10. A company is considering a new project. The CFO plans to calculate the project’s NPV by estimating the relevant cash

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10. A company is considering a new project. The CFO plans
to calculate the project’s NPV by estimating the relevant cash
flows for each year of the project’s life (i.e., the initial
investment cost, the annual operating cash flows, and the terminal
cash flows), then discounting those cash flows at the company’s
overall WACC. Which one of the following factors should the CFO be
sure to INCLUDE in the cash flows when estimating the relevant cash
flows?
a.
All sunk costs that have been incurred relating to the
project.
b.
All interest expenses on debt used to help finance the
project.
c.
The additional investment in net operating working capital
required to operate the project, even if that investment will be
recovered at the end of the project’s life.
d.
Sunk costs that have been incurred relating to the project, but
only if those costs were incurred prior to the current year.
e.
Effects of the project on other divisions of the firm, but only
if those effects lower the project’s own direct cash flows.
11. Other things held constant, which of the following
would increase the NPV of a project being considered?
a.
A shift from straight-line to MACRS depreciation.
b.
Making the initial investment in the first year rather than
spreading it over the first three years.
c.
An increase in the discount rate associated with the
project.
d.
An increase in required net operating working capital.
e.
The project would decrease sales of another product line.
12. When evaluating a new project, firms should include in
the projected cash flows all of the following EXCEPT:
a.
Changes in net operating working capital attributable to the
project.
b.
Previous expenditures associated with a market test to determine
the feasibility of the project, provided those costs have been
expensed for tax purposes.
c.
The value of a building owned by the firm that will be used for
this project.
d.
A decline in the sales of an existing product, provided that
decline is directly attributable to this project.
e.
The salvage value of assets used for the project that will be
recovered at the end of the project’s life.
13. Rowell Company spent $3 million two years ago to build
a plant for a new product. It then decided not to go forward with
the project, so the building is available for sale or for a new
product. Rowell owns the building free and clear--there is no
mortgage on it. Which of the following statements is CORRECT?
a.
Since the building has been paid for, it can be used by another
project with no additional cost. Therefore, it should not be
reflected in the cash flows of the capital budgeting analysis for
any new project.
b.
If the building could be sold, then the after-tax proceeds that
would be generated by any such sale should be charged as a cost to
any new project that would use it.
c.
This is an example of an externality, because the very existence
of the building affects the cash flows for any new project that
Rowell might consider.
d.
Since the building was built in the past, its cost is a sunk
cost and thus need not be considered when new projects are being
evaluated, even if it would be used by those new projects.
e.
If there is a mortgage loan on the building, then the interest
on that loan would have to be charged to any new project that used
the building.
14. 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.
15. Langston Labs has an overall (composite) WACC of 10%,
which reflects the cost of capital for its average asset. Its
assets vary widely in risk, and Langston evaluates low-risk
projects with a WACC of 8%, average-risk projects at 10%, and
high-risk projects at 12%. The company is considering the following
projects:
​
Project
Risk
Expected Return
A
High
15%
B
Average
12%
C
High
11%
D
Low
9%
E
Low
6%
​
Which set of projects would maximize shareholder wealth?
a.
A and B
b.
A, B, and C
c.
A, B, and D
d.
A, B, C, and D
e.
A, B, C, D, and E