Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1)
Which of the following statements is false?
1)
A)
Managers sometimes continue to invest in a project that has a negative NPV because they
have already invested a large amount in the project and feel that by not continuing it, the
prior investment will wasted.
B)
Sales will ultimately decline as the product nears obsolescence or faces increased competition.
C)
With straight–line depreciation the asset’s cost is divided equally over its life.
D)
A projects unlevered net income is equal to its incremental revenues less costs and
depreciation, evaluated on an pre–tax basis.
Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three
years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three–year life to a
residual value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net
working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of
its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
2)
The amount of incremental income taxes that the Sisyphean Company will pay in the first year on
this new project is closest to:
2)
A)
$5,200
B)
$2,800
C)
$6,300
D)
$3,500
3)
Which of the following statements is false?
3)
A)
Overhead expenses are often allocated to the different business activities for accounting
purposes.
B)
A capital budget lists the projects and investments that c company plans to undertake during
the coming year.
C)
When sales of a new product displace sales of an existing product, the situation is often
referred to as cannibalization.
D)
Income Tax = EBIT × (1 –c).
4)
Which of the following questions is false?
4)
A)
Tax loss carry backs allow corporations to take losses during the current year and use them to
offset income in future years.
B)
Because depreciation is not a cash flow, we do not include it in the cash flow forecast.
C)
Earnings are an accounting measure of firm performance.
D)
Net Working Capital = Current Assets – Current Liabilities.
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a
cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash
flow projects:
Year 0 1 2 3
Sales (Revenues) 100,000 100,000 100,000
– Cost of Goods Sold (50% of Sales) 50,000 50,000 50,000
– Depreciation 30,000 30,000 30,000
= EBIT 20,000 20,000 20,000
– Taxes (35%) 7000 7000 7000
= unlevered net income 13,000 13,000 13,000
+ Depreciation 30,000 30,000 30,000
+ changes to working capital –5,000 –5,000 10,000
– capital expenditures –90,000
5)
The free cash flow for the first year of Epiphany’s project is closest to:
5)
A)
$43,000
B)
$45,000
C)
$38,000
D)
$25,000
Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three
years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three–year life to a
residual value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net
working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of
its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
6)
The incremental EBIT in the first year for the Sisyphean Corporation’s project is closest to:
6)
A)
$11,700
B)
$5,200
C)
$18,000
D)
$8,000
7)
Which of the following statements is false?
7)
A)
Earnings include the cost of capital investments, but do not include non–cash charges, such as
depreciation.
B)
Sometimes the firm explicitly forecast free cash flow over a shorter horizon than the full
horizon of the project or investment.
C)
Depreciation is a method used for accounting and tax purposes to allocate the original
purchase cost of the asset over its life.
D)
Firms often report a different depreciation expense for accounting and for tax purposes.
Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three
years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three–year life to a
residual value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net
working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of
its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
8)
The required net working capital in the second year for the Sisyphean Corporation’s project is
closest to:
8)
A)
$5,940
B)
$4,360
C)
$3.190
D)
$3,960
9)
You are considering investing $600,000 in a new automated inventory system that will provide and
after–tax cost savings of $50,000 next year. These cost savings are expected to grow at the same rate
as sales. If sales are expected to grow at 5% per year and your cost of capital is 10%, then what is
the NPV of the automated inventory system?
9)
A)
$1,000,000
B)
$500,000
C)
$400,000
D)
–$100,000
10)
Which of the following statements is false?
10)
A)
Any money that has already been spent is a sunk cost and therefore irrelevant in the capital
budgeting process.
B)
Project externalities are direct effects of the project that may increase of decrease the profits of
other business activities of the firm.
C)
Incremental earnings are the amount by which the firm’s earnings are expected to change as a
result of the investment decision.
D)
The average selling price of a product and its cost of production will generally change over
time.
11)
An exploration of the effect on NPV of changing multiple project parameters is called
11)
A)
IRR analysis.
B)
accounting break–even analysis.
C)
sensitivity analysis.
D)
scenario analysis.
12)
Which of the following statements is false?
12)
A)
The firm cannot use its earnings to buy goods, pay employees, fund new investments, or pay
dividends to shareholders.
B)
Depreciation expenses have a positive impact on free cash flow.
C)
Free Cash Flow = (Revenues – Costs – Depreciation) × (1 –c) – Capital Expenditures –
NWC +c× Depreciation.
D)
The depreciation tax shield is the tax savings that results from the ability to deduct
depreciation.
13)
Which of the following statements is false?
13)
A)
When evaluating a capital budgeting decision, we generally include interest expense.
B)
As a practical matter, to derive the forecasted cash flows of a project, financial managers often
begin by forecasting earnings.
C)
Many projects use a resource that the company already owns.
