Q&A Hero

Q: In capital-budgeting decisions, simulation analysis gives a probability distribution only for cash flows.

Q: Using simulation provides the financial manager with a probability distribution of an investment's net present value or internal rate of return.

Q: Natick Nurseries has used scenario analysis to evaluate the purchase of a former dairy to use for nursery stock. The best case scenario produced a very favorable NPV of $4,000,000; the NPV of the most likely case was $2,000,000, but the worst case scenario resulted in an NPV of $(3,000,000) which would bring the company close to bankruptcy. Natick could improve its decision by: A) using sensitivity analysis. B) using simulation analysis. C) simply accepting the best case scenario and rejecting the other outcomes. D) weighting the favorable scenarios more heavily to increase the expected NPV.

Q: Cranston Plastic Packaging Solutions has run a simulation on a large project to produce eco-friendly packaging for personal hygiene products. The mean NPV is an impressive $8,000,000, but there is a 16% probability of a negative NPV and a 5% probability of an NPV worse than ($6,000,000). A) Cranston should reject the project. It is too risky. B) Cranston should accept the project. The odds are in their favor. C) Cranston should explore options to reduce the likelihood of very unfavorable outcomes. D) Cranston should change the probabilities used in the simulation to reduce the likelihood of a negative NPV.

Q: When using simulation to analyze a large capital project, the decision rule is: A) There is no clear cut decision rule, but the probabilities will produce a more informed decision. B) Accept the project if the probability of a positive NPV is greater than 50%. C) Reject the project if the probability of a negative NPV is greater than 5% D) Reject the project if the probability of a negative NPV is greater than 16%

Q: The end result of a simulation analysis is: A) a probability distribution of project cash flows. B) a clear decision on whether or not a project should be accepted. C) a probability distribution of possible NPV's. D) a list of value drivers and their probabilities.

Q: An appropriate tool to analyze the interaction of various value drivers for Destroya Extermination Services would be A) simulation B) scenario analysis C) sensitivity analysis D) either A or B

Q: Use the following information to answer the following question(s). Destroya Extermination Services projects next year's sales of its new X-Ray termite inspection service at 5,000 inspections priced at $175 each. The variable costs per inspection are expected to be $87.50 Fixed cash costs are expected to be $90,000 and depreciation $110,000. The company's marginal tax rate is 34%. Destroya believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected free cash flow for the worst case scenario? A) $153,973 B) $43,972 C) $84,910 D) $383,240

Q: Use the following information to answer the following question(s). Destroya Extermination Services projects next year's sales of its new X-Ray termite inspection service at 5,000 inspections priced at $175 each. The variable costs per inspection are expected to be $87.50 Fixed cash costs are expected to be $90,000 and depreciation $110,000. The company's marginal tax rate is 34%. Destroya believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected free cash flow for the best case scenario? A) $414,400 B) $330,000 C) $394,500 D) $383,240

Q: Use the following information to answer the following question(s). Destroya Extermination Services projects next year's sales of its new X-Ray termite inspection service at 5,000 inspections priced at $175 each. The variable costs per inspection are expected to be $87.50 Fixed cash costs are expected to be $90,000 and depreciation $110,000. The company's marginal tax rate is 34%. Destroya believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected free cash flow if the most likely estimates are used? A) $156,750 B) $266,750 C) $237,500 D) $383,240

Q: An appropriate tool to analyze the interaction of various value drivers for Orange Electronics would be A) simulation B) sensitivity analysis C) scenario analysis D) either A or C

Q: Use the following information to answer the following question(s). Orange Electronics projects sales of its new O-Phones for next year at 10,000 units priced at $150 each. The variable costs of an O-Phone are expected to be $75. Fixed cash costs are expected to be $150,000 and depreciation $100,000. The tax rate is 40%. Orange believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected net operating profit after tax (NOPAT) for the best case scenario? A) $493,500 B) $330,000 C) $394,500 D) $124,500

