CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

1. Because of improvements in forecasting techniques, estimating the cash flows associated with a project
has become the easiest step in the capital budgeting process.

a. True

b. Fals
e

ANSWER:

False

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Cash flow estimation

KEYWORDS: Bloom’s: Knowledge

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

2. Estimating project cash flows is generally the most important, but also the most difficult, step in the
capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than
obtaining a reasonably accurate estimate of projects' cash flows.

a. True

b. Fals
e

ANSWER:

True

POINTS:


1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Cash flow estimation

Cengage Learning Testing, Powered by Cognero

Page 2


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS


KEYWORDS: Bloom’s: Knowledge

3. Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate,
projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for
large product development projects.

a. True

b. Fals
e

ANSWER:

False

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:


STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

Cengage Learning Testing, Powered by Cognero

Page 3


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

TOPICS:

Cash flow estimation

KEYWORDS: Bloom’s: Knowledge

4. Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash
balance sheet accounts such as inventory are not included in a capital budgeting analysis.

a. True

b. Fals
e

ANSWER:

False


POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
Cengage Learning Testing, Powered by Cognero

Page 4


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

capital

TOPICS:

Relevant cash flows


KEYWORDS: Bloom’s: Knowledge

5. 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. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:


Cengage Learning Testing, Powered by Cognero

Page 5


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Relevant cash flows

KEYWORDS: Bloom’s: Knowledge

6. If debt is to be used to finance a project, then when cash flows for a project are estimated, interest
payments should be included in the analysis.

a. True

b. Fals
e

ANSWER:

False


POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
Cengage Learning Testing, Powered by Cognero

Page 6


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Relevant cash flows


KEYWORDS: Bloom's: Comprehension

7. Any cash flows that can be classified as incremental to a particular project—i.e., results directly from the
decision to undertake the project—should be reflected in the capital budgeting analysis.

a. True

b. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

Cengage Learning Testing, Powered by Cognero

Page 7


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS


LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Relevant cash flows

KEYWORDS: Bloom’s: Knowledge

8. We can identify the cash costs and cash inflows to a company that will result from a project. These could
be called "direct inflows and outflows," and the net difference is the direct net cash flow. If there are other
costs and benefits that do not flow from or to the firm, but to other parties, these are called externalities, and
they need not be considered as a part of the capital budgeting analysis.

a. True

b. Fals
e

ANSWER:


False

POINTS:

1

DIFFICULTY:

EASY

Cengage Learning Testing, Powered by Cognero

Page 8


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

REFERENCES:

12-1 Conceptual Issues in Cash Flow Estimation

LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and

cost of capital

TOPICS:

Externalities

KEYWORDS:

Bloom’s: Knowledge

9. In cash flow estimation, the existence of externalities should be taken into account if those externalities
have any effects on the firm's long-run cash flows.

a. True

b. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY:

EASY


Cengage Learning Testing, Powered by Cognero

Page 9


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

REFERENCES:

12-1 Conceptual Issues in Cash Flow Estimation

LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS:

Externalities

KEYWORDS:

Bloom’s: Knowledge


10. Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified
with any precision—estimates of its effect would really just be guesses. In this case, 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 really is.

a. True

b. Fals
e

ANSWER:

False

RATIONALE: If the externality is potentially important, it should not be ignored, because then a
large error might be made. At the very least, it should be discussed, and possibly

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

the analysis should be done using several scenarios of its possible effects.

POINTS:

1


DIFFICULTY: EASY

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
ARDS:
capital

TOPICS:

Externalities

KEYWORDS: Bloom's: Comprehension

11. Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis
because capital budgeting relates to fixed assets, not working capital.

a. True

b. Fals

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

e

ANSWER:

False

POINTS:

1

DIFFICULTY:

EASY

REFERENCES:

12-2 Analysis of an Expansion Project

LEARNING OBJECTIV FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:


United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS:

Changes in NOWC

KEYWORDS:

Bloom’s: Knowledge

12. The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated
depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life,
is greater.

a. True

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

b. Fals
e

ANSWER:


False

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-2 Analysis of an Expansion Project
:

LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Depreciation cash flows

KEYWORDS: Bloom's: Comprehension

13. The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated
depreciation the present value of the tax savings provided by depreciation will be higher, other things held

constant.

