Corporate Finance, Chapters 8, 9 & 10. Exam Questions:

1. A project’s opportunity cost of capital is: A. The forgone return from investing in the project.
2. Which of the following statements is correct for a project with a positive NPV? A. The IRR must be greater than 1.
3. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%? C. $16,085
4. The decision rule for net present value is to: C. Accept all projects with positive net present values
5. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%? C. $126,565
6. What is the NPV for the following project cash flows at a discount rate of 15%? [C₀= ($1,000), C₁= $700, C₃= $700.] C. $138
7. Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15%: Project A with three annual cash flows of $1,000; or project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually? A. Project A
8. What is the approximate IRR for a project that costs $100,000 and provides cash inflows of $30,000 for 6 years? A. 19.9%
9. What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years? A. 0.57%
10. Firms that make investment decisions based on the payback rule may be biased toward reject projects: B. With long lives
11. Projects that are calculated as having negative NPVs should be: D. Rejected or abandoned
12. If the adoption of a new product will reduce the sales of an existing product, then the: C. Incremental benefits of the new product may be overestimated.
13. The value of a proposed capital budgeting project depends on the: B. Incremental cash flows produced.
14. The rational e for not including sunk costs in capital budgeting decisions is that they: C. Have no incremental effect
15. When is it appropriate to include sunk costs in the evaluation of a project? D. It is never appropriate to include sunk costs.
16. Which of the following is least likely to influence the opportunity cost of an asset? D. Its current book value
17. Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and is currently worth $25,000. Ignoring taxes, the correct opportunity cost for this machine in capital budgeting decisions is: B. $25,000
18. Which of the following methods will provide a correct analysis for capital budgeting purposes? A. Discounting real cash flows with real taxes.
19. Your forecast shows $500,000 annually in sales for each of the next 3 years. If your second and third year predictions have failed to incorporate 2.5% expected annual inflation, how far off in total dollars is your 3-year forecast? A. $37,813
20. Capital budgeting proposals should be evaluated as if the project were financed: B. Entirely by equity
21. Adding depreciation expense to net profit equals: D. Cash flows from operations
22. What is the amount of the operating cash flow for a firm with $500,000 profit before tax, $100,000 depreciation expense, and a %35% marginal tax rate? D. $425,000
23. At current prices and a 13% cost of capital, a project’s NPV is $100,000. By what minimum amount must the initial cost of the project decrease (revenues will be unchanged) before you would wait 2 years to invest? C. $27,690
24. An investment today of $25,000 promises to return $10,000 annually for the next 3 years. What is the approximate real rate of return on this investment if inflation averages 6% annually during the period? A. 3.5%
25. What nominal annual return is required on an investment for an investor to experience a 12% gain in purchasing power? Assume inflation to be 4%. D. 16.48%
26. What is the undiscounted cash flow in the final year of an investment, assuming $10,000 after-tax cash flows from operations, $1,000 from the sale of a fully depreciated machine, $2,000 required in additional working capital, and a 35% tax rate? C. $12,650
27. For a profitable firm in the 30% marginal tax bracket with $100,000 of annual depreciation expense, the depreciation tax shield would be: B. $40,000
28. Why is accelerated depreciation often favored for the corporation’s set of tax books? D. It impacts favorably with the time value of money
29. Why is it likely that firms use straight-line depreciation methods for reporting to shareholders? D. It allows asset balances to decline more slowly
30. What is the net effect on a firm’s working capital if a new project requires $30,000 in inventory, $10,000 increase in accounts receivable, $35,000 increase in machinery, and a $20,000 increase in accounts payable? C. +$20,000
31. What level of management is responsible for originating capital budgeting proposals? D. All levels of management
32. Which of the following is  least likely to be responsible for a regional manager’s conflict of interest in promoting a capital budgeting proposal? B. Thorough knowledge of the region
33. Using a computer model to repeatedly vary the combination of project variables in order to compare NPVs is called: D. Simulation analysis
34. What is the maximum percentage of variable costs in relation to sales that a firm could experience and still break even with $5 million revenue, $1 million fixed costs, and $500,000 depreciation? B. 70%
35. A firm with 60% of sales going to variable costs, $1.5 million fixed costs, and $500,000 depreciation would show what accounting profit with sales of $3 million? Ignore taxes. D. $800,000 loss
36. Fixed costs: C. Are constant with changes in the level of output
37. The greater the ratio of variable costs to sales, the: C. More units must be sold to cover fixed charges.
38. What is the level of profits for a firm in which DOL=5 and fixed costs including depreciation=$300,000? B. $75,000
39. The purpose of sensitivity analysis is to show: D. How variables in a project affect profitability
40. How much could NPV be affected by a worst-case scenario of 25% reduction from the $3 million in expected annual cash flows on a 5-year project with 10% cost of capital? A. $2,843,090
41. What is the accounting break-even level of revenues for a firm with $6 million in sales, variable costs of $3.9 million, fixed costs of $1.2 million, and depreciation of $1 million? C. $6,285,714
42. The accounting break-even level of sales represents the point where: D. Fixed costs, variable costs, and depreciation are covered.
43. What percentage change in sales occurs if profits increase by 3% when the firm’s degree of operating leverage is 4.5? B. 0.67%
44. If pretax profits decrease by 13.8% when the DOL is 3.8, then the decrease in sales is: C. 3.63%
45. A firm with $600,000 fixed costs and $200,000 depreciation is expected to produce $225,000 in profits. What is its DOL? C. 4.56