Q: Use the following information to answer the following question(s). Orange Electronics projects sales of its new O-Phones for next year at 10,000 units priced at $150 each. The variable costs of an O-Phone are expected to be $75. Fixed cash costs are expected to be $150,000 and depreciation $100,000. The tax rate is 40%. Orange believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected net operating profit after tax (NOPAT) if the most likely estimates are used? A) $493,500 B) $330,000 C) $300,000 D) $124,500

Q: Use the following information to answer the following question(s). Orange Electronics projects sales of its new O-Phones for next year at 10,000 units priced at $150 each. The variable costs of an O-Phone are expected to be $75. Fixed cash costs are expected to be $150,000 and depreciation $100,000. The tax rate is 40%. Orange believes that any of its forecasts including fixed costs, but not depreciation or the tax rate which are known for certain, could be high or low by as much as 10%. What is the expected net operating profit after tax (NOPAT) for the worst case scenario? A) $300,000 B) $223,500 C) $174,000 D) $124,500

Q: Boulangerie Bouffard expects to sell 1 million croissants next year for $1.25 each. Variable cost of a croissant is $0.75. Fixed costs are $150,000, depreciation $200,000 and the tax rate is 25%. If the bakery can increase the price of a croissant to $1.50 sales will fall by 50,000 croissants. Free cash flow will increase or decrease by: A) $131,250 increase. B) $37,500 increase. C) $75,000 decrease. D) $250,000 increase.

Q: Boulangerie Bouffard expects to sell 1 million croissants next year for $1.25 each. Variable cost of a croissant is $0.75. Fixed costs are $150,000, depreciation $200,000 and the tax rate is 25%. If the bakery can increase the price of a croissant to $1.50 and all other variables remain the same, free cash flow will increase by ________. A) $37,500 B) $150,000 C) $187,500 D) $250,000

Q: When Charles River Publisher's sales revenue increased from $25 million to $27.5 million, net operation income increased from $3,750,000 to $3,937,500. Quineboag's degree of operating leverage (DOL) is ________. A) .5 B) 2 C) 6.67 D) .05

Q: When Quineboag Textile's sales revenue increased from $5.0 million to $5.25 million, net operation income increased from $500,000 to $575,000. Quineboag's degree of operating leverage (DOL) is ________. A) .015 B) .33 C) 3.00 D) 10

Q: Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price of $2,400 each. It believes that unit sales will grow between -5% and +5% per year and prices will rise or fall by as much as 5% per year. Forecast sales revenue for 2013 if both price and the number of units sold increase by 5% per year. A) $3,492,720 B) $3,500,658 C) $3,333,960 D) $3,175,200

Q: Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price of $2,400 each. It believes that unit sales will grow between -5% and +5% per year and prices will rise or fall by as much as 5% per year. Forecast sales revenue for 2013 if the number of units sold increases by 5% per year and prices remain flat. A) $2,880,000 B) $3,168,000 C) $3,333,960 D) $3,175,200

Q: Lemminburg Plastics estimates a 60% probability that sales of pink flamingo lawn ornaments in the summer of 2011 will be 45,000 units, about the same as in 2010. They believe there is a 20% probability that they will go viral and potential sales would be 90,000. There is also a 20% probability that restrictive zoning ordinances will limit sales to 30,000 units. Expected unit sales of the pink flamingos are ________. A) 55,000 B) 51,000 C) 67,500 D) 60,000

Q: Pederson Home Heating Inc. anticipates that cash flows from home heating fuel sales next year will be $800,000 if the winter is mild, $1,000,000 if winter is average, and $1,500,000 if winter is exceptionally cold. The probability of an average winter is 60%, while the probability of either a mild or an exceptionally cold winter is 20%. What is Pederson's expected cash flow from fuel sales next winter? A) $1,060,000 B) $1,100,000 C) $1,000,000 D) $1,150,000

Q: There is a 20% probability that the NPV of a project will be $20 million, a 50% probability that it will be sold for $45 million and a 30% probability that it will be for $15 million. What is the expected NPV of the project? A) $17.5 million B) $45 million C) $31 million D) $26.67 million

Q: There is a 30% probability that an office building will be sold after 5 years for $30 million, a 50% probability that it will be sold for $20 million and a 20% probability that it will be sold for $10 million. What is the expected value of the office building in 5 years? A) $20 million B) $21 million C) $30 million D) $10 million

