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Topsider Inc.is considering the purchase of a new leather-cutting machine to replace an existing machine that has a book value of $3,000 and can be sold for $1,500.The old machine is being depreciated on a straight-line basis,and its estimated salvage value 3 years from now is zero.The new machine will reduce costs (before taxes) by $7,000 per year.The new machine has a 3-year life,it costs $14,000,and it can be sold for an expected $2,000 at the end of the third year.The new machine would be depreciated over its 3-year life using the MACRS method.Assuming a 40 percent tax rate and a required rate of return of 16 percent,find the new machine's NPV.


A) -$2,822
B) $1,658
C) $4,560
D) $15,374
E) $9,821

F) B) and C)
G) C) and D)

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The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR  k at the margin)is called capital rationing.

A) True
B) False

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When evaluating the cash flows associated with a capital budgeting project,shipping and installation costs associated with the purchase of an asset,such as a lathe,are considered part of the


A) initial investment outlay because these expenses effectively are part of the asset's purchase price.
B) incremental operating cash flows because shipping and installation costs represent expenses that have to be written off over the life of the asset.
C) terminal cash flows, because these expenses aren't paid until the end of the asset's life.
D) sunk costs because these expenses do not affect any current or future cash flows associated with investing in the asset.
E) None of the above is a correct answer.

F) B) and D)
G) A) and B)

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Which of the following is not discussed in the text as a method for analyzing risk in capital budgeting?


A) Sensitivity analysis.
B) Beta, or CAPM, analysis.
C) Monte Carlo simulation.
D) Scenario analysis.
E) All of the above are discussed in the text as methods of analyzing risk in capital budgeting.

F) A) and D)
G) C) and E)

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In theory,the decision maker should view market risk as being of primary importance.However,within-firm,or corporate,risk is relevant to a firm's


A) Well-diversified stockholders, because it may affect debt capacity and operating income.
B) Management, because it affects job stability.
C) Creditors, because it affects the firm's credit worthiness.
D) All of the above are correct.
E) Only answers a and c are correct.

F) B) and E)
G) A) and E)

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If the firm is being operated so as to maximize shareholder wealth,and if our basic assumptions concerning the relationship between risk and return are true,then which of the following should be true?


A) If the beta of the asset is larger than the firm's beta, then the required return on the asset is less than the required return on the firm.
B) If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm.
C) If the beta of the asset is greater than the corporate beta prior to the addition of that asset, then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.
D) If the beta of an asset is larger than the corporate beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.
E) None of the above is a true statement.

F) D) and E)
G) A) and B)

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If a typical U.S.company uses the same discount rate to evaluate all projects,the firm will most likely become


A) Riskier over time, and its value will decline.
B) Riskier over time, and its value will rise.
C) Less risky over time, and its value will rise.
D) Less risky over time, and its value will decline.
E) There is no reason to expect its risk position or value to change over time as a result of its use of a single discount rate.

F) B) and C)
G) A) and D)

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Mom's Cookies Inc.is considering the purchase of a new cookie oven.The original cost of the old oven was $30,000; it is now 5 years old,and it has a current market value of $13,333.33.The old oven is being depreciated over a 10-year life towards a zero estimated salvage value on a straight line basis,resulting in a current book value of $15,000 and an annual depreciation expense of $3,000.The old oven can be used for 6 more years but has no market value after its depreciable life is over.Management is contemplating the purchase of a new oven whose cost is $25,000 and whose estimated salvage value is zero.Expected before-tax cash savings from the new oven are $4,000 a year over its full MACRS depreciable life.Depreciation is computed using MACRS over a 5-year life,and the required rate of return is 10 percent.Assume a 40 percent tax rate.What is the net present value of the new oven?


A) -$2,418
B) -$1,731
C) $1,568
D) $163
E) $1,731

F) C) and D)
G) A) and C)

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If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.

A) True
B) False

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A key difference between replacement and expansion project analyses is that with replacement,the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets.

A) True
B) False

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Which of the following rules are essential to successful cash flow estimates,and ultimately,to successful capital budgeting?


A) The return on invested capital is the only relevant cash flow.
B) Only incremental cash flows are relevant to the accept/reject decision.
C) Total cash flows are relevant to capital budgeting analysis and the accept/reject decision.
D) All of the above are correct.
E) Only answers a and b are correct.

F) B) and E)
G) A) and E)

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Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because


A) it represents a tax-deductible cash expense.
B) the firm has a cash outflow equal to the depreciation expense each year.
C) although it is a non-cash expense, depreciation has an impact on the taxes paid by the firm, which is a cash flow.
D) depreciation is a sunk cost.
E) None of the above is correct.

F) None of the above
G) D) and E)

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How do most firms deal with the risks of projects when making capital budgeting decisions?


A) Projects risks are not considered directly because the weighted average cost of capital (WACC) that is used as the required rate of return for capital budgeting decisions is based on the riskiness of the firm. As a result, all projects, no matter their risks, can be evaluated using WACC.
B) Evaluating risk is important only when the projects are similar to the firm's existing assets.
C) Most firms adjust the discount rates used to evaluate new projects that have significantly different risks than the risk associated with the firm's existing assets.
D) Firms generally increase the required rate of return used to evaluate projects that have significantly different risks than the risk associated with the firm's existing assets, regardless of whether the new projects' risks are higher or lower.
E) None of the above is a correct answer.

F) A) and E)
G) None of the above

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The stand-alone risk is the risk an asset would have if it were a firm's only asset and it is measured by the variability of the asset's expected returns.

A) True
B) False

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After a long drought,the manager of Long Branch Farm is considering the installation of an irrigation system which will cost $100,000.It is estimated that the irrigation system will increase revenues by $20,500 annually,although operating expenses other than depreciation will also increase by $5,000.The system will be depreciated using MACRS over its depreciable life (5 years) to a zero salvage value.If the tax rate on ordinary income is 40 percent,what is the project's IRR?


A) 12.6%
B) -1.3%
C) 13.0%
D) 10.2%
E) -4.8%

F) A) and B)
G) A) and C)

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The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.

A) True
B) False

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Which of the following cash flows are incremental cash flows that need to be considered when evaluating a capital project?


A) Interest expenses on the financing of the project.
B) Sunk costs of engineering study to determine the feasibility of the project.
C) Opportunity cost of land being used for project that the firm already owns.
D) Both a and b are correct.
E) None of the above.

F) None of the above
G) D) and E)

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Which of the following is not a cash flow that results from the decision to accept a project?


A) Changes in working capital.
B) Shipping and installation costs.
C) Sunk costs.
D) Opportunity costs.
E) Externalities.

F) C) and D)
G) A) and E)

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According to the text,the financial staff's role in the forecasting process centers on


A) Developing the original assumptions used in estimating each project's cash flows.
B) Making sure that no biases are inherent in the forecasts.
C) Deciding which projects are strategically important to the firm.
D) Setting the sales price and quantity estimates for use by other departments.
E) All of the above.

F) All of the above
G) D) and E)

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Which of the following statements is correct?


A) A relatively risky future cash outflow should be evaluated using a relatively low discount rate.
B) If a firm's managers want to maximize the value of the stock, they should concentrate exclusively on projects' market, or beta, risk.
C) If a firm evaluates all projects using the same required rate of return to determine NPVs, then the riskiness of the firm as measured by its beta will probably decline over time.
D) If a firm has a beta which is less than 1.0, say 0.9, this would suggest that its assets' returns are negatively correlated with the returns of most other firms' assets.
E) The above statements are all false.

F) C) and D)
G) A) and B)

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