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1) Which of the following statements is FALSE?
A) A capital budget lists the projects and investments that a company plans to undertake during the coming year.
B) Income Tax = EBIT × (1 - τc).
C) When sales of a new product displace sales of an existing product, the situation is often referred to as cannibalization.
D) Overhead expenses are often allocated to the different business activities for accounting purposes.
Answer: B
Explanation: Unlevered net income = EBIT × (1 - τc).
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Conceptual
2) Which of the following statements is FALSE?
A) Sales will ultimately decline as the product nears obsolescence or faces increased competition.
B) 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 be wasted.
C) With straight-line depreciation the asset's cost is divided equally over its life.
D) A project's unlevered net income is equal to its incremental revenues less costs and depreciation, evaluated on a pre-tax basis.
Answer: D
Explanation: A project's unlevered net income is equal to its incremental revenues less costs and depreciation, evaluated on an after-tax basis.
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Conceptual
3) Which of the following statements is FALSE?
A) We begin the capital budgeting process by determining the incremental earnings of a project.
B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income.
C) Investments in plant, property, and equipment are directly listed as expenses when calculating earnings.
D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.
Answer: C
Explanation: Investments in plant, property, and equipment are not directly listed as expenses when calculating earnings.
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Conceptual
4) Which of the following statements is FALSE?
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) A new product typically has lower sales initially, as customers gradually become aware of the product.
D) Sunk costs have been or will be paid regardless of the decision whether or not to proceed with the project.
Answer: A
Explanation: When evaluating a capital budgeting decision, the correct tax rate to use is the firm's marginal corporate tax rate.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
5) Which of the following statements is FALSE?
A) Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project.
B) Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis.
C) Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation.
D) When computing the incremental earnings of an investment decision, we should include all changes between the firm's earnings with the project versus without the project.
Answer: B
Explanation: Sunk costs are NOT incremental with respect to the current decision regarding the project and should NOT be included in its analysis.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
6) Which of the following statements is FALSE?
A) The firm deducts a fraction of the investments in plant, property, and equipment each year as depreciation.
B) If securities are fairly priced, the net present value of a fixed set of cash flows is independent of how those cash flows are financed.
C) Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in capital budgeting analysis.
D) A good rule to remember is that if our decision does not affect a cash flow then the cash flow should not affect our decision.
Answer: C
Explanation: Sunk cost fallacy is a term used to describe the tendency of people to be influenced by sunk costs and to "throw good money after bad" because they have already invested a large amount in the project and feel that by not continuing it, the prior investment will be wasted.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
7) Which of the following statements is FALSE?
A) The ultimate goal in capital budgeting is to determine the effect on the firm's cash flows of the decision to take a particular project..
B) To the extent that overhead costs are fixed and will be incurred in any case, they are incremental to the project and should be included in the capital budgeting analysis.
C) Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 - τc).
D) Earnings are not cash flows.
Answer: B
Explanation: To the extent that overhead costs are fixed and will be incurred in any case, they are NOT incremental to the project and should NOT be included in the capital budgeting analysis.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
8) Which of the following statements is FALSE?
A) Project externalities are direct effects of the project that may increase or decrease the profits of the business activities of other firms.
B) Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision.
C) The average selling price of a product and its cost of production will generally change over time.
D) Any money that has already been spent is a sunk cost and therefore irrelevant in the capital budgeting process.
Answer: A
Explanation: Project externalities are cash flows that occur when a project affects other areas of the company's business.
Diff: 3
Section: 8.1 Forecasting Earnings
Skill: Conceptual
9) Which of the following statements is FALSE?
A) Many projects use a resource that the company already owns.
B) When evaluating a capital budgeting decision, we generally include interest expense.
C) 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.
D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
Answer: B
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
10) Which of the following statements is FALSE?
A) A simple method often used to calculate depreciation is the straight-line method.
B) A sunk cost is any unrecoverable cost for which the firm is already liable.
C) Unlevered Net Income = EBIT × τc.
D) The decision to continue or abandon a project should be based only on the incremental costs and benefits of the project going forward.
Answer: C
Explanation: Unlevered net income = EBIT × (1 - τc).
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Conceptual
11) Which of the following costs would you consider when making a capital budgeting decision?
A) Sunk cost
B) Opportunity cost
C) Interest expense
D) Fixed overhead cost
Answer: B
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Conceptual
12) A decrease in the sales of a current project because of the launching of a new project is called:
A) cannibalization.
B) a sunk cost.
C) an overhead expense.
D) an irrelevant aspect of the investment decision.
Answer: A
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Definition
13) Money that has been or will be paid regardless of the decision whether or not to proceed with the project is:
A) cannibalization.
B) considered as part of the initial investment in the project.
C) an opportunity cost.
D) a sunk cost.
