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Chapter 12 - BUS 361 Sample Test```

1. Which of the following statements is correct?

a. Corporate risk is not important if a firm's stockholders are well-diversified.
b. Stockholders, including the owners of small businesses, who are not well-diversified are more concerned about corporate risk than market risk.
c. Empirical studies of the determinants of required rates of return (k) have found that only market risk affects stock prices.

2. ***Note: Problems 2, 3, 9 and 11 use the same information.***
You have been asked by the president of your company to evaluate the proposed acquisition of new equipment. The equipment's basic price is \$193,000, and shipping costs will be \$7,700. It will cost another \$23,200 to modify it for special use by your firm, and an additional \$13,500 to install the equipment. The equipment falls in the MACRS 3-year class, and it will be sold after three years for \$30,900. The equipment is expected to generate revenues of \$178,000 per year with annual operating costs (excluding depreciation) of \$84,000. The firm's tax rate is 45.0%. Under the MACRS 3-year class, you take 33% depreciation the first year, 45% the second year, 15% the third year, and 7% the fourth year. What is the operating cash flow for year 3 (ignoring the after-tax cash flow associated with the sale of the equipment)?

a. \$35,610
b. \$32,114
c. \$58,390
d. \$67,724

3. You have been asked by the president of your company to evaluate the proposed acquisition of new equipment. The equipment's basic price is \$193,000, and shipping costs will be \$7,700. It will cost another \$23,200 to modify it for special use by your firm, and an additional \$13,500 to install the equipment. The equipment falls in the MACRS 3-year class, and it will be sold after three years for \$30,900. The equipment is expected to generate revenues of \$178,000 per year with annual operating costs (excluding depreciation) of \$84,000. The firm's tax rate is 45.0%. Under the MACRS 3-year class, you take 33% depreciation the first year, 45% the second year, 15% the third year, and 7% the fourth year. What is the operating cash flow for year 2?

a. -\$7,056
b. \$99,774
c. -\$12,830
d. \$106,830

4. Ara Products estimated that a patented new product line has an NPV of \$6 million. However, the estimated NPV does not consider the fact that the new product line would reduce after-tax cash flows from existing lines. The estimated reduction would be \$750,000 per year for ten years. If the firm's cost of capital is 9.5%, what is the new product line's NPV after considering the reduction in after-tax cash flows for existing product lines?

a. \$6,000,000
b. -\$4,709,099
c. \$1,290,901
d. \$7,290,901

5. When evaluating a new project, the firm should consider 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 if the expenditures have been expensed for tax purposes.
c. Current rental income of a building owned by the firm if it is not used for this project.
d. The decline in sales of an existing product directly attributable to this project.

6. A cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected is called:

a. an incremental cost.
b. a sunk cost.
c. an externality.
d. a change in net operating working capital.

7. The increased current assets resulting from a new project minus the spontaneous increase in accounts payables and accruals is called the:

a. externalities.
b. opportunity cost.
c. sunk cost.
d. change in net operating working capital.

8. Which of the following statements is most correct?

a. Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.
b. One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of certain effects occurring, whereas scenario analysis does not consider probabilities.
c. Simulation analysis is a computerized version of scenario analysis that uses continuous probability distributions of the input variables.

9. You have been asked by the president of your company to evaluate the proposed acquisition of new equipment. The equipment's basic price is \$193,000, and shipping costs will be \$7,700. It will cost another \$23,200 to modify it for special use by your firm, and an additional \$13,500 to install the equipment. The equipment falls in the MACRS 3-year class, and it will be sold after three years for \$30,900. The equipment is expected to generate revenues of \$178,000 per year with annual operating costs (excluding depreciation) of \$84,000. The firm's tax rate is 45.0%. Under the MACRS 3-year class, you take 33% depreciation the first year, 45% the second year, 15% the third year, and 7% the fourth year. What is the value of the terminal year non-operating cash flows at the end of Year 3? (What is the after-tax cash flow associated with the sale of the equipment?)

a. \$24,473
b. \$16,995
c. \$14,282
d. \$7,855

10. ______________ is a technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or base-case, situation.

a. Cannibalization
b. Opportunity cost
c. Externalities
d. Scenario analysis

11. You have been asked by the president of your company to evaluate the proposed acquisition of new equipment. The equipment's basic price is \$193,000, and shipping costs will be \$7,700. It will cost another \$23,200 to modify it for special use by your firm, and an additional \$13,500 to install the equipment. The equipment falls in the MACRS 3-year class, and it will be sold after three years for \$30,900. The equipment is expected to generate revenues of \$178,000 per year with annual operating costs (excluding depreciation) of \$84,000. The firm's tax rate is 45.0%. Under the MACRS 3-year class, you take 33% depreciation the first year, 45% the second year, 15% the third year, and 7% the fourth year. What is the operating cash flow for year 1?

a. \$8,612
b. \$78,342
c. \$86,954
d. \$15,658

12. ______________ is the return on the best alternative use of an asset, or the highest return that will not be earned if funds are invested in a particular project.

a. Externalities
b. Sunk cost
c. Opportunity cost
d. Cannibalization

13. Beta from the CAPM can be used to measure the market risk of a project.

a. True
b. False

14. A company estimates that an average-risk project has a WACC of 10 percent, a below-average risk project has a WACC of 8 percent, and an above-average risk project has a WACC of 12 percent. Which of the following independent projects should the company accept?

a. Project A has average risk and a return of 9 percent.
b. Project B has below-average risk and a return of 8.5 percent.
c. Project C has above-average risk and a return of 11 percent.
d. All of the projects above should be accepted.

15. Based on "average" economic conditions, Becky Corporation has estimated that a project under consideration has an NPV of \$6 million. However, the company's president forecasts there is only a 50% chance that economic conditions will be average during the project's life. Recognizing this uncertainty, she has performed a scenario analysis. She feels there is a 20% chance that conditions will be below average and is this occurs the project's NPV would fall to -\$10 million. On the other hand, she feels there is also a 30% chance that conditions will be above average and if this occurs the project's NPV would rise to \$12 million. What is the project's expected NPV?

a. \$2.67 million
b. \$4.60 million
c. \$6.00 million
d. \$8.00 million