Deck 11: Capital Budgeting: Cash Flows and Risk

Question 1

When a new product competes with, and therefore affects, the sales of another product of the same company, this is referred to as:

A) cannibalization
B) competitive advantage
C) comparative advantage

Answer 1

cannibalization

Question 2

In the winter, a restaurant serves three hearty soups in addition to its regular menu. A concern about how the sales of the soup could negatively affect the sales of sandwiches would best be described as a concern about:

A) cannibalization
B) competitive advantage
C) comparative advantage

Answer 2

cannibalization

Question 3

In the sale of goods on account, which of the accounts is not increased from the sale?

A) Sales
B) Inventory
C) Cost of goods sold
D) Accounts receivable

Answer 3

Inventory

Question 4

In the sale of goods on account, which of the accounts is not increased from the sale?

A) Cash
B) Sales
C) Cost of goods sold
D) Accounts receivable

Question 5

In the sale of goods on account, which of the following accounts is decreased from the collection of cash from the sale on account?

A) Cash
B) Inventory
C) Cost of goods sold
D) Accounts receivable

Question 6

Which of the following would not be considered a sunk cost when performing a cash flow analysis of a new project?

A) Engineering costs to develop estimates of the eventual project cost
B) Marketing research conducted to see if this would be a viable project
C) Increased inventory the company will have to carry for the new project
D) Research and development expenses incurred coming up with the idea of the project
E) Cost of land and building to be used for the project that the company has owned for many years

Question 7

Which of the following should be considered when performing a cash flow analysis of a new project?

A) sunk costs.
B) externalities.
C) financing costs.
D) opportunity costs.

Question 8

The right to delay, abandon or reject a project is referred to as a:

A) sunk cost.
B) real option.
C) externality.
D) capital budgeting.

Question 9

Which one of the following would not be considered a real option? The option to:

A) expand into another country.
B) expand production if the product is successful.
C) abandon a project if the prices of products decline.
D) buy shares of stock at a fixed price within a specified period of time.
E) switch from coal-fired production to natural-gas powered production if this results in a savings in production costs.

Question 10

The Über Corporation is evaluating a new product. The cost of the equipment to produce the new product is $100 million, and the cost to set up the equipment is $1 million. Über spent $5 million on research and development for this new product. In addition, Über will need to use a building that originally cost $200 million, but which is on the books at $20 million; Über has no other use for this building and it would be unused if it does not use this building. The initial cash outlay associated with this project is closest to:

A) $100 million.
B) $101 million
C) $106 million
D) $120 million
E) $126 million

Question 11

The Proto Corporation is evaluating a new product. The cost of the equipment to produce the new product is $10 million, and the cost to set up the equipment is $0.1 million. Proto spent $4 million on research and development for this new product. In addition, Proto will need to use a building that originally cost $200 million, but which is on the books at $6 million; Proto has no other use for this building and it would be unused if it does not use this building. The initial cash outlay associated with this project is closest to:

A) $10.0 million.
B) $10.1 million
C) $14.1 million
D) $20.1 million

Question 12

Which of the following does not refer to the total cash outlay required to initiate an investment project?

A) Initial cash flow
B) Working capital
C) Initial cash outlay
D) Investment cash flow

Question 13

The system of depreciation prescribed by U.S. tax law is best described as the:

A) straight-line depreciation.
B) declining balance method.
C) sum-of-the-years-digits method.
D) modified accelerated cost recovery system (MACRS).

Question 14

The tax savings associated with the depreciation deduction for tax purposes is best described as:

A) a tax credit.
B) depreciation.
C) a depreciation tax shield.
D) the modified accelerated cost recovery system (MACRS).

Question 15

Suppose an investment requires the purchase of equipment for $10,000 and decreases working capital by $500. The company must spend $1,000 to install the equipment. The investment cash flow is closest to:

A) - $8,500
B) - $9,500
C) - $10,500
D) - $11,500

Question 16

Consider a project that requires the purchase of equipment for $10,000 and increases working capital by $500. The company must spend $1,000 to install the equipment. The investment cash flow is closest to:

A) - $8,500
B) - $9,500
C) - $10,500
D) - $11,500

Question 17

Consider a project that requires investing $100,000 in an asset that is classified as a 3-year asset for tax purposes, even though its useful life is four years. If the investing company's marginal tax rate is 38 percent, the depreciation tax shield for the second year is closest to:

A) $9,500
B) $16,891
C) $27,559
D) $44,450

Question 18

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset's depreciation for tax purposes for the first year is $30,000, the depreciation tax shield for the first year of the asset's useful life, if the tax rate is 35 percent, is closest to:

