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Financial Management 2017 - Quiz and Case Study Guides - Foundations of Finance, 9e (Keown/Martin/Petty) - Quiz - Chapter 11

Financial Management 2016 - 2017

FINANCIAL MANAGEMENT 2017 - QUIZ AND CASE STUDY GUIDES

Foundations of Finance, 9e (Keown/Martin/Petty)

Chapter 11   Cash Flows and Other Topics in Capital Budgeting

 

 

Foundations of Finance, 9e (Keown/Martin/Petty)

Chapter 11   Cash Flows and Other Topics in Capital Budgeting

 

Learning Objective 11.1

 

1) Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity.

Answer:  FALSE

Diff: 1      Page Ref: 369

Keywords:  Capital Budgeting Decisions, Accounting Profits vs Cash Flow

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

2) Capital budgeting decisions are based on free cash flow because free cash flow better reflects when money is received and available for reinvestment than account profits.

Answer:  TRUE

Diff: 1      Page Ref: 369

Keywords:  Capital Budgeting Decisions, Free Cash Flow, Accounting Profits

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

3) The guiding rule in deciding if a free cash flow is incremental is to look at the company with, versus without, the new project.

Answer:  TRUE

Diff: 1      Page Ref: 369

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

4) A grocery store decides to offer beer for sale and this decision results in more potato chip sales. This is an example of a synergistic effect.

Answer:  TRUE

Diff: 1      Page Ref: 370

Keywords:  Synergistic Effects

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

5) Additional investment in working capital, even if it may be recovered at the end of a project, must be included in capital budgeting analysis because of the time value of money.

Answer:  TRUE

Diff: 1      Page Ref: 370

Keywords:  Additional Working Capital, Recovery of Additional Working Capital, Time Value of Money

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

 

6) Sunk costs are cash outflows that will occur regardless of the current accept/reject decision, and therefore should be excluded from the analysis.

Answer:  TRUE

Diff: 1      Page Ref: 371

Keywords:  Sunk Costs

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

7) Overhead costs are sometimes incremental cash flows and other times are considered sunk costs.

Answer:  TRUE

Diff: 1      Page Ref: 371

Keywords:  Overhead Costs, Incremental Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

8) Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

Answer:  FALSE

Diff: 1      Page Ref: 369

Keywords:  Financing Cash Flow, Incremental Cash Flow

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

9) To be included in a capital budgeting analysis, all incremental free cash flows must be expensed on the company's books, otherwise generally accepted accounting principles will be violated.

Answer:  FALSE

Diff: 1      Page Ref: 369

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

10) In measuring cash flows, we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.

Answer:  TRUE

Diff: 1      Page Ref: 369

Keywords:  Incremental After-Tax Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

11) The initial outlay for a new project is an example of an opportunity cost.

Answer:  FALSE

Diff: 1      Page Ref: 371

Keywords:  Opportunity Cost

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

12) Synergistic benefits from an investment project include cannibalism.

Answer:  FALSE

Diff: 1      Page Ref: 370

Keywords:  Synergistic Effects, Cannibalism

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

13) Toyota's capital budgeting analysis for the Prius, a gas-electric hybrid, was faulty because the car line has not made a profit to date.

Answer:  FALSE

Diff: 1      Page Ref: 368, 369

Keywords:  Capital Budgeting

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

14) Accounting profits, adjusted for taxes and differences in accounting methods, provide the best measure of relevant cash flows for capital budgeting purposes.

Answer:  FALSE

Diff: 1      Page Ref: 369

Keywords:  Accounting Profits, Cash Flow

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

15) Hershey's expects to sell $2 million of its new candy bar, although $200,000 of this amount would have been spent on its existing candy bar. The $2 million is the appropriate cash inflow for the new candy bar project, while the $200,000 will be counted against the return on the old candy bar.

Answer:  FALSE

Diff: 1      Page Ref: 370

Keywords:  Incremental Cash Flows, Cannibalism

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

16) Adding gourmet coffee stations to my convenience store is expected to increase sales of my breakfast sandwiches; however, the sales of breakfast sandwiches should not be included in the evaluation of the gourmet coffee project because only relevant, incremental cash flows should be considered.

Answer:  FALSE

Diff: 1      Page Ref: 370

Keywords:  Synergistic Effects

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

17) As a rule, any cash flows that are not affected by the accept/reject criterion should not be included in capital-budgeting analysis.

Answer:  TRUE

Diff: 1      Page Ref: 371

Keywords:  Sunk Costs

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

18) If a project uses an asset the corporation already owns, the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets.

Answer:  FALSE

Diff: 2      Page Ref: 371

Keywords:  Opportunity Cost

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

19) For companies in competitive markets, the evolution and introduction of new products may serve more to preserve market share than to expand it.

Answer:  TRUE

Diff: 1      Page Ref: 370

Keywords:  Capital Budgeting, Synergistic Effects

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

20) TRL, Inc. has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000. The present value of all benefits the center will produce in its lifetime are $19,000,000, so TRL should not build the convention center.

Answer:  FALSE

Diff: 2      Page Ref: 371

Keywords:  Sunk Costs

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

21) An opportunity cost is a relevant incremental cost for capital budgeting decisions.

Answer:  TRUE

Diff: 1      Page Ref: 371

Keywords:  Opportunity Costs, Incremental Costs

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

22) The calculation of incremental free cash flows over a project's life should include

  1. A) labor and material saving.
  2. B) additional revenue.
  3. C) interest to bondholders.
  4. D) A and B.

Answer:  D

Diff: 1      Page Ref: 369, 370

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

23) Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very popular. So many new customers come to the store that the sales of existing ice cream products are increased. The extra sales revenue

  1. A) should not be counted as incremental revenue for the polar cream project because the sales come from existing products.
  2. B) are synergistic effects that should be counted as incremental revenues for the polar cream project.
  3. C) are cannibalized sales that should be excluded from the analysis.
  4. D) should be included in the analysis, but not the cost of the ice cream that is sold as that is a recurring expense.

Answer:  B

Diff: 1      Page Ref: 370

Keywords:  Synergistic Effects, Incremental Revenues

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

24) Sunk costs are

  1. A) recoverable.
  2. B) incremental.
  3. C) not relevant in capital budgeting.
  4. D) not deductible for tax purposes.

Answer:  C

Diff: 1      Page Ref: 371

Keywords:  Sunk Costs

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

25) Solar Confectionary develops a new candy bar and plans to sell each bar for $1. Solar predicts that 1 million candy bars will be sold in the first year if the new candy bar is produced and sold, and includes $1 million of incremental revenues in its capital budgeting analysis. A senior executive in the company believes that 1 million candy bars will be sold, but lowers the estimate of incremental revenue to $700,000. What would explain this change?

  1. A) cannibalization of 300,000 of Solar Confectionary's other candy bars
  2. B) excessive marketing costs to sell the 1 million candy bars
  3. C) a lower discount rate
  4. D) a higher selling price for the new candy bars

Answer:  A

Diff: 1      Page Ref: 370

Keywords:  Incremental Revenues, Cannibalization

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

26) Redrock Inc. is a household products firm that is considering developing a new detergent. In evaluating whether to go ahead with the new detergent project, which of the following statements is MOST correct?

  1. A) The company will produce the detergent in a building that they already own. The cost of the building is therefore zero and should be excluded from the analysis.
  2. B) The company will need to use some equipment that it could have leased to another company. This equipment lease could have generated $200,000 per year in after-tax income. The $200,000 should be excluded because the equipment can no longer be leased.
  3. C) The company will need to hire 10 new workers whose salaries and benefits will total $400,000 per year. Labor costs are not part of capital budgeting and should be excluded.
  4. D) The company will produce the detergent in a building that it renovated 2 years ago for $300,000. The $300,000 should be excluded from the analysis.

Answer:  D

Diff: 2      Page Ref: 371

Keywords:  Opportunity Costs, Sunk Costs, Incremental Expenses

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

27) AFB Systems is considering a new marketing campaign that will require the addition of a new computer programmer and new software. The programmer will occupy an office in AFB's current building and will be paid $8,000 per month. The software license costs $1,000 per month. The rent for the building is $4,000 per month. AFB's computer system is always on, so running the new software will not change the current monthly electric bill of $900. The incremental expenses for the new marketing campaign are

  1. A) $13,900 per month.
  2. B) $9,000 per month.
  3. C) $13,000 per month.
  4. D) $8,000 per month.

Answer:  B

Diff: 1      Page Ref: 371

Keywords:  Overhead Costs, Incremental Expenses

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

28) A local restaurant owner is considering expanding into another rural area. The expansion project will be financed through a line of credit with City Bank. The administrative costs of obtaining the line of credit are $500, and the interest payments are expected to be $1,000 per month. The new restaurant will occupy an existing building that can be rented for $2,500 per month. The incremental cash flows for the new restaurant include

  1. A) $500 administrative costs, $1,000 per month interest payments, $2,500 per month rent.
  2. B) $500 administrative costs, $2,500 per month rent.
  3. C) $1,000 per month interest payments, $2,500 per month rent.
  4. D) $2,500 per month rent.

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Financing Cash Flow, Incremental Cash Flow

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

29) Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month. As more drivers bring in their vehicles, Butler expects to also do more oil changes and brake repairs. As a result, inventory levels of oil and brake parts must be increased by $5,000. Revenues from oil changes and brake jobs are expected to increase by $4,000 per month. An example of a synergistic effect from the new diagnostic testing procedure is the

  1. A) increase in inventory levels of oil and brake parts.
  2. B) increase in revenue of $10,000 per month for the diagnostic testing.
  3. C) increase in revenues from oil changes and brake jobs of $4,000 per month.
  4. D) increase in all activities totaling $19,000 per month.

Answer:  C

Diff: 1      Page Ref: 370

Keywords:  Synergistic Effects

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

30) Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month. As more drivers bring in their vehicles, Butler expects to also do more oil changes and brake repairs. As a result, inventory levels of oil and brake parts must be increased by $5,000. Revenues from oil changes and brake jobs are expected to increase by $4,000 per month. An example of an increase in net working capital requirements from the new diagnostic testing procedure is the

  1. A) increase in inventory levels of oil and brake parts of $5,000.
  2. B) increase in revenue of $10,000 per month for the diagnostic testing.
  3. C) increase in revenues from oil changes and brake jobs of $4,000 per month.
  4. D) increase in all activities totaling $19,000 per month.

Answer:  A

Diff: 1      Page Ref: 370

Keywords:  Net Working Capital

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

31) Incremental cash flows refer to

  1. A) the difference between after-tax cash flows and before-tax accounting profits.
  2. B) the new cash flows that will be generated if a project is undertaken.
  3. C) the cash flows of a project, minus financing costs.
  4. D) the cash flows that are foregone if a firm does not undertake a project.

Answer:  B

Diff: 1      Page Ref: 369

Keywords:  Incremental Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

 

32) Which of the following should be included in an analysis of a new project's cash flows?

