A firm in the 40% corporate tax bracket has two asset pools. There is no other asset left in Pool B after the sale.

	Asset Pool A	Asset Pool B
Existing un-depreciated capital cost (UCC)	$150	$350
Assets sold
Original cost	$400	$100
Proceeds from sales	$450	$300

1. What is the CCA recapture for Pool A and its total tax liability, if any?

____

A) $100; $0

B) $250; $100

C) $300; $180

D) $300; $50

E) $250; $110

1. How much is the terminal loss for Pool B?

____

A) $250

B) $200

C) $100

D) $50

E) Undetermined

1. Given the depreciable base C₀ = $250, CCA rate d = 20%, corporate tax rate T_c = 40%, and year 2 project operating income (S C) = $150, estimate the operating cash flow (OCF) at the end of year 2. The half-year rule applies when calculating the CCA deduction.

____

A) $250

B) $190

C) $108

D) $90

E) None of the above

Hint: OCF_t = (S_t C_t)(1 T_c) + (CCA_t)(T_c)

(The following information relates to Questions 7 to 9)

You are considering an investment in a process that promises to save you $75 every year. This process has an economic life of four years with a cost of $100. Such a capital cost is depreciated to zero with the straight-line method. Assume a 34% corporate tax rate and a discount rate of 10%.

1. What is the value of tax shields in each period that arises from the investment in this process?

____

A) $16.50

B) $26.95

C) $34.00

D) $8.50

E) None of the above

1. What is the (total) annual operating cash flow over the life of the project?

____

A) $49.50

B) $58.00

C) $75.00

D) $83.50

Hint:

1. What is the NPV of the investment in this process?

____

A) $62.25

B) $83.85

C) $114.50

D) $132.00

Hint:

1. Which of the following will NOT decrease the present value of the CCA tax shields associated with a capital investment project?

____

A) A decrease in the corporate tax rate

B) An increase in the discount rate

C) A decrease in the CCA rate

D) All of the above

E) None of the above

Hint:

1. If a project is expected to reduce inventory by $150, increase accounts payable by $100 and increase accounts receivable by $10, what kind of effect does working capital have during the life of the project?

____

A) Reduce investment outlay by $240

B) Reduce investment outlay by $60

C) Raise investment outlay by $40

D) Working capital has no effect during the life of this project

Hint:

1. M&M is considering the purchase of a new machine for $50,000, installed. M&M will use the CCA method to depreciate the machine. This machine is included in CCA class 8 (20%). MM expects to sell the machine at the end of its 4-year operating life for $10,000. If M&Ms tax rate is 40%, what will the present value of the CCA tax shield when it disposes of the machine at the end of year 4? Assume that the relevant discount rate is 10%.

____

A) $10,905

B) $9,059

C) $9,400

D) $8,930

E) $1,822

1. Consider a project with real cash flows (RCF) given below.

Year	0	1	2	3
Real Cash Flow	-$30	$10	$15	$20

The expected inflation rate (^e) is 5% a year and the nominal discount rate (k) is 15.5%. What is the NPV?

____

A) $2.88

B) $6.52

C) $10.40

D) -$16.50

Hint:

1. Which of the following is TRUE for capital budgeting analysis?

____

A) The interest paid on funds borrowed to finance a project must be included in the projects estimated cash flows

B) Only incremental cash flows are relevant when making accept/reject decisions

C) Since sunk costs are excluded from the annual cash flow calculation, they must be deducted from the present value of the projects other costs when reaching the accept/reject decision

D) All of the above

E) None of the above

1. ABC Co. is considering a new project whose data are shown below. The equipment has a constant capital cost allowance (CCA) over its 3-year life with a zero salvage value. No new working capital will be required. Revenues and cash operating costs are expected to be constant over the projects 3-year life. However, this project would compete with other ABC products and would reduce their pre-tax annual cash flows. What is the projects NPV?

