1 CORRECT

Capital budgeting analysis focuses on profits as opposed to cash flows. True A) False B) Feedback: When making capital budgeting decisions, inancial manage! should p!epa!e cash" lo# estimates o! use in net p!esent $alue anal%sis&

' CORRECT

MACRS places assets into one of six classes, each of which has an assumed life. Most industrial e uipment falls into the !" and #"year classes. True A) False B)

( )*CORRECT

$ro%ects that are calculated as ha&ing negati&e '$(s should be) depreciated o&er a longer time period. A) charged less in o&erhead costs. B) discounted using lower rates. C) re%ected or abandoned. +) Feedback: ,!o-ects that a!e calculated as ha$ing negati$e *,.s should be !e-ected o! abandoned&

/ )*CORRECT

The &alue of a proposed capital budgeting pro%ect depends upon the) total cash flows produced. A) incremental cash flows produced. B) accounting profits produced. C) increase in total sales produced. +) Feedback: The $alue o a p!oposed capital budgeting p!o-ect depends upon the inc!emental cash lo#s p!oduced&

0 )*CORRECT

*hen is it appropriate to include sun+ costs in the e&aluation of a pro%ect, -nclude sun+ costs when they are relati&ely large. A)

-nclude sun+ costs if it impro&es the pro%ect.s '$(. B) -nclude sun+ costs if they are considered to be o&erhead costs. C) -t is ne&er appropriate to include sun+ costs. +) Feedback: )t is ne$e! app!op!iate to include sunk costs in the e$aluation o a p!o-ect&

1 )*CORRECT

Assume your firm has an unused machine that originally cost /#!,000, has a boo+ &alue of /10,000, and is currently worth /1!,000. -gnoring taxes, the correct opportunity cost for this machine in capital budgeting decisions is) /#!,000 A) /1!,000 B) /10,000 C) /!,000 +) Feedback: The oppo!tunit% cost o! the machine in capital budgeting decisions is its cu!!ent ma!ket $alue&

2 CORRECT

-f a pro%ect is expected to increase in&entory by /2!,000, increase accounts payable by /20,000, and decrease accounts recei&able by /2,000, what effect does wor+ing capital ha&e during the life of the pro%ect, -ncreases in&estment by /3,000. A) -ncreases in&estment by /!,000. B) -ncreases in&estment by /4,000. C) *or+ing capital has no effect during the life of the pro%ect. +) Feedback: Wo!king capital is de ined to be the di e!ence bet#een cu!!ent assets and cu!!ent liabilities& The!e o!e, #o!king capital inc!eases b% 310,444 5 1,444 5 14,444), o! /,444&

6 CORRECT

*hich of the following methods will pro&ide a correct analysis for capital budgeting purposes, 5iscounting real cash flows with real rates. A) 5iscounting real cash flows with nominal rates. B) 5iscounting nominal cash flows with real rates. C)

All of the abo&e methods will pro&ide similar results. +) Feedback: +iscounting !eal cash lo#s #ith !eal !ates #ill p!o$ide a co!!ect anal%sis o! capital budgeting pu!poses&

7 CORRECT

6our forecast shows /!00,000 annually in sales for each of the next three years. -f your second and third year predictions ha&e failed to incorporate 1.!7 expected annual inflation, how far off in total dollars is your three"year forecast, /8#,928 A) /!0,000 B) /!1,!!0 C) /#4,1!0 +) Feedback:

14 )*CORRECT

-n what manner does depreciation expense affect in&estment pro%ects, -t reduces cash flows by the amount of the depreciation expense. A) -t increases interest expense by the amount of the depreciation expense. B) -t reduces taxable income by the amount of the depreciation expense. C) -t reduces taxes by the amount of the depreciation expense. +) Feedback: +ep!eciation e8pense !educes ta8able income b% the amount o itsel &

11 )*CORRECT

For a profitable firm in the 8!7 marginal tax brac+et with /200,000 of annual depreciation expense, the depreciation tax shield would be) /20,!00 A) /80,000 B) /8!,000

C) /4!,000 +) Feedback: +ep!eciation e8pense !educes ta8able income b% the amount o itsel & )n this 9uestion, the dep!eciation ta8 shield, o! the !educed ta8 due to the !educed ta8able income, is 144,444 8 (0:, o! (0,444&

1' )*CORRECT

*hat is the amount of the operating cash flow for a firm with /!00,000 profit before tax, /200,000 depreciation expense, and a 8!7 marginal tax rate, /140,000 A) /81!,000 B) /840,000 C) /31!,000 +) Feedback:

1( )*CORRECT

The Modified Accelerated Cost Reco&ery System allows an increase) in total depreciation o&er the asset.s life. A) in annual depreciation during earlier years. B) in real but not nominal depreciation expense. C) in the number of years in each reco&ery class. +) Feedback: The ;odi ied Accele!ated Cost Reco$e!% <%stem allo#s an inc!ease in annual dep!eciation du!ing ea!lie! %ea!s&

1/ )*CORRECT

*hen a depreciable asset is ultimately sold, the sales price is) fully taxable. A) non"taxable. B) not taxable only if accelerated depreciation was used. C) taxable if sales price exceeds boo+ &alue.

