Question 1

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

Accepted Answer

Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. This means that any cash flows that would occur regardless of whether or not the project is accepted are not considered in the analysis. Only the additional or incremental cash flows that result from the project are relevant.

Question 2

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.

Question 3

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 clear⎯there is no mortgage on it.Which of the following statements is CORRECT?

Accepted Answer

The answer of While developing a new product line, Cook...

Question 4

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

Accepted Answer

The end-of-project recovery of any working capital required to operate the project should be included in the cash flows used to estimate a project's NPV. This is because working capital is typically invested to cover upfront costs and ongoing expenses, and at the end of a project, any remaining working capital should be returned to the company. Interest on funds borrowed, cannibalization effects, expenditures on research and development, and costs incurred prior to the analysis being conducted are all factors that may or may not be relevant to a project's cash flows, depending on the specific circumstances.

Question 5

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 costs associated with R&D have already been expensed and cannot be recovered, therefore they are not incremental cash flows and should not be included in the capital budgeting analysis. The other options all involve cash flow changes that should be considered in the analysis.

Question 6

The CFO of Cicero Industries plans to calculate a new project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow), then discounting those cash flows at the company's overall WACC.Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

Accepted Answer

The CFO should include the investment in working capital required to operate the project, even if that investment will be recovered at the end of the project's life. This is because the working capital investment is a cash outflow at the beginning of the project and a cash inflow at the end of the project, and therefore affects the project's overall cash flows. Sunk costs that have been incurred prior to the current year should not be included, as they are already incurred and are irrelevant to future cash flows. Interest expenses on debt used to finance the project should be included in the cost of capital used to discount cash flows, but not in the actual cash flows themselves. Effects of the project on other divisions of the firm should also not be included, unless they directly affect the project's own cash flows.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

The opportunity cost of using an asset that could be sold or leased should be included in the project's cash flows, as it represents a foregone benefit.

Question 8

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

Accepted Answer

With accelerated depreciation, larger depreciation expenses are taken in the earlier years which results in higher tax savings that have a higher present value when discounted back to the current time. This is because the tax savings are received earlier, allowing the business to reinvest them sooner.

Question 9

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

Sunk costs, such as the $3 million already spent and expensed for tax purposes on research, should not be considered in the evaluation of future projects because these costs cannot be recovered and do not affect the future cash flows of the new project.

Question 10

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.

Question 11

The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant.

Accepted Answer

Accelerated depreciation causes net income to be lower in the early years of a project's life due to higher depreciation expenses, but it does not affect the total cash flows from operations, as depreciation is a non-cash expense. Over the life of the project, the total depreciation expense is the same for both methods, just allocated differently over time.

Question 12

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Accepted Answer

Accelerated depreciation increases early cash flows due to tax savings, but it does not change the total cash flows over the project's life, only their timing.

Question 13

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.

Accepted Answer

This statement is correct. Accelerated depreciation does have the advantage of increasing the present value of cash flows for profitable firms, but it also lowers reported profits in the current year due to higher depreciation expenses. However, the problem of lower reported profits can be addressed by using different depreciation methods for tax and stockholder reporting purposes.

Question 14

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater.

Accepted Answer

The total amount of depreciation that can be taken over an asset's life is the same under both methods; the difference lies in the timing of the depreciation expense, with accelerated depreciation allowing for higher expenses in the earlier years.

Question 15

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.

Accepted Answer

This is because accelerated depreciation results in higher tax savings in the earlier years of the project, which increases the cash flows in those years and therefore increases the NPV and IRR of the project.

Question 16

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 that was completed last year and expensed for tax purposes cannot be considered incremental and should not be included in the capital budgeting analysis. It is a sunk cost and cannot be recovered. All other options (A, B, D, and E) involve cash flows that are incremental and should be included in the analysis.

Question 17

The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Accepted Answer

The change in net working capital associated with new projects can be positive or negative depending on the working capital needs of the project. While it is true that some new projects may require more working capital, others may require less. Additionally, replacement projects may also result in a positive or negative change in net working capital depending on the differences in working capital needs between the existing and replacement assets.

Question 18

Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

Accepted Answer

Changes in net working capital should be reflected in a capital budgeting cash flow analysis because they represent cash flows related to the investment and operation of the fixed asset.

Question 19

Which of the following statements is CORRECT?

Accepted Answer

Accelerated depreciation affects the timing of cash flows by increasing depreciation expenses in the early years, which can lead to tax savings and thus affect the NPV, even though the total cash flows over the project's life remain the same.

Question 20

Which of the following statements is CORRECT?

Accepted Answer

An externality refers to a situation where the actions of a firm or project have an impact on 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 an example of a positive externality affecting the bank's other operations.

Quiz 11: Cash Flow Estimation and Risk Analysis

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

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

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

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?

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.

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

The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and cash flows higher, during every year of a project's life, other things held constant.

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater.

A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.

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?

The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?