Corporate Finance, 12e (Ross)
1) The changes in a firm’s future cash flows that are a direct consequence of accepting a project
are called ________ cash flows.
A) incremental
B) stand-alone
C) opportunity
D) net present value
E) erosion
2) A cost that has already been paid, or a liability to pay that has already been incurred, is
classified as a(n):
A) salvage value expense.
B) net working capital expense.
C) sunk cost.
D) opportunity cost.
E) erosion cost.
3) The most valuable investment given up if an alternative investment is chosen is referred to as
a(n):
A) salvage value expense.
B) net working capital expense.
C) sunk cost.
D) opportunity cost.
E) erosion cost.
4) A decrease in a firm’s current cash flows resulting from the implementation of a new project is
referred to as:
A) salvage value expenses.
B) net working capital expenses.
C) sunk costs.
D) opportunity costs.
E) erosion costs.
5) One purpose of identifying all the incremental cash flows related to a proposed project is to:
A) isolate the total sunk costs so they can be evaluated to determine if the project will add value
to the firm.
B) eliminate any cost which has previously been incurred so that it can be omitted from the
analysis of the project.
C) make each project appear as profitable as possible for the firm.
D) include both the proposed and the current operations of a firm in the analysis of the project.
E) identify any and all changes in the cash flows of the firm for the past year so they can be
included in the analysis.
6) Sunk costs include any cost that:
A) will change if a project is undertaken.
B) will be incurred if a project is accepted.
C) has previously been incurred and cannot be changed.
D) will be paid to a third party and cannot be refunded for any reason whatsoever.
E) will occur if a project is accepted and once incurred, cannot be recouped.
7) You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up
and you are trying to decide whether to fix them or trade the car in for a newer model. In
analyzing the brake situation, the $500 you spent fixing the transmission is a(n) ________ cost.
A) opportunity
B) fixed
C) incremental
D) sunk
E) relevant
8) Erosion can be explained as the:
A) additional income generated from the sales of a newly added product.
B) loss of current sales due to a new project being implemented.
C) loss of revenue due to employee theft.
D) loss of revenue due to customer theft.
E) decrease in expected annual revenues as a new product ages.
9) Which one of these is an example of erosion that should be included in project analysis?
A) The anticipated loss of current sales when a new product is launched.
B) The expected decline in sales as the market for a product becomes saturated.
C) The reduction in sales that occurs when a competitor introduces a new product.
D) The sudden loss of sales due to a major employer in your community implementing massive
layoffs.
E) The reduction in sales price that will most likely be required to sell inventory that has aged.
10) Which one of the following should be excluded from the analysis of a project?
A) Erosion costs
B) Incremental fixed costs
C) Incremental variable costs
D) Sunk costs
E) Opportunity costs
11) The cash flows of a project should:
A) be computed on a pretax basis.
B) include all sunk costs and opportunity costs.
C) include all incremental and opportunity costs.
D) be applied to the year when the related expense or income is recognized by GAAP.
E) include all financing costs related to new debt acquired to finance the project.
12) All of the following are anticipated effects of a proposed project. Which of these should be
considered when computing the cash flow for the final year of the project?
A) Operating cash flow and salvage values only
B) Salvage values and net working capital recovery only
C) Operating cash flow, net working capital recovery, salvage values
D) Net working capital recovery and operating cash flow only
E) Operating cash flow only
13) Changes in the net working capital:
A) can affect the cash flows of a project every year of the project’s life.
B) only affect the initial cash flows of a project.
C) are included in project analysis only if they represent cash outflows.
D) are generally excluded from project analysis due to their irrelevance to the total project.
E) can only affect the initial and the final cash flows of a project.
14) The net working capital of a firm will decrease if there is:
A) a decrease in accounts payable.
B) an increase in inventory.
C) a decrease in accounts receivable.
D) an increase in the checking account balance.
E) a decrease in fixed assets.
15) Net working capital:
A) can be ignored in project analysis because any expenditure is normally recouped by the end of
the project.
