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[41].Which of the following should be considered when a company

Question : [41].Which of the following should be considered when a company : 1416414

[41].Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

 

a.The new project is expected to reduce sales of one of the company’s existing products by 5%.

b.Since the firm’s director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project’s initial cost.

c.The company has spent and expensed $1 million on research and development costs associated with the new project.

d.The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.

e.The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.

 

[42].Dalrymple Inc. is considering production of a new product.  In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

 

a.The company will produce the new product in a vacant building that was used to produce another product until last year.  The building could be sold, leased to another company, or used in the future to produce another of the firm's products.

b.The project will utilize some equipment the company currently owns but is not now using.  A used equipment dealer has offered to buy the equipment.

c.The company has spent and expensed for tax purposes $3 million on research related to the new product.  These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future.

d.The new product will cut into sales of some of the firm’s other products.

e.If the project is accepted, the company must invest an additional $2 million in net operating working capital.  However, all of these funds will be recovered at the end of the project’s life.

 

[43].Which of the following rules is CORRECT for capital budgeting analysis?

 

a.The interest paid on funds borrowed to finance a project must be included in estimates of the project’s cash flows.

b.Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions for capital budgeting projects.

c.Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project’s other costs when reaching the accept/reject decision.

d.A proposed project’s estimated net income as determined by the firm’s accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project’s cost, the project should be accepted.

e.If a product is competitive with some of the firm’s other products, this fact should be incorporated into the estimate of the relevant cash flows.  However, if the new product is complementary to some of the firm’s other products, this fact need not be reflected in the analysis.

[44].Which of the following statements is CORRECT?

 

a.In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to an upward bias in the NPV.

b.In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project’s cash flows will lead to a downward bias in the NPV.

c.The existence of any type of “externality” will reduce the calculated NPV versus the NPV that would exist without the externality.

d.If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.

e.If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.

 

[45].Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

 

a.A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.

b.A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products.

c.A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery.

d.A firm has spent $2 million on research and development associated with a new product.  These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.

e.A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products.

 

[46].Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

 

a.Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.  This space could be used for other products if it is not used for the project under consideration.

b.Revenues from an existing product would be lost as a result of customers switching to the new product.

c.Shipping and installation costs associated with a machine that would be used to produce the new product.

d.The cost of a study relating to the market for the new product that was completed last year.  The results of this research were positive, and they led to the tentative decision to go ahead with the new product.  The cost of the research was incurred and expensed for tax purposes last year.

e.It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm.

 

[47].A company is considering a proposed new plant that would increase productive capacity.  Which of the following statements is CORRECT?

 

a.In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC.  If interest were deducted when estimating cash flows, this would, in effect,  “double count” it.

b.Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.

c.When estimating the project’s operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.

d.Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis.

e.The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.  To do otherwise would bias the NPV upward.

 

[48].Taussig Technologies is considering two potential projects, X and Y.  In assessing the projects’ risks, the company estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted thorough scenario and simulation analyses.  This research produced the following data:

 

 

Project X

Project Y

Expected NPV

$350,000

$350,000

Standard deviation (σNPV)

$100,000

$150,000

Project beta (vs. market)

1.4

0.8

Correlation of the
  project cash flows with
  cash flows from currently
  existing projects

Cash flows are not
  correlated with the
  cash flows from
  existing projects

Cash flows are highly
  correlated with the
  cash flows from
  existing projects

 

Which of the following statements is CORRECT?

 

a.Project X has more stand-alone risk than Project Y.

b.Project X has more corporate (or within-firm) risk than Project Y.

c.Project X has more market risk than Project Y.

d.Project X has the same level of corporate risk as Project Y.

e.Project X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects.

 

[49].Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy.  The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project.  Also, the new project’s sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.  On the basis of this information, which of the following statements is CORRECT?

 

a.The proposed new project would have more stand-alone risk than the firm’s typical project.

b.The proposed new project would increase the firm’s corporate risk.

c.The proposed new project would increase the firm’s market risk.

d.The proposed new project would not affect the firm’s risk at all.

e.The proposed new project would have less stand-alone risk than the firm’s typical project.

 

[50].A firm is considering a new project whose risk is greater than the risk of the firm’s average project, based on all methods for assessing risk.  In evaluating this project, it would be reasonable for management to do which of the following?

 

a.Increase the estimated IRR of the project to reflect its greater risk.

b.Increase the estimated NPV of the project to reflect its greater risk.

c.Reject the project, since its acceptance would increase the firm’s risk.

d.Ignore the risk differential if the project would amount to only a small fraction of the firm’s total assets.

e.Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.

 

 

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