CH 9

Question 1

1) A capital budget lists the potential projects a company may undertake in future years.

Answer 1

FALSE

Question 2

Capital budgeting decisions use the Net Present Value rule so that those decisions
maximize net present value (NPV).

Answer 2

FALSE

Question 3

The capital budgeting process begins by ________.
A) analyzing alternate projects
B) evaluating the net present value (NPV) of each project’s cash flows
C) compiling a list of potential projects
D) forecasting the future consequences for the firm of each potential project

Answer 3

C

Question 4

The ultimate goal of the capital budgeting process is to ________.
A) determine how the consequences of making a particular decision affects the firm’s
revenues and costs
B) list the projects and investments that a company plans to undertake in the future
C) forecast the consequences of a list of future projects for the firm
D) determine the effect of the decision to accept or reject a project on the firm’s cash flows

Answer 4

D

Question 5

Which of the following best defines incremental earnings?
A) cash flows arising from a particular investment decision
B) the amount by which a firm’s earnings are expected to change as a result of an investment
decision
C) the earnings arising from all projects that a company plans to undertake in a fixed time
span
D) the net present value (NPV) of earnings that a firm is expected to receive as the result of an
investment decision

Answer 5

B

Question 6

Which of the following best describes why the predicted incremental earnings arising from
a given decision are not sufficient in and of themselves to determine whether that decision is
worthwhile?
A) They do not tell how the decision affects the firm’s reported profits from an accounting
perspective.
B) They are not easily predicted from historical financial statements of a firm and its
competitors.
C) These earnings are not actual cash flows.
D) They do not show how the firm’s earnings are expected to change as the result of a
particular decision.

Answer 6

C

Question 7

When evaluating the effectiveness of an improved manufacturing process we should
evaluate the total sales and costs generated by this process.

Answer 7

FALSE

Question 8

Interest and other financing-related expenses are excluded when determining a project’s
unlevered net income.

Answer 8

TRUE

Question 9

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon
chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed.
Building a clean room in the plant for the machine will cost an additional $3 million. The
machine is expected to have a working life of six years. Which of these activities will be
reported as an operating expense?
A) the delivery and install cost only
B) the cost of the depositor only
C) the delivery and install cost and the cost of the depositor
D) None of these costs should be reported an an operating expense.

Answer 9

D

Question 10

Which of the following is usually NOT a factor that must be considered when estimating
the revenues and costs arising from a new product?
A) the fluctuations in the cost of capital over the period in question
B) the sales of a new product will typically accelerate, plateau, and ultimately decline over
time
C) the prices of technology products generally fall over time
D) competition tends to reduce profit margins over time in most industries

Answer 10

A

Question 11

Which of the following is NOT a factor that a manager should bear in mind when
estimating a project’s revenues and costs?
A) Sales of a product will typically accelerate, stabilize, and then decline as the product
becomes outdated or faces increased competition.
B) A new product typically has its highest sales immediately after release as customers are
attracted by the novelty of the product.
C) The prices of technology products tend to fall over time as newer, superior technologies
emerge and production costs decline.
D) Prices and costs tend to rise with the general level of inflation in the economy.

Answer 11

B

Question 12

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 expense when
calculating earnings.
D) The opportunity cost of using a resource is the value it could have provided in its best
alternative use.

Answer 12

C

Question 13

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 13

B

Question 14

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 14

B

Question 15

Which of the following would you NOT consider when making a capital budgeting
decision?
A) the additional taxes a firm would have to pay in the next year
B) the cost of a marketing study completed last year
C) the opportunity to lease out a warehouse instead of using it to house a new production
line
D) the change in direct labor expense due to the purchase of a new machine

Answer 15

B

Question 16

Which of the following is an example of cannibalization?
A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its
product line.
B) A grocery store begins selling T-shirts featuring the local university’s mascot.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A convenience store begins selling pre-paid cell phones.

Answer 16

A

Question 17

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for
the firm’s earnings.

Answer 17

FALSE

Question 18

The cash flow effect from a change in Net Working Capital is always equal in size and
opposite in sign to the changes in Net Working Capital.

Answer 18

TRUE

Question 19

3) Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?
A) adding depreciation
B) adding all non-cash expenses
C) subtracting increases in Net Working Capital
D) subtracting depreciation expenses from taxable earnings

Answer 19

D

Question 20

Which of the following formulas will correctly calculate Net Working Capital?
A) Cash + Inventory + Receivables + Payables
B) Cash + Inventory + Receivables - Payables
C) Cash + Inventory - Receivables + Payables
D) Cash - Inventory + Receivables + Payables

Answer 20

B

Question 21

1) Firms should use the most accelerated depreciation scheme allowable.

Answer 21

TRUE

Question 22

An announcement by the government that they will decrease corporate marginal tax rates
in the future would increase the attractiveness of MACRS depreciation.

Answer 22

FALSE

Question 23

The term “cannibalization” refers to ________.
A) decrease in the sales of current project caused by the launching of new project
B) decrease in the sunk cost caused by launching of new project
C) decrease in overhead expenses incurred due to launch of new project
D) cost of using a resource for the best value it could provide in its best alternative

Answer 23

A

Question 24

A company spends $20 million researching whether it is possible to create a durable plastic
from the process waste from feedstock preparation. The $20 million should best be
considered ________.
A) as a sunk cost
B) as an opportunity cost
C) as a fixed overhead expense
D) as a capital cost

Answer 24

A

Question 25

) Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the
movie in question that make him realize that he will not enjoy it. He goes to see it anyway,
rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk
Cost Fallacy, and why?
A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
B) No, because the cost of the movie was not recoverable and would have been lost whatever
action he took.
C) No, because going to see the movie means that the product of his initial investment was
realized as originally planned.
D) Yes, because he incurred no further costs by going to see the movie.

