1. Which of the following is NOT a cash flow that should be included in the analysis of a project? a. Changes in net operating working capital.
b. Shipping and installation costs.
c. Cannibalization effects.
d. Opportunity costs.
e. Sunk costs that have been expensed for tax purposes.
2. When evaluating a new project, firms should include in the projected cash flows all of the following factors 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 that 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 that is directly attributable to this project. e. Salvage value of assets used for the project at the end of the project’s life.
3. A company is considering a proposed expansion to its facilities. Which of the following statements is CORRECT? a. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are handled by discounting at the WACC. If interest was deducted in the cash flow estimation, it would thus be “double counted.” b. Since depreciation is a non-cash expense, the firm does not need to know the depreciation rate to calculate the operating cash flows. c. When estimating the project’s operating cash flows, it is important to include any opportunity costs and sunk costs, but the firm should ignore cash flows from externalities since they are accounted for elsewhere. d. Capital budgeting analysis should be based on before-tax cash flows. e. Since depreciation is a cash expense, the firm should consider depreciation rates when calculating operating cash flows.
4. Laurier Inc., a household products firm, is considering production of a new detergent. In evaluating whether to go ahead with the project, which of the following items should NOT BE CONSIDERED EXPLICITLY when cash flows are estimated? a. The company will produce the detergent in a vacant building that was renovated last year. The building could be sold, leased to another company, or used in the future to produce other Laurier products. b. The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. c. The company has spent and expensed for tax purposes $3 million on research related to the new detergent. These funds cannot be recovered, but the research might benefit other projects that might be proposed in the future. d. The new detergent will cut into sales of the firm’s other detergents. e. If the project is accepted, the company must invest $2 million in working capital. However, these funds will be recovered at the end of the project’s life. 5. Which of the following rules is CORRECT for capital budgeting analysis? a. The interest paid on funds borrowed to finance a project must be included in the project’s estimated cash flows. b. Only incremental cash flows are relevant when making accept/reject decisions. c. Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project’s other costs when reaching the accept/reject decision. d. A proposed project’s estimated net income as determined by the firm’s accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income exceeds the project’s cost, the project should be accepted. e. If a product is competitive with some of the firm’s other products, this should be incorporated into the estimate of the relevant cash flows, but if the...