B) requirements generally, but not always, create a cash inflow at the beginning of a project.
C) expenditures commonly occur at the end of a project.
D) is frequently affected by the additional sales generated by a new project.
E) is the only expenditure where at least a partial recovery can be made at the end of a project.
16) A company that opts to forego bonus depreciation and instead uses the MACRS system of
depreciation:
A) will have equal depreciation costs for each year of an asset’s life.
B) will expense the largest percentage of the cost during an asset’s first year of life.
C) can depreciate the cost of land, if it so desires.
D) will write off the entire cost of an asset over the asset’s class life.
E) cannot expense any of the cost of a new asset during the first year of the asset’s life.
17) Champion Toys just purchased some MACRS 5-year property at a cost of $230,000. The
MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76
percent for Years 1 to 6, respectively. Assuming the firm foregoes all bonus depreciation, the
book value of the asset as of the end of Year 2 can be calculated as:
A) $230,000(1 − .20 − .32).
B) $230,000([1 − (.20)(.32)].
C) $230,000(1 − .20)(1 − .32).
D) $230,000/(1 − .20 − .32).
E) $230,000(.20)(.32).
18) Pete’s Garage just purchased some equipment at a cost of $650,000. What is the proper
methodology for computing the depreciation expense for Year 3 if the equipment is classified as
5-year property for MACRS? The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52
percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. Ignore bonus
depreciation.
A) $650,000(1 − .20)(1 − .32)(1 − .192)
B) $650,000(1 − .20)(1 − .32)
C) $650,000(1 − .20)(1 − .32)(.192)
D) $650,000(1 − .192)
E) $650,000(.192)
19) The book value of an asset is primarily used to compute the:
A) annual depreciation tax shield.
B) amount of cash received from the sale of the asset.
C) amount of tax saved annually due to the depreciation expense.
D) amount of tax due on the sale of that asset.
E) change in depreciation needed to reflect the market value of the asset.
20) The salvage value of an asset creates an aftertax cash flow in an amount equal to the sales
price:
A) of the asset.
B) minus the remaining book value.
C) minus [Tax rate × (Sales price − Book value)].
D) minus [Tax rate × (Book value − Sales price)].
E) plus the remaining book value.
21) The pretax salvage value of an asset is equal to the:
A) book value if straight-line depreciation is used.
B) book value if MACRS depreciation is used.
C) market value minus the book value.
D) book value minus the market value.
E) market value.
22) Which depreciation method currently permitted under U.S. tax law provides the fastest
means of depreciating an asset?
A) MACRS depreciation
B) Bonus depreciation only
C) Straight-line depreciation
D) Sum-of-years digits depreciation
E) Partial bonus depreciation combined with MACRS
23) For a tax-paying firm, the net present value of a project will increase when:
A) the initial net working capital requirement increases.
B) depreciation is decreased during the early years of a project’s life.
C) the life of the fixed assets used by that project is increased.
D) the operating cash flows increase.
E) the tax rate increases.
24) A project’s operating cash flow will increase when the:
A) depreciation expense increases.
B) sales projections are lowered.
C) interest expense is lowered.
D) net working capital requirement increases.
E) earnings before interest and taxes decreases.
25) The cash flow tax savings generated as a result of a firm’s tax-deductible depreciation
expense is called the:
A) aftertax depreciation savings.
B) depreciable basis.
C) depreciation tax shield.
D) operating cash flow.
E) aftertax salvage value.
26) Assume a firm has no interest expense or extraordinary items. Given this, the operating cash
flow can be computed as:
A) EBIT − Taxes.
B) EBIT(1 − Tax rate) + Depreciation(Tax rate).
C) (Sales − Costs)(1 − Tax rate).
D) EBIT − Depreciation + Taxes.
E) Net income + Depreciation.
27) The bottom-up approach to computing the operating cash flow applies only when:
A) both the depreciation expense and the interest expense are equal to zero.
B) the interest expense is equal to zero.
C) the project is a cost-cutting project.
D) no fixed assets are required for the project.