  1. A) any sales from existing products that would be lost if customers were expected to purchase a new product instead
  2. B) all financing costs
  3. C) all sunk costs
  4. D) no opportunity costs

Answer:  A

Diff: 1      Page Ref: 370

Keywords:  Cannibalization, Financing Cash Flows, Sunk Costs, Opportunity Costs

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

33) It is important to consider a new project's affect on the cash flows of existing projects because of

  1. A) cannibalism.
  2. B) synergy.
  3. C) sunk costs.
  4. D) A and B above.

Answer:  D

Diff: 1      Page Ref: 370

Keywords:  Cannibalism, Synergy

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

34) Which of the following expenses associated with a project should NOT be included in a capital budgeting analysis?

  1. A) additional allocated fixed overhead from corporate headquarters
  2. B) additional maintenance expenses associated with new equipment
  3. C) reengineering of a production line associated with a new project
  4. D) training sales staff on a new product

Answer:  A

Diff: 1      Page Ref: 371

Keywords:  Incremental Cash Flows, Overhead, Initial Outlay

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

35) A company is expanding and has already signed a lease on new office space that costs $10,000 per month. The company also needs a new information system and hired a consultant to recommend new software. The consultant was paid $5,000 for her recommendation. Now the company is trying to make a choice between three competing software products. In the capital budgeting decision to purchase new software, the monthly rent for the office space is ________ and the consultant's fee is ________.

  1. A) a sunk cost; a sunk cost
  2. B) an opportunity cost; a sunk cost
  3. C) incremental cash outflow; an opportunity cost
  4. D) a sunk cost; a part of the initial outlay

Answer:  A

Diff: 2      Page Ref: 371

Keywords:  Sunk Costs

Learning Obj.:  L.O. 11.1

AACSB:  Analytical Thinking

 

36) As part of its expansion project, A.J. Industries Equipment Division has expanded its office space by 200 square feet. The company's administrative overhead is allocated based on the square footage of each business segment. Although the total administrative overhead for the company will remain the same, the Equipment Division will be charged more for administrative overhead. For the Equipment Division expansion project, the administrative overhead is an example of a(n)

  1. A) incremental cash flow.
  2. B) sunk cost.
  3. C) opportunity cost.
  4. D) incremental opportunity cash flow.

Answer:  B

Diff: 2      Page Ref: 371

Keywords:  Sunk Costs, Overhead, Incremental Cash Flow

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

37) What is an incremental cash flow? What is a sunk cost? Why must you account for opportunity costs?

Answer:  An incremental cash flow is a free cash flows the company as a whole will receive if the company takes on a given project. Therefore, a guiding rule in deciding if a free cash flow is incremental is to look at the company with, versus without, the new project. In determining the free cash flows associated with the proposed project, we should consider only the incremental sales brought to the company as a whole. Just moving sales from one product line to a new product line does not bring anything new into the company. But if sales are captured from competitors or if sales that would have been lost to new competing products are retained, then these are relevant incremental free cash flows.

Cash flows that have already taken place are often referred to as "sunk costs" because they have been sunk into the project and cannot be recovered. As a rule, any cash flows that are not affected by the accept/reject criterion should not be included in capital-budgeting analysis.

Finally, opportunity costs are cash flows that are lost because a given project consumes scarce resources that would have produced cash flows if that project had been rejected. For example, a product consumes valuable floor space in a production facility. The space could have been rented out. The key point is that opportunity-cost cash flows should reflect the net cash flows that would have been received if the project under consideration had been rejected.

Diff: 2      Page Ref: 369, 370, 371

Keywords:  Incremental Cash Flows

Learning Obj.:  L.O. 11.1

AACSB:  Reflective Thinking

 

Learning Objective 11.2

 

1) In general, a project's free cash flows will fall in one of the following three categories: initial outlay, differential cash flows over the project's life, and the terminal cash flow.

Answer:  TRUE

Diff: 1      Page Ref: 372

Keywords:  Free Cash Flow, Initial Outlay, Differential Cash Flows, Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

 

2) If an old asset is sold for less than its book value, the resulting loss will save the company taxes, hence lowering the cost of the project.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Tax Effect, Sale of Old Machine, Book Value

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

3) If an old asset is sold for its depreciated, or book, value, then no taxes result and there is no tax effect from the sale.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Tax Effect, Sale of Old Asset, Book Value

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

4) One example of a terminal cash flow is the recapture of the net working capital associated with the project.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Terminal Cash Flow, Recapture, Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

5) The initial outlay of a project may be reduced by the after-tax salvage value of replaced equipment.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Initial Outlay, Salvage Value

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

6) A weakness in the capital budgeting process is the funds for an investment proposal obtained by issuing bonds, and the respective interest payments, are not considered in the capital budgeting process.

Answer:  FALSE

Diff: 1      Page Ref: 374

Keywords:  Interest Payments, Capital Budgeting Process

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

7) The initial outlay includes the immediate cash outflow necessary to purchase the asset and put it in operating order.

Answer:  TRUE

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

 

8) If the increase in net working capital is recovered entirely at the end of the project, then it may be ignored.

Answer:  FALSE

Diff: 1      Page Ref: 373

Keywords:  Net Working Capital, Recovery of Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

9) Cash flows associated with a project's termination generally include the salvage value of the project net of any taxes associated with the sale.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Terminal Year Cash Flows, Salvage Value, Tax Effect

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

10) Increasing depreciation expense results in a decrease of the incremental after-tax free cash flow.

Answer:  FALSE

Diff: 1      Page Ref: 373

Keywords:  Depreciation, Incremental Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

11) Increases in working capital needs should be included as part of the initial outlay of a project, but decreases in working capital for a project should not be considered because they are not guaranteed.

Answer:  FALSE

Diff: 1      Page Ref: 374

Keywords:  Working Capital Requirements, Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

12) Any increase in interest payments caused by a project should be counted in the incremental cash flows.

Answer:  FALSE

Diff: 1      Page Ref: 374

Keywords:  Interest Payments, Financing Cash Flows, Incremental Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

13) Terminal cash flows are always positive because they result from the shutting down of a project with the sale of any assets with remaining value.

Answer:  FALSE

Diff: 1      Page Ref: 375

Keywords:  Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

 

14) Proceeds from the issuance of new debt and principal payments upon maturity of debt used to finance a project should be included in the calculation of the project's after-tax cash flows.

Answer:  FALSE

Diff: 1      Page Ref: 374

Keywords:  Financing Cash Flow, Incremental After-tax Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

15) Interest payments on debt are not included in a project's incremental cash flows, but are instead accounted for in the project's discount rate.

Answer:  TRUE

Diff: 1      Page Ref: 374

Keywords:  Interest Payments, Financing Cash flows, Incremental Cash Flows, Discount Rate

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

16) Depreciation is a non-cash deduction so it may be ignored in the calculation of a project's incremental after-tax cash flows.

Answer:  FALSE

Diff: 1      Page Ref: 373

Keywords:  Depreciation, Non-cash Expense, Incremental After-tax Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

17) Depreciation expense produces a cash inflow equal to the depreciation expense multiplied by the firm's marginal tax rate.

Answer:  TRUE

Diff: 1      Page Ref: 373

Keywords:  Depreciation Expense, Cash Inflow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

18) Free cash flow calculations can be broken down into three parts: cash flows from operations, cash flows associated with working-capital requirements, and financing cash flows relating to interest and dividend payments.

Answer:  FALSE

Diff: 1      Page Ref: 375

Keywords:  Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

19) Capital budgeting projects that expand sales are more likely to involve increases in working capital than are projects that involve the replacement of existing assets.

Answer:  TRUE

Diff: 2      Page Ref: 373

Keywords:  Working-Capital Requirements

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

20) Increases in inventory and accounts receivable expected to occur if a proposed advertising campaign is undertaken are examples of sunk costs.

Answer:  FALSE

Diff: 2      Page Ref: 373

Keywords:  Working-Capital Requirements, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

21) In general, a project's free cash flows will fall into one of three categories: (1) incremental costs, (2) sunk costs, and (3) opportunity costs.

Answer:  FALSE

Diff: 1      Page Ref: 372

Keywords:  Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

22) The initial outlay includes the cost of purchasing the asset and getting it operational, including the purchase price, shipping and installation, and any training costs for employees who will be operating the equipment, and any increases in working capital requirements.

Answer:  TRUE

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

23) The initial outlay includes the cost of purchasing the asset and getting is operational, but this excludes any training costs for employees which should be included as part of differential cash flows over the life of the project.

Answer:  FALSE

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

24) In a replacement decision, the initial outlay is equal to the cost of the new asset less the reduction in depreciation from elimination of the old asset.

Answer:  FALSE

Diff: 1      Page Ref: 373

Keywords:  Replacement Project, Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

25) Operating cash flow is equal to the change in EBIT less the change in interest expense, less the change in taxes, plus the change in depreciation.

Answer:  FALSE

Diff: 1      Page Ref: 375

Keywords:  Operating Cash Flow, Interest Expense

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

26) Changes in capital spending are not incorporated directly into capital budgeting problems because the amounts are included in the operating cash flows through the inclusion of depreciation expense.

Answer:  FALSE

Diff: 1      Page Ref: 374

Keywords:  Capital Spending, Free Cash Flows, Operating Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

27) A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

Answer:  TRUE

Diff: 1      Page Ref: 375

Keywords:  Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

28) A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

Answer:  TRUE

Diff: 1      Page Ref: 375

Keywords:  Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

29) Interest expenses are not included as incremental free cash flows because the cost of funds is recognized when cash flows are discounted back to present value.

Answer:  TRUE

Diff: 1      Page Ref: 374

Keywords:  Interest Expense, Risk-Adjusted Discount Rate

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

30) Blackjack Inc. wants to replace a 9-year-old machine with a new machine that is more efficient. The old machine cost $70,000 when new and has a current book value of $15,000. Blackjack can sell the machine to a foreign buyer for $14,000. Blackjack's tax rate is 35%. The effect of the sale of the old machine on the initial outlay for the new machine is

  1. A) ($14,350).
  2. B) ($13,650).
  3. C) ($9,100).
  4. D) $1,000.

Answer:  A

Diff: 2      Page Ref: 373

Keywords:  Tax Effect, Sale of Old Machine, Book Value

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

31) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the initial outlay required to fund this project?

  1. A) $80,000
  2. B) $84,000
  3. C) $90,000
  4. D) $94,000

Answer:  D

Diff: 2      Page Ref: 373

Keywords:  Initial Outlay, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

32) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the incremental free cash flow for the first year of the project?

  1. A) $23,800
  2. B) $29,850
  3. C) $32,440
  4. D) $37,750

Answer:  D

Diff: 2      Page Ref: 375

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

33) You are analyzing the purchase of new equipment. Since you are not an expert on this type of equipment, you hire a consulting firm to make recommendations. The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp. of America. The equipment costs $80,000, and it will cost another $10,000 to modify it for special use by your firm. The equipment will be depreciated on a straight-line basis over six years with no salvage value. You expect the equipment will be sold after three years for $28,000. Use of the equipment will require an increase in your company's net working capital of $4,000, but this $4,000 will be recovered at the end of year three. The use of the equipment will have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs. Your company's marginal tax rate is 35%. What is the terminal cash flow for this project?

