Question 1

It is important to consider a new project's affect on the cash flows of existing projects because of

Accepted Answer

Cannibalism and synergy both describe how a new project can impact the cash flows of existing projects. Cannibalism refers to the negative impact where the new project eats into the sales of existing products. Synergy refers to the positive impact where the new project may enhance the sales or reduce costs of existing projects. Sunk costs are past costs and do not affect future cash flows.

Question 2

Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month.As more drivers bring in their vehicles,Butler expects to also do more oil changes and brake repairs.As a result,inventory levels of oil and brake parts must be increased by $5,000.Revenues from oil changes and brake jobs are expected to increase by $4,000 per month.An example of a synergistic effect from the new diagnostic testing procedure is the

Accepted Answer

The synergistic effect refers to the additional benefits realized due to a new action or decision that creates opportunities beyond its direct outcomes. In this case, the new diagnostic testing procedure indirectly increases revenues from oil changes and brake jobs by $4,000 per month, showcasing a synergistic effect.

Question 3

If an old asset is sold for its depreciated,or book,value,then no taxes result and there is no tax effect from the sale.

Accepted Answer

When an old asset is sold for its depreciated or book value, it means the asset is being sold for the amount it is recorded on the company's books. Since the company has already claimed tax deductions on the asset during its useful life, selling it for its book value does not result in any taxable gain or loss. Therefore, there is no tax effect from the sale.

Question 4

Solar Confectionary develops a new candy bar and plans to sell each bar for $1.Solar predicts that 1 million candy bars will be sold in the first year if the new candy bar is produced and sold,and includes $1 million of incremental revenues in its capital budgeting analysis.A senior executive in the company believes that 1 million candy bars will be sold,but lowers the estimate of incremental revenue to $700,000.What would explain this change?

Accepted Answer

The senior executive may have taken into consideration the possibility of the new candy bar cannibalizing sales of 300,000 of Solar Confectionary's other candy bars, resulting in lower incremental revenues of $700,000 instead of $1 million.

Question 5

If an old asset is sold for less than its book value,the resulting loss will save the company taxes,hence lowering the cost of the project.

Accepted Answer

When an old asset is sold for less than its book value, the resulting loss is considered a tax-deductible expense. This will lower the company's taxable income and ultimately reduce the amount of taxes owed. Therefore, the cost of the project will also be lowered.

Question 6

Incremental cash flows refer to

Accepted Answer

Incremental cash flows refer to the new cash flows that will be generated if a project is undertaken. It is the difference between the cash flows with the project and the cash flows without the project. Incremental cash flows are relevant to investment decisions because they represent the additional cash flows that a project will generate. Options A, C, and D are incorrect because they do not accurately define incremental cash flows.

Question 7

The calculation of incremental free cash flows over a project's life should include

Accepted Answer

Incremental free cash flows should include both labor and material savings (A) as well as additional revenue (B). Interest to bondholders (C) is not relevant to calculating incremental free cash flows. Therefore, the best choice is D, which includes both A and B.

Question 8

As part of its expansion project,A.J.Industries Equipment Division has expanded its office space by 200 square feet.The company's administrative overhead is allocated based on the square footage of each business segment.Although the total administrative overhead for the company will remain the same,the Equipment Division will be charged more for administrative overhead.For the Equipment Division expansion project,the administrative overhead is an example of a(n)

Accepted Answer

The administrative overhead is a sunk cost because it is a cost that has already been incurred and cannot be recovered.

Question 9

Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month.As more drivers bring in their vehicles,Butler expects to also do more oil changes and brake repairs.As a result,inventory levels of oil and brake parts must be increased by $5,000.Revenues from oil changes and brake jobs are expected to increase by $4,000 per month.An example of an increase in net working capital requirements from the new diagnostic testing procedure is the

Accepted Answer

The increase in inventory levels of oil and brake parts of $5,000 is an example of an increase in net working capital requirements, as it represents an increase in the amount of cash tied up in inventory. The other options are either increases in revenue or increases in all activities, but they do not necessarily represent an increase in net working capital requirements.

Question 10

Which of the following should be included in an analysis of a new project's cash flows?