Answer: D
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Definition
14) The value of currently unused warehouse space that will be used as part of a new capital budgeting project is:
A) an opportunity cost.
B) irrelevant to the investment decision.
C) an overhead expense.
D) a sunk cost.
Answer: A
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Definition
Use the information for the question(s) below.
Ford Motor Company is considering launching a new line of Plug-in Electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $35 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 21% tax rate on its pre-tax income.
15) The amount that Ford Motor Company will owe in taxes next year without the launch of the new SUV is closest to:
A) $16.8 million.
B) $56.0 million.
C) $31.5 million.
D) $9.45 million.
Answer: A
Explanation: = $80 million × .21 = $16.8 million
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Analytical
16) The amount that Ford Motor Company will owe in taxes next year with the launch of the new SUV is closest to:
A) $9.45 million.
B) $31.5 million.
C) $56.0 million.
D) $24.0 million.
Answer: A
Explanation: = ($80 million - $35 million) × .21 = $9.45 million
Diff: 1
Section: 8.1 Forecasting Earnings
Skill: Analytical
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.
17) The level of incremental sales associated with introducing the new one-hour photo service is closest to:
A) $90,000.
B) $150,000.
C) $60,000.
D) $120,000.
Answer: A
Explanation: = $150,000 - (cannibalized sales) = $150,000 - .60 × $100,000 = $90,000
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Analytical
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:
A) $60,000.
B) $150,000.
C) $90,000.
D) $120,000.
Answer: D
Explanation: = $150,000 - (cannibalized sales) = $150,000 - (.60 × .50) × $100,000 = $120,000
Note that the rate of cannibalization is only 30% (.60 × .50) since the other 30% would have taken their film elsewhere.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Analytical
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 firm's EBIT is closest to:
A) a decline of $1.5 million.
B) an increase of $1.5 million.
C) a decline of $2.4 million.
D) an increase of $2.4 million.
Answer: A
Explanation: Without price cut = 100,000 units × ($129 - 50) = $7,900,000
With price cut = 130,000 units × ($99 - 50) = $6,370,000
So, incremental = $6,370,000 - $7,900,000 = -$1,530,000
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Analytical
20) 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 firm's EBIT is closest to:
A) a decline of $1.5 million.
B) a decline of $0.7 million.
C) an increase of $0.7 million.
D) an increase of $1.5 million.
Answer: C
Explanation: Without Price Cut
Monitor sales = 100,000 × ($129 - $50) = $7,900,000
Strip sales = 100,000 × ($100 - $25) = $7,500,000
Total EBIT = $7,900,000 + $7,500,000 = $15,400,000
With Price Cut
Monitor sales = 130,000 × ($99 - $50) = $6,370,000
Strip sales = 130,000 × ($100 - $25) = $9,750,000
Total EBIT = $6,370,000 + $9,750,000 = $16,120,000
Incremental = $16,120,000 - $15,400,000 = $720,000
Diff: 3
Section: 8.1 Forecasting Earnings
Skill: Analytical
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 2000 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 manufacturing cost 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 21% tax bracket, and has a cost of capital of 10%.
21) The incremental EBIT in the first year for the Sisyphean Corporation's project is closest to:
A) $18,000.
B) $8000.
C) $11,700.
D) $5200.
B
Diff: 3
Section: 8.1 Forecasting Earnings
Skill: Analytical
22) The incremental unlevered net income in the first year for the Sisyphean Corporation's project is closest to:
A) $8000.
B) $18,000.
C) $6320.
D) $11,700.
Answer: C Explanation:
Diff: 3
Section: 8.1 Forecasting Earnings
Skill: Analytical
23) The depreciation tax shield for the Sisyphean Corporation's project in the first year is closest to:
A) $8000.
B) $2100.
C) $2800.
D) $5200.
Answer: B
Explanation: Depreciation tax shield = depreciation × τc = ($30,000/3) × .21 = $2100
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Analytical
24) The amount of incremental income taxes that the Sisyphean Company will pay in the first year on this new project is closest to:
A) $6300.
B) $5200.
C) $3500.
D) $1680.
Answer: D
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Analytical
25) What is a sunk cost? Should it be included in the incremental cash flows for a project? Why or why not?
Answer: A sunk cost is any unrecoverable cost for which the firm is already liable. Sunk costs will have to be paid regardless of the decision whether or not to proceed with the project. Therefore, sunk costs are not incremental with respect to the current decision regarding the project and should not be included in its analysis.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
26) What is an opportunity cost? Should it be included in the incremental cash flows for a project? Why or why not?
Answer: Many projects use resources that the company already owns. An opportunity cost is the cost of using a resource that otherwise could have provided value to the firm. The opportunity cost of using a resource is the value it could have provided in its best alternative use. Because this value is lost when a resource is used by another project, we should always include the opportunity cost as an incremental cost of the project.