+) Feedback: When a dep!eciable asset is ultimatel% sold, the sales p!ice is ta8able i sales p!ice e8ceeds book $alue&

10 )*CORRECT

*hich of the following is not accurate in depicting cash flows from operations, :re&enues " expenses;:2 " tax rate; < :depreciation; A) Applying =5ollars in Minus 5ollars >ut= rule? B) :net income < depreciation; C) :re&enues " cash expenses " taxes paid; +) Feedback: Take onl% the items !om the income statement that !ep!esent actual cash lo#s& This means that %ou sta!t #ith cash !e$enues and subt!act cash e8penses and ta8es paid& =ou do not, ho#e$e!, subt!act a cha!ge o! dep!eciation because this does not in$ol$e cash going out the doo!& Thus, Ope!ating cash lo# > !e$enues " cash e8penses " ta8es

11 )*CORRECT

*hich of the following is not correct when we calculate the cash flows of a proposed new pro%ect, a. 5iscount cash flows, not profits. b. @stimate the pro%ect.s incremental cash flowsAthat is, the difference between the cash flows with the pro%ect and those without the pro%ect. c. -nclude all indirect effects of the pro%ect, such as its impact on the sales of the firm.s other products. d. Count sun+ costs. a. A) b. B) c. C) d. +) Feedback: When #e calculate the cash lo#s o a p!oposed ne# p!o-ect, #e should igno!e sunk costs completel%&

12 )*CORRECT

*hich of the following are incorrect when we calculate the cash flows of a proposed new pro%ect, a. -nclude opportunity costs, such as the &alue of land that you could otherwise sell. b. Beware of allocated o&erhead charges for heat, light, and so on. These may not reflect the marginal effects of the pro%ect on these costs. c. Remember the in&estment in wor+ing capital. As sales increase, the firm may need to ma+e additional in&estments in wor+ing capital, and as the pro%ect finally comes to an end, it will reco&er these in&estments. d. Treat inflation consistently. -f cash flows are forecast in nominal terms

:including the effects of future inflation;, use a nominal discount rate. 5iscount real cash flows at a real rate. e. 5o not include debt interest or the cost of repaying a loan. *hen calculating '$(, assume that the pro%ect is financed entirely by the shareholders and that they recei&e all the cash flows. This separates the in&estment decision from the financing decision. a. A) b. B) c and d. C) e. +)

16 )*CORRECT

*hich of the following is not correct regarding cash flows of a pro%ect, a. $ro%ect cash flow does not e ual profit. 6ou must allow for changes in wor+ing capital as well as noncash expenses such as depreciation. b. -f you use a nominal cost of capital, consistency re uires that you forecast nominal cash flowsAthat is, cash flows that recogniCe the effect of inflation. a. A) b. B) a and b. C) neither a nor b is incorrect. +) Feedback: Both statements a!e co!!ect&

17 )*CORRECT

*hich of the following is incorrect regarding a company.s tax bill and depreciation, a. 5epreciation is not a cash flow. Dowe&er, because depreciation reduces taxable income, it reduces taxes. b. The tax reduction caused by depreciation is called the depreciation tax shield. c. Modified accelerated cost reco&ery system :MACRS; depreciation schedules allow more of the depreciation allowance to be ta+en in early years than is possible under straight"line depreciation. This increases the present &alue of the tax shield. a. A) b. B) c. C) d. +)

'4 )*CORRECT

Dow do changes in wor+ing capital affect pro%ect cash flows, -ncreases in net wor+ing capital such as accounts recei&able or in&entory are A)in&estments and therefore use cash. -ncreases in net wor+ing capital reduce the net cash flow pro&ided by the B)pro%ect in that period. *hen wor+ing capital is run down, cash is freed up, so cash flow increases. C) All of the abo&e are correct. +) Feedback: )nc!eases in net #o!king capital such as accounts !ecei$able o! in$ento!% a!e in$estments and the!e o!e use cash?that is, the% !educe the net cash lo# p!o$ided b% the p!o-ect in that pe!iod& When #o!king capital is !un do#n, cash is !eed up, so cash lo# inc!eases&