Fundamentals of Corporate Finance 3e Test Bank
Chapter 11: Cash Flows and Capital Budgeting
1.
The term incremental in the context of incremental after-tax free cash flows refers to the fact
that the firm’s total after-tax free cash flows will change if the new project is adopted.
A)
True
B)
False
Ans:
A
2.
Conceptually, free cash flows are what is left over for distribution to creditors and stockholders
after the firm has made the necessary investments in working capital and long-term assets.
A)
True
B)
False
Ans:
A
AICPA: Industry/Sector Perspective
3.
Incremental cash flow from operations is the cash flow from a project that is expected to be
generated after all operating expenses and taxes have been paid.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
4.
The purchase of a factory building for a prospective project is an example of an incremental
addition to working capital.
A)
True
B)
False
Ans:
B
AICPA: Industry/Sector Perspective
5.
If a firm expects to increase its investment in inventory due to a prospective project, then this is
an example of an incremental capital expenditure.
A)
True
B)
False
Ans:
B
6.
The stand-alone principle says that we can treat a project as if it were a stand-alone firm that
has its own revenue, expenses, and investment requirements.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
7.
If you start with incremental net operating profits after tax (NOPAT) and add depreciation and
amortization to it, then you will obtain incremental cash flow from operations.
A)
True
B)
False
Ans:
A
8.
Free cash flow equals cash flow from operations minus required investments.
A)
True
B)
False
Ans:
A
AICPA: Industry/Sector Perspective
9.
Increases in working capital are considered cash flows associated with investments.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
10.
Accounting earnings are a reliable measure of the costs and benefits of a project.
A)
True
B)
False
Ans:
B
11.
If taken without accompanying changes in cash flow, changes in a company’s accounting
earnings do not impact the overall value of the firm.
A)
True
B)
False
Ans:
A
12.
Allocated costs such as corporate overhead should be included in cash flow calculations.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
13.
The impact of a project on another project’s cash flows should be ignored.
A)
True
B)
False
Ans:
B
14.
Opportunity costs should always be included in the cash flow calculations of a project.
A)
True
B)
False
Ans:
A
15.
The research and development costs to date of a project should be considered when analyzing
the cash flows of a prospective project.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
16.
Since our perspective when evaluating a project is that of all of the investors in the firm,
creditors as well as stockholders, then we should evaluate the pretax cash flows produced by a
project.
A)
True
B)
False
Ans:
B
17.
Since our perspective when evaluating a project is that of all the shareholders only, then we
should evaluate the after-tax cash flows produced by a project.
A)
True
B)
False
Ans:
B
18.
BioGeological Pharmaceuticals invested $100 million on a heart drug that does not prevent
heart disease. BioGeological has since found that the drug does prevent diabetes. When
considering whether to market the drug as a diabetic panacea, the firm should consider the $100
million spent while investigating the heart-related effects.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
19.
When analyzing a project, if the expected future cash flows are denominated in nominal dollars,
then the discount rate should represent a nominal rate as well.
A)
True
B)
False
Ans:
A
20.
Nominal interest rates incorporate the expected rate of inflation.
A)
True
B)
False
Ans:
A
AICPA: Industry/Sector Perspective
21.
If the current market price of corn is $100 per bushel and the nominal rate of interest is 10
percent, then the real price of corn next period should also be $100.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
22.
A progressive tax system means that a taxpayer will pay a higher tax rate for a given dollar of
earnings for every successive year.
A)
True
B)
False
Ans:
B
23.
It is possible for a firm to have one depreciation schedule for tax purposes and another for
financial reporting purposes.
A)
True
B)
False
Ans:
A
24.
The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate
for a total of four years.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
25.
Terminal-year free cash flows may differ from the cash flows provided in the typical year of a
project for reasons such as the return/repayment of increases/reductions in additional working
capital in the prior years.
A)
True
B)
False
Ans:
A
26.
If the salvage value, at the time of an asset disposition, is less than the book value of the asset,
then the firm will effectively receive a positive cash flow from taxes on the sale.
A)
True
B)
False
Ans:
A
27.