D)
Only include as incremental expenses in your capital budgeting analysis the additional
overhead expenses that arise because of the decision to take on the project.
14)
Which of the following statements is false?
14)
A)
In the final year of a project, the firm ultimately recovers the investment in net working
capital.
B)
NWCt=NWCt–NWCt – 1.
C)
The main components of net working capital are cash, inventory, receivables, and property,
plant and equipment.
D)
Most projects will require the firm to invest in net working capital.
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
15)
The incremental unlevered net income Shepard Industries in year two is closest to:
15)
A)
$600
B)
$510
C)
$355
D)
$415
Explanation:
16)
A decrease in the sales of a current project because of the launching of a new project is
16)
A)
a sunk cost.
B)
an overhead expense.
C)
irrelevant to the investment decision.
D)
cannibalization.
Explanation:
Explanation:
Use the information for the question(s) below.
Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000, to diabetic patients for $129.
GSI plans on lowering their price next year to $99 per unit. The cost of goods sold for each Glucoscan unit is $50, and GSI
expects to sell 100,000 units over the next year.
17)
Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales over
the next year by 30% to 130,000 units. Also suppose that for each Glucoscan monitor sold, GSI
expects additional sales of $100 per year on glucose testing strips and these strips have a gross
profit margin of 75%. Considering the increase in the sale of testing strips, the incremental impact
of this price drop on the firms EBIT is closest to:
17)
A)
An increase of 1.5 million
B)
Adecline of 0.7 million
C)
An increase of 0.7 million
D)
A decline of 1.5 million
Use the information for the question(s) below.
Food For Less (FFL), a grocery store, is considering offering one hour photo developing in their store. The firm expects that
sales from the new one hour machine will be $150,000 per year. FFL currently offers overnight film processing with annual
sales of $100,000. While many of the one hour photo sales will be to new customers, FFL estimates that 60% of their current
overnight photo customers will switch and use the one hour service.
18)
Suppose that of the 60% of FFL’s current overnight photo customers, half would start taking their
film to a competitor that offers one hour photo processing if FFL fails to offer the one hour service.
The level of incremental sales in this case is closest to:
18)
A)
$90,000
B)
$150,000
C)
$120,000
D)
$60,000
Use the information for the question(s) below.
Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000, to diabetic patients for $129.
GSI plans on lowering their price next year to $99 per unit. The cost of goods sold for each Glucoscan unit is $50, and GSI
expects to sell 100,000 units over the next year.
19)
Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales over
the next year by 30% to 130,000 units. The incremental impact of this price drop on the firms EBIT
is closest to:
19)
A)
an increase of 1.5 million
B)
a decline of 2.4 million
C)
an increase of 2.4 million
D)
a decline of 1.5 million
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
20)
The incremental EBIT for Shepard Industries in year one is closest to:
20)
A)
$360
B)
$750
C)
$510
D)
$595
21)
The depreciation tax shield for Shepard Industries project in year two is closest to:
21)
A)
$84
B)
$72
C)
$196
D)
$96
22)
The difference between scenario analysis and sensitivity analysis is:
22)
A)
Scenario analysis considers the effect on NPV of changing multiple project parameters.
B)
Only sensitivity analysis allows us to change our estimated inputs of our NPV analysis.
C)
Scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV.
D)
Only Scenaripo analysis breaks the NPV calculation into its component assumptions.
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
23)
The free cash flow from Shepard Industries project in year one is closest to:
23)
A)
$390
B)
$240
C)
–$5
D)
$300
24)
Which of the following statements is false?
24)
A)
The break–even level of an input is the level for which the investment has an IRR of zero.
B)
The most difficult part of capital budgeting is deciding how to estimate the cash flows and the
cost of capital.
C)
Sensitivity analysis reveals which aspects of the project are most critical when we are actually
managing the project.
D)
When evaluating a capital budgeting project, financial managers should make the decision
that maximizes NPV.
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a
cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash
flow projects:
Year 0 1 2 3
Sales (Revenues) 100,000 100,000 100,000
– Cost of Goods Sold (50% of Sales) 50,000 50,000 50,000
– Depreciation 30,000 30,000 30,000
= EBIT 20,000 20,000 20,000
– Taxes (35%) 7000 7000 7000
= unlevered net income 13,000 13,000 13,000
+ Depreciation 30,000 30,000 30,000
+ changes to working capital –5,000 –5,000 10,000
– capital expenditures –90,000
25)
The NPV for Epiphany’s Project is closest to:
25)
A)
$20,400
B)
$11,946
C)
$39,000
D)
$4,825
26)
You are considering adding a micro brewery on to one of your firm’s existing restaurants. This will
entail an increase in inventory of $8,000, an increase in accounts payables of $2,500, and an increase
in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The
change in net working capital resulting from the addition of the micro brewery is:
26)
A)
$6,500
B)
$45,500
C)
$10,500
D)
$5,500
27)
Which of the following statements is false?
