Chapter 12

Other things held constant, which of the following would increase the NPV of a project being considered?

a. A shift from straight-line to MACRS depreciation.

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.

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?

a. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

Which of the following statements is CORRECT?

a. Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

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

a. The new project is expected to reduce sales of one of the company's existing products by 5%.

Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy. The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project. Also, the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong. On the basis of this information, which of the following statements is CORRECT?

a. The proposed new project would have more stand-alone risk than the firm's typical project.

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.

Which of the following statements is CORRECT?

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.

Rowell 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. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT?

b. 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.

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

b. Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions for capital budgeting projects.

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

b. Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.

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?

b. Project B, which has below-average risk and an IRR = 8.5%.

Which of the following statements is CORRECT?

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.

Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

c. Larger total undiscounted profits from the project over the project's life.

Taussig 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: Project X Project Y Expected NPV $350,000 $350,000 Standard deviation (σNPV) $100,000 $150,000 Project beta (vs. market) 1.4 0.8 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?

c. Project X has more market risk than Project Y.

A company is considering a new project. The CFO plans to calculate the 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 flows), 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?

c. The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life.

Dalrymple Inc. is considering production of 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?

c. The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future.

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

c. The end-of-project recovery of any additional net operating working capital required to operate the project.

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?

d. A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

d. 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.

Which of the following statements is CORRECT?

d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.

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?

d. The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

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.

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?

e. Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.

Which of the following statements is CORRECT?

e. Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

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

e. Sunk costs that have been expensed for tax purposes.