Answer 25

A

Question 26

An insurance office owns a large building downtown. The sixth floor of this building
currently houses its entire Human Resources Department. After carrying out a survey to see
whether the sixth floor could be rented and for what price, the company must decide whether
to split the Human Resources Department between currently unoccupied spaces on several
floors and rent out the entire sixth floor or to leave things as they currently are. Which of the
following should NOT be considered when deciding whether to rent out the sixth floor?
A) the amount obtained by renting the sixth floor
B) the cost of refurbishing the new space to be occupied by the Human Resources
Department
C) cost involved with a loss of efficiency resulting from the Human Resources Department
being split between several spaces
D) the cost of the research into the feasibility of renting the sixth floor

Answer 26

D

Question 27

Which of the following is an example of cannibalization?
A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its
product line.
B) A grocery store begins selling T-shirts featuring the local university’s mascot.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A convenience store begins selling pre-paid cell phones.

Answer 27

A

Question 28

A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The
manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80
each to produce. Selling, general, and administrative expenses are $500,000. The machinery
required to produce the knives cost $1.4 million, depreciated by straight-line depreciation
over five years. The maker determines that the EBIT break-even point for units sold and sale
price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A,
and depreciation are greater than these estimates, so decides to go ahead with manufacturing
the knife. Was this the correct decision?
A) No, since the cost per unit should be greater than the EBIT break-even point for cost of
goods if the project is to have a positive EBIT.
B) Yes, since if the estimates for each parameter are correct, the EBIT will be positive.
C) Yes, since a positive EBIT ensures that the project will have a positive net present value
(NPV).
D) It cannot be determined whether the decision was correct, since other factors contributing
to the project’s net present value (NPV), such as the upfront investment, have not been
included in the analysis.

Answer 28

D

Question 29

The manufacturer of a brand of kitchen knives is investigating the likely effects that an
increase in the cost of the raw materials required to make these knives will have on the cost of
manufacturing the knives, the selling price of the knives, the number of knives that will then
be sold, and the project’s net present value (NPV). Which of the following best describes what
type of analysis the manager is performing?
A) scenario analysis
B) sensitivity analysis
C) break-even analysis
D) EBIT-break even analysis

Answer 29

A

Question 30

Which of the following statements is FALSE?
A) The break-even level of an input is the level for which the investment has an internal rate
of return (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 net present value (NPV).
D) Sensitivity analysis reveals those aspects of the project which are most critical when we are
actually managing the project.

Answer 30

A

Question 31

Which of the following statements is FALSE?
A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our
net present value (NPV) analysis for the project.
B) To compute the net present value (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 31

D

Question 32

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 net present value (NPV) of changing multiple
project parameters.
C) The difference between the internal rate of return (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 net present value (NPV) calculation into its component
assumptions and shows how the net present value (NPV) varies as each one of the
underlying assumptions changes.

Answer 32

D

Question 33

The difference between scenario analysis and sensitivity analysis is ________.
A) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is
based upon net present value (NPV)
B) only sensitivity analysis allows us to change estimated inputs of net present value (NPV)
analysis
C) scenario analysis considers the effect on net present value (NPV) of changing multiple
project parameters
D) only scenario analysis breaks the net present value (NPV) calculation into its component
assumptions

Answer 33

C

Question 34

An exploration of the effect of changing multiple project parameters on net present value
(NPV) is called ________.
A) scenario analysis
B) internal rate of return (IRR) analysis
C) accounting break-even analysis
D) sensitivity analysis

Answer 34

A

Question 35

An analysis that breaks the net present value (NPV) calculation into its component
assumptions and shows how the net present value (NPV) varies as one of the underlying
assumptions changes is called ________.
A) scenario analysis
B) internal rate of return (IRR) analysis
C) accounting break-even analysis
D) sensitivity analysis

Answer 35

D

Question 36

Which of the following will cause the EBIT Break-Even for sales to increase?
A) a decrease in the sales price
B) a decrease in depreciation expense
C) a decrease in selling, general, and administrative expenses
D) a decrease in the number of units sold

Answer 36

A

Question 37

A real option is the obligation to take a particular business action.

Answer 37

FALSE

Question 38

Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm
in the future, giving access to the farmland from a nearby city and thus making the land
attractive to housing developers. Expecting the net present value (NPV) of the sale to be
greater after the highway is built, he decides not to sell at this time. What real option is Jim
taking?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch

Answer 38

A

Question 39

After research into where to place a new restaurant, Burger Billies, a small fast-food chain,
plans to open a new store near a small college. The anticipated customer base is students
attending the college. They learn that a major fast food chain will be opening a franchise
within the college, which leads the owners of Burger Billies to revise their estimate of sales to
one below the break-even point. Which of the following is most likely the best real option for
Burger Billies to take with regard to the proposed restaurant site?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch

Answer 39

C

Question 40

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC
gaming market by creating gaming versions of its traditional peripheral devices. It decides to
start with a gaming version of its standard keyboard, increasing the number of macro keys,
adding a small LCD screen to display game data, and giving the user the ability to backlight
keys in different colors. If this device is a success, the manufacturer plans to release gaming
versions of its trackballs and other peripherals. What option is the manufacturer gaining by
the release of the new keyboard?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch

Answer 40

B

Question 41

Which of the following statements regarding real options is NOT correct?
A) Real options should only be exercised when they increase the NPV of a project.
B) Real options enhance the forecast of a project’s expected future cash flows by
incorporating, at the start of the project, the effect of decisions that will be made at a later
date.
C) Real options give owners the right, but not the obligation, to exercise these opportunities
at a later date.
D) Real options build greater flexibility into a project and thus increase its net present value
(NPV).

Answer 41

B