Diff: 2
Section: 8.1 Forecasting Earnings
Skill: Conceptual
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 2000 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 manufacturing cost 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 21% tax bracket, and has a cost of capital of 10%.
27) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Corporation's project.
Diff: 3
Section: 8.1 Forecasting Earnings Skill:
1) Which of the following statements is FALSE?
A) Depreciation is not a cash expense paid by the firm.
B) Net Working Capital = Cash + Inventory + Payables - Receivables.
C) Prior to 2018, companies could "carry back" losses for two years and "carry forward" losses for 20 years.
D) Earnings do not represent real profits.
Answer: B
Explanation: Net Working Capital = Cash + Inventory + Receivables - Payables.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
2) Which of the following questions is FALSE?
A) Net Working Capital = Current Assets - Current Liabilities.
B) Because depreciation is not a cash flow, we do not include it in the cash flow forecast.
C) Tax loss carrybacks allow corporations to take losses during the current year and use them to offset income in future years.
D) Earnings are an accounting measure of firm performance.
Answer: C
Explanation: Tax loss carryforwards allow corporations to take losses during the current year and use them to offset income in future years.
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
3) Which of the following statements is FALSE?
A) Depreciation is a method used for accounting and tax purposes to allocate the original purchase cost of the asset over its life.
B) Sometimes the firm explicitly forecasts free cash flow over a shorter horizon than the full horizon of the project or investment.
C) Earnings include the cost of capital investments, but do not include non-cash charges, such as depreciation.
D) Firms often report different depreciation expenses for accounting and for tax purposes.
Answer: C
Explanation: Earnings include non-cash charges, such as depreciation, but do not include the cost of capital investment.
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
4) Which of the following statements is FALSE?
A) Most projects will require the firm to invest in net working capital.
B) The main components of net working capital are cash, inventory, receivables, and property, plant and equipment.
C) ΔNWCt = NWCt - NWCt - 1.
D) In the final year of a project, the firm ultimately recovers the investment in net working capital.
Answer: B
Explanation: The main components of net working capital are cash, inventory, receivables, and payables.
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
5) Which of the following statements is FALSE?
A) Depreciation expenses have a positive impact on free cash flow.
B) Free Cash Flow = (Revenues - Costs - Depreciation) × (1 - τc) - Capital Expenditures - ΔNWC + τc × Depreciation.
C) The firm cannot use its earnings to buy goods, pay employees, fund new investments, or pay dividends to shareholders.
D) The depreciation tax shield is the tax savings that results from the ability to deduct depreciation.
Answer: B
Explanation: Free Cash Flow = (Revenues - Costs) × (1 - τc) - Capital Expenditures ΔNWC + τc × Depreciation.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
6) Which of the following statements is FALSE?
A) Because only the tax consequences of depreciation are relevant for free cash flow, we should use the depreciation expense that the firm will use for tax purposes in our free cash flow forecasts.
B) A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into based on its overall level of pre-tax income, though C-corporations only have a single tax rate as a result of the Tax Cuts and Jobs Act of 2017.
C) Free Cash Flow = (Revenues - Costs) × (1 - τc) - Capital Expenditures - ΔNWC + τc × Depreciation.
D) Net working capital is found by subtracting current assets from current liabilities.
Answer: D
Explanation: Net working capital is found by subtracting current liabilities from current assets.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
7) Which of the following statements is FALSE?
A) The terminal or 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) The incremental effect of a project on the firm's available cash is the project's free cash flow.
C) (1 - τc) × Depreciation is called the depreciation tax shield.
D) To evaluate a capital budgeting decision, we must determine its consequences for the firm's available cash.
Answer: C
Explanation: The depreciation tax shield is calculated as τc × Depreciation.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
8) Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in?
A) The tax savings brought about by the project's depreciation expense
B) The cost of a marketing survey you conducted to determine demand for the proposed project
C) Interest payments on debt used to finance the project
D) Research and Development expenditures you have made
Answer: A
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Conceptual
9) Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $100,000. However a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land and would be willing to pay $650,000 for it. When calculating the NPV of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is:
A) $650,000.
B) $0.
C) $100,000.
D) $750,000.
Answer: A
Explanation: It is appropriate to use the market value. If taxes are included, the value would be the aftertax value of the land.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Definition
10) You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an increase in inventory of $8000, an increase in accounts payable of $2500, 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 microbrewery is:
A) $45,500.
B) $10,500.
C) $6500.
D) $5500.
Answer: D
Explanation: NWC = CA - CL = $8000 - $2500 = $5500
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
11) You are considering adding a microbrewery 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 21%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation?