  1. A) ($17,000)
  2. B) $24,500
  3. C) $33,950
  4. D) $37,950

Answer:  D

Diff: 2      Page Ref: 375

Keywords:  Terminal Cash Flow, Recapture of Net Working Capital, Tax Effect

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

34) A new project is expected to generate $800,000 in revenues, $250,000 in cash operating expenses, and depreciation expense of $150,000 in each year of its 10-year life. The corporation's tax rate is 35%. The project will require an increase in net working capital of $85,000 in year one and a decrease in net working capital of $75,000 in year ten. What is the free cash flow from the project in year one?

  1. A) $298,000
  2. B) $375,000
  3. C) $380,000
  4. D) $410,000

Answer:  D

Diff: 2      Page Ref: 375

Keywords:  Free Cash Flow, EBIT, Depreciation Expense, Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

35) Smith Manufacturing Inc. expects the following results in year one of a new project:

 

Revenue

$400,000

Cash Expenses

150,000

Depreciation

90,000

EBIT

$160,000

Taxes

48,000

Net Income

$112,000

 

The annual change in operating cash flow is equal to

  1. A) $298,000.
  2. B) $202,000.
  3. C) $160,000.
  4. D) $250,000.

Answer:  B

Diff: 1      Page Ref: 375

Keywords:  Operating Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

36) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the incremental free cash flow for year one?

  1. A) $18,875
  2. B) $19,985
  3. C) $22,305
  4. D) $24,220

Answer:  D

Diff: 2      Page Ref: 375

Keywords:  Incremental Free Cash Flows, Depreciation

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

37) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the terminal cash flow?

  1. A) $23,000
  2. B) $18,000
  3. C) $17,250
  4. D) $16,700

Answer:  D

Diff: 2      Page Ref: 375

Keywords:  Terminal Cash Flow, Salvage Value, Tax Effect, Recapture of Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

38) The recapture of net working capital at the end of a project will

  1. A) increase terminal year free cash flow.
  2. B) decrease terminal year free cash flow by the change in net working capital times the corporate tax rate.
  3. C) increase terminal year free cash flow by the change in net working capital times the corporate tax rate.
  4. D) have no effect on the terminal year free cash flow because the net working capital change has already been included in a prior year.

Answer:  A

Diff: 1      Page Ref: 374

Keywords:  Recapture of Net Working Capital, Terminal Year Free Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

39) If depreciation expense in year one of a project increases for a highly profitable company,

  1. A) net income decreases and incremental free cash flow decreases.
  2. B) net income increases and incremental free cash flow increases.
  3. C) the book value of the depreciating asset increases at the end of year one.
  4. D) net income decreases and incremental free cash flow increases.

Answer:  D

Diff: 1      Page Ref: 373

Keywords:  Depreciation Expense, Incremental Free Cash Flow, Taxes

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

40) Salvage value would most likely NOT be considered by

  1. A) net present value.
  2. B) internal rate of return.
  3. C) payback.
  4. D) A and B.

Answer:  C

Diff: 1      Page Ref: 375

Keywords:  Salvage Value, Payback Period

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

41) Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal?

  1. A) increase in accounts receivable
  2. B) cost of issuing new bonds if the project is financed by a new bond issue
  3. C) installation costs
  4. D) None of the above—all are considered.

Answer:  B

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay, Financing Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

42) Which of the following is NOT considered in the calculation of incremental cash flows?

  1. A) tax saving due to increased depreciation expense
  2. B) interest payments if new debt is issued
  3. C) increased dividend payments if additional preferred stock is issued
  4. D) B and C

Answer:  D

Diff: 1      Page Ref: 374

Keywords:  Incremental Cash Flows, Financing Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

43) XYZ, Inc. has developed a project which results in additional accounts receivable of $400,000, additional inventory of $180,000, and additional accounts payable of $70,000. What is the additional investment in net working capital?

  1. A) $580,000
  2. B) $510,000
  3. C) $270,000
  4. D) $150,000

Answer:  B

Diff: 2      Page Ref: 374

Keywords:  Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

44) AFB, Inc. requires an investment in equipment of $600,000 to replace existing equipment. The existing equipment will produce after-tax salvage value of $70,000. Net working capital requirements are increased by $50,000. What is the total cash outflow at time zero?

  1. A) $720,000
  2. B) $650,000
  3. C) $530,000
  4. D) $580,000

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay, Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

45) A six-year project for Little Egypt, Inc. results in additional accounts receivable of $150,000, additional inventory of $50,000, and additional accounts payable of $80,000 today. What is the change in the NPV of a project solely due to the additional net working capital (NWC) needs? Assume a 14% discount rate, and the recovery of net working capital at the end of the project.

  1. A) a decrease of $34,606
  2. B) a decrease of $42,670
  3. C) a decrease of $120,000
  4. D) a decrease of $58,689

Answer:  B

Diff: 2      Page Ref: 374

Keywords:  Additional Net Working Capital, NPV

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

46) Which of the following should be included in the initial outlay?

  1. A) taxable gain on the sale of old equipment being replaced
  2. B) first year depreciation expense on any new equipment purchased
  3. C) preexisting firm overhead reallocated to the new project
  4. D) increased investment in inventory and accounts receivable

Answer:  D

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

47) Increased depreciation expenses affect tax-related cash flows by

  1. A) increasing taxable income, thus increasing taxes.
  2. B) decreasing taxable income, thus reducing taxes.
  3. C) decreasing taxable income, with no effect on cash flow since depreciation is a non-cash expense.
  4. D) pushing a corporation into a higher tax bracket.

Answer:  B

Diff: 1      Page Ref: 373

Keywords:  Depreciation Expense, Tax-Related Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

48) Which of the following are included in the terminal cash flow?

  1. A) the expected salvage value of the asset
  2. B) any tax payments or receipts associated with the salvage value of the asset
  3. C) recapture of any working capital increase included in the initial outlay
  4. D) all of the above

Answer:  D

Diff: 1      Page Ref: 375

Keywords:  Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

49) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. Trinitron must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. What will depreciation expense be during the first year?

  1. A) $13,000
  2. B) $12,500
  3. C) $11,625
  4. D) $11,500

Answer:  B

Diff: 2      Page Ref: 373

Keywords:  Depreciation Expense

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

50) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. Trinitron, Inc. must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. Trinitron is replacing an old machine that was purchased 6 years ago for $50,000. The old machine was being depreciated on a straight-line basis over a ten year expected useful life. The machine was sold for $15,000. Trinitron's marginal tax rate is 40%. What is the amount of the initial outlay?

  1. A) $89,000
  2. B) $87,000
  3. C) $91,000
  4. D) $85,000

Answer:  B

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

51) When terminating a project for capital budgeting purposes, the working capital outlay required at the initiation of the project will

  1. A) not affect the terminal cash flow.
  2. B) decrease the terminal cash flow because it is a historical cost.
  3. C) increase the terminal cash flow because it is recaptured.
  4. D) decrease the terminal cash flow because it is an outlay.

Answer:  C

Diff: 1      Page Ref: 374

Keywords:  Recapture, Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

52) J.B. Enterprises purchased a new molding machine for $85,000. The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets. J.B. must maintain a supply of special lubricating oil just in case the machine breaks down. The company purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years. Which of the following statements concerning the change in working capital is MOST accurate?

  1. A) The $4,000 paid for oil is added to the initial outlay, offset by the tax savings $1600.
  2. B) The $4,000 may be expensed each year over the life of the project as part of the incremental free cash flows.
  3. C) The $4,000 is added to the initial outlay and recaptured during the terminal year, hence having no impact on the projects NPV or IRR.
  4. D) Even if the $4,000 is fully recovered at the end of the project, the project's NPV and IRR will be lower if the change in working capital is included in the analysis.

Answer:  D

Diff: 2      Page Ref: 374

Keywords:  Working Capital, Initial Outlay, Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

53) AFB, Inc. is considering replacing an old machine with a new one. Two months ago their chief engineer completed a training seminar on the new machine's operation and efficiency. The $3,000 cost for this training session has already been paid. If the new machine is purchased, it would require $7,000 in installation and modification costs to make it suitable for operation in the factory. The old machine originally cost $80,000 five years ago and is being depreciated by $10,000 per year. The new machine will cost $100,000 before installation and modification. It will be depreciated by $12,000 per year. The old machine can be sold today for $12,000. The marginal tax rate for the firm is 40%. Compute the relevant initial outlay in this capital budgeting decision.

  1. A) $79,500
  2. B) $97,800
  3. C) $90,800
  4. D) $87,800

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay, Sunk Costs, Tax Effect on Sale of Old Asset

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

54) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The initial outlay for the new machine is

  1. A) $113,000.
  2. B) $112,200.
  3. C) $111,000.
  4. D) $109,800.

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

55) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during year 1 of the project?

  1. A) $12,800
  2. B) $14,400
  3. C) $11,400
  4. D) $15,200

Answer:  B

Diff: 2      Page Ref: 373

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

56) Which of the following should be excluded in an analysis of a new project's cash flows?

  1. A) additional investment in fixed assets
  2. B) additional investment in accounts receivable
  3. C) additional investment in inventory
  4. D) additional interest expenses on debt financing

Answer:  D

Diff: 1      Page Ref: 374

Keywords:  Financing Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

 

57) A new machine can be purchased for $1,200,000. It will cost $35,000 to ship and $15,000 to modify the machine. A $12,000 recently completed feasibility study indicated that the firm can employ an existing factory owned by the firm, which would have otherwise been sold for $180,000. The firm will borrow $750,000 to finance the acquisition. Total interest expense for 5-years is expected to approximate $350,000. What is the investment cost of the machine for capital budgeting purposes?

  1. A) $2,180,000
  2. B) $1,780,000
  3. C) $1,442,000
  4. D) $1,430,000

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

58) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased for $4,550,000. It will cost $65,000 to ship and $190,500 to install the processor. A recently completed feasibility study that was performed at a cost of $45,000 indicated that the processor would produce a positive NPV. Studies have shown that employee-training expenses will be $150,000. What is the total investment in the processing line for capital budgeting purposes?

  1. A) $4,550,000
  2. B) $4,700,000
  3. C) $4,955,500
  4. D) $5,000,500

Answer:  C

Diff: 2      Page Ref: 372

Keywords:  Initial Outlay, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

59) Which of the following should NOT be included as investment costs in evaluating a capital asset?

  1. A) interest payments and other financing cash flows that result from raising funds to finance a project
  2. B) employee training expenses
  3. C) shipping expenses
  4. D) installation expenses

Answer:  A

Diff: 1      Page Ref: 372

Keywords:  Incremental Cash Flows, Financing Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

 

60) A new machine can be purchased for $1,800,000. It will cost $35,000 to ship and $15,000 to fine-tune the machine. The new machine will replace an older version that is fully depreciated and will be sold for $200,000. The firm's income tax rate is 35%. What is the initial outlay for capital budgeting purposes?

