Question 16 Which of the following statements is CORRECT? Answer A sunk cost is any cost that must b

 
   

Need your ASSIGNMENT done? Use our paper writing service to score better and meet your deadlines.  

Question 16
 
Which of the following statements is CORRECT?
Answer    A sunk cost is any cost that must beexpended in order to complete a project and bring it intooperation.
   A sunk cost is any cost that was expended in the pastbut can be recovered if the firm decides not to go forward with theproject.
   A sunk cost is a cost that was incurred and expensedin the past and cannot be recovered if the firm decides not to goforward with the project.
   Sunk costs were formerly hard to deal with but nowthat the NPV method is widely used, it is possible to simplyinclude sunk costs in the cash flows and then calculate the PV ofthe project.
   A good example of a sunk cost is a situation whereHome Depot opens a new store, and that leads to a decline in salesof one of the firm’s existing stores.
 .
2 points  
Question 17
 
Rowell Company spent $3 million two years ago to build a plant fora new product.  It then decided not to go forward with theproject, so the building is available for sale or for a newproduct.  Rowell owns the building free and clear–there is nomortgage on it.  Which of the following statements isCORRECT?
Answer    Since the building has been paid for, itcan be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any newproject.
   If the building could be sold, then the after-taxproceeds that would be generated by any such sale should be chargedas a cost to any new project that would use it.
   This is an example of an externality, because the veryexistence of the building affects the cash flows for any newproject that Rowell might consider.
   Since the building was built in the past, its cost isa sunk cost and thus need not be considered when new projects arebeing evaluated, even if it would be used by those newprojects.
   If there is a mortgage loan on the building, then theinterest on that loan would have to be charged to any new projectthat used the building.
 .
2 points  
Question 18
 
When evaluating a new project, firms should include in theprojected cash flows all of the following EXCEPT:
Answer    Changes in net working capitalattributable to the project.
   Previous expenditures associated with a market test todetermine the feasibility of the project, provided those costs havebeen expensed for tax purposes.
   The value of a building owned by the firm that will beused for this project.
   A decline in the sales of an existing product,provided that decline is directly attributable to this project.
   The salvage value of assets used for the project thatwill be recovered at the end of the project’s life.
 .
2 points  
Question 19
 
Which of the following statements is CORRECT?
Answer    An example of a sunk cost is the costassociated with restoring the site of a strip mine once the ore hasbeen depleted.
   Sunk costs must be considered if the IRR method isused but not if the firm relies on the NPV method.
   A good example of a sunk cost is a situation where abank opens a new office, and that new office leads to a decline indeposits of the bank’s other offices.
   A good example of a sunk cost is money that a bankingcorporation spent last year to investigate the site for a newoffice, then expensed that cost for tax purposes, and now isdeciding whether to go forward with the project.
   If sunk costs are considered and reflected in aproject’s cash flows, then the project’s calculated NPV will behigher than it otherwise would be.
 .
2 points  
Question 20
 
Which of the following statements is CORRECT?
Answer    If a firm is found guilty ofcannibalization in a court of law, then it is judged to have takenunfair advantage of its competitors.  Thus, cannibalization isdealt with by society through the antitrust laws.
   If a firm is found guilty of cannibalization in acourt of law, then it is judged to have taken unfair advantage ofits customers.  Thus, cannibalization is dealt with by societythrough the antitrust laws.
   If cannibalization exists, then the cash flowsassociated with the project must be increased to offset theseeffects.  Otherwise, the calculated NPV will be biaseddownward.
   If cannibalization is determined to exist, then thismeans that the calculated NPV if cannibalization is considered willbe higher than the NPV if this effect is not recognized.
   Cannibalization, as described in the text, is a typeof externality that is not against the law, and any harm it causesis done to the firm itself.
 .
2 points  
Question 21
 
Which one of the following would NOT result in incremental cashflows and thus should NOT be included in the capital budgetinganalysis for a new product?
Answer    A firm has a parcel of land that can beused for a new plant site or be sold, rented, or used foragricultural purposes.
   A new product will generate new sales, but some ofthose new sales will be from customers who switch from one of thefirm’s current products.
   A firm must obtain new equipment for the project, and$1 million is required for shipping and installing the newmachinery.
   A firm has spent $2 million on R&D associated witha new product.  These costs have been expensed for taxpurposes, and they cannot be recovered regardless of whether thenew project is accepted or rejected.
   A firm can produce a new product, and the existence ofthat product will stimulate sales of some of the firm’s otherproducts.
 .
2 points  
Question 22
 
Which of the following statements is CORRECT?
Answer    An externality is a situation where aproject would have an adverse effect on some other part of thefirm’s overall operations.  If the project would have afavorable effect on other operations, then this is not
an externality.
   An example of an externality is a situation where abank opens a new office, and that new office causes deposits in thebank’s other offices to increase.
   The NPV method automatically deals correctly withexternalities, even if the externalities are not specificallyidentified, but the IRR method does not.  This is anotherreason to favor the NPV.
   Both the NPV and IRR methods deal correctly withexternalities, even if the externalities are not specificallyidentified.  However, the payback method does not.
   Identifying an externality can never lead to anincrease in the calculated NPV.
 .
2 points  
Question 23
 