The expected cash flows for a project are fixed amounts that have zero variability in the
projected values.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
AICPA: Industry/Sector Perspective
28.
The unadjusted NPV of two projects with different useful lives can be compared to evaluate
which project is the better of the two.
A)
True
B)
False
Ans:
B
29.
You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent
per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not
to begin harvesting the element. The correct choice is to begin harvesting immediately if the
current NPV of the project is positive.
A)
True
B)
False
Ans:
A
AICPA: Industry/Sector Perspective
30.
You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent
per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not
to begin harvesting the element. The correct choice is to begin harvesting immediately under all
circumstances.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
31.
The cash flows used in capital budgeting calculations are based on:
A)
historical estimates.
B)
forecasts of future cash revenues, expenses, and investment outlays.
C)
forecasts of net income.
D)
forecasts of retained earnings available for financing projects.
Ans:
B
32.
The NPV of a project is estimated by:
A)
discounting the expected cash flows of a project in the future.
B)
discounting only the certain cash flows of a project in the future.
C)
discounting the variance of the expected cash flows of a project in the future.
D)
None of the above.
Ans:
A
33.
The ___________ is intended to reconcile changes in the balance sheet cash accounts.
A)
capital budgeting cash flow calculation
B)
accounting statement of cash flows
C)
accounting statement of income
D)
None of the above.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
34.
The term ___________ refers to the fact that these cash flows reflect the amount by which the
firm’s total after-tax free cash flows will change if the project is adopted.
A)
Periodic
B)
ending cash flows
C)
Incremental
D)
None of the above.
Ans:
C
AICPA: Industry/Sector Perspective
35.
_________ refers to the cash flow that a project is expected to generate after all operating
expenses and taxes have been paid.
A)
Incremental cash flow from operations
B)
Operating income
C)
EBITDA
D)
None of the above.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
36.
In order to calculate free cash flow by starting with incremental cash flow from operations, we
should
A)
subtract the incremental capital expenditures and add the incremental additions to
working capital.
B)
add the incremental capital expenditures and the incremental additions to working
capital.
C)
subtract the incremental capital expenditures and the incremental additions to working
capital.
D)
None of the above.
Ans:
C
AICPA: Industry/Sector Perspective
37.
The idea that we can evaluate the cash flows from a project independently of the cash flows for
the firm is known as:
A)
the stand-alone principle.
B)
the dependent principle.
C)
the independent principle.
D)
None of the above.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
38.
The firm’s ____________ is used to calculate NOPAT because the profits from a project are
assumed to be incremental to the firm.
A)
average tax rate
B)
marginal tax rate
C)
lowest marginal tax rate
D)
None of the above.
Ans:
B
AICPA: Industry/Sector Perspective
39.
Additions to tangible assets, intangible assets ,and current assets can be described as:
A)
cash flows associated with investments.
B)
operating cash flows.
C)
free cash flows.
D)
None of the above.
Ans:
A
40.
The impact of a project on a firm’s overall value depends on
A)
a firm’s accounting earnings.
B)
a firm’s cash flow.
C)
a project’s cash flow.
D)
None of the above.
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
41.
Which of the following should not be included in a project’s cash flow calculations?
A)
cash expenses
B)
cash revenues
C)
allocated expenses
D)
None of the above.
Ans:
C
42.
Corporate overhead allocations should only be taken into account on project analysis if:
A)
the firm is currently covering all of its overhead allocations.
B)
the firm is currently unable to cover all of its overhead allocations.
C)
the overhead allocations involve cash expenditures.
D)
None of the above.
Ans:
D
AICPA: Industry/Sector Perspective
43.
Brown Mack, Inc., currently has two large manufacturing divisions that share a single plant.
Brown Mack owns the plant but has calculated that $6 million of overhead expenses should be
allocated to the two equal-sized divisions. If Brown Mack starts a third manufacturing division,
of equal size to the other two divisions, then what overhead cost should the new division take
into account on its capital budgeting cash flow analysis?
A)
$0
B)
$2 million
C)
$3 million
D)
$6 million
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
44.