Relevant discount rate 10%

Pre-tax cash flow reduction in other products

(cannibalization) $5,000

Investment cost $65,000

Annual CCA $21,665

Annual sales revenues $75,000

Annual cash operating costs $25,000

Corporate tax rate 35%

____

A) $25,269

B) $26,599

C) $27,929

D) $29,325

Hint: Cash flows are constant in years 1 to 3. The proposed CCA is for computational convenience although the actual CCA varies in years 1 to 3.

1. XYZ Inc. is considering investing in some new projection equipment whose data are shown below. The required equipment has a 7-year project life falling into a CCA class of 30%, but it would have a positive pre-tax salvage value at the end of year 7. Also, some new working capital will be needed, but it can be recovered at the end of the projects life. Revenues and cash operating costs are expected to be constant over the projects 7-year life. What is the NPV?

Relevant discount rate 12%

Net capital investment in fixed assets $950,000

Required new working capital $30,000

Sales revenues, each year $580,000

Cash operating costs, each year $330,000

Expected pre-tax salvage value $50,000

Corporate tax rate 35%

____

A) $13,965

B) $15,226

C) $16,910

D) $17,882

Hint:

NPV = PV(projects CF) + PV(tax shield) + PV(ending CF) initial investment

1. Which of the following is true regarding externalities?

____

A) If a project can create employment in a depressed region, firm should include such an externality in its NPV calculations

B) If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward

C) An externality is a situation where a project would have an adverse effect on some other part of the firms overall operations. If the project would have a favorable effect on other operations, then this is not an externality

D) Sometimes analysts think that an externality is present in a project, but they recognize that the particular externality cannot be quantified with any precision estimates of its effect would really just be guesses. In such a situation, the externality should be ignored, i.e. not considered at all, because if it were considered it would make the analysis appear more precise than it actually is

E) None of the above

1. Which of the following is true about capital cost allowance (CCA)?

____

A) Since CCA deduction is not a cash expense, it plays no role in capital budgeting

B) The CCA method uses a specific mandated CCA rate for each asset class

C) The CCA deduction is equal to the year-end UCC of the pool divided by the mandated CCA rate

D) The CCA method allows that the net capital cost of an asset is added to the pool in the year the asset is put in use.

E) Under the CCA method, higher CCA deductions occur in the early years. This reduces the early cash flows and thus lowers a projects projected NPV

1. What is the net operating cash flow in a particular year for a proposed project with the following data?

Sales revenues $35,000

Capital cost allowance, CCA $10,000

Cash operating costs $17,000

Interest expense $4,000

Tax rate 35%

____

A) $12,380

B) $13,032

C) $14,440

D) $15,200

1. DEF ltd. Is building a manufacturing plant that will require a cash outlay of $300,000 for the initial purchase of a building, $450,000 for remodeling in first year, and $710,000 for new equipment in the second year. If the firms discount rate is 12%, what will be the total investment cost at time zero?

____

A) $300,000

B) $1,460,000

C) $1,267,720

D) $1,132,070

1. A decision tree shows a 30% probability of $2 million in returns and a 70% chance of $1 million in returns. What is the maximum you would invest today in this project if the cash inflow occurs one year in the future and the discount rate is 10%?

____

A) $818,182

B) $1,181,818

C) $1,300,000

D) $1,363,636

1. Which of the following sources would most likely be responsible for persistent project cost overruns?

____

A) Rapidly rising inflation

B) Delays in obtaining contracts and permits

C) Lack of raw materials

D) Forecasting bias by the sponsoring manager

1. What is the NPV break-even for a project costing $4 million and generating cash flows according to (0.3 sales - $450,000)? Assume this project lasts for ten years and requires a discount rate of 12%.

____

A) $2,093,654

B) $2,359,047

C) $3,859,798

D) $13,783,333

Hint: PVIFA (12%, 10) = 5.65

1. If a 20% reduction in forecast sales would not extinguish a projects profitability, then sensitivity analysis would suggest

____

A) De-emphasizing that variable as a critical factor

B) Requiring a more detailed sales forecast

C) The initial sales forecast were inflated

D) A reallocation of fixed costs to this project

1. What happens to the NPV of a one-year project if fixed costs increase from $400 to $600? The firm has a 15% tax rate and a 12% cost of capital.