Q: ________ is a risk analysis technique in which the best- and worst-case net present values are compared with the project's expected net present value. A) Project standing alone risk B) Decision tree analysis C) Scenario analysis D) Pure play method

Q: Which of the following results in a probability distribution for possible project outcomes rather than a dollar estimate? A) Sensitivity analysis B) Simulation C) Value driver analysis D) Scenario analysis

Q: Which of the following is considered the major risk when analyzing projects in a multinational environment? A) Currency fluctuations B) Inflation C) Political risk D) Lack of available betas

Q: Scenario analysis is the form of risk analysis: A) that examines the relationship between total firm cash flows and the NPV of a particular project. B) that examines the volatility of NPV. C) that examines the impact of key variables such as sales or costs in various combinations. D) that examines the impact of key variables such as sales or costs one at a time.

Q: The form of risk analysis which examines the effect of various combinations of value drivers is known as: A) scenario analysis. B) sensitivity analysis. C) value driver analysis. D) expected value analysis.

Q: Sensitivity analysis is the form of risk analysis: A) that examines the relationship between total firm cash flows and the NPV of a particular project. B) that examines the volatility of NPV. C) that examines the impact of key variables such as sales or costs in various combinations. D) that examines the impact of key variables such as sales or costs one at a time.

Q: The form of risk analysis intended to identify the most important forces for the success or failure of a project is known as: A) scenario analysis. B) sensitivity analysis. C) value driver analysis. D) expected value analysis.

Q: ________ is a method of quantifying uncertainty without having to estimate probabilities. A) Standard deviation B) Sensitivity analysis C) Coefficient of variation D) Decision tree analysis

Q: The simulation approach provides us with: A) a single value for the risk-adjusted net present value. B) an approximation of the systematic risk level. C) a probability distribution of the project's net present value or internal rate of return. D) a graphic exposition of the year-by-year sequence of possible outcomes.

Q: Why is it important to perform risk analysis before accepting or rejecting major projects?

Q: What are the consequences of excessive optimism or pessimism in forecasting expected project cash flows?

Q: Jeffrey believes that if he can make a good case for opening a new store in the chain for which he works, he will be promoted to manager. Can we be confident that Jeffrey's sales forecasts are accurate?

Q: A would be entrepreneur is considering buying a franchise from a national chain of fitness centers. Identify some of the risks she might face.

Q: Most of the variables used in forecasting cash flows are known with certainty.

Q: In reality, anticipated cash flows are only estimates and are thus uncertain.

Q: What is the approximate failure rate for new businesses after five years? A) 20% B) 40% C) 60% D) 80%

Q: What is the approximate five year survival rate for new businesses? A) 20% B) 40% C) 60% D) 80%

Q: Approximately what percentage of new businesses survive their first year? A) 20% B) 40% C) 60% D) 80%

Q: Approximately what percentage of new businesses fail in their first year? A) 20% B) 40% C) 60% D) 80%

Q: Which of the following are usually known with a high level of confidence at the beginning of a project? A) The number of units that will be sold. B) The price per unit that will result in the desired number of units sold. C) Tax rates and depreciation rates. D) None of the above.

Q: Which of the following abilities are crucial for risk analysis? A) A knowledge of marketing B) A knowledge of cost accounting C) A knowledge of economics D) All of the above

Q: Which of the following are reasons to analyze the risk of capital projects? A) The people who propose projects have a vested interest in getting them accepted. B) Cash flows can rarely be estimated with certainty. C) Many of the variables in capital budgeting analysis are highly sensitive to changes in economic conditions. D) All of the above.

Q: Which of the following is a reason why risk analysis is an important part of capital budgeting? A) The people who propose projects have no vested interest in whether or not they are accepted. B) Marketing managers are rarely excessively optimistic. C) Project cash flows can be highly uncertain. D) Financial analysts are rarely excessively pessimistic.