A) $1680
B) $14,000
C) $5200
D) $26,000
Answer: A
Explanation: First, figure out the straight-line depreciation.
$40,000/5 years = $8000 depreciation per year.
Then .21 × $8000 = $1680 depreciation tax shield per year.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
12) The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's corporate tax rate is 21%, then what is the value of the depreciation tax shield on their new project?
A) $750,000
B) $525,000
C) $1,500,000
D) $1,750,000
Answer: B
Explanation: The depreciation tax shield = $2,500,000 × .21 = $525,000
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
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 2000 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 manufacturing cost 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 5% of its annual sales in accounts payable. The firm is in the 21% tax bracket, and has a cost of capital of 10%.
13) The required net working capital in the first year for the Sisyphean Corporation's project is closest to:
A) $3600.
B) $3960.
C) $2880.
D) $5400.
A
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
14) The required net working capital in the second year for the Sisyphean Corporation's project is closest to:
A) $3960.
B) $4360.
C) $3190.
D) $5940.
Answer: A
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
15) The change in Net working capital from year one to year two is closest to:
A) A decrease of $360.
B) An increase of $360.
C) An increase of $396.
D) A decrease of $396.
Answer: B
Change = $3960 - $3600 = $360
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
16) Bubba Ho-Tep Company reported net income of $300 million for the most recent fiscal year. The firm had depreciation expenses of $125 million and capital expenditures of $150 million. Although they had no interest expense, the firm did have an increase in net working capital of $20 million. What is Bubba HoTep's free cash flow?
A) $170 million
B) $255 million
C) $150 million
D) $5 million
Answer: B
Explanation: FCF = NI + Dep - Capital Ex - chg NWC = $300 million + $125 million - $150 million - $20 million = $255 million
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
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 set up 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 21%.
17) Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and only year of operation?
A) $5.0 million
B) $3.75 million
C) $8.0 million
D) $6.95 million
Answer: D
Explanation: FCF = (revenues - expenses - depreciation) × (1 - tax rate) + depreciation
FCF = ($20 - $12 - $3) million × (1 - .21) + $3 million = $6.95 million
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
18) Assume that THSI's cost of capital for this project is 15%. The NPV of this temporary housing project is closest to:
A) $1,043,500.
B) -$650,000.
C) $1,960,000.
D) -$435,000.
Answer: A
Explanation: FCF = ($20 - $12 - $3) million × (1 - .21) + $3 million = $6.95 million
So, NPV = -$5.0 million + $6.95 million/1.15 = $1,043,478
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
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).
19) The incremental EBIT for the Shepard Industries project in year one is closest to:
A) $360 million.
B) $750 million.
C) $595 million.
D) $510 million.
2
Section: 8.2 Determining Free Cash Flow and NPV
Skill:
20) The incremental EBIT for the Shepard Industries project in year two is closest to:
A) $415 million.
B) $875 million.
C) $595 million.
D) $510 million.
C
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
21) The incremental unlevered net income of the Shepard Industries project in year one is closest to:
A) $510 million.
B) $470 million.
C) $600 million.
D) $403 million.
D
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
22) The incremental unlevered net income of the Shepard Industries project in year two is closest to:
A) $403 million.
B) $470 million.
C) $600 million.
D) $510 million.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV Skill:
23) The depreciation tax shield for the Shepard Industries project in year one is closest to:
A) $59 million.
B) $168 million.
C) $96 million.
D) $50 million.
Answer: D
Explanation: $240 million × .21 = $50.4 million
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
24) The depreciation tax shield for the Shepard Industries project in year two is closest to:
A) $59 million.
B) $196 million.
C) $50 million.
D) $96 million.
Answer: A
Explanation: $280 million × .21 = $58.8 million
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
25) The free cash flow from the Shepard Industries project in year one is closest to:
A) $283 million.
B) $300 million.
C) -$5 million.
D) $390 million.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
26) The free cash flow from the Shepard Industries project in year two is closest to:
A) $345 million.
B) $455 million.
C) $330 million.
D) -$5 million.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
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 projections:
27) The free cash flow for the first year of Epiphany's project is closest to:
A) $43,000.
B) $25,000.
C) $40,800.
D) $45,000.
C
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
28) The free cash flow for the last year of Epiphany's project is closest to:
A) $55,800.
B) $38,000.
C) $35,000.
D) $43,000.
Answer: A
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
29) The NPV for Epiphany's Project is closest to:
A) $4825.
B) $39,000.
C) $18,671.
D) $20,400.
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
30) Luther Industries has outstanding tax loss carryforwards of $70 million from losses over the past four years. If Luther earns $15 million per year in pre-tax income from now on, Luther will fully deplete their NOL carryforwards in:
A) 7 years.
B) 2 years.
C) 4 years.
D) 6 years.