A) $0
B) $10,500
C) $19,500
D) $30,000

Question 19

Suppose an investment requires the company to increase inventories by $30,000 at the beginning of the project. The company's marginal tax rate is 40 percent. The effect of this change in inventory on the initial cash outlay closest to:

A) -$30,000
B) -$12,000
C) $12,000
D) $30,000

Question 20

Suppose an investment requires the company to increase inventories by $30,000 at the beginning of the project. However, the financial manager expects that accounts payable will increase by $10,000 initially. The company's marginal tax rate is 40 percent. The effect of this change in inventory and accounts payable on the initial cash outlay closest to:

A) -$40,000
B) -$30,000
C) -$20,000
D) $20,000
E) $40,000

Question 21

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $20,000, the depreciation tax shield for the second year of the asset's useful life if the tax rate is 35 percent is closest to:

A) $0.00
B) $2,333.10
C) $3,111.50
D) $7,000.00
E) $8,890.00

Question 22

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $20,000, the depreciation tax shield for the fifth year of the asset's useful life if the tax rate is 35 percent is closest to:

A) $0.00
B) $2,333.10
C) $3,111.50
D) $7,000.00
E) $8,890.00

Question 23

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $30,000, the depreciation tax shield for the first year of the asset's useful life if the tax rate is 25 percent is closest to:

A) $0.00
B) $2,499.75
C) $7,500.00
D) $9,999.00

Question 24

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $30,000, the depreciation tax shield for the second year of the asset's useful life if the tax rate is 25 percent is closest to:

A) $0.00
B) $2,499.75
C) $3,333.75
D) $7,500.00
E) $13,335.00

Question 25

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $30,000, the depreciation tax shield for the fifth year of the asset's useful life if the tax rate is 25 percent is closest to:

A) $0.00
B) $2,499.75
C) $3,333.75
D) $7,500.00
E) $13,335.00

Question 26

Suppose a company has equipment that had an original cost of $10,000, and it sells this equipment 5 years later for $2,000. If the carrying value of this equipment for tax purposes is $1,000 and the company's marginal tax rate is 35 percent, the tax on the depreciation recapture associated with the sale of this equipment is closest to:

A) $0
B) $350
C) $1,000
D) $1,650
E) $2,000

Question 27

Suppose a company has equipment that had an original cost of $10,000, and it sells this equipment 5 years later for $2,000. If the carrying value of this equipment for tax purposes is $1,000 and he company's marginal tax rate is 35 percent, the cash flow associated with the sale of this equipment is closest to:

A) $0
B) $350
C) $1,000
D) $1,650
E) $2,000

Question 28

Suppose a company has equipment that had an original cost of $15,000, and it sells this equipment 5 years later for $5,000. If the carrying value of this equipment for tax purposes is $2,000 and the company's marginal tax rate is 25 percent, the tax on the depreciation recapture associated with the sale of this equipment is closest to:

A) $0
B) $750
C) $2,000
D) $3,000
E) $4,250

Question 29

Suppose a company has equipment that had an original cost of $15,000, and it sells this equipment 5 years later for $5,000. If the carrying value of this equipment for tax purposes is $2,000 and the company's marginal tax rate is 25 percent, the tax on the depreciation recapture associated with the sale of this equipment is closest to:

A) $750
B) $2,000
C) $2,500
D) $3,000
E) $4,250

Question 30

Which of the following is not one of the three basic pieces when evaluating a project?

A) Terminal cash flow
B) Financing cash flows
C) Investment cash flow
D) Operating cash flows

Question 31

Consider a project that requires investing $100,000 in an asset that is classified as a 3-year asset for tax purposes, even though its useful life is four years. If the investing company's marginal tax rate is 40 percent and the appropriate cost of capital for this project is 10 percent, the present value of the depreciation tax shields is closest to:

A) $27,321
B) $31,265
C) $33,289
D) $40,000

Question 32

Consider a project that requires investing $20,000 in an asset that is classified as a 3-year asset for tax purposes, even though its useful life is four years. If the investing company's marginal tax rate is 40 percent and the appropriate cost of capital for this project is 10 percent, the present value of the depreciation tax shields is closest to:

A) $5,464
B) $6,253
C) $6,658
D) $8,000

Question 33

Consider a project that requires investing $100,000 in an asset that is classified as a 3-year asset for tax purposes. The project's useful life is three years, at which time the asset will be disposed of without generating any cost of sales proceeds. The project will increase revenues by $40,000 each year, and there will be no change in operating expenses or working capital associated with this project. If the investing company's marginal tax rate is 30 percent and the appropriate cost of capital for this project is 10 percent. The project's net cash flow for the third and final year is closest to:

