Question 1

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.

Accepted Answer

The lost sales on the older book are considered an opportunity cost, not a sunk cost. This is because the potential revenue lost from the older book directly results from the decision to publish the new book, and thus should be considered in the analysis.

Question 2

The change in net operating working capital associated with new projects is always positive,because new projects mean that more operating working capital will be required.

Accepted Answer

The change in net operating working capital for new projects can be positive or negative, depending on whether the project requires an increase or decrease in current assets relative to current liabilities.

Question 3

Which of the following statements is CORRECT?
A) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations.If the project would have a favorable effect on other operations,then this is not an externality.
B) An example of an externality is a situation where a bank opens a new office,and that new office causes deposits in the bank's other offices to decline.
C) The NPV method automatically deals correctly with externalities,even if the externalities are not specifically identified,but the IRR method does not.This is another reason to favor the NPV.
D) Both the NPV and IRR methods deal correctly with externalities,even if the externalities are not specifically identified.However,the payback method does not.
E) Identifying an externality can never lead to an increase in the calculated NPV.

Accepted Answer

An externality can be either positive or negative and affects parties who are not directly involved in the transaction or decision. The example of a bank opening a new office and causing deposits in other offices to decline is a negative externality affecting the bank's other operations, making statement B correct.

Question 4

Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

Accepted Answer

Extending the lives of projects to a common life is only useful if there is a high likelihood of the projects being repeated beyond their initial lifetimes. Otherwise, the comparison is not meaningful.

Question 5

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the present value approach.

Accepted Answer

The answer of The two methods discussed in the text...

Question 6

Which of the following statements is CORRECT?
A) A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.
B) A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.
C) A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.
D) Sunk costs were formerly hard to deal with,but once the NPV method came into wide use,it became possible to simply include sunk costs in the cash flows and then calculate the project's NPV.
E) A good example of a sunk cost is a situation where Home Depot opens a new store,and that leads to a decline in sales of one of the firm's existing stores.

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered, regardless of whether or not the project moves forward. Option A is incorrect because not all costs required to complete a project are sunk costs. Option B is also incorrect because sunk costs, by definition, cannot be recovered. Option D is partially correct but is not a statement about sunk costs specifically. Option E is incorrect because a decline in sales of an existing store is not a sunk cost.

Question 7

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

Accepted Answer

The answer of Replacement chain or EAA analysis is required...

Question 8

Which of the following statements is CORRECT?
A) Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
B) Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
C) Corporations must use the same depreciation method (e.g. ,straight line or accelerated)for stockholder reporting and tax purposes.
D) Since depreciation is not a cash expense,it has no effect on cash flows and thus no effect on capital budgeting decisions.
E) Under accelerated depreciation,higher depreciation charges occur in the early years,and this reduces the early cash flows and thus lowers a project's projected NPV.

Accepted Answer

Accelerated depreciation affects the timing of tax deductions, leading to earlier tax savings and potentially higher NPV due to the time value of money, despite not changing the total amount of depreciation over an asset's life.

Question 9

Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR)is affected by a small change in one of the input variables,say sales.Other things held constant,with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis,the steeper the graph of the relationship line,the more risky the project,other things held constant.

Accepted Answer

This statement accurately describes sensitivity analysis and how it measures a project's stand-alone risk. If a small change in one of the input variables, such as sales, has a significant impact on the NPV or IRR, the project is considered riskier. The steeper the graph of the relationship line between the independent variable and the NPV, the more sensitive the project is to changes in that variable and therefore, the riskier it is.

Question 10

Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.

Accepted Answer

The replacement chain approach is used in practice for dealing with mutually exclusive projects that have different lives. It is a method to compare projects by extending their cash flows over a common period, making it easier to evaluate their worth or profitability over the same timeframe. The method is practical and useful, especially in capital budgeting decisions, despite its assumptions.

Question 11

Which of the following statements is CORRECT?
A) An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations.If the project would have a favorable effect on other operations,then this is not an externality.
B) An example of an externality is a situation where a bank opens a new office,and that new office causes deposits in the bank's other offices to increase.
C) The NPV method automatically deals correctly with externalities,even if the externalities are not specifically identified,but the IRR method does not.This is another reason to favor the NPV.
D) Both the NPV and IRR methods deal correctly with externalities,even if the externalities are not specifically identified.However,the payback method does not.
E) Identifying an externality can never lead to an increase in the calculated NPV.

Accepted Answer

An externality can be either positive or negative, affecting other operations within the firm. The example of a bank opening a new office and causing deposits in other offices to increase is a positive externality, demonstrating how actions in one part of a firm can beneficially impact other parts.

Question 12

The relative risk of a proposed project is best accounted for by which of the following procedures?
A) Adjusting the discount rate upward if the project is judged to have above-average risk.
B) Adjusting the discount rate upward if the project is judged to have below-average risk.
C) Reducing the NPV by 10% for risky projects.
D) Picking a risk factor equal to the average discount rate.
E) Ignoring risk because project risk cannot be measured accurately.

Accepted Answer

The best way to account for the relative risk of a proposed project is by adjusting the discount rate upward if the project is judged to have above-average risk. This is because a higher discount rate reflects the higher risk and lower present value of future cash flows. Adjusting the discount rate downward for below-average risk would not account for the relative risk of the project. Options C and D do not provide a consistent approach to adjusting for risk, and option E is not a valid approach as project risk can be quantified and measured.

