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

- A project’s opportunity cost of capital is: A. The forgone return from investing in the project.
- Which of the following statements is correct for a project with a positive NPV? A. The IRR must be greater than 1.
- 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
- The decision rule for net present value is to: C. Accept all projects with positive net present values
- 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
- What is the NPV for the following project cash flows at a discount rate of 15%? [C
_{0}= ($1,000), C_{1}= $700, C_{3}= $700.] C. $138 - 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
- 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%
- 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%
- Firms that make investment decisions based on the payback rule may be biased toward reject projects: B. With long lives
- Projects that are calculated as having negative NPVs should be: D. Rejected or abandoned
- 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.
- The value of a proposed capital budgeting project depends on the: B. Incremental cash flows produced.
- The rational e for not including sunk costs in capital budgeting decisions is that they: C. Have no incremental effect
- When is it appropriate to include sunk costs in the evaluation of a project? D. It is never appropriate to include sunk costs.
- Which of the following is least likely to influence the opportunity cost of an asset? D. Its current book value
- 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
- Which of the following methods will provide a correct analysis for capital budgeting purposes? A. Discounting real cash flows with real taxes.
- 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
- Capital budgeting proposals should be evaluated as if the project were financed: B. Entirely by equity
- Adding depreciation expense to net profit equals: D. Cash flows from operations
- 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
- 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
- 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%
- 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%
- 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
- 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
- Why is accelerated depreciation often favored for the corporation’s set of tax books? D. It impacts favorably with the time value of money
- Why is it likely that firms use straight-line depreciation methods for reporting to shareholders? D. It allows asset balances to decline more slowly
- 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
- What level of management is responsible for originating capital budgeting proposals? D. All levels of management
- 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
- Using a computer model to repeatedly vary the combination of project variables in order to compare NPVs is called: D. Simulation analysis
- 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%
- 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
- Fixed costs: C. Are constant with changes in the level of output
- The greater the ratio of variable costs to sales, the: C. More units must be sold to cover fixed charges.
- What is the level of profits for a firm in which DOL=5 and fixed costs including depreciation=$300,000? B. $75,000
- The purpose of sensitivity analysis is to show: D. How variables in a project affect profitability
- 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
- 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
- The accounting break-even level of sales represents the point where: D. Fixed costs, variable costs, and depreciation are covered.
- 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%
- If pretax profits decrease by 13.8% when the DOL is 3.8, then the decrease in sales is: C. 3.63%
- 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