should be included only at the start of a project's life, which is incorrect since changes in working capital occur throughout the life of a project and can have an impact on cash flows. Option D states that changes in net working capital refer only to current assets and liabilities, which is incorrect since changes in long-term assets and liabilities can also affect working capital. Option E states that an asset sold for less than its book value will always generate a negative terminal cash flow, which is incorrect since it may still generate a positive cash flow if the salvaged value exceeds the tax loss resulting from the sale.

Question 13

Which of the following statements is CORRECT?

Accepted Answer

Regarding e and a, note that since interest should not be considered, exclusion will not lead to any type of bias, positive or negative.

Question 14

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

Accepted Answer

Research and Development (R&D) costs that have already been expensed and cannot be recovered are considered sunk costs and should not be included in the capital budgeting analysis.

Question 15

Wansley Enterprises is considering a new project.The company has a beta of 1.0, and its sales and profits are positively correlated with the overall economy.The company estimates that the proposed new project would have a higher standard deviation and coefficient of variation than an average company project.Also, the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.On the basis of this information, which of the following statements is CORRECT?

Accepted Answer

Statement e is t because the project has a relatively high standard deviation and thus more stand-alone risk than average.The project's revenues would be countercyclical to the rest of the firm's and to other firms' revenues, hence its within-firm and market risks would be relatively low.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

Sensitivity analysis examines how changes in one variable affect the outcome (e.g., NPV) but does not typically incorporate the probability of these changes occurring, making it incomplete in terms of risk assessment.

Question 17

Tallant Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data:

Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects.
Which of the following statements is CORRECT?

Accepted Answer

Statement b is t, while the other statements are f.Stand-alone risk is measured by standard deviation.Therefore, since Y's standard deviation is higher than X's, Y has higher stand-alone risk than X.Statement a is f because corporate risk is affected by the correlation of project cash flows with other company cash flows, and since Y's cash flows are more highly correlated with the cash flows of existing projects than X's, Y has more corporate risk than X.Market risk is measured by beta.Therefore, since X's beta is greater than Y's, statement b is true.

Question 18

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow?

Accepted Answer

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Question 19

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:

Accepted Answer

Previous expenditures such as costs associated with a market test that have already been expensed for tax purposes are considered sunk costs and should not be included in the projected cash flows of a new project. These costs have already occurred and cannot be recovered or changed by the decision to undertake or reject the project.

Question 20

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

Accepted Answer

Opportunity costs, such as the reduction in sales of existing products due to the new project, should be considered in cash flow estimation. Other options involve sunk costs or financing costs, which are not included in project cash flow analysis.

Quiz 11: Cash flow estimation and risk analysis

A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?

Collins Inc.is investigating whether to develop a new product.In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

Which of the following rules is CORRECT for capital budgeting analysis?

Which of the following statements is CORRECT?

Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?

You have just landed an internship in the CFO's office of Hawkesworth Inc.Your first task is to estimate the Year 1 cash flow for a project with the following data.What is the Year 1 cash flow?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

Which of the following statements is CORRECT?

In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow?

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?