A) $17,633
B) $32,443
C) $34,666
D) $37,999

Question 34

Consider a project that requires investing $10,000 in an asset that is classified as a 3-year asset for tax purposes. The project's useful life is three years, at which time the asset will be disposed of without generating any cost of sales proceeds. The project will increase revenues by $3,800 each year, and there will be no change in operating expenses or working capital associated with this project. If the investing company's marginal tax rate is 30 percent and the appropriate cost of capital for this project is 10 percent. The project's net cash flow for the second year of operations is closest to:

A) -$457
B) $327
C) $3,327
D) $3,660
E) $3,994

Question 35

Consider a project that requires investing $10,000 in an asset that is classified as a 3-year asset for tax purposes. The project's useful life is three years, at which time the asset will be disposed of without generating any cost of sales proceeds. The project will increase revenues by $3,800 each year, and there will be no change in operating expenses or working capital associated with this project. If the investing company's marginal tax rate is 30 percent and the appropriate cost of capital for this project is 10 percent. The project's net present value is closest to:

A) -$1,040
B) -$873
C) -$706
D) $8,960
E) $9,127

Question 36

Consider a project that requires investing $100,000 in an asset that is classified as a 3-year asset for tax purposes. The project's useful life is three years, at which time the asset will be disposed of without generating any cost of sales proceeds. The project will increase revenues by $45,000 each year, and there will be no change in operating expenses or working capital associated with this project. If the investing company's marginal tax rate is 35 percent and the appropriate cost of capital for this project is 12 percent. The project's net present value is closest to:

A) -$1,622
B) $224
C) $251
D) $24,871

Question 37

An examination of how an investment changes as one input at a time is changed is best described as:

A) input analysis.
B) scenario analysis.
C) sensitivity analysis.
D) simulation analysis.

Question 38

Projects that add something extra to the company in terms of sales or cost savings are best described as:

A) expansion projects.
B) construction projects.
C) replacement projects.
D) manufacturing projects.

Question 39

Sensitivity analysis helps the financial manager determine the:

A) degree to which a project is reliant upon the fixed costs.
B) level of variable costs in relation to the fixed costs of a project.
C) internal rate of return, given the best and the worst possible situations.
D) range of possible outcomes, given possible ranges for every uncertain variable.
E) degree that the attractiveness of a project reacts to changes in a single variable.

Question 40

Projects that add something extra to the company in terms of sales or cost savings are best described as:

A) expansion projects.
B) construction projects.
C) replacement projects.
D) manufacturing projects.

Question 41

Suppose Congress increases the marginal tax rate for businesses from 35 percent to 40 percent. This will most likely have the effect of:

A) increasing depreciation tax shields.
B) decreasing depreciation tax shields.
C) increasing cash flows from revenues.
D) decreasing cash flows from revenues.

Question 42

Suppose Congress decreases the marginal tax rate for businesses from 35 percent to 30 percent. This will most likely have the effect of:

A) increasing depreciation tax shields.
B) decreasing depreciation tax shields.
C) increasing cash flows from revenues.
D) decreasing cash flows from revenues.

Question 43

Looking at a project and how it would fare in different economic, competitive, and regulatory environments would be best described as:

A) input analysis.
B) scenario analysis.
C) sensitivity analysis.
D) simulation analysis.

Question 44

Consider a replacement project, replacing Asset A with Asset B. Asset A cost $100,000 and was classified as a 5-year MACRS asset when it was acquired three years ago, and Asset B also costs $100,000 and is classified as a 5-year asset. The company's marginal tax rate is 35 percent. The change in the depreciation tax shield for this replacement decision for the first year of operations for Asset A is closest to:

A) $2,968.
B) $4,032.
C) $7,000.
D) $8,480.

Question 45

Consider a replacement project, replacing Asset C with Asset D. Asset C cost $10,000 and was classified as a 5-year MACRS asset when it was acquired three years ago, and Asset D also costs $10,000 and is classified as a 5-year asset. The company's marginal tax rate is 35 percent. The change in the depreciation tax shield for this replacement decision for the third year of operations for Asset C is closest to:

A) $403.
B) $470.
C) $874.
D) $1,152.

Question 46

Which element of a project's cash flow does inflation not affect?

A) Sales
B) Expenses
C) Depreciation
D) Cost of capital

Question 47

Increasing inflation:

A) reduces the present value of depreciation tax shields.
B) increases the present value of depreciation tax shields.
C) does not affect the present value of depreciation tax shields

Question 48

When performing capital budgeting analysis, the effect of taxes should be ignored.

Question 49

A new project is going to require the company to carry more inventories and increase the level of accounts receivable. This should have a positive effect on cash flows.