27)
A)
When evaluating a capital budgeting decision, the correct tax rate to use is the firm’s average
corporate tax rate.
B)
To determine the capital budget, firms analyze alternative projects and decide which ones to
accept through a process called capital budgeting.
C)
Sunk costs have been or will be paid regardless of the decision whether or not to proceed with
the project.
D)
A new product typically has lower sales initially, as customers gradually become aware of the
product.
Use the information for the question(s) below.
Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing
facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups
providing relief services to the area. THSI estimates that this project will initially cost $5 million to setup and will generate
$20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to
total $12 million during this year and depreciation expense will be another $3 million. THSI will require no working capital
for this investment. THSI’s marginal tax rate is 35%.
28)
Ignoring the original investment of $5 million, what is THSI’s free cash flow for the first and only
year of operation?
28)
A)
$8.0 million
B)
$5.0 million
C)
$3.75 million
D)
$6.25 million
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
29)
The free cash flow from Shepard Industries project in year two is closest to:
29)
A)
$275
B)
$345
C)
$455
D)
–$5
30)
Which of the following cash flows are relevant incremental cash flows for a project that you are
currently considering investing in?
30)
A)
The tax savings brought about by the projects depreciation expense.
B)
Research and Development expenditures you have made.
C)
Interest payments on debt used to finance the project.
D)
The cost of a marketing survey you conducted to determine demand for the proposed project.
Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three
years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three–year life to a
residual value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net
working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of
its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
31)
The depreciation tax shield for the Sisyphean Corporation’s project in the first year is closest to:
31)
A)
$3,500
B)
$8,000
C)
$5,200
D)
$2,800
32)
Which of the following statements is false?
32)
A)
The terminal of continuation value of the project represents the market value (as of the last
forecast period) of the free cash flow from the project at all future dates.
B)
(1 –c) × Depreciation is called the depreciation tax shield.
C)
The incremental effect of a project on the firm’s available cash is the project’s free cash flow.
D)
To evaluate a capital budgeting decision, we must determine its consequences for the firm’s
available cash.
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
33)
The incremental EBIT for Shepard Industries in year two is closest to:
33)
A)
$510
B)
$595
C)
$415
D)
$875
34)
An analysis that breaks the NPV calculation into its component assumptions and shows how the
NPV varies as one of the underlying assumptions is changed is called
34)
A)
accounting break–even analysis.
B)
scenario analysis.
C)
sensitivity analysis.
D)
IRR analysis.
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a
cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash
flow projects:
Year 0 1 2 3
Sales (Revenues) 100,000 100,000 100,000
– Cost of Goods Sold (50% of Sales) 50,000 50,000 50,000
– Depreciation 30,000 30,000 30,000
= EBIT 20,000 20,000 20,000
– Taxes (35%) 7000 7000 7000
= unlevered net income 13,000 13,000 13,000
+ Depreciation 30,000 30,000 30,000
+ changes to working capital –5,000 –5,000 10,000
– capital expenditures –90,000
35)
The free cash flow for the last year of Epiphany’s project is closest to:
35)
A)
$43,000
B)
$35,000
C)
$53,000
D)
$38,000
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
36)
The depreciation tax shield for Shepard Industries project in year one is closest to:
36)
A)
$84
B)
$72
C)
$96
D)
$168
37)
The value of currently unused warehouse space that will be used as part of a new capital budgeting
project is
37)
A)
an opportunity cost.
B)
an overhead expense.
C)
a sunk cost.
D)
irrelevant to the investment decision.
A
38)
You are considering adding a micro brewery on to one of your firm’s existing restaurants. This will
entail an investment of $40,000 in new equipment. This equipment will be depreciated straight line
over five years. If your firm’s marginal corporate tax rate is 35%, then what is the value of the
micro brewery’s depreciation tax shield in the first year of operation?
38)
A)
$14,000
B)
$2,800
C)
$5,200
D)
$26,000
B
B
39)
Which of the following statements is false?
39)
A)
Scenario analysis considers the effect on NPV of changing multiple project parameters.
B)
The difference between the IRR of a project and the cost of capital tells you how much error in
the cost of capital it would take to change the investment decision.
C)
Scenario analysis breaks the NPV calculation into its component assumptions and show how
the NPV varies as each one of the underlying assumptions change.
D)
We can use scenario analysis to evaluate alternative pricing strategies for our project.
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year 1 2
Revenues 1200 1400
Operating Expense 450 525
Depreciation 240 280
Increase in working capital 60 70
Capital expenditures 300 350
Marginal corporate tax rate 30% 30%
40)
The incremental unlevered net income Shepard Industries in year one is closest to:
40)
A)
$415
B)
$355
C)
$600
D)
$510