Answer: D
Explanation: The number of years the tax loss carryforwards will last can be calculated as the tax loss carryforward divided by 80% of the annual pre-tax income or:
Years with no tax = = 5.83 years, so Luther won't have to pay taxes on their full pre-tax income for the next 6 years and will completely eliminate the remaining tax loss carryforwards in year 6..
Diff: 1
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
31) You are considering investing $600,000 in a new automated inventory system that will provide aftertax 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?
A) $400,000
B) $500,000
C) -$100,000
D) $1,000,000
Answer: A
Explanation: NPV = - $600,000 = $400,000
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
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 2000 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 manufacturing cost 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 21% tax bracket, and has a cost of capital of 10%.
32) Calculate the total Free Cash Flows for each of the three years for the Sisyphean Corporation's new project.
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV Skill: Analytical
Use the information for the question(s) below.
Kinston Industries is considering investing in a machine that will cost $125,000 and will last for three years. The machine will generate revenues of $120,000 each year and the cost of goods sold will be 50% of sales. At the end of year three the machine will be sold for $15,000. The appropriate cost of capital is 10% and Kinston is in the 21% tax bracket.
33) Assume that Kinston's new machine will be depreciated straight line to a salvage value of $5000 at the end of year three. What is the after-tax salvage value of this project?
Answer: The machine is depreciated straight line to a book value of $5000. So, $15,000 - $5000 = $10,000 gain on the sale which is taxable. Then, the after-tax salvage value = $15,000 - $10,000 × .21 (tax rate) = $12,900.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
34) Assume that Kinston's new machine will be depreciated straight line to a salvage value of $5,000 at the end of year three. What is the NPV for this project?
Liquidation/Salvage Value Calculation:
The machine is depreciated straight line to a book value of $5,000, and sold for $15,000 at the end of year
3. So, $15,000 - $5,000 = $10,000 gain on the sale which is taxable. Then, the after-tax salvage value = $15,000 - $10,000 × .21 (tax rate) = $12,900.
Diff: 3
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
Copyright © 2020 Pearson Education, Inc.
35) Assume that Kinston's new machine will be depreciated using MACRS according to the following schedule:
What is the NPV of this project?
The machine is depreciated using MACRS depreciation to a book value of 7.41% × $125,000 = $9263. So, $15,000 - $9263 = $5737 gain on the sale which is taxable. Then, the after-tax salvage value = $15,000$5737 × .21 (tax rate) = $13,795.
Diff: 2
Section: 8.2 Determining Free Cash Flow and NPV
Skill: Analytical
Use the following information to answer the question(s) below.
Galt Motors currently produces 500,000 electric motors a year and expects output levels to remain steady in the future. It buys armatures from an outside supplier at a price of $2.50 each. The plant manager believes that it would be cheaper to make these armatures rather than buy them. Direct in-house production costs are estimated to be only $1.80 per armature. The necessary machinery would cost $700,000 and would be obsolete in 10 years. This investment would be depreciated to zero for tax purposes using a 10-year straight line depreciation. The plant manager estimates that the operation would require additional working capital of $40,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. The expected proceeds from scrapping the machinery after 10 years are estimated to be $10,000. Galt Motors pays tax at a rate of 21% and has an opportunity cost of capital of 14%.
1) The incremental cash flow that Galt Motors will incur today (Year 0) if they elect to manufacture armatures in-house is closest to:
A) -$740,000.
B) -$700,000.
C) -$660,000.
D) $740,000.
Answer: A
Explanation: CF0 = -$700,000 + - $40,000 = -$740,000
Diff: 1
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
2) The incremental cash flow that Galt Motors will incur in year 4 if they elect to manufacture armatures in-house is closest to:
A) $25,000.
B) $350,000.
C) $365,000.
D) $1,250,000.
Answer: C
Explanation: Incremental cash flow = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 = $364,700
Diff: 1
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
3) The incremental cash flow that Galt Motors will incur in year 10 if they elect to manufacture armatures in-house is closest to:
A) $40,000.
B) $335,000.
C) $375,000.
D) $405,000.
Answer: D
Explanation: Incremental cash flow = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 + $40,000 =
$404,700
Diff: 2
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
4) The NPV of manufacturing the armatures in-house is closest to:
A) 1,095,000.
B) 1,215,000.
C) 1,173,000.
D) 1,250,000.
Answer: C
Explanation: CF0 = -$700,000 + - $40,000 = -$740,000
CF(1 - 9) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 = $364,700
CF(10) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 + $40,000 = $404,700
CF0 = -740,000, CFj = $364,700. nj = 9, CFj = $404,700, Nj = 1, I = 14, compute NPV = $1,173,107
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
5) The IRR of manufacturing the armatures in-house is closest to:
A) 48%.
B) 49%.
C) 50%.