____

A) NPV decreases by $200.00

B) NPV decreases by $173.91

C) NPV decreases by $130.00

D) NPV decreases by $113.04

1. A firm has to select a project from among four mutually exclusive projects with the risk/return characteristics in the table below. Which of the following statements BEST describes how this selection should be made?

Project	A	B	C	D
Expected Return	23%	15%	18%	20%
Standard Deviation	12%	7.69%	8.23%	10.67%

____

A) Project A should be chosen because it has the highest expected return

B) Project B should be selected because it has a standard deviation of only 7.69%

C) Project C should be accepted because it has the lowest coefficient of variation

D) Project D should be picked because it has the highest coefficient of variation

1. Which of the flowing technique may be more appropriate to analyze projects with interrelated variables?

____

A) Sensitivity analysis

B) Scenario analysis

C) Breakeven analysis

D) Decision tree analysis

1. What is the maximum percentage of variable costs in relation to sales that a firm can experience and still break even with $5 million revenues, $1 million fixed costs and $500,000 depreciation?

____

A) 60%

B) 70%

C) 80%

D) 90%

Hint: EBIT = S C - D

1. Economic value added

____

A) Aligns the decision-making process with the objective of profit maximization

B) Aligns the decision-making process with the objective of share price maximization

C) Aligns the decision-making process with the objective of value maximization

D) Aligns the decision-making process with the objective of cost minimization

1. ABC Co. is deciding whether to invest in a project today or to postpone the decision until next year. The project has a positive expected NPV, but its cash flows could be less than expected, in which case the NPV would be negative. No competitors are likely to invest in a similar project if ABC decides to wait. Which of the following best describes the issues that ABC faces when considering this investment timing option?

____

A) The more uncertainty about the future cash flows, the more logical it is for ABC to go ahead with this project today

B) Since the project has a positive expected NPV today, this means that its expected NPV will be even higher if it chooses to wait a year

C) With a positive expected NPV today, the project should be accepted in order to lock in that NPV

D) Waiting would probably reduce the projects risk

1. Which of the following is not a real option?

____

A) The option to expand production if the product is successful

B) The option to buy shares of stock if its price goes up

C) The option to expand into a new geographic region

D) The option to switch the type of fuel used in an industrial furnace

E) None of the above

1. Which of the following is true about real options?

____

A) Real options affect the size, but not the risk, of a projects expected cash flows

B) Real options are most valuable when the underlying source of risk is very low

C) Real options are rights to buy real assets, like stocks, rather than interest-bearing assets, like bonds

D) All of the above

E) None of the above

1. Generally, the existence of a(n) ___ option reduces the downside risk of a project and should be considered in project analysis.

____

A) Abandonment

B) Flexibility

C) Timing

D) Growth

1. If an asset consistently goes up (down) by 1.2% when the market portfolio goes up (down) by 1.6%, then its beta equals

____

A) 0.75

B) 1.33

C) 1.92

D) Undetermined

Hint:

1. What is the beta for a portfolio with 60% invested in X and 40% invested in Y?

	Stock X	Stock Y
Expected Return	14%	18%
Standard Deviation	40%	54%
Beta	1.2	1.5
Correlation (X, Y) = 0.25

____

A) 1.42

B) 1.32

C) 1.22

D) 1.12

Hint:

1. What is the beta of the risk-free asset?

____

A) +1.0

B) 0

C) -0.5

D) -1.0

1. A common stock has a beta of 0.9, the risk-free rate is 7% and the market risk premium is 3%. If the rate of return is expected to be 8.5%, this stock has been ____ and its price would ____.

____

A) under-priced; rise

B) under-priced; fall

C) over-priced; rise

D) over-priced; fall