Q: National Geographic is replacing an old printing press with a new one. The old press is being sold for $350,000 and it has a net book value of $75,000. Assume that National Geographic is in the 40% income tax bracket. How much will National Geographic pay in income taxes from the sale? A) $140,000 B) $45,000 C) $110,000 D) $87,010

Q: Al's Fabrication Shop is purchasing a new rivet machine to replace an existing one. The new machine costs $8,000 and will require an additional cost of $1,000 for modification and training. It will be depreciated using simplified straight line depreciation over five years. The new machine operates much faster than the old machine and with better quality. Consequently, sales are expected to increase by $2,100 per year for the next five years. While it is faster, it is fully automated and will result in increased electricity costs for the firm by $700 per year. It will, however, save about $850 per year in labor costs. The old machine is 20 years old and has already been fully depreciated. If the firm's marginal tax rate is 28%, compute the after tax incremental cash flows for the new machine for years 1 through 5. A) $2,698 B) $450 C) $2,124 D) $1,620

Q: What would cause the initial cash outlay of an investment decision to be affected by the sale of an existing asset? A) If the investment decision is a replacement decision B) If the asset being purchased is technologically superior C) If the asset being sold has exceeded its MACR's recovery allowance period D) All of the above E) None of the above

Q: Use the following information to answer the following question(s). A firm is trying to determine whether to replace an existing asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital during the asset's life of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago for $25,000, has a remaining life of five years, and is being depreciated using the straight-line method. The expected salvage value at the end of the asset's life (i.e., five years from now) is $5,000; however, the current sale price of the existing asset is $20,000, and its current book value is $15,625. The firm's marginal tax rate is 34 percent and its required rate of return is 12 percent. If the new machine is purchased, operating cash flow for years 1 through 5 will increase or decrease by: A) $15,000. B) $9,900. C) $12,246. D) $5,346.

Q: Use the following information to answer the following question(s). A firm is trying to determine whether to replace an existing asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital during the asset's life of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago for $25,000, has a remaining life of five years, and is being depreciated using the straight-line method. The expected salvage value at the end of the asset's life (i.e., five years from now) is $5,000; however, the current sale price of the existing asset is $20,000, and its current book value is $15,625. The firm's marginal tax rate is 34 percent and its required rate of return is 12 percent. Increased taxes on the sale of the old machine are: A) $1,487.50. B) $2,500.50. C) $3,823.50. D) $4,312.50.

Q: Use the following information to answer the following question(s). A firm is trying to determine whether to replace an existing asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital during the asset's life of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago for $25,000, has a remaining life of five years, and is being depreciated using the straight-line method. The expected salvage value at the end of the asset's life (i.e., five years from now) is $5,000; however, the current sale price of the existing asset is $20,000, and its current book value is $15,625. The firm's marginal tax rate is 34 percent and its required rate of return is 12 percent. If the new machine is purchased, depreciation expense will increase or decrease by: A) increase $8,000 B) increase $6,900 C) Increase $6,300 D) decrease $5,000

Q: Tversky and Co. have devised a new psychological test for investors' risk tolerance. They expect to sell 10,000 tests in the first year at $150 each. Cash costs associated with producing, administering and scoring the test are $50 per unit. In the second year, volume is expected to be the same, but both the price and the costs will increase 2.5%. Forecast gross profit in the second year.

Q: What is meant by "real dollars" and the "real" discount rate? How can they be used to account for inflation when evaluating capital budgeting proposals?

Q: Greenspan Inc. discounts cash flows at a nominal rate of 10%. Inflation over the next few years is expected to average 3%. Which of the following would be a correct adjustment for inflation when computing net present value? A) Discount cash flows at 10%; increase revenues and expenses by 3% each year. B) Discount cash flows at 13%; increase revenues and expenses by 3% each year. C) Discount cash flows at 7%; ignore inflation when forecasting revenues and expenses. D) Either A or C would be acceptable.

Q: In 2010, Sunny Electronics expects to sell 100,000 3-D television sets for an average price of $1,000. Expected production costs are $600 per unit. In 2011, volume is expected to increase by 10%, Inflation will increase the cost per unit by 3%, but to attract more buyers, Sunny will reduce the price by 5%. In real dollars, expected gross profit for 2011 is: A) $45.32 million. B) $40 million. C) $38 million. D) $36.52 million.