D) 53%.
Answer: A
Explanation: CF0 = -$700,000 + - $40,000 = -$740,000
CF(1 - 9) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 = $364,700
CF(10) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 + $40,000 = $404,700
CF0 = -$740,000, CFj = $364,700. nj = 9, CFj = $404,700, Nj = 1, I = 14, compute IRR = 48.3818%
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
6) What decision should Galt Motors take regarding manufacturing the armatures in house?
A) Proceed with in-house manufacture since NPV is negative
B) Proceed with in-house manufacture since NPV is positive
C) Reject in-house manufacture since NPV is negative
D) Reject in-house manufacture since IRR is greater than 14%
Answer: B
Explanation: CF0 =
-$700,000 + - $40,000 = -$740,000
CF(1 - 9) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 = $364,700
CF(10) = 500,000 units × ($2.50 - $1.80) + .21 × $700,000/10 + $40,000 = $404,700
CF0 = -740,000, CFj = $364,700. nj = 9, CFj = $404,700, Nj = 1, I = 14, compute NPV = $1,173,107
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
Use the following information to answer the question(s) below
Two years ago, Krusty Krab Restaurant purchased a grill for $50,000. The owner, Eugene Krabs, has learned that a new grill is available that will cook Krabby Patties twice as fast as the existing grill. This new grill can be purchased for $80,000 and would be depreciated straight line over 8 years, after which it would have no salvage value. Eugene Krab expects that the new grill will produce EBITDA of $50,000 per year for the next eight years while the existing grill produces EBITDA of only $35,000 per year. The current grill is being depreciated straight line over its useful life of 10 years after which it will have no salvage value. All other operating expenses are identical for both grills. The existing grill can be sold to another restaurant now for $30,000. Krusty Krab's tax rate is 21%.
7) The incremental cash flow that Krusty Krab will incur today (Year 0) if they elect to upgrade to the new grill is closest to:
A) -$80,000.
B) -$50,000.
C) -$47,900.
D) +$30,000.
Answer: C
Explanation: CF0 = -$80,000 + $30,000 + .21($40,000 - $30,000) [tax write-off old grill sold at loss] = -
$47,900
Diff: 2
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
Copyright © 2020 Pearson Education, Inc.
8) The incremental cash flow that Krusty Krab will incur in year 1 if they elect to upgrade to the new grill is closest to:
A) $6500.
B) $7800.
C) $10,800.
D) $11,500.
Answer: D
Explanation: Incremental EBITDA = $50,000 - $35,000 = $15,000
Incremental Depreciation = $80,000/8 - $50,000/10 = $5000
Incremental cash flow = ($15,000 - $5000) × (1 - .21) + $5000 = $12,900
Diff: 2
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
9) The incremental after-tax cash flow that Krusty Krab will receive from selling the existing grill is closest to:
A) $19,500.
B) $30,000.
C) $32,100.
D) $50,000.
Answer: C
Explanation: $30,000 [sale price] + .21($40,000 - $30,000) [tax write-off old grill sold at loss] = $32,100
Diff: 2
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
10) If Krusty Krab's opportunity cost of capital is 12%, then the NPV for upgrading to the new grill is closest to:
A) -$22,875.
B) -$15,025.
C) $7130.
D) $16,180.
Answer: D
Explanation: CF0 = -$80,000 + $30,000 + .21($40,000 - $30,000) [tax write-off old grill sold at loss] = -
$47,900
Incremental EBITDA = $50,000 - $35,000 = $15,000
Incremental Depreciation = $80,000/8 - $50,000/10 = $5000
Incremental cash flow (years 1 - 8) = ($15,000 - $5000) × (1 - .21) + $5000 = $12,900
CF0 = -$47,900, CFj = 12,900. nj = 8, I = 12, compute NPV = $16,182.55
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
11) If Krusty Krab's opportunity cost of capital is 12%, then the IRR for upgrading to the new grill is closest to:
A) 3.25%.
B) 16.00%.
C) 18.25%.
D) 21.00%.
Answer: D
Explanation: CF0 = -$80,000 + $30,000 + .21($40,000 - $30,000) [tax write-off old grill sold at loss] = -
$47,900
Incremental EBITDA = $50,000 - $35,000 = $15,000
Incremental Depreciation = $80,000/8 - $50,000/10 = $5000
Incremental cash flow (years 1 - 8) = ($15,000 - $5000) × (1 - .21) + $5000 = $12,900
CF0 = -$47,900, CFj = 12,900. nj = 8, compute IRR = 21.11%
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
12) If Krusty Krab's opportunity cost of capital is 12%, what decision should Krusty Krab take regarding the new grill?
