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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 clear¾there is no mortgage on it.Which of the following statements is CORRECT?


A) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.
B) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.
C) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.
D) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
E) Since the building has been paid for, it can be used by another project with no additional cost.Therefore, it should not be reflected in the cash flows for any new project.

F) B) and D)
G) B) and C)

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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.

A) True
B) False

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Tallant Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data: Tallant Technologies is considering two potential projects, X and Y.In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses.This research produced the following data: Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT? A) Project X has more corporate (or within-firm) risk than Project Y. B) Project X has more market risk than Project Y. C) Project X has the same level of corporate risk as Project Y. D) Project X has less market risk than Project Y. E) Project X has more stand-alone risk than Project Y. Correlation of the project cash flows with cash flows from currently existing projects.Cash flows are not correlated with the cash flows from existing projects.Cash flows are highly correlated with the cash flows from existing projects. Which of the following statements is CORRECT?


A) Project X has more corporate (or within-firm) risk than Project Y.
B) Project X has more market risk than Project Y.
C) Project X has the same level of corporate risk as Project Y.
D) Project X has less market risk than Project Y.
E) Project X has more stand-alone risk than Project Y.

F) B) and C)
G) A) and E)

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Which of the following statements is CORRECT?


A) Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
B) It is unrealistic to believe that any increases in net working capital required at the start of an expansion project can be recovered at the project's completion.Working capital like inventory is almost always used up in operations.Thus, cash flows associated with working capital should be included only at the start of a project's life.
C) If equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit.In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.
D) Changes in net working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities.Therefore, changes in net working capital should not be considered in a capital budgeting analysis.
E) If an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm, hence its terminal cash flow will be negative.

F) All of the above
G) A) and B)

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McLeod Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?


A) 0.67
B) 0.73
C) 0.81
D) 0.89
E) 0.98

F) None of the above
G) A) and B)

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Which of the following statements is CORRECT?


A) In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV.
B) The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator.
C) Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values.
D) As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis.
E) Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

F) B) and C)
G) A) and E)

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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) Shipping and installation costs.
B) Cannibalization effects.
C) Opportunity costs.
D) Sunk costs that have been expensed for tax purposes.
E) Changes in net working capital.

F) A) and D)
G) B) and D)

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DeVault Services recently hired you as a consultant to help with its capital budgeting process.The company is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value.No new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? DeVault Services recently hired you as a consultant to help with its capital budgeting process.The company is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value.No new working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? A) $15, 740 B) $16, 569 C) $17, 441 D) $18, 359 E) $19, 325


A) $15, 740
B) $16, 569
C) $17, 441
D) $18, 359
E) $19, 325

F) A) and D)
G) D) and E)

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Brandt Enterprises is considering a new project that has a cost of $1, 000, 000, and the CFO set up the following simple decision tree to show its three most likely scenarios.The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties.How much is the option to abandon worth to the firm? Brandt Enterprises is considering a new project that has a cost of $1, 000, 000, and the CFO set up the following simple decision tree to show its three most likely scenarios.The firm could arrange with its work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to obtain this abandonment option, it would have to make a payment to those parties.How much is the option to abandon worth to the firm? A) $55.08 B) $57.98 C) $61.03 D) $64.08 E) $67.29


A) $55.08
B) $57.98
C) $61.03
D) $64.08
E) $67.29

F) A) and B)
G) A) and C)

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Kasper Film Co.is selling off some old equipment it no longer needs because its associated project has come to an end.The equipment originally cost $22, 500, of which 75% has been depreciated.The firm can sell the used equipment today for $6, 000, and its tax rate is 40%.What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value, the firm will receive a tax credit as a result of the sale.


A) $5, 558
B) $5, 850
C) $6, 143
D) $6, 450
E) $6, 772

F) A) and B)
G) A) and E)

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A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk.In evaluating this project, it would be reasonable for management to do which of the following?


A) Increase the estimated NPV of the project to reflect its greater risk.
B) Reject the project, since its acceptance would increase the firm's risk.
C) Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets.
D) Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
E) Increase the estimated IRR of the project to reflect its greater risk.

F) None of the above
G) C) and E)

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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.

A) True
B) False

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Whitestone Products is considering a new project whose data are shown below.The required equipment has a 3-year tax life, and the accelerated rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life.What is the project's Year 4 cash flow? Whitestone Products is considering a new project whose data are shown below.The required equipment has a 3-year tax life, and the accelerated rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life.What is the project's Year 4 cash flow? A) $11, 904 B) $12, 531 C) $13, 190 D) $13, 850 E) $14, 542


A) $11, 904
B) $12, 531
C) $13, 190
D) $13, 850
E) $14, 542

F) A) and E)
G) A) and B)

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In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? In your first job with TBL Inc.your task is to consider a new project whose data are shown below.What is the project's Year 1 cash flow? A) $8, 903 B) $9, 179 C) $9, 463 D) $9, 746 E) $10, 039


A) $8, 903
B) $9, 179
C) $9, 463
D) $9, 746
E) $10, 039

F) D) and E)
G) A) and B)

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The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

A) True
B) False

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Taylor Inc., the company you work for, is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Taylor Inc., the company you work for, is considering a new project whose data are shown below.What is the project's Year 1 cash flow? A) $25, 816 B) $27, 175 C) $28, 534 D) $29, 960 E) $31, 458


A) $25, 816
B) $27, 175
C) $28, 534
D) $29, 960
E) $31, 458

F) A) and C)
G) B) and D)

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Your new employer, Freeman Software, is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected life.What is the Year 1 cash flow? Your new employer, Freeman Software, is considering a new project whose data are shown below.The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected life.What is the Year 1 cash flow? A) $30, 333 B) $31, 849 C) $33, 442 D) $35, 114 E) $36, 869


A) $30, 333
B) $31, 849
C) $33, 442
D) $35, 114
E) $36, 869

F) None of the above
G) A) and C)

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The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

A) True
B) False

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Which of the following statements is CORRECT?


A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
B) If firms use accelerated depreciation, they 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.
C) 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.
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 higher than they would be if straight-line depreciation were required for tax purposes.
E) 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.

F) None of the above
G) All of the above

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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.

A) True
B) False

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