  1. A) $1,580,000
  2. B) $1,630,000
  3. C) $1,650,000
  4. D) $1,720,000

Answer:  D

Diff: 1      Page Ref: 372

Keywords:  Initial Outlay, Tax Effect of Sale of Old Asset

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

61) Waterford Industries is considering the purchase of a new machine. It will replace an existing but obsolete machine that will be sold for $50,000. The existing machine is 8 years old, cost $200,000, had a 10-year useful life, and is being depreciated to zero using the straight-line method. Waterford's income tax rate is 35%. What is the after-tax salvage value of the old machine?

  1. A) $42,000
  2. B) $46,500
  3. C) $50,000
  4. D) $53,500

Answer:  B

Diff: 2      Page Ref: 375

Keywords:  After-tax Salvage Value, Depreciation

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

62) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased for $3,750,000; it will have a 10-year useful life. It will cost $165,000 to ship and $85,250 to install the processor. A recently completed feasibility study that was performed at a cost of $65,000 indicated that the processor would produce a positive NPV. The processor will be depreciated using the straight-line method to zero expected salvage value. Studies have shown that employee-training expenses will be $125,000. What will be the annual depreciation expense of the processing line for capital budgeting purposes?

  1. A) $375,000
  2. B) $419,025
  3. C) $390,000
  4. D) $400,025

Answer:  D

Diff: 2      Page Ref: 373

Keywords:  Initial Depreciation Value, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

63) Propell Inc. is considering the purchase of a new machine that will cost $178,000, plus an additional $12,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated using the straight-line method. The machine is expected to generate new sales of $85,000 per year and is expected to increase operating costs by $10,000 annually. Propell's income tax rate is 40%. What is the projected incremental cash flow of the machine for year 1?

  1. A) $54,800
  2. B) $60,200
  3. C) $66,350
  4. D) $68,200

Answer:  B

Diff: 2      Page Ref: 373

Keywords:  Incremental Cash Flows, Depreciation Expense

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

64) Lasalle Industries is considering the purchase of a new machine that will cost $250,000, plus an additional $10,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to have a salvage value of $30,000 at the end of year five. LaSalle's income tax rate is 40%. The additional net working capital from this project of $50,000 is expected to return to its pre-project level upon termination. What is the non-operating terminal cash flow of the machine?

  1. A) -$32,000
  2. B) $48,000
  3. C) $68,000
  4. D) $80,000

Answer:  C

Diff: 2      Page Ref: 375

Keywords:  Terminal Cash Flow, Recapture of Net Working Capital, Salvage Value

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

65) LaSalle Industries is considering the purchase of a new strapping machine, which will cost $150,000, plus an additional $10,500 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years. The machine is expected to have a salvage value of $20,000. LaSalle's income tax rate is 35%. What is the machine's IRR?

  1. A) 15.75%
  2. B) 18.86%
  3. C) 19.15%
  4. D) 20.03%

Answer:  C

Diff: 3      Page Ref: 382

Keywords:  Incremental After-Tax Cash Flows, Internal Rate of Return, Initial Outlay, Depreciation Expense

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

66) An asset with an original cost of $100,000 and a current book value of $20,000 is sold for $50,000 as part of a capital budgeting project. The company has a tax rate of 30%. This transaction will have what impact on the project's initial outlay?

  1. A) reduce it by $20,000
  2. B) reduce it by $50,000
  3. C) reduce it by $6,000
  4. D) reduce it by $15,000

Answer:  D

Diff: 2      Page Ref: 372

Keywords:  Tax Effect, Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

67) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during years 2 through 10 of the project?

  1. A) $13,600
  2. B) $14,400
  3. C) $15,800
  4. D) $16,400

Answer:  D

Diff: 2      Page Ref: 373

Keywords:  Incremental Free Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

68) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the project's terminal cash flow?

  1. A) $3,000
  2. B) $5,000
  3. C) $6,000
  4. D) $8,000

Answer:  C

Diff: 2      Page Ref: 375

Keywords:  Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

69) Mountain Recreation, Inc. is considering a new product line. The company currently manufactures several lines of snow skiing apparel. The new products, insulated ski bikinis, are expected to generate sales of $1.2 million per year for the next five years. They expect that during this five-year period, they will lose about $150,000 each year in sales on their existing lines of longer ski pants. The new line will require no additional equipment or space in the plant and can be produced in the same manner as the apparel products. The new project will, however, require that the company spend an additional $50,000 per year on insurance in case customers sue for frostbite. Also, a new marketing director would be hired to oversee the line at $75,000 per year in salary and benefits. Because of the different construction of the bikinis, an increase in inventory of $9,000 would be required initially. If the marginal tax rate is 35%, compute the incremental after-tax cash flows for years 1-5.

  1. A) $634,500 per year
  2. B) $625,000 per year
  3. C) $601,250 per year
  4. D) $537,500 per year

Answer:  C

Diff: 1      Page Ref: 375

Keywords:  Incremental After-Tax Cash Flows, Cannibalism, Additional Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

70) Bellington, Inc. is considering the purchase of new, sophisticated machinery for a special three-year project. The machinery requires a special lubricating oil that probably will never be used, but must be available at all times should the machine break down. Bellington purchases $2,000 of lubricating oil to keep on hand just in case it is needed. At the end of the three-year project, it is expected the lubricating oil can be sold back to the distributor for $2,000. Which of the following statements is MOST correct?

  1. A) The lubricating oil is a sunk cost that should be excluded from the analysis.
  2. B) The $2,000 for the lubricating oil should be excluded from the analysis because it is recovered at the end of three years, so the final cost is zero.
  3. C) The $2,000 represents an additional investment in working capital that should be included in the capital budgeting analysis.
  4. D) The $2,000 for lubricating oil is simply an accounting entry and does not represent a real cash flow.

Answer:  C

Diff: 1      Page Ref: 376

Keywords:  Additional Investment in Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

71) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the tax effect of selling the old machine?

  1. A) a savings of $2,800
  2. B) a savings of $2,450
  3. C) additional taxes paid of $2,450
  4. D) a tax savings of $1,400

Answer:  A

Diff: 2      Page Ref: 375

Keywords:  Tax Effect, Sale of Old Machine, Depreciation

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

 

72) Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. The new van will be depreciated using the simplified straight-line method over its 5-year useful life. The company's tax rate is 35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the initial outlay required to fund this replacement project?

  1. A) $81,200
  2. B) $78,600
  3. C) $74,500
  4. D) $73,580

Answer:  A

Diff: 2      Page Ref: 373

Keywords:  Initial Outlay, Tax Effect of Sale of Old Machine, Depreciation, Net Working Capital

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

73) Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial size oven will cost $1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful life. The old oven cost the company $800,000 just four years ago. The old oven is being depreciated on a straight-line basis over its expected ten-year useful life. (That is, the old oven is expected to last six more years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold today for $100,000. The new oven will allow the company to expand, increasing sales by $300,000 per year. Expenses will also decrease by $50,000 per year due to the more energy efficient design of the new oven. Premium Pie Company is in the 40% marginal tax bracket and has a required rate of return of 10%.

  1. Calculate the net present value and internal rate of return of replacing the existing machine
  2. Explain the impact on NPV of the following:
  3. Required rate of return increases
  4. Operating costs of new machine are increased

        iii.   Existing machine sold for less

Answer: 

  1. Calculate Initial Outlay

 

Purchase Price

$1,200,000

Sale of old

(100,000)

Tax savings from sale ($100,000 - 480,000) × .40

($152,000)

   

948,000

 

Incremental Cash Flow

 

 

Book Profit

Cash Flow

Increased Sales

$300,000

 300,000

Reduced costs

50,000

50,000

Increased depreciation*

(120,000)

 

Net savings (before tax)

$230,000 

 

Less taxes (40%)

(92,000)

(92,000)

 

Net cash flow

 

$258,000

 

*Depreciation on old machine:

$800,000/10 = $80,000

Depreciation on new machine:

$1,200,000/6 = $200,000

Increase Depreciation = $200,000 - $80,000 = $120,000

NPV = $175,657

IRR = 16.1%

 

  1. Impact on NPV
  2. NPV decreases
  3. NPV decreases

iii.   NPV decreases

Diff: 3      Page Ref: 379

Keywords:  Incremental After-Tax Cash Flows, Net Present Value, Initial Outlay

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

74) Agri-Industries purchased some agricultural land at the edge of a large metropolitan area for $250,000 five years ago. In order to have the land classified as agricultural for property tax purposes, the company has been leasing the property to neighboring farmers. The before-tax return from leasing the property is $12,000 per year. This company's corporate tax rate is 35 percent. If the company sells the land for $400,000 today, what is the internal rate of return on this investment?

Answer:  Initial investment at time 0 = $250,000

 

Incremental after-tax cash flows time 1-5:

(1-.35)($12,000)= $7,800

 

Terminal after-tax cash flow time 5:

$400,000 - ($400,000 - $250,000)(.35) = $347,500

 

IRR = 9.56%

Diff: 2      Page Ref: 379

Keywords:  Incremental After-Tax Cash Flows, Initial Outlay, Internal Rate of Return

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

75) Calculate the internal rate of return on the following projects:

  1. Initial outlay of $60,500 with an after-tax cash flow of $11,897 per year for eight years.
  2. Initial outlay of $647,000 with an after-tax cash flow of $118,000 per year for ten years.
  3. Initial outlay of $25,400 with an after-tax cash flow $11,788 per year for three years.

Answer: 

  1. IRR = 11.33%
  2. IRR = 12.74%
  3. IRR = 18571%

Diff: 2      Page Ref: 379

Keywords:  Initial Outlay, Incremental Cash Flows, Internal Rate of Return

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

76) Kelly Corporation is considering an investment proposal that requires an initial investment of $150,000 in equipment. Fully depreciated existing equipment may be disposed of for $40,000 pre-tax. The proposed project will have a five-year life, and is expected to produce additional revenue of $65,000 per year. Expenses other than depreciation will be $15,000 per year. The new equipment will be depreciated to zero over the five-year useful life, but it is expected to actually be sold for $20,000. Kelly has a 35% tax rate.

  1. What is the net initial outlay for the proposed project?
  2. What is the operating cash flow for years 1-4?
  3. What is the total cash flow at the end of year five (operating cash flow for year 5 plus terminal cash flow)?

Answer: 

  1. Net initial outlay = $150,000 - ($40,000 * (1 -.35)) = $124,000

 

  1. Annual operating cash flows:

First, depreciation expense will be $150,000/5 = $30,000

OCF   = (Rev. - Exp.)(1 - T) + TD

            = ($65,000 - $15,000) × (1 - .35) + (.35 × ($150,000/5))

            = $32,500 + $10,500 = $43,000

 

  1. Year 5 cash flow = $43,000 + .65($20,000) = $56,000

Diff: 2      Page Ref: 379

Keywords:  Initial Outlay, Incremental Operating Cash Flows, Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

77) Dave Company, Inc. is considering purchasing a new grinding machine with a useful life of five years. The initial outlay for the machine is $165,000. The expected cash inflows are as follows:

 

Year

After-tax Expected Cash Flow

1

15,000

2

35,000

3

70,000

4

90,000

5

70,000

 

Given that the firm has a 10% required rate of return, what is the NPV?