Q: In 2010, Sunny Electronics expects to sell 100,000 3-D television sets for an average price of $1,000. Expected production costs are $600 per unit. In 2011, volume is expected to increase by 10%, while inflation will increase both the sales price and the cost per unit by 3%. In real dollars, expected gross profit for 2011 is: A) $40 million. B) $45.32 million. C) $48.2 0 million. D) $50 million.

Q: In 2010, Sunny Electronics expects to sell 100,000 3-D television sets for an average price of $1,000. Expected production costs are $600 per unit. In 2011, volume is expected to increase by 10%, while inflation will increase both the sales price and the cost per unit by 3%. In nominal dollars, expected gross profit for 2011 is: A) $40 million. B) $45.32 million. C) $48.20 million. D) $50 million.

Q: What is the advantage, if any, to using MACRS rather than straight line depreciation?

Q: Marguerite's Florist is considering the purchase of a new delivery van. It will cost $25,000 plus another $3,000 to have it painted in the company's characteristic floral motif. The van will be depreciated over 5 years using MACRS percentages and a half year convention. Compute depreciation for the second year in the life of the van.

Q: Cape Cod Cranberry Products is evaluating the introduction of a new line of juice drinks consisting of cranberry juice blended with sweeter juices such as apple or grape. In the first year the product line is introduced, sales are forecasted at $2,000,000, Cost of Goods Sold at $1,200,000, other cash expenses at $300,000, depreciation expense at $800,000. The company has many other profitable product lines. It's marginal tax rate is 35%. Compute operating cash flow for the first year.

Q: LaVigne Wineries is purchasing a new wine press. The equipment will cost $250,000. Transportation and installation will cost another $35,000. Because of increased production, inventories will increase by $15,000. The press will be depreciated using the straight line method to a book value of $0.00 over its useful life of 7 years. Compute depreciation for each year of the project.

Q: Cash flows associated with a project's termination generally include the salvage value of the project plus or minus any taxable gains or losses associated with its sale.

Q: Sales captured from the firm's competitors can be relevant to the capital-budgeting decision.

Q: Expenses incurred to install an asset are part of the asset's initial cash outflow.

Q: A marketing survey completed last year to determine a project's feasibility would be included as part of the project's initial cash outflow.

Q: The hardest step in capital budgeting analysis is calculating the cash flows of a project.

Q: Accounting profits represents free cash flows that are available for reinvestment.

Q: By examining cash flows, we are correctly able to analyze the timing of the benefits.

Q: Additional cash needed to fill increased working capital requirements should be included in the initial cost of a product when analyzing an investment.

Q: Working capital requirements are considered a cash flow even though they do not leave the company.

Q: It is not necessary to consider depreciation in estimating cash flows for a new capital project.

Q: Working capital for a project includes investment in fixed assets.

Q: The capital budgeting decision-making process involves measuring the expected incremental cash flows of an investment proposal and evaluating the value of these cash flows relative to the project's cost.

Q: Because installment costs of a new asset are a current cash expense, they are excluded from the initial outlay.

Q: When an old asset is sold for exactly its depreciated value, the only taxable income is the difference between the initial cost of the machine and the selling price.

Q: A project under consideration by Bizet Co. will require the purchase of machinery for $50,000 and additional inventory for $15,000? Accounts receivable will increase by $12,000 and accounts payable by $14,000. Liability insurance will increase by $2,500 per year and utilities expense by $1,500 per year. What is the investment in working capital required by this project? A) $77,000 B) $41,000 C) $13,000 D) $4,000

Q: If Morgan Tool & Die Co. acquires a new turret lathe, the lathe will cost $80,000, transportation $6,000, installation $7,500. Installing the new lathe will allow Morgan to reduce its finished goods inventory by $10,000. For capital budgeting purposes, the initial investment required for the new lathe is: A) $83,500. B) $87,500. C) $93,500. D) $103,500.

Q: Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal? A) Training expense B) Working capital investments C) Installation costs of an asset D) Before-tax selling price of old machine