A firm is considering taking a project that will produce $12 million of revenue per year. Cash
expenses will be $5 million, and depreciation expenses will be $1 million per year. If the firm
takes that project, then it will reduce the cash revenues of an existing project by $2 million.
What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax
rate?
A)
$2.4 million
B)
$3.4 million
C)
$4.6 million
D)
$5.0 million
Ans:
B
45.
Whenever a project has a negative impact on an existing project’s cash flows, then that effect
should:
A)
be ignored.
B)
be ignored if the project is evaluated using the correct cost of capital.
C)
be included as a negative revenue amount on the new project’s cash flow analysis.
D)
be included if the impact is limited to noncash expenditures.
Ans:
C
Fundamentals of Corporate Finance 3e Test Bank
46.
If a firm has the option of leasing some factory space to another firm or utilizing it for another
product line, then if the firm chose the product line how should it handle the lost lease
payments on the factory space?
A)
Ignore it.
B)
Include it as an opportunity cost.
C)
Include half of it as additional revenue for the project.
D)
None of the above.
Ans:
B
47.
Which of the following is the best example of a sunk cost?
A)
Future payments on a leased building.
B)
Future research and development costs.
C)
Historical research and development costs.
D)
Historical noncash expenses.
Ans:
C
48.
_____________ represent dollars stated in terms of constant purchasing power.
A)
Nominal dollars
B)
Real dollars
C)
Inflated dollars
D)
None of the above
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
49.
If inflation is anticipated to be 10 percent during the next year while a nominal rate of 20
percent will be earned on U.S. Treasury bills, then what is the accurate real rate of return on
these securities?(Round final percentage answer to decimal places.)
A)
20.05%
B)
10.01%
C)
9.09%
D)
None of the above.
Ans:
C
1 + 0.2 = (1 + 0.1) x (1 + r)
1.0909 = 1 + r
0.0909 = r
50.
If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation is
anticipated to be 8 percent, then what should nominal rate of return be? (Round final percentage
answer to decimal places.)
A)
14.05%
B)
33.05%
C)
23.12%
D)
None of the above.
Ans:
C
1 + k = (1 + 0.08) x (1 + 0.14)
1 + k = 1.2312
Fundamentals of Corporate Finance 3e Test Bank
51.
If you are discounting a project’s cash flows using the nominal cost of capital, then that means
that you have taken the following into account:
A)
the real rate of return.
B)
the expected rate of inflation.
C)
Both of the above.
D)
None of the above.
Ans:
C
AICPA: Industry/Sector Perspective
52.
A tax system in which taxpayers pay a progressively larger share of their income in taxes as
their income rises is called:
A)
a flat tax system.
B)
a progressive tax system.
C)
a digressive tax system.
D)
a political tax system.
Ans:
B
AICPA: Industry/Sector Perspective
53.
For a U.S. corporation with income above $20 million,
A)
the average tax rate is less than the marginal tax rate.
B)
the average tax rate is equal to the marginal tax rate.
C)
the average tax rate is greater than the marginal tax rate.
D)
None of the above.
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
54.
When compared to the straight-line depreciation method, MACRS has:
A)
a greater proportion of its depreciation early in the life of the asset.
B)
a lesser proportion of its depreciation early in the life of the asset.
C)
an equal proportion of its depreciation early in the life of the asset.
D)
None of the above.
Ans:
A
55.
In order for a project to generate a positive net working capital cash flow at the conclusion of a
project,
A)
the project must have generated a cumulative negative cash flow during the life of the
project.
B)
the project must have generated a cumulative positive cash flow during the life of the
project.
C)
the project must have generated a cumulative negative cash flow at the conclusion of the
project.
D)
the project could not have generated a positive cash flow at the opening of the project.
Ans:
A
AICPA: Industry/Sector Perspective
56.
If you are deciding whether to take one project or another, where the projects have different
useful lives, then you could utilize:
A)
a repeated investment analysis to decide which project is better for the firm.
B)
an equivalent annual annuity analysis to decide which project is better for the firm.
C)
Either of the above.
D)
None of the above.