Which of the following statements is CORRECT?
Answer    Since depreciation is a cash expense, thefaster an asset is depreciated, the lower the projected NPV frominvesting in the asset.
   Under current laws and regulations, corporations mustuse straight-line depreciation for all assets whose lives are 5years or longer.
   Corporations must use the same depreciation method forboth stockholder reporting and tax purposes.
   Using accelerated depreciation rather than straightline normally has the effect of speeding
up cash flows and thus increasing a project’s forecasted NPV.
   Using accelerated depreciation rather than straightline normally has no effect on a project’s total projected cashflows nor would it affect the timing of those cash flows or theresulting NPV of the project.
 .
2 points  
Question 24
 
Which of the following is NOT a relevant cash flow and thus shouldnot be reflected in the analysis of a capital budgetingproject?
Answer    Changes in net working capital.
   Shipping and installation costs.
   Cannibalization effects.
   Opportunity costs.
   Sunk costs that have been expensed for taxpurposes.
 .
2 points  
Question 25
 
Currently, Powell Products has a beta of 1.0, and its sales andprofits are positively correlated with the overall economy. The company estimates that a proposed new project would have ahigher standard deviation and coefficient of variation than anaverage company project.  Also, the new project’s sales wouldbe countercyclical in the sense that they would be high when theoverall economy is down and low when the overall economy isstrong.  On the basis of this information, which of thefollowing statements is CORRECT?
Answer    The proposed new project would have morestand-alone risk than the firm’s typical project.
   The proposed new project would increase the firm’scorporate risk.
   The proposed new project would increase the firm’smarket risk.
   The proposed new project would not affect the firm’srisk at all.
   The proposed new project would have less stand-alonerisk than the firm’s typical project.
 .
2 points  
Question 26
 
Which of the following statements is CORRECT?
Answer    Since depreciation is not a cash expense,and since cash flows and not accounting income are the relevantinput, depreciation plays no role in capital budgeting.
   Under current laws and regulations, corporations mustuse straight-line depreciation for all assets whose lives are 3years or longer.
   If firms use accelerated depreciation, they will writeoff assets slower than they would under straight-line depreciation,and as a result projects’ forecasted NPVs are normally lower thanthey would be if straight-line depreciation were required for taxpurposes.
   If they use accelerated depreciation, firms can writeoff assets faster than they could under straight-line depreciation,and as a result projects’ forecasted NPVs are normally lower thanthey would be if straight-line depreciation were required for taxpurposes.
   If they use accelerated depreciation, firms can writeoff assets faster than they could under straight-line depreciation,and as a result projects’ forecasted NPVs are normally higher thanthey would be if straight-line depreciation were required for taxpurposes.
 .
2 points  
Question 27
 
Which of the following statements is CORRECT?
Answer    In a capital budgeting analysis where partof the funds used to finance the project would be raised as debt,failure to include interest expense as a cost when determining theproject’s cash flows will lead to an upward
bias in the NPV.
   In a capital budgeting analysis where part of thefunds used to finance the project would be raised as debt, failureto include interest expense as a cost when determining theproject’s cash flows will lead to a downward
bias in the NPV.
   The existence of any type of “externality” will reducethe calculated NPV versus the NPV that would exist without theexternality.
   If one of the assets to be used by a potential projectis already owned by the firm, and if that asset could be sold orleased to another firm if the new project were not undertaken, thenthe net after-tax proceeds that could be obtained should be chargedas a cost to the project under consideration.
   If one of the assets to be used by a potential projectis already owned by the firm but is not being used, then any costsassociated with that asset is a sunk cost and should beignored.
 .
2 points  
Question 28
 
Dalrymple Inc. is considering production of a new product.  Inevaluating whether to go ahead with the project, which of thefollowing items should NOT be explicitly considered when cash flowsare estimated?
Answer    The company will produce the new productin a vacant building that was used to produce another product untillast year.  The building could be sold, leased to anothercompany, or used in the future to produce another of the firm’sproducts.
   The project will utilize some equipment the companycurrently owns but is not now using.  A used equipment dealerhas offered to buy the equipment.
   The company has spent and expensed for tax purposes $3million on research related to the new detergent.  These fundscannot be recovered, but the research may benefit other projectsthat might be proposed in the future.
   The new product will cut into sales of some of thefirm’s other products.
   If the project is accepted, the company must invest $2million in working capital.  However, all of these funds willbe recovered at the end of the project’s life.
 .
2 points  
Question 29
 
Which of the following statements is CORRECT?
Answer    Sensitivity analysis is a good way tomeasure market risk because it explicitly takes into accountdiversification effects.
   One advantage of sensitivity analysis relative toscenario analysis is that it explicitly takes into account theprobability of specific effects occurring, whereas scenarioanalysis cannot account for probabilities.
   Well-diversified stockholders do not need to considermarket risk when determining required rates of return.
   Market risk is important, but it does not have adirect effect on stock prices because it only affects beta.
   Simulation analysis is a computerized version ofscenario analysis where input variables are selected randomly onthe basis of their probability distributions.
 .
2 points  
Question 30
 
Langston Labs has an overall (composite) WACC of 10%, whichreflects the cost of capital for its average asset.  Itsassets vary widely in risk, and Langston evaluates low-riskprojects with a WACC of 8%, average-risk projects at 10%, andhigh-risk projects at 12%.  The company is considering thefollowing projects:
 
                             Project                          Risk                  Expected Return
                                  A                              High                           15%
                                  B                           Average                        12%
                                  C                              High                           11%
                                  D                              Low                             9%
                                  E                              Low                             6%
 
Which set of projects would maximize shareholder wealth?
Answer    A and B.
   A, B, and C.
   A, B, and D.
   A, B, C, and D.
   A, B, C, D, and E.