A) Do not install the new grill since NPV is approximately = - $16,183
B) Install the new grill since NPV is approximately = + $16,183
C) Install the new grill since IRR is approximately = 15%
D) Do not install the new grill since IRR is less than 12%
Answer: B
Explanation: CF0 = -$80,000 + $30,000 + .21($40,000 - $30,000) [tax write-off old grill sold at loss] = -
$47,900
Incremental EBITDA = $50,000 - $35,000 = $15,000
Incremental Depreciation = $80,000/8 - $50,000/10 = $5000
Incremental cash flow (years 1 - 8) = ($15,000 - $5000) × (1 - .21) + $5000 = $12,900
CF0 = -$47,900, CFj = 12,900. nj = 8, I = 12, compute NPV = $16,182.55; compute IRR = 21.11%
Diff: 3
Section: 8.3 Choosing Among Alternatives
Skill: Analytical
Use the following information to answer the question(s) below.
(Include the MACRS Table from the Appendix.)
Casa Grande Farms is considering purchasing multiple tractors for a total purchase price of $540,000. These tractors are expected to generate EBITDA of $250,000 for each of the next three years. Casa Grande Farms has a 21% tax rate and has a cost of capital of 10%.
1) Assuming that Casa Grande Farms depreciates these tractors straight line over the three-year life, then the annual depreciation tax shield in year 2 is closest to:
A) $37,800.
B) $80,000.
C) $84,000.
D) $117,000.
Answer: A
Explanation: Depreciation Tax Shield = ($540,000/3) × .21 = $37,800
Diff: 1
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
2) Assuming that Casa Grande Farms depreciates these tractors using MACRS depreciation method for three-year property starting immediately, then the annual depreciation tax shield in year 2 is closest to:
A) $20,785.
B) $16,795.
C) $84,000.
D) $180,000.
Answer: B
Explanation: Depreciation Tax Shield = $540,000 × .1481 × .21 = $16,795
Diff: 2
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
3) Assume that Casa Grande Farms is planning to sell the tractors after two years, when their book value is $119,988, for a total price of $180,000. What is the effect on free cash flow in the year they are sold?
A) A cash inflow of $60,012
B) A cash outflow of $60,012
C) A cash inflow of $47,949
D) A cash outflow of $47,949
Answer: C
Explanation: Gain on sale = $180,000 - $119,988 = $60,012; tax on gain = .21 × $60,012 = $12,603
Cash inflow = $60,012 - $12,603 = $47,949
Diff: 3
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
4) Assuming that Casa Grande Farms depreciates these tractors straight line over the three-year life, then the NPV of buying the tractors is closest to:
A) $45,156.
B) $36,225.
C) $81,715.
D) $513,235.
Answer: A
Explanation: Cash Flows (1 - 3) = ($250,000 - $540,000 × 1/3) × (1 - .21) + $540,000 × 1/3 = $235,300
CF0 = - 540,000, CFj = 235,300, Nj = 3, I = 10, Compute NPV = $45,156.27
Diff: 2
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
5) Assuming that Casa Grande Farms depreciates these tractors using MACRS depreciation method for three-year property starting immediately, then the NPV of buying the tractors is closest to:
A) $20,785.
B) $54,965.
C) $81,715.
D) 513,235.
E) $560,785.
Answer: B
Explanation: CF0 = -$540,000 + $540,000 × .3333 × .21 = -$502,203.78
CF1 = ($250,000 - $540,000 × .4445) × (1 - .21) + $540,000 × .4445 = $247,906.30
CF2 = ($250,000 - $540,000 × .1481) × (1 - .21) + $540,000 × .1481 = $214,294.54
CF3 = ($250,000 - $540,000 × .0741) × (1 - .21) + $540,000 × .0741 = $205,902.94
I = 10
Compute NPV = $54,966.44
Diff: 3
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
Use the following information to answer the question(s) below.
Taggart Transcontinental is considering adding a trucking division to expand the coverage of its existing rail lines. The trucking division will cost $1,000,000 and is expected to generate free cash flows of $100,000 for each of the next five years. Taggart Transcontinental forecasts that future free cash flows after year 5 will grow at 2% per year, forever. Taggart Transcontinental's cost of capital is 10%.
6) The continuation value for the trucking division in year five is closest to:
A) $1,000,000.
B) $1,250,000.
C) $1,275,000.
D) $1,375,000.
Answer: C
Explanation: Continuation value (year 5) = PMT(1 + g)/(i - g) = $100,000(1.02)/(.10 - .02) = $1,275,000
Diff: 2
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
Copyright © 2020 Pearson Education, Inc.
7) The NPV for the trucking division is closest to:
A) $170,750.
B) $200,000.
C) $212,550.
D) $250,000.
E) $312,500.