Answer:  NPV = $35,089.72

Diff: 2      Page Ref: 379

Keywords:  Net Present Value, Initial Outlay, Incremental After-tax Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

78) P.D. Corporation is considering the purchase of a high-speed lathe that has an invoice price of $250,000. The cost to ship the lathe to P.D.'s factory is $10,000, and the existing facilities will require modifications that are expected to cost $20,000. The machine will be depreciated on a straight-line basis over its useful life of 10 years, assuming no salvage value. P.D. Corporation is planning on paying for the lathe using a line of credit at the bank that has an interest rate of 6 percent per year. The lathe is expected to increase production and sales. Sales are expected to increase by $100,000 per year. Inventory and accounts receivable balances are expected to increase by $10,000 and $20,000 respectively. Expenses to operate the lathe are $25,000 per year. P.D.'s marginal tax rate is 40%.

  1. Calculate the initial outlay required to fund this project.
  2. Calculate the incremental after-tax cash flow in year one of the project.

Answer: 

  1. Invoice price plus shipping plus modifications plus additional net working capital items:

       $250,000 + $10,000 + $20,000 + $10,000 + $20,000 = $310,000

 

  1. (Sales - operating expenses - depreciation) (1 - t) + Depreciation =

       ($100,000 - $25,000 - $28,000) (1 - .4) + $28,000 = $56,200

Diff: 2      Page Ref: 379

Keywords:  Initial Outlay, Incremental After-Tax Cash Flows

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

79) LEE Corporation intends to purchase equipment for $1,500,000. The equipment has a 5-year useful life and will be depreciated on a straight-line basis. Addition of the equipment requires additional working capital of $20,000. The $20,000 is expected to be recaptured at the end of the project. LEE's marginal tax rate is 40%. Use of the equipment is expected to change the company's reported EBIT by $600,000 in year one, $700,000 in year two, $550,000 in year three, $200,000 in year four, and $100,000 in year five. Due to changing market conditions, the equipment did have a salvage value of $100,000 at the end of year five.

  1. Calculate the initial outlay and the incremental free cash flows over the life of the project.
  2. If the risk-adjusted discount rate for this project is 20%, calculate the project's net present value and internal rate of return and comment on the acceptability of the project.

Answer: 

  1. Initial Outlay = $1,500,000 + $20,000 = $1,520,000

 

Incremental Free Cash Flows:

 

 

Year 1

Year 2

Year 3

Year 4

Year 5

EBIT

$600,000

$700,000

$550,000

$200,000

$100,000

Less Taxes (40%)

240,000

280,000

220,000

80,000

40,000

Plus Depreciation

300,000

300,000

300,000

300,000

300,000

Operating Cash Flow

$660,000

$720,000

$630,000

$420,000

$360,000

Free Cash Flow

$660,000

$720,000

$630,000

$420,000

$360,000

Salvage Value

 

 

 

 

$100,000

Minus Tax on Gain

 

 

 

 

-40,000

Plus Recovery of Working Capital

 

 

 

 

20,000

Terminal Cash Flow

 

 

 

 

$80,000

Total Final Year Cash Flow

 

 

 

 

$440,000

 

  1. NPV = $273,956 and the project is acceptable since the NPV is positive.

       IRR = 28.73% and the project is acceptable since the IRR exceeds the required return.

Diff: 2      Page Ref: 379

Keywords:  Incremental Free Cash Flows, Net Present Value, Internal Rate of Return

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

80) J.B. Corporation is considering the purchase of equipment that has an invoice price of $450,000. The equipment was recommended by a consulting firm that did an analysis for J.B. Corporation. J.B. paid the consulting firm $12,000 for its report. The cost of shipping and installation is $50,000. The equipment will be depreciated on a straight-line basis over its useful life of 10 years, assuming no salvage value. The equipment will replace existing assets that have a current book value of $100,000 and which could be sold for $150,000. Additional net working capital of $15,000 will be required to maintain the equipment and to support higher sales. J.B.'s marginal tax rate is 40%. Calculate the initial outlay required to fund this project.

Answer:  Depreciable cost of the new equipment = $450,000 + $50,000 = $500,000

Proceeds from the Sale of Old Assets = $150,000

Gain on Sale of Old Assets = $150,000 - $100,000 = $50,000

Tax Effect of Sale of Old Assets = $50,000 ∗ 40% = $20,000

Additional Net Working Capital = $15,000

 

Initial Outlay = $500,000 - $150,000 + $20,000 + $15,000 = $385,000

Diff: 2      Page Ref: 379

Keywords:  Initial Outlay, Tax Effect of Sale of Old Assets, Additional Net Working Capital, Sunk Costs

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

 

81) In general, a project's cash flows will fall into one of three categories. What are these categories?

Answer:  In general, a project's free cash flows will fall into one of three categories: (1) the initial outlay, (2) the annual free cash flows over the project's life, and (3) the terminal free cash flow.

The initial outlay is the immediate cash outflow necessary to purchase the asset and put it in operating order. This amount includes (1) the cost of purchasing the asset and getting it operational, including the purchase price, shipping and installation, and any training costs for employees who will be operating the equipment, and (2) any increases in working-capital requirements. If the investment decision is a replacement decision, the cash inflow associated with the selling price of the old asset, in addition to any tax effects resulting from its sale, must be included. It should be stressed that the incremental nature of the cash flow is of great importance. In many cases, if the project is not accepted, then the status quo for the firm will simply not continue.

Annual free cash flows come from operating cash flows (that is, what you've made as a result of taking on the project), changes in working capital, and any capital spending that might take place. In our calculations, we'll begin with our pro forma statements and work from there. We will have to make adjustments for interest, depreciation, and working capital, along with any capital expenditures that might occur.

The terminal cash flow is associated with the project's termination and includes the annual free cash flow and salvage value of the project plus or minus any taxable gains or losses associated with its sale.

Diff: 2      Page Ref: 372-375

Keywords:  Free Cash Flow, Initial Outlay, Differential Cash Flows, Terminal Cash Flow

Learning Obj.:  L.O. 11.2

AACSB:  Reflective Thinking

 

Learning Objective 11.3

 

1) Three of the most common options that can add value to a capital budgeting project are the option to delay the project, the option to expand the project, and the option to abandon the project.

Answer:  TRUE

Diff: 1      Page Ref: 383

Keywords:  Options in Capital Budgeting

Learning Obj.:  L.O. 11.3

AACSB:  Reflective Thinking

 

2) A major corporation is considering a capital budgeting project that involves the development of a new technology. The controller estimates the net present value to be negative, yet argues that the company should invest in the project. Which of the following statements is MOST correct?

  1. A) The controller should be fired for making such a poor decision.
  2. B) The controller may be considering the option to expand or modify the project in the future.
  3. C) The profitability index may be greater than one, giving an accept decision.
  4. D) Capital rationing may exist for the current year.

Answer:  B

Diff: 1      Page Ref: 383

Keywords:  Capital Budgeting Options

Learning Obj.:  L.O. 11.3

AACSB:  Reflective Thinking

 

3) Give an example of an option to delay a project. Why might this be of value?

Answer:  There is no question that the estimated cash flows associated with a project can change over time. In fact, as a result of changing expected cash flows, a project that currently has a negative net present value may have a positive net present value in the future. The ability to delay this project with the hope that technological and market conditions will change, making this project profitable, lends value to the project and it is called an option to delay. An example of the option to delay a project until the future cash flows are more favorable could be a firm that owns the oil rights to some oil-rich land and is considering an oil-drilling project. Suppose that after all of the costs and the expected oil output are considered, the project has a negative net present value. Does that mean the firm should give away its oil rights or that those oil rights have no value? Certainly not. There is a chance that in the future oil prices could rise to the point that this negative NPV project could become a positive NPV project. It is this ability to delay development that provides value. Thus, the value in this seemingly negative NPV project is provided by the option to delay it until the future cash flows are more favorable.

Diff: 2      Page Ref: 383

Keywords:  Options in Capital Budgeting

Learning Obj.:  L.O. 11.3

AACSB:  Reflective Thinking

 

4) Give an example of an option to expand a project. Why might this be of value?

Answer:  The estimated cash flows associated with a project can change over time, making it valuable

to expand a project. The flexibility to adjust production to demand has value. For example, a firm might deliberately build a production plant with excess capacity so that if the product has greater than-anticipated demand, the firm can simply increase production. Alternatively, taking on this project might provide the firm with a foothold in a new industry and lead to other products that would not have otherwise been feasible. This reasoning has led many firms to expand into e-businesses, hoping to gain know-how and expertise that will lead to other profitable projects down the line. It also provides some of the rationale for research and development expenditures to explore new markets.

Diff: 2      Page Ref: 383, 384

Keywords:  Options in Capital Budgeting

Learning Obj.:  L.O. 11.3

AACSB:  Reflective Thinking

 

5) Give an example of an option to abandon a project. Why might this be of value?

Answer:  The option to abandon a project as the estimated cash flows associated with it change over time also has value. Again, it is this flexibility to adjust to new information that provides the value. For example, a project's sales in the first year or two might not live up to expectations, with the project being barely profitable. The firm might then decide to liquidate the project and sell the plant and all of the equipment. That liquidated value may be more than the value of keeping the project going.

As a result, the value of abandoning the project and selling the technology might be more than the value of keeping the project running. Again, it is the value of flexibility associated with the possibility of modifying the project in the future—in this case abandoning the project—that can produce positive value.

Diff: 2      Page Ref: 384

Keywords:  Options in Capital Budgeting

Learning Obj.:  L.O. 11.3

AACSB:  Reflective Thinking

 

Learning Objective 11.4

 

1) A small, family-owned corporation would be more likely to use the contribution-to-firm risk criteria rather than the systematic risk to evaluate capital budgeting projects.

Answer:  TRUE

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk, Systematic Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

2) Since stockholders are able to reduce their exposure to risk by efficiently diversifying their holdings of securities, there is no reason for individual firms to seek diversification of their holdings of assets.

Answer:  FALSE

Diff: 2      Page Ref: 387

Keywords:  Diversification, CAPM

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

3) According to the CAPM, systematic risk is the only relevant risk for capital budgeting purposes.

Answer:  TRUE

Diff: 1      Page Ref: 383

Keywords:  CAPM, Systematic Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

4) A project's contribution-to-firm risk does allow for diversification within the firm.

Answer:  TRUE

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk, Diversification

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

5) A project's standing alone risk allows for diversification within a sole firm.

Answer:  FALSE

Diff: 1      Page Ref: 386

Keywords:  Standing Alone Risk, Diversification

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

6) The most relevant measure of risk for capital budgeting is project standing alone risk.

Answer:  FALSE

Diff: 1      Page Ref: 386

Keywords:  Project Standing Alone Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

7) A project's contribution to firm risk is relevant for undiversified investors or when bankruptcy costs exist.