E) taxes are ignored and the interest expense is equal to zero.
28) The top-down approach to computing the operating cash flow:
A) ignores all noncash items.
B) applies only if a project produces sales.
C) can only be used if the entire cash flows of a firm are included.
D) is equal to: Sales − Costs − Taxes + Depreciation.
E) includes the interest expense related to a project.
29) For a profitable firm, an increase in which one of the following will increase the operating
cash flow?
A) Employee salaries
B) Office rent
C) Building maintenance
D) Depreciation
E) Equipment rental
30) The term “tax shield” refers to a reduction in taxes created by:
A) a reduction in sales.
B) an increase in interest expense.
C) noncash expenses.
D) a project’s incremental expenses.
E) opportunity costs.
31) A project which is designed to improve the manufacturing efficiency of a firm but will
generate no additional sales revenue is referred to as a(n) ________ project.
A) sunk cost
B) opportunity
C) cost-cutting
D) revenue-cutting
E) revenue-generating
32) The annual annuity stream of payments with the same present value as a project’s costs is
called the project’s ________ cost.
A) incremental
B) sunk
C) opportunity
D) erosion
E) equivalent annual
33) Toni’s Tools is comparing machines to determine which one to purchase. The machines sell
for differing prices, have differing operating costs, differing machine lives, and will be replaced
when worn out. These machines should be compared using:
A) net present value only.
B) both net present value and the internal rate of return.
C) their equivalent annual costs.
D) the depreciation tax shield approach.
E) the replacement cost approach.
34) The pro forma income statement for a cost reduction project:
A) will reflect a reduction in the sales of the firm.
B) will generally reflect no incremental sales.
C) has to be prepared reflecting the total sales and expenses of the entire firm.
D) cannot be prepared due to the lack of any project related sales.
E) will always reflect a negative project operating cash flow.
35) The equivalent annual cost method is most useful in determining:
A) the annual operating cost of an idle machine that is currently owned by a firm.
B) the tax shield benefits of depreciation given the purchase of new assets for a project.
C) operating cash flows for cost-cutting projects of equal duration.
D) which one of two machines to acquire given equal machine lives but unequal machine costs.
E) which one of two machines to purchase when the machines are mutually exclusive, have
differing lives, and will be replaced.
36) Interest rates or rates of return on investments that have been adjusted for the effects of
inflation are called ________ rates.
A) real
B) nominal
C) effective
D) stripped
E) coupon
37) The increase you realize in buying power as a result of owning an investment is referred to as
the ________ rate of return.
A) inflated
B) realized
C) nominal
D) real
E) risk-free
38) Marshall’s purchased a corner lot five years ago at a cost of $498,000 and then spent $63,500
on grading and drainage so the lot could be used for storing outdoor inventory. The lot was
recently appraised at $610,000. The company now wants to build a new retail store on the site.
The building cost is estimated at $1.1 million. What amount should be used as the initial cash
outflow for this building project?
A) $1,661,500
B) $1,100,000
C) $1,208,635
D) $1,710,000
E) $1,498,000
39) Samson’s purchased a lot four years ago at a cost of $398,000. At that time, the firm spent
$289,000 to build a small retail outlet on the site. The most recent appraisal on the property
placed a value of $629,000 on the property and building. Samson’s now wants to tear down the
original structure and build a new strip mall on the site at an estimated cost of $2.3 million. What
amount should be used as the initial cash outflow for the new project?
A) $2,987,000
B) $2,242,000
C) $2,058,000
D) $2,300,000
E) $2,929,000
40) Jamestown Ltd. currently produces boat sails and is considering expanding its operations to
include awnings. The expansion would require the use of land the firm purchased three years ago
at a cost of $142,000 that is currently valued at $137,500. The expansion could use some
equipment that is currently sitting idle if $6,700 of modifications were made to it. The equipment
originally cost $139,500 six years ago, has a current book value of $24,700, and a current market
value of $39,000. Other capital purchases costing $780,000 will also be required. What is the
amount of the initial cash outflow for this expansion project?