Question 13

Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project?
A) Changes in net operating working capital.
B) Shipping and installation costs for machinery acquired.
C) Cannibalization effects.
D) Opportunity costs.
E) Sunk costs that have been expensed for tax purposes.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered. They should not be considered in the analysis of a new project because they will remain the same regardless of the decision made about the project.

Question 14

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 results in lower net income in the early years of an asset's life due to higher depreciation expense, but it does not directly affect cash flows since depreciation is a non-cash expense. Cash flows are higher only in terms of tax savings due to the higher depreciation expense reducing taxable income.

Question 15

Which of the following statements is CORRECT?
A) An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
B) Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
C) A good example of a sunk cost is a situation where a bank opens a new office,and that new office leads to a decline in deposits of the bank's other offices.
D) A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office,then expensed that cost for tax purposes,and now is deciding whether to go forward with the project.
E) If sunk costs are considered and reflected in a project's cash flows,then the project's calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored.

Accepted Answer

Sunk costs are past costs that have already been incurred and cannot be recovered. The money spent on investigating a site for a new office, which was expensed for tax purposes and cannot be recovered, is a classic example of a sunk cost. This cost should not influence the decision to proceed with the project since it cannot be changed by any future actions.

Question 16

Which of the following statements is CORRECT?
A) Since depreciation is not a cash expense,and since cash flows and not accounting income are the relevant input,depreciation plays no role in capital budgeting.
B) Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
C) If they use accelerated depreciation,firms will write off assets slower than they would under straight-line depreciation,and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
D) If they use accelerated depreciation,firms can write off assets faster than they could under straight-line depreciation,and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
E) If they use accelerated depreciation,firms can write off assets faster than they could under straight-line depreciation,and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.

Accepted Answer

Accelerated depreciation allows firms to write off assets faster, leading to higher depreciation expenses in the early years of an asset's life. This reduces taxable income sooner, resulting in tax savings and potentially higher Net Present Value (NPV) for projects compared to using straight-line depreciation.

Question 17

Which of the following statements is CORRECT?
A) If a firm is found guilty of cannibalization in a court of law,then it is judged to have taken unfair advantage of its competitors.Thus,cannibalization is dealt with by society through the antitrust laws.
B) If a firm is found guilty of cannibalization in a court of law,then it is judged to have taken unfair advantage of its customers.Thus,cannibalization is dealt with by society through the antitrust laws.
C) If cannibalization exists,then the cash flows associated with the project must be increased to offset these effects.Otherwise,the calculated NPV will be biased downward.
D) If cannibalization is determined to exist,then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized.
E) Cannibalization,as described in the text,is a type of externality that is not against the law,and any harm it causes is done to the firm itself.

Accepted Answer

Cannibalization refers to a situation where a company's new product eats into the sales of one of its older products. This is not illegal or against antitrust laws; it's a strategic decision that can impact a firm's own products and market share, not an unfair practice against competitors or customers.

Question 18

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the equivalent annual annuity (EAA)approach.

Accepted Answer

The statement is true. The two methods discussed in the text for dealing with unequal project lives are the replacement chain approach and the equivalent annual annuity (EAA) approach.

Question 19

Which of the following statements is CORRECT?
A) Since depreciation is a cash expense,the faster an asset is depreciated,the lower the projected NPV from investing in the asset.
B) Under current laws and regulations,corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
C) Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
D) Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
E) Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV.

Accepted Answer

Using accelerated depreciation means that more depreciation expense is taken in the earlier years of an asset's life, which reduces taxable income and therefore taxes paid. This results in increased cash flows in the earlier years, leading to a higher forecasted NPV.

Question 20

Suppose Tapley Inc.uses a WACC of 8% for below-average risk projects,10% for average-risk projects,and 12% for above-average risk projects.Which of the following independent projects should Tapley accept,assuming that the company uses the NPV method when choosing projects?
A) Project A,which has average risk and an IRR = 9%.
B) Project B,which has below-average risk and an IRR = 8.5%.
C) Project C,which has above-average risk and an IRR = 11%.
D) Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
E) All of these projects should be accepted as they will produce a positive NPV.

Accepted Answer

The answer of Suppose Tapley Inc.uses a WACC of 8%...

Quiz 12: Cash Flow Estimation and Risk Analysis

The change in net operating working capital associated with new projects is always positive,because new projects mean that more operating working capital will be required.

Which of the following statements is CORRECT?

Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the present value approach.

Which of the following statements is CORRECT?

Replacement chain or EAA analysis is required when analyzing projects that have different lives.This is true regardless of whether the projects are mutually exclusive or independent of one another.

Which of the following statements is CORRECT?

Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.

Which of the following statements is CORRECT?

The relative risk of a proposed project is best accounted for by which of the following procedures?

Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting 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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the equivalent annual annuity (EAA)approach.

Which of the following statements is CORRECT?

Suppose Tapley Inc.uses a WACC of 8% for below-average risk projects,10% for average-risk projects,and 12% for above-average risk projects.Which of the following independent projects should Tapley accept,assuming that the company uses the NPV method when choosing projects?