Answer:  TRUE

Diff: 1      Page Ref: 386

Keywords:  Project's Contribution to Firm Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

8) The use of risk-adjusted discount rates is based on the concept that investors require a higher rate of return for more risky projects.

Answer:  TRUE

Diff: 1      Page Ref: 387

Keywords:  Risk-Adjusted Discount Rate, Risk-Return Trade-off

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

9) The risk-adjusted discount rate method implicitly assumes that distant cash flows have the same risk as near cash flows.

Answer:  FALSE

Diff: 1      Page Ref: 387

Keywords:  Risk-Adjusted Discount Rate

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

10) If the cash flows of an accepted investment project are negatively correlated with the average cash flow of the firm's existing assets, then the company's total exposure to risk can decrease.

Answer:  TRUE

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk, Negative Correlation

Learning Obj.:  L.O. 11.4

AACSB:  Analytical Thinking

 

11) Financial theory assumes that individuals are risk averse.

Answer:  TRUE

Diff: 1      Page Ref: 386

Keywords:  Risk Aversion

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

12) The risk-adjusted discount rate for a replacement decision will be less than the rate used by the same firm when considering a new product line.

Answer:  TRUE

Diff: 2      Page Ref: 387

Keywords:  Risk-Adjusted Discount Rate, Replacement Decision

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

13) The less-risky investment is always the more desirable choice.

Answer:  FALSE

Diff: 1      Page Ref: 386

Keywords:  Risk-Return Trade-off

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

14) A method for estimating a project's beta that attempts to identify publicly traded firms engage solely in the same business as the project is called the pure play method.

Answer:  TRUE

Diff: 1      Page Ref: 391

Keywords:  Pure Play Method, Beta

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

15) Sensitivity analysis involves changing one variable at a time.

Answer:  TRUE

Diff: 1      Page Ref: 393

Keywords:  Sensitivity Analysis

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

16) A typical decision rule used in simulation is to accept the project if the probability is sufficiently high that the net present value is positive.

Answer:  TRUE

Diff: 1      Page Ref: 391

Keywords:  Simulation

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

17) Reducing the probability of bankruptcy is a benefit of diversification.

Answer:  TRUE

Diff: 1      Page Ref: 387

Keywords:  Diversification, Probability of Bankruptcy

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

18) Using simulation provides the financial manager with a probability distribution of an investment's net present value or internal rate of return.

Answer:  TRUE

Diff: 1      Page Ref: 391

Keywords:  Simulation, Probability Distribution

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

19) A wildcat oil driller has enough capital to invest in only one project, that is, to drill one well in an East Texas oil field. A major oil company is drilling 100 wells in the same field. The probability of successfully striking oil is 10% for any well drilled in this field. Which of the following statements is MOST correct concerning the risk involved in these capital budgeting projects?

  1. A) The risk for the wildcat driller is the same as the risk for the major oil company since they are both drilling in the same oil field.
  2. B) The appropriate risk for the wildcat driller is systematic risk.
  3. C) The appropriate risk for the major oil company is contribution-to-firm risk, if all shareholders of the firm are well diversified.
  4. D) The best measure of risk for the wildcat oil driller is project standing alone risk.

Answer:  D

Diff: 1      Page Ref: 386

Keywords:  Project Standing Alone Risk, Contribution-to-firm Risk, Systematic Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

20) Bill and Mary own a small chain of high fashion boutiques that represent almost 100% of their net worth. When considering capital budgeting projects for their boutiques, the appropriate measure of risk is

  1. A) project standing alone risk.
  2. B) systematic risk.
  3. C) contribution-to-firm risk.
  4. D) beta risk.

Answer:  C

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk, Project Standing Alone Risk, Systematic Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

21) If bankruptcy costs and/or shareholder under diversification are an issue, what measure of risk is relevant when evaluating project risk in capital budgeting?

  1. A) total project risk
  2. B) contribution-to-firm risk
  3. C) systematic risk
  4. D) capital rationing risk

Answer:  B

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk, Bankruptcy, Diversification

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

22) Which of the following is the most relevant measure of risk for capital budgeting purposes?

  1. A) project standing alone risk
  2. B) contribution-to-firm risk
  3. C) symbiotic risk
  4. D) unsystematic risk

Answer:  B

Diff: 1      Page Ref: 386

Keywords:  Contribution-To-Firm Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

23) Which of the following statements about project standing alone risk is true?

  1. A) It ignores the fact that much of the risk of a project will be diversified away as the project is combined with the firm's other projects.
  2. B) It ignores the cash flows that are associated with a project that occur beyond the payback period.
  3. C) It takes into consideration the effects of diversification of the firm's shareholders.
  4. D) It provides the best measure of project risk for a large, widely-held company.

Answer:  A

Diff: 1      Page Ref: 386

Keywords:  Project Standing Alone Risk, Diversification

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

24) A bakery company is considering one capital budgeting project involving the replacement of a sophisticated brick oven, and another capital budgeting project involving research and development into synthetic food substitutes. Which of the following statements is MOST correct concerning the risk-adjusted discount rate(s) for the projects?

  1. A) The rate will likely be higher for the replacement project because the likelihood of success is higher.
  2. B) The rate will likely be higher for the research and development project because of the uncertainty involved with research and development projects.
  3. C) The rate should be the same for both projects because they are being considered by one company with the same common shareholders.
  4. D) The rate should be higher for the replacement project because the company is more certain of the returns from a project similar to their existing business.

Answer:  B

Diff: 1      Page Ref: 387

Keywords:  Risk-Adjusted Discount Rate

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

25) The pure play method

  1. A) calculates beta using only project returns.
  2. B) uses the beta of a firm that is similar to the project being analyzed to determine the required rate of return for the project.
  3. C) selects a firm similar to the project being analyzed and uses its returns as the market return in estimating a project beta.
  4. D) selects one of the firm's existing projects that is similar to the project being analyzed and uses that project's required rate of return.

Answer:  B

Diff: 1      Page Ref: 387

Keywords:  Pure Play Method, Beta

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

26) Which of the following is NOT an important consideration in measuring risk for a capital budgeting project for a well-diversified firm?

  1. A) systematic risk
  2. B) contribution to firm risk
  3. C) total project risk
  4. D) None of the above—all may be important in measuring project risk.

Answer:  C

Diff: 1      Page Ref: 386

Keywords:  Risk, Total Project Risk, Systematic Risk, Contribution-to-firm Risk

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

27) Humongous Corporation is a multidivisional conglomerate. The Food Division is undergoing a capital budgeting analysis and must estimate the division's beta. This division has a different level of systematic risk than is typical for Humongous Corporation as a whole. The most appropriate method for estimating this beta is

  1. A) the regression coefficient from a time series regression of Humongous Corporation stock returns on a market index.
  2. B) to multiply the company's beta by the ratio of the Food Division's total assets/Humongous Corporation total assets.
  3. C) the regression coefficient from a time series regression of Food Division's net income on the Humongous Corporation's return on assets.
  4. D) the regression coefficient from a time series regression of Food Division's return on assets on a market index.

Answer:  D

Diff: 1      Page Ref: 391

Keywords:  Beta, Time Series Regression

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

28) One method of accounting for systematic risk for a project involves identifying a publicly traded firm that is engaged in the same business as that project and using its required rate of return to evaluate the project. This method is referred to as

  1. A) the accounting beta method.
  2. B) scenario analysis.
  3. C) the pure play method.
  4. D) sensitivity analysis.

Answer:  C

Diff: 1      Page Ref: 391

Keywords:  Pure Play Method

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

29) Creighton Industries is considering the purchase of a new strapping machine, which will cost $150,000, plus an additional $10,500 to ship and install. The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method. The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years. The machine is expected to have a salvage value of $20,000. Creighton's income tax rate is 35%. Creighton uses a 12.5% discount rate for capital budgeting purposes. What is the machine's NPV?

  1. A) $29,888
  2. B) $25,062
  3. C) $22,153
  4. D) $27,894

Answer:  D

Diff: 3      Page Ref: 387

Keywords:  Incremental After-Tax Cash Flows, Initial Outlay, Net Present Value, Risk-Adjusted Discount Rate

Learning Obj.:  L.O. 11.4

AACSB:  Analytical Thinking

 

 

30) Advantages of using simulation include

  1. A) adjustment for risk in the resulting distribution of net present values.
  2. B) a range of possible outcomes presented.
  3. C) is good only for single period investments since discounting is not possible.
  4. D) graphically displays all possible outcomes of the investment.

Answer:  B

Diff: 1      Page Ref: 391

Keywords:  Keywords: Simulation

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

31) What method is used for calculation of the accounting beta?

  1. A) simulation
  2. B) regression analysis
  3. C) sensitivity analysis
  4. D) both A and C

Answer:  B

Diff: 1      Page Ref: 391

Keywords:  Accounting Beta, Regression Analysis

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

32) The simulation approach provides us with

  1. A) a single value for the risk-adjusted net present value.
  2. B) an approximation of the systematic risk level.
  3. C) a probability distribution of the project's net present value or internal rate of return.
  4. D) a graphic exposition of the year-by-year sequence of possible outcomes.

Answer:  C

Diff: 1      Page Ref: 391

Keywords:  Simulation, Probability Distribution

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

33) Which of the following is NOT an acceptable method of measuring risk for capital budgeting purposes?

  1. A) modified internal rate of return
  2. B) sensitivity analysis
  3. C) using a risk-adjusted discount rate
  4. D) proxy, or pure play method for estimating a project's beta

Answer:  A

Diff: 1      Page Ref: 388

Keywords:  Risk, Sensitivity Analysis, Risk-Adjusted Discount Rate, Pure Play Method

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

34) The financial manager selecting one of two projects of differing risk should

  1. A) select the project with the larger risk-adjusted net present value.
  2. B) choose the project with the least relative risk.
  3. C) choose the project with greater return even if that project has greater risk.
  4. D) choose the project with less risk even though that project has less return.

Answer:  A

Diff: 1      Page Ref: 387

Keywords:  Net Present Value

Learning Obj.:  L.O. 11.2

AACSB:  Analytical Thinking

35) KLE Holdings is considering a capital budgeting project with a life of 7 years that requires an initial outlay of $277,400. The probability distribution for annual incremental cash flows is as follows:

 

Probability

Incremental Free Cash Flow

4%

-$15,000

16%

    18,000

55%

    65,000

25%

    99,000

 

  1. The risk-adjusted required rate of return for this project is 12%. Calculate the risk-adjusted net present value of the project and the project's IRR.
  2. Should the project be accepted?

