Exam 11: Cash Flow Estimation and Risk Analysis

A) previous expenditures associated with a market test to determine the feasibility of the project provided those costs have been expensed for tax purposes
B) the value of a building owned by the firm that will be used for this project
C) a decline in the sales of an existing product provided that decline is directly attributable to this project
D) the salvage value of assets used for the project at the end of the project's life

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A) Increase the estimated IRR 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 the project's higher-than- average risk.

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A) all overhead costs incurred
B) interest on funds borrowed to help finance the project
C) the end-of-project recovery of any working capital required to operate the project
D) cannibalization effects, but only if those effects increase the project's projected cash flows

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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 money that a banking corporation spent last year to investigate the site for a new office, then expensed those funds for tax purposes, and now is deciding whether to go forward with the project.
D) 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 be.

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A) Straightforward sensitivity analysis, as it is generally employed, is incomplete in that it fails to consider the range of likely values for the key input variables and the probabilities of different input values.
B) A statistically based behavioural approach to project analysis that applies pre-determined probability distributions is the scenario approach.
C) A method for evaluating a project that uses a number of possible values for a given variable, such as cash inflows, to assess its impact on the firm's return is simulation analysis.
D) Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key variables and the likely range of variable values.

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A) $10,585
B) $10,913
C) $11,250
D) $11,588

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A) $16,213.00
B) $20,067.50
C) $22,497.50
D) $18,863.50

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A) Using CCA method rather than straight-line depreciation 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) Corporations must use the same depreciation method (e.g., straight-line or CCA) for stockholder reporting and tax purposes.
C) Since CCA deduction is not a cash expense, it has no affect on cash flows and thus no affect on capital budgeting decisions.
D) Under CCA rules, higher CCA deductions occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.

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A) all interest expenses on debt used to help finance the project
B) the investment in working capital required to operate the project, even if that investment will be recovered at the end of the project's life
C) sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year
D) effects of the project on other divisions of the firm, but only if those effects lower the direct cash flows of the project

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A) A, B, and C.
B) A, B, and D.
C) A, B, C, and D.
D) A, B, C, D, and E.

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A) Project A, which has average risk and an IRR of 9%
B) Project B, which has below-average risk and an IRR of 8.5%
C) Project C, which has above-average risk and an IRR of 11%
D) Without information about the projects' NPVs we cannot determine which one(s) should be accepted

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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, it would in effect be "double-counted."
B) Since depreciation is a noncash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.
C) When estimating the project's operating cash flows, it is important to include any opportunity costs and sunk costs, but the firm should ignore cash flow effects of externalities since they are accounted for in the discounting process.
D) Capital budgeting decisions should be based on BEFORE-TAX cash flows.

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A) $12,380
B) $13,032
C) $14,440
D) $15,200

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A) the land that would be used for the new project could be sold to another firm.
B) revenues from an existing product that would be lost as a result of customers switching to the new product.
C) shipping and installation costs associated with preparing a machine that would be used to produce the new product.
D) the cost of a marketing study that was completed last year related to the new product. This research led to the tentative decision to go ahead with the new product, and the cost of the research was expensed for tax purposes last year.

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