Answer: A
Explanation: Continuation value (year 5) = PMT(1 + g)/(i - g) = $100,000(1.02)/(.10 - .02) = $1,275,000
PMT = $100,000, FV = $1,275,000, N = 5, I = 10, Compute PV = $1,170,753.36 - $1,000,000 = $170,753.36
Diff: 2
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
Use the following information to answer the question(s) below.
Really Big Conglomerate (RBC) is considering acquiring POP, Inc., a smaller unsuccessful Internet firm. POP has outstanding tax loss carryforwards of $320 million from losses over the past six years. RBC has pre-tax income of $100 million per year, a cost of capital of 10%, and pays 21% in taxes. The Tax Cuts and Jobs Act of 2017 will limit RBC's ability to write off the carryforwards to 80% of RBC's annual pre-tax income.
8) If RBC acquires POP, in what year will RBC completely use up the tax loss carryforward?
A) 2 years
B) 3 years
C) 4 years
D) 5 years
Answer: C
Explanation: The tax shield will last for $320 million/($100 million × 0.80) = 4.0 years.
Diff: 1
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
9) If RBC acquires POP, then the NPV of POP tax loss carryforwards to RBC is closest to:
A) $53 million.
B) $236 million.
C) $262 million.
D) $320 million.
Answer: A
Explanation: The total of $320 million in tax loss carryforwards will offset income of $80 million in years
1-4. The tax savings will be 21% of these amounts, so the NPV of the tax loss carryforwards in millions is
$16.8 million/(1.10)1 + $16.8 million/(1.10)2 + $16.8 million(1.10)3 + $16.8 million/(1.10)4 = $53.25 million
Diff: 2
Section: 8.4 Further Adjustments to Free Cash Flow
Skill: Analytical
1) Which of the following statements is FALSE?
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) When evaluating a capital budgeting project, financial managers should make the decision that maximizes NPV.
D) Sensitivity analysis reveals which aspects of the project are most critical when we are actually managing the project.
Answer: A
Explanation: The break-even level of an input is the level for which the investment has an NPV of zero.
Diff: 1
Section: 8.5 Analyzing the Project
Skill: Conceptual
2) Which of the following statements is FALSE?
A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our NPV analysis for the project.
B) To compute the NPV for a project, you need to estimate the incremental cash flows and choose a discount rate.
C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
Answer: D
Explanation: When we are UNCERTAIN regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
Diff: 2
Section: 8.5 Analyzing the Project
Skill: Conceptual
3) Which of the following statements is FALSE?
A) We can use scenario analysis to evaluate alternative pricing strategies for our project.
B) Scenario analysis considers the effect on NPV of changing multiple project parameters.
C) 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.
D) Scenario analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each one of the underlying assumptions change.
Answer: D
Explanation: Scenario analysis shows how the NPV varies as MULTIPLE underlying assumptions change.
Diff: 2
Section: 8.5 Analyzing the Project Skill: Conceptual
4) The difference between scenario analysis and sensitivity analysis is that:
A) scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV.
B) only sensitivity analysis allows us to change our estimated inputs of our NPV analysis.
C) only scenario analysis considers the effect on NPV of changing multiple project parameters.
D) only scenario analysis breaks the NPV calculation into its component assumptions.
Answer: C
Diff: 2
Section: 8.5 Analyzing the Project
Skill: Definition
5) An exploration of the effect on NPV of changing multiple project parameters is called:
A) scenario analysis.
B) IRR analysis.
C) accounting break-even analysis.
D) sensitivity analysis.
Answer: A
Diff: 1
Section: 8.5 Analyzing the Project
Skill: Definition
6) 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:
A) scenario analysis.
B) IRR analysis.
C) accounting break-even analysis.
D) sensitivity analysis.
Answer: D
Diff: 1
Section: 8.5 Analyzing the Project Skill: Definition
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 projections:
7) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate. How much can the discount rate vary before the NPV reaches zero?
8) What is sensitivity analysis?
Answer: Sensitivity analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each of the underlying assumptions change. Sensitivity analysis allows us to explore the effects of errors in the estimated inputs to the NPV calculations and reveals which aspects of the project are most critical when actually managing the project.
Diff: 2
Section: 8.5 Analyzing the Project Skill: Conceptual
9) How does scenario analysis differ from sensitivity analysis?
Answer: Where sensitivity analysis considers the change in NPV for individual parameter changes, scenario analysis considers the effect on NPV of changing multiple project parameters simultaneously.
Diff: 2
Section: 8.5 Analyzing the Project Skill: Conceptual
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 projections:
10) What is the NPV of the Epiphany's project?
11) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate. How much can the discount rate vary before the NPV reaches zero?
Section: 8.5 Analyzing the Project Skill: Analytical
12) Epiphany is worried about the reliability of the sales forecast. How sensitive is the project's NPV to a 10% change in sales?