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

a. True

b. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-2 Analysis of an Expansion Project
:

LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
BJECTIVES:


NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Depreciation cash flows

KEYWORDS: Bloom's: Comprehension

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

14. Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line
depreciation. This is because the total cash flows over the project's life will be higher if accelerated
depreciation is used, other things held constant.

a. True

b. Fals
e


ANSWER:

False

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-2 Analysis of an Expansion Project
:

LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Depreciation cash flows

KEYWORDS: Bloom's: Comprehension
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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

15. A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a
given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being
equal.

a. True

b. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-2 Analysis of an Expansion Project
:

LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
BJECTIVES:


NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

Cengage Learning Testing, Powered by Cognero

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

TOPICS:

Depreciation cash flows

KEYWORDS: Bloom's: Comprehension

16. Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward,
thus increasing their present value. On the other hand, using accelerated depreciation generally lowers the
reported current year's profits because of the higher depreciation expenses. However, the reported profits
problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

a. True

b. Fals

e

ANSWER:

True

POINTS:

1

DIFFICULTY: EASY

REFERENCES 12-2 Analysis of an Expansion Project
:

LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

Cengage Learning Testing, Powered by Cognero

Page 17


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Depreciation cash flows

KEYWORDS: Bloom's: Comprehension

17. If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with
the appropriate risk-adjusted discount rate.

a. True

b. Fals
e

ANSWER:

True

POINTS:

1

DIFFICULTY:

EASY

REFERENCES:


12-4 Risk Analysis in Capital Budgeting

LEARNING OBJECTIV FOFM.BRIG.16.12.04 - Risk Analysis in Capital Budgeting
ES:

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS:

Risk-adjusted discount rate

KEYWORDS:

Bloom’s: Knowledge

18. Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital

estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject
decisions for capital budgeting projects.

a. True

b. Fals
e

ANSWER:

False

POINTS:

1

DIFFICULTY: MODERATE

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
Cengage Learning Testing, Powered by Cognero

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

BJECTIVES:


NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Cash flow estimation

KEYWORDS: Bloom’s: Knowledge

19. It is extremely difficult to estimate the revenues and costs associated with large, complex projects that
take several years to develop. This is why subjective judgment is often used for such projects along with
discounted cash flow analysis.

a. True

b. Fals
e

ANSWER:

True

POINTS:


1

DIFFICULTY: MODERATE

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
Cengage Learning Testing, Powered by Cognero

Page 20


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

:

LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.15.03 - Capital budgeting and cost of
ARDS:
capital
United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds

TOPICS:

Cash flow estimation

KEYWORDS: Bloom’s: Knowledge


20. The two cardinal rules that financial analysts should follow to avoid errors are: (1) in the NPV equation,
the numerator should use income calculated in accordance with generally accepted accounting principles,
and (2) all incremental cash flows should be considered when making accept/reject decisions for capital
budgeting projects.

a. True

b. Fals
e

ANSWER:

False

POINTS:

1

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Page 21


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

DIFFICULTY: MODERATE

REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation
:


LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
BJECTIVES:

NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
ANDARDS:

STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds
ARDS:
United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS:

Relevant cash flows

KEYWORDS: Bloom’s: Knowledge

21. Opportunity costs include those cash inflows that could be generated from assets the firm already owns if
those assets are not used for the project being evaluated.

a. True

b. Fals
e

ANSWER:

True


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Page 22


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

POINTS:

1

DIFFICULTY:

MODERATE

REFERENCES:

12-1 Conceptual Issues in Cash Flow Estimation

LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital


TOPICS:

Opportunity costs

KEYWORDS:

Bloom’s: Knowledge

22. Suppose Walker Publishing Company is considering bringing out a new finance text whose projected
revenues include some revenues that will be taken away from another of Walker's books. The lost sales on
the older book are a sunk cost and as such should not be considered in the analysis for the new book.

a. True

b. Fals
e

ANSWER:

False

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Page 23


CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

POINTS:


1

DIFFICULTY:

MODERATE

REFERENCES:

12-1 Conceptual Issues in Cash Flow Estimation

LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS:

Sunk costs

KEYWORDS:

Bloom's: Comprehension

23. The change in net operating working capital associated with new projects is always positive, because

new projects mean that more operating working capital will be required.

a. True

b. Fals
e

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CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS

ANSWER:

False

POINTS:

1

DIFFICULTY:

MODERATE

REFERENCES:

12-2 Analysis of an Expansion Project


LEARNING OBJECTIV FOFM.BRIG.16.12.02 - Analysis of an Expansion Project
ES:

NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking
DS:

STATE STANDARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS:

NOWC

KEYWORDS:

Bloom's: Comprehension

24. The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be
lower, and cash flows higher, during every year of a project's life, other things held constant.

a. True

b. Fals
e

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Page 25