A) $953,400
B) $962,300
C) $948,900
D) $927,800
E) $963,200
41) The Boat Works currently produces boat sails and is considering expanding its operations to
include awnings. The expansion would require the use of land the firm purchased three years ago
at a cost of $197,000 that is currently valued at $209,500. The expansion could use some
equipment that is currently sitting idle if $7,500 of modifications were made to it. The equipment
originally cost $387,500 five years ago, has a current book value of $132,700, and a current
market value of $139,000. Other capital purchases costing $520,000 will also be required. What
is the value of the opportunity costs that should be included in the initial cash outflow for the
expansion project?
A) $425,000
B) $485,000
C) $329,700
D) $348,500
E) $537,200
42) Walks Softly currently sells 14,800 pairs of shoes annually at an average price of $59 a pair.
It is considering adding a lower-priced line of shoes that will be priced at $39 a pair. The
company estimates it can sell 6,000 pairs of the lower-priced shoes annually but will sell 3,500
less pairs of the higher-priced shoes each year by doing so. What annual sales revenue should be
used when evaluating the addition of the lower-priced shoes?
A) $27,500
B) $24,000
C) $31,300
D) $789,100
E) $900,700
43) Foamsoft currently sells 16,850 pairs of shoes annually at an average price of $79 a pair. It is
considering adding a new line of shoes that would sell for $49 a pair. The company estimates it
can sell 5,000 pairs of the lower-priced shoes annually but will sell 1,250 less pairs of the higher-
priced shoes each year by doing so. What is the estimated value of the annual erosion cost that
should be charged to the lower-priced shoe project?
A) $138,750
B) $146,250
C) $98,750
D) $52,000
E) $123,240
44) Sue purchased a house for $89,000, spent $56,000 upgrading it, and currently had it
appraised at $212,900. The house is being rented to a family for $1,200 a month, the
maintenance expenses average $200 a month, and the property taxes are $4,800 a year. If she
sells the house she will incur $20,000 in expenses. She is considering converting the house into
professional office space. What opportunity cost, if any, should she assign to this property if she
has been renting it for the past two years?
A) $178,500
B) $120,000
C) $185,000
D) $192,900
E) $232,900
45) Jamie’s Motor Home Sales currently sells 110 Class A motor homes, 220 Class C motor
homes, and 280 pop-up trailers each year. They are considering adding a mid-range camper with
expected annual sales of 300 units. However, if the new camper is added, Class A sales will
decline to 85 units and the Class C camper sales will decline to 200 units. The sales of pop-ups
will not be affected. Class A motor homes sell for an average of $140,000 each. Class C homes
are priced at $59,500, and the pop-ups sell for $5,000 each. The new mid-range camper will sell
for $42,900. What is the annual erosion cost of adding the mid-range camper?
A) $5,425,000
B) $4,690,000
C) $5,375,000
D) $6,315,000
E) $7,875,000
46) Lee’s Furniture just purchased $24,000 of fixed assets that are classified as 5-year MACRS
property. The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52
percent, and 5.76 percent for Years 1 to 6, respectively. What is the amount of the depreciation
expense for the third year if the firm applies the new bonus method of depreciation?
A) $2,304
B) $2,507
C) $4,608
D) $0
E) $4,800
47) Lew just purchased $67,600 of equipment that is classified as 5-year MACRS property. The
MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76
percent for Years 1 to 6, respectively. What will be the book value of this equipment at the end
of four years if he ignores bonus depreciation?
A) $11,681.28
B) $18,280.20
C) $17,040.00
D) $19,468.80
E) $22,672.00
48) Northern Enterprises just purchased $1,900 of fixed assets that are classified as 3-year
MACRS property. The MACRS rates are 33.33 percent, 44.44 percent, 14.82 percent, and 7.41
percent for Years 1 to 4, respectively. What is the amount of the depreciation expense for Year
2? Ignore bonus depreciation.
A) $562.93
B) $633.27
C) $719.67
D) $844.36
E) $1,477.63