Chapter 12: Cash Flow Estimation and Risk Analysis
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a. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure
to include interest expense as a cost when determining the project’s cash flows will lead to an upward bias in the NPV.
b. In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure
to include interest expense as a cost when determining the project’s cash flows will lead to a downward bias in the NPV.
c. The existence of any type of “externality” will reduce the calculated NPV versus the NPV that would exist
without the externality.
d. If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or
leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be
charged as a cost to the project under consideration.
e. If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any
costs associated with that asset is a sunk cost and should be ignored.
45. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the
capital budgeting analysis for a new product?
a. A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural
purposes.
b. A new product will generate new sales, but some of those new sales will be from customers who switch from one
of the firm’s current products.
c. A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new
machinery.
d. A firm has spent $2 million on research and development associated with a new product. These costs have been
expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.
e. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s
other products.
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48. Taussig Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company
estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted
thorough scenario and simulation analyses. This research produced the following data:
Project X Project Y
Expected NPV $350,000 $350,000
Standard deviation ( NPV) $100,000 $150,000
Project beta (vs. market) 1.4 0.8
Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are not correlated
with the cash flows from existing projects. Cash flows are highly correlated with the cash flows
from existing projects.
Which of the following statements is CORRECT?
a. Project X has more stand-alone risk than Project Y.
b. Project X has more corporate (or within-firm) risk than Project Y.
c. Project X has more market risk than Project Y.
d. Project X has the same level of corporate risk as Project Y.
e. Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of
existing projects.
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B Average 12%
C High 11%
D Low 9%
E Low 6%
Which set of projects would maximize shareholder wealth?
a. A and B
b. A, B, and C
c. A, B, and D
d. A, B, C, and D
e. A, B, C, D, and E
55. Which of the following statements is CORRECT?
a. If an asset is sold for less than its book value at the end of a project’s life, it will generate a loss for the firm,
hence its terminal cash flow will be negative.
b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported
accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
c. It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion
project can be recovered at the project’s completion. Operating working capital like inventory is almost always used up in
operations. Thus, cash flows associated with operating working capital should be included only at the start of a project’s
life.
d. If equipment is expected to be sold for more than its book value at the end of a project’s life, this will result in a
profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold
at book value, other things held constant.
e. Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes
in long-term assets and liabilities, hence they should not be considered in a capital budgeting analysis.
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Sales revenues, each year $60,000
Operating costs (excl. depr.) $25,000
Tax rate 25.0%
a. $33,040
b. $32,008
c. $29,598
d. $28,222
e. $26,250
59. As a member of UA Corporation’s financial staff, you must estimate the Year 1 cash flow for a proposed project with
the following data. Under the new tax law, the equipment used in the project is eligible for 100% bonus depreciation, so it
will be fully depreciated at t = 0. What is the Year 1 cash flow? Do not round the intermediate calculations and round the
final answer to the nearest whole number.
Sales revenues, each year $45,000
Other operating costs $17,000
Interest expense $4,000
Tax rate 25.0%
a. $22,922
b. $17,677
c. $20,785
d. $21,375
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e. $17,871
60. Fool Proof Software is considering a new project whose data are shown below. The equipment that would be used has
a 3-year tax life. Under the new tax law, the equipment used in the project is eligible for 100% bonus depreciation, so it
will be fully depreciated at t = 0. Revenues and operating costs are expected to be constant over the project’s 10-year
expected life. What is the Year 1 cash flow?
Equipment cost $55,000
Sales revenues, each year $90,000
Operating costs (excl. depr.) $25,000
Tax rate 25.0%
a. $33,177
b. $22,409
c. $48,750
d. $26,483
e. $22,991
