Cash Flow Estimation and Risk Analysis

In capital budgeting, which of the following best defines an incremental cash flow?

A company spent 2 million dollars on a site study for a new store. The total additional cost to open the store is 17 million dollars. A standard NPV analysis of the 17 million dollar investment yields a positive 1 million dollars. How should the 2 million dollar study cost be handled in the decision-making process?

A company is considering opening a new coffee shop that is expected to reduce the after-tax cash flows of its existing, nearby shop by 50 dollars per year. This effect is known as what?

What are the three distinct types of risk involved in capital budgeting?

Which type of project risk is considered theoretically the most relevant because it is the one reflected in stock prices?

What is the primary objective of sensitivity analysis in capital budgeting?

A project has a base-case NPV of 78.82 dollars. If the firm uses accelerated depreciation, and then switches to straight-line depreciation, what is the most likely effect on the project's NPV?

What is the primary difference between scenario analysis and sensitivity analysis?

When comparing two mutually exclusive projects with unequal lives that can be repeated, what does the replacement chain (common life) approach involve?

A firm is considering a project with a 4-year life. The initial cost for equipment is 900 dollars. The firm will also need an initial increase in net operating working capital of 100 dollars. The equipment can be salvaged for 50 dollars at the end of the project, and the firm's tax rate is 40 percent. What is the total terminal cash flow for the project at the end of Year 4, before considering the operating cash flow in that year?

What is the primary reason that interest charges are not deducted when calculating a project's cash flows for use in a capital budgeting analysis?

A company is considering a replacement project. The old machine can be sold today for 400 dollars. The new machine costs 2,000 dollars. What is the initial investment outlay (net cash flow at Year 0) for this replacement project?

An abandonment option allows a firm to stop a project before the end of its physical life. How does this option typically affect a project's expected NPV and its risk?

Faleye Consulting is choosing between two repeatable, mutually exclusive computer systems. System A has a 6-year life and an NPV of 21,000 dollars. System B has a 3-year life and an NPV of 11,000 dollars. The company's WACC is 10 percent. Using the Equivalent Annual Annuity (EAA) method, which system should be chosen?

In a scenario analysis for a project, the best-case scenario results in an NPV of 7,450 dollars, the base-case in an NPV of 79 dollars, and the worst-case in an NPV of negative 4,782 dollars. The probability is 25 percent for the best case, 50 percent for the base case, and 25 percent for the worst case. What is the project's expected NPV?

Which of the following is NOT considered a relevant, incremental cash flow for a capital budgeting decision?

If a firm uses an accelerated depreciation method for a profitable project instead of the straight-line method, what is the most likely impact on the project's early-year cash flows and its total cash flows over its life?

When is it most critical to perform an unequal life analysis, such as the replacement chain or EAA method?

A growth option, which is a type of real option, refers to an opportunity to do what?

A project requires an initial investment of 1000 dollars. It is expected to generate after-tax cash flows of 500, 400, and 300 dollars in years 1, 2, and 3 respectively. If the WACC is 10 percent, what is the project's discounted payback period?

What is the primary weakness of both the regular payback and the discounted payback methods?

What does a project's stand-alone risk, as measured by the coefficient of variation of its NPV, represent?

A firm's overall WACC is 10 percent. It assigns a risk-adjusted cost of capital to its projects by adding a 5 percent risk premium for high-risk projects and subtracting 2 percent for low-risk projects. If the firm is evaluating a new high-risk project, what discount rate should it use?

When analyzing a replacement project, how are the relevant cash flows for the NPV analysis determined?

What is the primary characteristic of an investment timing option?

In a Monte Carlo simulation for capital budgeting, how is the project's expected NPV determined?

A company is considering two mutually exclusive projects. Project A has a 2-year life and an NPV of 1,750 dollars. Project B has a 4-year life and an NPV of 2,750 dollars. The firm's WACC is 10 percent and the projects are repeatable. Using the Equivalent Annual Annuity (EAA) method, what is the EAA for Project A?

If a firm does not handle sunk costs properly and includes them in a project's initial investment, what is the likely outcome?

A firm owns a building with a market value of 1 million dollars that could be sold. If the firm decides to use this building for a new project, how should the 1 million dollars be treated in the capital budgeting analysis?

In theory, what is the best method for classifying a new project's risk level?

What does a negative value for 'Taxes paid on salvaged assets' indicate?

The value of a project is equal to the present value of its free cash flows discounted at what rate?

A project requires an initial investment of 1,000 dollars and has a cost of capital of 10 percent. Its cash inflows are 500 dollars in Year 1, 400 dollars in Year 2, 300 dollars in Year 3, and 100 dollars in Year 4. What is this project's NPV?

What is the primary reason managers consider a project's payback period even though NPV is a superior method?

An investment timing option has the most value under which condition?

Which of the following is NOT one of the three components of a project's cash flows as divided in Table 12.1?

If a project is expected to have a significant positive impact on the sales of one of the firm's other products, this effect is known as a:

The expected NPV of a project without a growth option is 122,000 dollars. If the firm undertakes a related expansion, the project's expected NPV rises to 1,503,000 dollars. Assuming the initial project's expected NPV is positive, what is the value of the growth option?

If a project has an abandonment option, and its expected NPV without the option is negative 58,000 dollars, while its expected NPV with the option is 214,000 dollars, what is the value of the abandonment option?

In the context of the MACRS depreciation system, what does the half-year convention assume?

A new machine has a cost of 8 million dollars and is classified as a 5-year asset under MACRS. According to the recovery allowance percentages in Appendix 12A, what is the depreciation expense for Year 2?

According to the textbook, which of the following is NOT a common category used by firms to classify capital budgeting projects?

A project costs 1,000 dollars and has an IRR of 14.489 percent. The firm's WACC is 10 percent. Based on the IRR rule for an independent project with normal cash flows, what should the decision be?

What is the primary flaw of the Internal Rate of Return (IRR) method that the Modified Internal Rate of Return (MIRR) is designed to correct?

Two mutually exclusive projects, S and L, have a crossover rate of 11.975 percent. If the firm's WACC is 10 percent, which project will have the higher NPV?

What does a negative NPV for a project imply?

If a project has an IRR of 25 percent and another IRR of 400 percent, what can be concluded about the project?

A project costs 1,000 dollars and has a single cash inflow of 1,579.50 dollars at the end of Year 4. What is the project's Modified Internal Rate of Return (MIRR)?

How does an NPV profile graph for a project with normal cash flows depict the project's IRR?

If a project has an expected NPV of 14,000 dollars and a standard deviation of NPV of 1,179,000 dollars, what is the project's coefficient of variation (CV)?