Accepted Answer

The analysis of a new project's cash flows should include any sales from existing products that would be lost if customers were expected to purchase a new product instead. This is because the new project may cannibalize existing products, leading to lost revenue. All financing costs and sunk costs should also be included, but opportunity costs should not be excluded from the analysis.

Question 11

A company is expanding and has already signed a lease on new office space that costs $10,000 per month.The company also needs a new information system and hired a consultant to recommend new software.The consultant was paid $5,000 for her recommendation.Now the company is trying to make a choice between three competing software products.In the capital budgeting decision to purchase new software,the monthly rent for the office space is ________ and the consultant's fee is ________.

Accepted Answer

The monthly rent for the office space is a sunk cost because it is a cost that has already been incurred and cannot be recovered. The consultant's fee is also a sunk cost for the same reason.

Question 12

A local restaurant owner is considering expanding into another rural area.The expansion project will be financed through a line of credit with City Bank.The administrative costs of obtaining the line of credit are $500,and the interest payments are expected to be $1,000 per month.The new restaurant will occupy an existing building that can be rented for $2,500 per month.The incremental cash flows for the new restaurant include

Accepted Answer

The answer of A local restaurant owner is considering expanding...

Question 13

Redrock Inc.is a household products firm that is considering developing a new detergent.In evaluating whether to go ahead with the new detergent project,which of the following statements is MOST correct?

Accepted Answer

The renovation of the building is a sunk cost, meaning that it has already been incurred and cannot be recovered. Therefore, it should not be included in the analysis of the new detergent project. Choices A, B, and C are incorrect because all of these items are relevant costs and should be included in the analysis. The cost of the building and the opportunity cost of leasing equipment are both opportunity costs that should be considered, and the cost of labor is a direct cost of the new project.

Question 14

Sunk costs are

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered. They are not relevant in capital budgeting decisions because they have no impact on future cash flows or the profitability of a project. Therefore, they should not be considered when making investment decisions. Choices A, B, and D are incorrect because sunk costs are not recoverable, are not incremental, and are not deductible for tax purposes.

Question 15

In general,a project's free cash flows will fall in one of the following three categories: initial outlay,differential cash flows over the project's life,and the terminal cash flow.

Accepted Answer

This statement is true. The free cash flows of a project can typically be broken down into these three categories: the initial outlay, which includes all of the upfront costs associated with starting the project; the differential cash flows over the life of the project, which represent the incremental cash flows that the project generates during its operation; and the terminal cash flow, which is the cash flow generated by the project at the end of its life or when it is sold or otherwise disposed of.

Question 16

An opportunity cost is a relevant incremental cost for capital budgeting decisions.

Accepted Answer

Opportunity cost is the cost of the next best alternative that is foregone in order to pursue a certain action or decision. This is a relevant concept in capital budgeting decisions as it helps in comparing different options and choosing the one that provides the highest return relative to the opportunity cost. Therefore, opportunity cost is a relevant incremental cost for capital budgeting decisions.

Question 17

Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very popular.So many new customers come to the store that the sales of existing ice cream products are increased.The extra sales revenue

Accepted Answer

The extra sales revenue from existing ice cream products are synergistic effects that should be counted as incremental revenues for the polar cream project because the success of the new product led to increased overall sales for the company.

Question 18

Which of the following expenses associated with a project should NOT be included in a capital budgeting analysis?

Accepted Answer

Allocated fixed overhead from corporate headquarters should not be included in a capital budgeting analysis because these costs are not incremental or directly attributable to the project. They would likely occur regardless of the project's implementation.

Question 19

AFB Systems is considering a new marketing campaign that will require the addition of a new computer programmer and new software.The programmer will occupy an office in AFB's current building and will be paid $8,000 per month.The software license costs $1,000 per month.The rent for the building is $4,000 per month.AFB's computer system is always on,so running the new software will not change the current monthly electric bill of $900.The incremental expenses for the new marketing campaign are

Accepted Answer

Incremental expenses are additional costs directly resulting from a new decision. Here, they include the programmer's salary ($8,000 per month) and the software license ($1,000 per month), totaling $9,000. Rent and electricity are not incremental as they do not change with the decision.

Question 20

What is an incremental cash flow? What is a sunk cost? Why must you account for opportunity costs?

Accepted Answer

The answer of What is an incremental cash flow? What...

Quiz 11: Cash Flows and Other Topics in Capital Budgeting