FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 12: Cash Flow Estimation and Risk Analysis

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 1

Multiple Choice

Review LaterAdd Note

Review Later

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.
B) Since depreciation is a non-cash 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 both opportunity costs and sunk costs,but the firm should ignore the 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 because WACC is calculated on a before-tax basis.
E) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.To do otherwise would bias the NPV upward.

Correct Answer

verified

Show Answer

Question 2

Multiple Choice

Review LaterAdd Note

Review Later

Which of the following statements is CORRECT?

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 a situation where a bank opens a new office,and that new office leads to a decline in deposits of the bank's other offices.
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.
E) 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 have been had the sunk costs been ignored.

Correct Answer

verified

Show Answer

Question 3

True/False

Review LaterAdd Note

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.

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken,assuming the asset is used for its full tax life,is greater.

Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward,thus increasing their present value.On the other hand,using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses.However,the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

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

The two cardinal rules that financial analysts should follow to avoid errors are: (1)in the NPV equation,the numerator should use income calculated in accordance with generally accepted accounting principles,and (2)all incremental cash flows should be considered when making accept/reject decisions for capital budgeting projects.

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?

The relative risk of a proposed project is best accounted for by which of the following procedures?

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

Langston Labs has an overall (composite) WACC of 10%,which reflects the cost of capital for its average asset.Its assets vary widely in risk,and Langston evaluates low-risk projects with a WACC of 8%,average-risk projects at 10%,and high-risk projects at 12%.The company is considering the following projects: ​ ​ Which set of projects would maximize shareholder wealth?

Temple Corp.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 change in net operating 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? Do not round the intermediate calculations and round the final answer to the nearest whole number.

Thomson Media is considering some new equipment whose data are shown below.The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years,but it would have a positive pre-tax salvage value at the end of Year 3,when the project would be closed down.Also,additional net operating working capital would be required,but it would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number.

Which of the following statements is CORRECT?

Aggarwal 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?

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate,projects' initial outlays and subsequent costs can be forecasted with great accuracy.This is especially true for large product development projects.

Because of improvements in forecasting techniques,estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower,and cash flows higher,during every year of a project's life,other things held constant.

Which of the following statements is CORRECT?

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher,other things held constant.