Answer: 

  1. Expected annual cash flow

       = (.04 × -$15,000) + (.16 × $18,000) + (.55 × $65,000) + (.25 × $99,000)

       = $62,780

 

Risk adjusted NPV = $9,112.64; IRR =13.03%

 

  1. Accept because NPV is positive and IRR exceeds the risk adjusted required return.

Diff: 2      Page Ref: 387

Keywords:  Risk-Adjusted Net Present Value, IRR

Learning Obj.:  L.O. 11.4

AACSB:  Analytical Thinking

 

 

36) John Q. Enterprises is considering two potential investments. The probability distributions of annual end-of-year cash flows for the respective projects are:

 

Project A

Project B

Probability

Outcome

Probability

Outcome

0.25

$10,000

0.25

$12,000

0.50

$15,000

0.50

$15,000

0.25

$20,000

0.25

$18,000

 

Both projects will require an initial outlay of $45,000 and will have an estimated life of 6 years. Project A is considered a riskier investment and will have to have a risk-adjusted required rate of return of 15%, while Project B's risk-adjusted required rate of return is 12%.

  1. Determine the expected value of each project's annual cash flow.
  2. Determine each project's risk-adjusted net present value.

Answer: 

       Project A            Project B

  1. $15,000 $15,000
  2. $11,767.24 $16,671.11

Diff: 2      Page Ref: 387

Keywords:  Expected Incremental Cash Flows, Risk-adjusted Net Present Value

Learning Obj.:  L.O. 11.4

AACSB:  Analytical Thinking

37) What is the most commonly used method for incorporating risk into the capital-budgeting decision? How is this technique related to Principle 3: Risk Requires a Reward?

Answer:  Under the risk adjusted discount rate approach in capital budgeting, if the risk associated with the investment is greater than the risk involved in a typical endeavor, the discount rate is adjusted upward to compensate for this added risk. Once the firm determines the appropriate required rate of return for a project with a given level of risk, the cash flows are discounted back to the present at the risk-adjusted discount rate. Then the normal capital budgeting criteria are applied, except in the case of the IRR. For the IRR, the hurdle rate with which the project's IRR is compared now becomes the risk-adjusted discount rate. Expressed mathematically, the NPV using the risk-adjusted discount rate becomes.

The use of risk-adjusted discount rates is based on the concept that investors demand higher returns for more risky projects. This is the basic principle behind Principle 3: Risk Requires a Reward.

Diff: 2      Page Ref: 387, 388

Keywords:  Risk-Adjusted Net Present Value, IRR

Learning Obj.:  L.O. 11.4

AACSB:  Reflective Thinking

 

 

 

 

 

 

 

 

 

 -----

Key Contents: Financial Management and Corporate Finance
------
Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business, University of Western Ontario
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown
International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick, Columbia University
------
Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University, Jarrad Harford, University of Washington

-----

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, Virginia Polytechnic Instit. and State University
Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
------
Part 1: Fundamental Concepts and Basic Tools of Finance
1. Financial Management
2. Financial Statements
3. The Time Value of Money (Part 1)
4. The Time Value of Money (Part 2)
5. Interest Rates
Part 2: Valuing Stocks and Bonds and Understanding Risk and Return
6. Financial Management Bonds and Bond Valuation
7. Stocks and Stock Valuation
8. Risk and Return
Part 3: Capital Budgeting
9: Capital Budgeting Decision Models
10: Cash Flow Estimation
11: The Cost of Capital
Part 4: Financial Planning and Evaluating Performance
12. Forecasting and Short-Term Financial Planning
13. Working Capital Management
14. Financial Ratios and Firm Performance
Part 5: Other Selected Finance Topics
15. Raising Capital
16. Capital Structure
17. Dividends, Dividend Policy, and Stock Splits
18. International Financial Management
Appendix 1 Future Value Interest Factors
Appendix 2 Present Value Interest Factors
Appendix 3 Future Value Interest Factors of an Annuity
Appendix 4 Present Value Interest Factors of an Annuity
Appendix 5 Answers to Prepping for Exam Questions
------
1. Overview of Financial Management
2. Sizing Up a Business: A Non-Financial Perspective
3. Understanding Financial Statements
4. Measuring Financial Performance
5. Managing Day-To-Day Cash Flow
6. Projecting Financial Requirements and Managing Growth
7. Time Value of Money Basics and Applications
8. Making Investment Decisions
9. Overview of Capital Markets: Long-Term Financing Instruments
10. Assessing the Cost of Capital: What Investors Require
11. Understanding Financing and Payout Decisions
12. Designing an Optimal Capital Structure
13. Measuring and Creating Value
14. Comprehensive Case Study: Wal-Mart Stores, Inc.

1. Overview of Financial Management
• 1.1: Financial Management and the Cash Flow Cycle
• 1.2: The Role of Financial Managers
• 1.3: A Non-Financial Perspective of Financial Management
• 1.4: Financial Management’s Relationship with Accounting and Other Disciplines
• 1.5: Types of Firms
• 1.6: A Financial Management Framework
• 1.7: Relevance for Managers
• 1.8: Summary
• 1.9: Additional Readings
• 1.10: End of Chapter Problems
2. Sizing Up a Business: A Non-Financial Perspective
• 2.1: Sizing Up The Overall Economy
o 2.1.1: GDP Components
o 2.1.2: Sector-Related Fluctuations
o 2.1.3: Inflation and Interest Rates
o 2.1.4: Capital Markets
o 2.1.5: Economic Size-Up Checklist
• 2.2: Sizing Up the Industry
o 2.2.1: Industry Life Cycles
o 2.2.2: The Competitive Environment
o 2.2.3: Opportunities and Risks
o 2.2.4: Industry Size-up Checklist
• 2.3: Sizing Up Operations Management and Supply Risk
• 2.4: Sizing Up Marketing Management and Demand Risk
• 2.5: Sizing Up Human Resource Management and Strategy
• 2.6: Sizing Up Home Depot: An Example
• 2.7: Relevance for Managers
• 2.8 Summary
• 2.9: Additional Readings and Information
• 2.10: End of Chapter Problems
3. Understanding Financial Statements
• 3.1: Understanding Balance Sheets
o 3.1.1: Understanding Assets
o 3.1.2: Understanding Liabilities
o 3.1.3: Understanding Equity
• 3.2: Understanding Income Statements
o 3.2.1: Understanding Revenues, Costs, Expenses, and Profits
o 3.2.2: Connecting a Firm’s Income Statement and Balance Sheet
• 3.3: Understanding Cash Flow Statements
o 3.3.1: Cash Flows Related to Operating Activities
o 3.3.2: Cash Flows from Investing Activities
o 3.3.3: Cash Flows from Financing Activities
• 3.4: Relevance for Managers
• 3.5: Summary
• 3.6: Additional Readings and Sources of Information
• 3.7: End of Chapter Problems
4. Measuring Financial Performance
• 4.1: Performance Measures
o 4.1.1: Return on Equity
o 4.1.2: Profitability Measures
o 4.1.3: Resource Management Measures
o 4.1.4: Liquidity Measures
o 4.1.5: Leverage Measures
o 4.1.6: Application: Home Depot
• 4.2: Reading Annual Reports
• 4.3: Relevance for Managers
• 4.4: Summary
• 4.5: Additional Readings and Sources of Information
• 4.6: End of Chapter Problems
5. Managing Day-To-Day Cash Flow
• 5.1: Cash Flow Cycles
• 5.2: Working Capital Management
o 5.2.1: Managing Inventory
o 5.2.2: Managing Accounts Receivable
o 5.2.3: Managing Accounts Payable
o 5.2.4: Application: Home Depot
• 5.2.4.1: Orange Computers and Little Orange Computers
• 5.2.4.2: Home Depot
• 5.3: Short-Term Financing
o 5.3.1: Bank Loans
o 5.3.2: Commercial Paper
o 5.3.3: Banker’s Acceptance
• 5.4: Relevance for Managers
• 5.5: Summary
• 5.6: Additional Readings
• 5.7: End of Chapter Problems

6. Projecting Financial Requirements and Managing Growth
• 6.1: Generating Pro Forma Income Statements
o 6.1.1: Establishing the Cost of Goods Sold and Gross Profit
o 6.1.2: Establishing Expenses
o 6.1.3: Establishing Earnings
• 6.2: Generating Pro Forma Balance Sheets
o 6.2.1: Establishing Assets
o 6.2.2: Establishing Liabilities and Equity
• 6.3: Generating Pro Forma Cash Budgets
o 6.3.1: Establishing Cash Inflows
o 6.3.2: Establishing Cash Outflows
o 6.3.3: Establishing Net Cash Flows
• 6.4: Performing Sensitivity Analysis
o 6.4.1: Sales Sensitivity
o 6.4.1: Interest Rate Sensitivity
o 6.4.3: Working Capital Sensitivity
• 6.5: Understanding Sustainable Growth and Managing Growth
• 6.6: Relevance for Managers
• 6.7: Summary
• 6.8: Additional Readings and Resources
• 6.9: Problems

7. Time Value of Money Basics and Applications
• 7.1: Exploring Time Value of Money Concepts
o 7.1.1: Future Values
o 7.1.2: Present Values
o 7.1.3: Annuities
o 7.1.4: Perpetuities
• 7.2: Applying Time Value of Money Concepts to Financial Securities
o 7.2.1: Bonds
o 7.2.2: Preferred Shares
o 7.2.3: Common Equity
• 7.3: Relevance for Managers
• 7.4: Summary
• 7.5: Additional Readings
• 7.6: End of Chapter Problems

8. Making Investment Decisions
• 8.1: Understanding the Decision-Making Process
• 8.2: Capital Budgeting Techniques
o 8.2.1: Payback
• 8.2.1.1: Strengths and Weaknesses of the Payback Method
o 8.2.2: Net Present Value
• 8.2.2.1: Strengths and Weaknesses of the Net Present Value Method
o 8.2.3: Internal Rate of Return
• 8.2.3.1: Strengths and Weaknesses of the Internal Rate of Return Method
• 8.2.3.2: Modified Internal Rate of Return
• 8.3: Capital Budgeting Extensions
o 8.3.1: Profitability Index
o 8.3.2: Equivalent Annual Cost and Project Lengths
o 8.3.3: Mutually Exclusive Projects and Capital Rationing
• 8.4: Relevance for Managers
• 8.5: Summary
• 8.6: Additional Readings
• 8.7: End of Chapter Problems

9. Overview of Capital Markets: Long-Term Financing Instruments
• 9.1: Bonds
o 9.1.1: Changing Bond Yields
o 9.1.2: Bond Features
o 9.1.3: Bond Ratings
• 9.2: Preferred Shares
• 9.3: Common Shares
o 9.3.1: Historical Returns
• 9.4: Capital Markets Overview
o 9.4.1: Private versus Public Markets
o 9.4.2: Venture Capital and Private Equity
o 9.4.3: Initial Offerings versus Seasoned Issues
o 9.4.4: Organized Exchanges versus Over-The-Counter Markets
o 9.4.5: Role of Intermediaries
• 9.5: Market Efficiency
o 9.5.1: Weak Form
o 9.5.2: Semi-strong Form
o 9.5.3: Strong Form
o 9.5.4: U.S. Stock Market Efficiency
• 9.6: Relevance for Managers
• Appendix: Understanding Bond and Stock Investment Information
• 9.7: Summary
• 9.8: Additional Readings
• 9.9: End of Chapter Problems

