Question 1

In cash flow estimation,the presence of externalities has no direct cash flow effects.

Accepted Answer

Externalities can have indirect cash flow effects, such as affecting sales or expenses, and should be considered in cash flow estimation.

Question 2

Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier.

Accepted Answer

False

Question 3

Replacement analysis involves the decision of whether to replace an existing asset that is still productive with a new asset.

Accepted Answer

This is true. Replacement analysis is used to determine whether the benefits of replacing an existing asset with a new one outweigh the costs. Factors such as the cost of the new asset, expected remaining life of the existing asset, and expected cash flows from each option are considered in the analysis.

Question 4

Quantification of risk is the easiest part of incorporating risk into capital budgeting; treatment of that calculated risk measure is more difficult.

Accepted Answer

Quantification of risk involves complex statistical and financial analysis to accurately measure potential risks, which is often challenging. Treatment of risk, while also complex, follows established strategies once risks are quantified.

Question 5

When calculating the cash flows for a project,you should include interest payments.

Accepted Answer

The answer of When calculating the cash flows for a...

Question 6

With the current techniques available,estimating cash flows has become the easiest step in the analysis of a capital budgeting project.

Accepted Answer

While there are various techniques available to estimate cash flows, it is still a crucial and challenging step in capital budgeting analysis. It involves forecasting future revenues, expenses, and other relevant cash inflows and outflows, and there is always a degree of uncertainty and risk associated with these projections. Therefore, a thorough and accurate cash flow estimation is essential for making sound investment decisions.

Question 7

If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.

Accepted Answer

The opportunity cost of the land is the potential return that the firm could have earned by using that land for an alternative purpose. Therefore, when the land is being used for a specific investment project, the project should be charged with the opportunity cost of the land.

Question 8

Net incremental operating cash flow is calculated by adding back the change in depreciation to the change in income after taxes.

Accepted Answer

Net incremental operating cash flow is calculated by adding back the change in depreciation to the change in income after taxes. This is because depreciation is a non-cash expense, meaning it does not affect actual cash flow, and thus needs to be added back to obtain the true cash flow generated by operations.

Question 9

If an asset being considered for acquisition has beta of zero,its purchase will have no effect on the firm's market risk.

Accepted Answer

The answer of If an asset being considered for acquisition...

Question 10

The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR  k at the margin)is called capital rationing.

Accepted Answer

Capital rationing refers to the situation where a firm limits its investments due to budget constraints, not when it accepts projects until the IRR equals the required rate of return.

Question 11

One problem with Monte Carlo simulation analysis is that,while the simulation may provide some insights into the riskiness of a project,the analysis does not lead to a clear-cut accept versus reject decision.

Accepted Answer

Monte Carlo simulation analysis does not provide a clear-cut accept or reject decision because it is based on probability and uncertainty. The results of the simulation can help to inform decision-making, but ultimately the decision to accept or reject a project will involve additional factors and judgment beyond the simulation results.

Question 12

Capital budgeting decisions must be based on the accounting income the project generates since stockholders are concerned with the reported net income the firm generates.

Accepted Answer

Capital budgeting decisions should not solely be based on accounting income but also consider other factors such as cash flows, timing of cash flows, and the project's impact on the overall value of the firm. Stockholders are ultimately concerned with the cash flows and overall value of the firm, rather than just reported net income.

Question 13

Although it is difficult to make accurate forecasts,the initial outlays and subsequent costs of large projects are forecast with great accuracy,but revenues are more uncertain and large errors are not uncommon.

Accepted Answer

The answer of Although it is difficult to make accurate...

Question 14

When risk is explicitly accounted for in capital budgeting,a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return.

Accepted Answer

When risk is explicitly accounted for in capital budgeting, a project will be acceptable to a firm if its NPV exceeds zero (or if its profitability index is greater than 1), not if its IRR is greater than the firm's average required rate of return. This is because the IRR calculation does not take into account the size of the project or the reinvestment rate assumptions, which can lead to multiple IRRs or incorrect conclusions about the project's value.

Question 15

A particular project might have very uncertain cash flows,hence a highly uncertain NPV and IRR,yet it may not have high market risk.

Accepted Answer

Market risk and project risk are two different things. Market risk is related to how the overall market conditions affect the performance of a project, whereas project risk is related to the uncertainty of the project's cash flows. A project may have a high level of project risk but not necessarily have high market risk. Therefore, a project with uncertain cash flows and uncertain NPV and IRR may still not have high market risk.

Question 16

If a firm is considering purchasing an asset whose beta is greater than the current beta of the firm,it should use a discount rate greater than the firm's average required rate of return to evaluate the possible investment.

Accepted Answer

This is true because the discount rate should reflect the risk associated with the investment, and an asset with a higher beta indicates higher risk. Using a higher discount rate would incorporate the additional risk into the evaluation of the investment.

Question 17

Empirical studies of risk strongly support the contention that investors who are well diversified focus exclusively on market risk when they establish required returns.

Accepted Answer

The answer of Empirical studies of risk strongly support the...

Question 18

A key difference between replacement and expansion project analyses is that with replacement,the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

Accepted Answer

This statement accurately describes the difference between replacement and expansion project analyses. Replacement projects involve comparing the cash flows of the current productive assets with the cash flows of the proposed new assets, while expansion projects involve analyzing the cash flows from the added capacity or new project.

Question 19

A sunk is a cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected.These sunk costs are extremely important in capital budgeting decisions.

Accepted Answer

The answer of A sunk is a cash outlay that...

Question 20

Inflation does not need to be built into expected cash flows; the discount rate used in net present value calculations captures the effect of inflation.If you were to include expected inflation into cash flows,all net present value calculations would be incorrect.

Accepted Answer

Inflation should be accounted for in expected cash flows as it directly affects the purchasing power of future cash flows. The discount rate used in net present value calculations may capture the effect of inflation to some extent, but it does not adjust the cash flows for inflation. Not including expected inflation in cash flows would result in incorrect net present value calculations.

Quiz 10: Project Cash Flows and Risk