Question 50

A sunk cost is any cost that has been incurred prior to the capital project decision, and these sunk costs should be included in the capital project decision.

Question 51

Opportunity cost should not influence current capital budgeting decisions.

Question 52

Opportunity cost is cash flows that must be forgone as a result of an investment decision.

Question 53

Snow removal from a company's parking lot is a capital cost and as such should be capitalized and the value expensed through depreciation expenses over future periods.

Question 54

In the initial investment of a project, a required decrease in capital decreases the amount of initial cash flow calculation.

Question 55

When using MACRS, the depreciable life of an asset for tax purposes is determined by reference to the tax code; the company does not choose the depreciable life, but rather looks it up.

Question 56

When using MACRS, an asset classified as having a 5 year depreciable life will be fully depreciated at the end of 5 years.

Question 57

When using MACRS, depreciation expense is lower in Year 1 because of the half-year rule, then is the highest in Year 2, and declines thereafter.

Question 58

Depreciation that creates tax savings for the company in the amount of the change in depreciation multiplied by the company's marginal tax rate is referred to as the depreciation tax shield.

Question 59

Terminal cash flow includes operating cash flows from the final year of the project.

Question 60

Salvage value is the best guess estimate of what a firm can sell an asset for at the end of the project.

Question 61

The discount rate is one of the things varied when conducting sensitivity analysis.

Question 62

The analysis that uses statistical procedures to analyze the distribution of net cash flows when many inputs are uncertain is best described as simulation analysis.

Question 63

Expansion projects are projects that involve the replacement of an existing asset with a new asset.

Question 64

The difference in rates of inflation can change an acceptable project into an unacceptable project.

Question 65

Depreciation need not be considered in a replacement decision.

Question 66

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $10,000, what is the depreciation tax shield for the first year of the asset's useful life if the tax rate is 40 percent?

Question 67

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $100,000, what is the depreciation tax shield for the first year of the asset's useful life if the tax rate is 25 percent.

Question 68

Suppose an asset is classified as a 3-year asset for tax purposes, but has a useful life of 5 years. If the asset has an initial cost of $100,000, what is the depreciation tax shield for the second year of the asset's useful life if the tax rate is 25 percent.

Question 69

Suppose a company has equipment that had an original cost of $50,000, and it sells this equipment 5 years later for $10,000. If the carrying value of this equipment for tax purposes is $8,000, what is the tax on the depreciation recapture and the cash flow associated with the sale of this equipment? The company's marginal tax rate is 40 percent.

Question 70

Depreciation is a non-cash expense, but the depreciation tax-shield represents:

A) economic rent.
B) tax savings from the deductibility of interest.
C) the additional taxes because depreciation cannot be deducted for tax purposes.

Question 71

Suppose a capital project is a result of a new product that took three years to develop and $500 million in research and development. This $500 million is best described as a:

A) sunk cost.
B) opportunity cost.
C) complimentary cost.

Question 72

The salvage value of an asset is:

A) irrelevant in capital budgeting.
B) used in the MACRS depreciation calculation.
C) an estimate of the proceeds from the sale of the asset at the end of its useful life.

Question 73

An increase in inventory levels at the beginning of the project is:

A) irrelevant for the project analysis.
B) a cash inflow at the initiation of the project.
C) a cash outflow at the initiation of the project.

Question 74

If a project will change taxable income by $50 million, the depreciation expense for tax purpose is $5 million, and the company's marginal tax rate is 40 percent, the cash flow attributable to the project is closest to:

A) $18 million.
B) $20 million.
C) $27 million.
D) $30 million.

Question 75

Selling an asset for more than its book value, but less than its original cost, will result in all but which of the following?

A) Capital gain
B) Tax on gain
C) Recapture of depreciation

Question 76

If Congress changes the cost recovery system, such that it is slower than the current 200DB based MACRS, this most likely will result in:

A) projects becoming less attractive.
B) projects becoming more attractive.
C) no effect on the selection of projects.

Question 77

Increasing the project's cost of capital will most likely results in:

A) the project becoming less attractive.
B) the project becoming more attractive.
C) no effect on the attractiveness of the project.

Question 78

Consider two, mutually exclusive projects, Project A with a useful life of 4 years and Project B with a useful life of 5 years. Project A has a net present value of $4,000, whereas Project B has a net present value of $5,000. If the project cost of capital for both projects is 8 percent, what is the most appropriate decision?

A) Reject both projects.
B) Accept both projects.
C) Accept Project A and reject Project B
D) Accept Project B and reject Project A

Question 79

Inflation does not affect a project's profitability because inflation affects both the cash flows and the discount rate.