10. Assessing the Cost of Capital: What Investors Require
• 10.1: Understanding the Cost of Capital: An Example
• 10.2: Understanding the Implications of the Cost of Capital
• 10.3: Defining Risk
• 10.4: Estimating the Cost of Debt
• 10.5: Estimating the Cost of Preferred Shares
• 10.6: Estimating the Cost of Equity
o 10.6.1: Dividend Model Approach
o 10.6.2: Capital Asset Pricing Model
• 10.6.2.1: Risk-Free Rate
• 10.6.2.2: Market Risk Premium
• 10.6.2.3: Beta
• 10.7: Estimating Component Weights
• 10.8: Home Depot Application
• 10.9: Hurdle Rates
• 10.10: Relevance for Managers
• 10.11: Summary
• 10.12: Additional Readings
• 10.13: Problems
11. Understanding Financing and Payout Decisions
• 11.1: Capital Structure Overview
• 11.2: Understanding the Modigliani-Miller Argument: Why Capital Structure Does Not Matter
• 11.3: Relaxing the Assumptions: Why Capital Structure Does Matter
o 11.3.1: Understanding the Impact of Corporate Taxes
o 11.3.2: Understanding the Impact of Financial Distress
o 11.3.3: Combining Corporate Taxes and Financial Distress Costs
o 11.3.4: Impact of Asymmetric Information
• 11.4: Understanding Payout Policies
o 11.4.1: Paying Dividends
o 11.4.2: Repurchasing Shares
o 11.4.3: Do Dividend Policies Matter?
• 11.5: Relevance for Managers
• 11.6: Summary
• 11.7: Additional Resources
• 11.8: End of Chapter Problems
• Appendix: Why Dividend Policy Doesn’t Matter: Example

12. Designing an Optimal Capital Structure
• 12.1: Factor Affecting Financing Decisions: The FIRST Approach
o 12.1.1: Maximizing Flexibility
o 12.1.2: Impact on EPS: Minimizing Cost
• 12.1.2.1: A Simple Valuation Model
• 12.1.2.2: Earnings before Interest and Taxes Break-Even: What Leverage Really Means
• 12.1.2.3: Does Issuing Equity Dilute the Value of Existing Shares?
o 12.1.3: Minimizing Risk
o 12.1.4: Maintaining Shareholder Control
o 12.1.5: Optimal Training
• 12.2: Tradeoff Assessment: Evaluating FIRST Criteria
• 12.3: Relevance for Managers
• 12.4: Summary
• 12.5: Additional Resource
• 12.6: End of Chapter Problems

13. Measuring and Creating Value
• 13.1: An Overview of Measuring and Creating Value
• 13.2: Measuring Value: The Book Value Plus Adjustments Method
o 13.2.1: Pros and Cons of the Book Value of Equity Plus Adjustments Method
• 13.3: Measuring Value: The Discount Cash Flow Analysis Method
o 13.3.1: Estimating Free Cash Flows
o 13.3.2: Estimating the Cost of Capital
o 13.3.3: Estimating the Present Value of Free Cash Flows
o 13.3.4: Estimating the Terminal Value
o 13.3.5: Estimating the Value of Equity
o 13.3.6: Pros and Cons of the Free Cash Flow to the Firm Approach
• 13.4: Measuring Value: Relative Valuations and Comparable Analysis
o 13.4.1: The Price-Earnings Method
• 13.4.1.1: Pros and Cons of the Price-Earnings Approach
o 13.4.2: The Enterprise Value-to-EBITDA Method
• 13.4.2.1: Pros and Cons of the EV/EBITDA Approach
• 13.5: Creating Value and Value-Based Management
• 13.6: Valuing Mergers and Acquisitions
o 13.6.1: Valuing Comparable M&A Transactions
• 13.7: Relevance for Managers
• 13.8: Summary
• 13.9: Additional Readings
• 13.10: End of Chapter Problems

14. Comprehensive Case Study: Wal-Mart Stores, Inc.
• 14.1: Sizing Up Wal-Mart
o 14.1.1: Analyzing the Economy
o 14.1.2: Analyzing the Industry
o 14.1.3: Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy
• 14.1.3.1: Analyzing Walmart’s Operations
• 14.1.3.2: Analyzing Walmart’s Marketing
• 14.1.3.3: Analyzing Walmart’s Management and Strategy
o 14.1.4: Analyzing Walmart’s Financial Health
• 14.2: Projecting Walmart’s Future Performance
o 14.2.1: Projecting Walmart’s Income Statement
o 14.2.2: Projecting Walmart’s Balance Sheet
o 14.2.3: Examining Alternate Scenarios
• 14.3: Assessing Walmart’s Long-Term Investing and Financing
o 14.3.1: Assessing Walmart’s Investments
o 14.3.2: Assessing Walmart’s Capital Raising and the Cost of Capital
• 14.4: Valuing Walmart
o 14.4.1: Measuring Walmart’s Economic Value Added
o 14.4.2: Estimating Walmart’s Intrinsic Value: The DCF Approach
o 14.4.3: Estimating Walmart’s Intrinsic Value: Comparable Analysis
o 14.4.4: Creating Value and Overall Assessment of Walmart
• 14.5: Relevance for Managers and Final Comments
• 14.6: Additional Readings and Sources of Information
• 14.7: End of Chapter Problems
------
Part 1: Introduction to Financial Management
Chapter 1: Getting Started - Principles of Finance
Chapter 2: Firms and the Financial Market
Chapter 3: Understanding Financial Statements, Taxes, and Cash Flows
Chapter 4: Financial Analysis - Sizing Up Firm Performance
Part 2: Valuation of Financial Assets
Chapter 5: Time Value of Money - The Basics
Chapter 6: The Time Value of Money - Annuities and Other Topics
Chapter 7: An Introduction to Risk and Return - History of Financial Market Returns
Chapter 8: Risk and Return - Capital Market Theory
Chapter 9: Debt Valuation and Interest Rates
Chapter 10: Stock Valuation
Part 3: Capital Budgeting
Chapter 11: Investment Decision Criteria
Chapter 12: Analyzing Project Cash Flows
Chapter 13: Risk Analysis and Project Evaluation
Chapter 14: The Cost of Capital
Part 4: Capital Structure & Dividend Policy
Chapter 15: Capital Structure Policy
Chapter 16: Dividend Policy
Part 5: Liquidity Management & Special Topics in Finance
Chapter 17: Financial Forecasting and Planning
Chapter 18: Working Capital Management
Chapter 19: International Business Finance
Chapter 20: Corporate Risk Management
------
PART I: INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS
Chapter 1: Globalization and the Multinational Corporation
Chapter 2: The Foreign Exchange Market
Chapter 3: Forward Markets and Transaction Exchange Risk
Chapter 4: The Balance of Payments
Chapter 5: Exchange Rate Systems
PART II: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION
Chapter 6: Interest Rate Parity
Chapter 7: Speculation and Risk in the Foreign Exchange Market
Chapter 8: Purchasing Power Parity and Real Exchange Rates
Chapter 9: Measuring and Managing Real Exchange Risk
Chapter 10: Exchange Rate Determination and Forecasting

PART III: INTERNATIONAL CAPITAL MARKETS
Chapter 11: International Debt Financing
Chapter 12: International Equity Financing
Chapter 13: International Capital Market Equilibrium
Chapter 14: Political and Country Risk

PART IV: INTERNATIONAL CORPORATE FINANCE
Chapter 15: International Capital Budgeting
Chapter 16: Additional Topics in International Capital Budgeting
Chapter 17: Risk Management and the Foreign Currency Hedging Decision
Chapter 18: Financing International Trade
Chapter 19: Managing Net Working Capital

PART V: FOREIGN CURRENCY DERIVATIVES
Chapter 20: Foreign Currency Futures and Options
Chapter 21: Interest Rate and Foreign Currency Swaps
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
PART 7: OPTIONS
20. Financial Options
21. Option Valuation
22. Real Options

PART 8: LONG-TERM FINANCING
23. Raising Equity Capital
24. Debt Financing
25. Leasing
PART 9: SHORT-TERM FINANCING
26. Working Capital Management
27. Short-Term Financial Planning
PART 10: SPECIAL TOPICS
28. Mergers and Acquisitions
29. Corporate Governance
30. Risk Management
31. International Corporate Finance
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
------
------
PART 1 INTRODUCTION
Chapter 1 Corporate Finance and the Financial Manager
Chapter 2 Introduction to Financial Statement Analysis
PART 2 INTEREST RATES AND VALUING CASH FLOWS
Chapter 3 Time Value of Money: An Introduction
Chapter 4 Time Value of Money: Valuing Cash Flow Streams
Chapter 5 Interest Rates
Chapter 6 Bonds
Chapter 7 Stock Valuation
PART 3 VALUATION AND THE FIRM
Chapter 8 Investment Decision Rules
Chapter 9 Fundamentals of Capital Budgeting
Chapter 10 Stock Valuation: A Second Look
PART 4 RISK AND RETURN
Chapter 11 Risk and Return in Capital Markets
Chapter 12 Systematic Risk and the Equity Risk Premium
Chapter 13 The Cost of Capital
PART 5 LONG-TERM FINANCING
Chapter 14 Raising Equity Capital
Chapter 15 Debt Financing
PART 6 CAPITAL STRUCTURE AND PAYOUT POLICY
Chapter 16 Capital Structure
Chapter 17 Payout Policy
PART 7 FINANCIAL PLANNING AND FORECASTING
Chapter 18 Financial Modeling and Pro Forma Analysis
Chapter 19 Working Capital Management
Chapter 20 Short-Term Financial Planning
PART 8 Special Topics
Chapter 21 Option Applications and Corporate Finance
Chapter 22 Mergers and Acquisitions
Chapter 23 International Corporate Finance  

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FINANCIAL MANAGEMENT AND CORPORATE FINANCE - COLLECTION 2017 (FREE DOWNLOAD)

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Free download - PPT - Link
Free donwload - PPT - Link


Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business
Free download - PPT - Link

International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick
Free download - PPT 1 - Link
Free download - PPT 2 - Link

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Free download - PPT 1 - Link
Free download - PPT 2 - Link
Free download - PPT 3 - Link

Free download Link - Core 4

Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, 
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown

 

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Free download - PPT  - Link


Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Free download - PPT  - Link


Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Free download - PPT  - Link


Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, 
Free download - PPT  - Link


Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Free download - PPT  - Link


Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
 Free download - PPT  - Link

 

DOWNLOAD ALL TEST BANKs & CASE STUDY GUIDES - 2017

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University - Test bank

Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business - Test bank

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University - Test bank

International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick - Test bank

Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown - Test bank

Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo - Test bank

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017 - Test bank

Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016 - Test bank

Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University - Test bank

Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown - Test bank

Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin - Test bank

Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter - Test bank

 

------

For Test Bankz, Quiz Answers and Case study Guides, email to: This email address is being protected from spambots. You need JavaScript enabled to view it.

All Free downloads - LINK

 

Good Luck and Success, Enjoy Your Study !

 

 

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