CHAPTER 13 CAPITAL BUDGETING: ESTIMATING CASH FLOWS AND ANALYZING RISK (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: (13.1) Relevant cash flows Answer: a Diff: E 1 . Any cash flow that can be classified as incremental is relevant in a capital budgeting project analysis. a. True b. False (13.1) Cash flow estimation Answer: b Diff: E 2 . With the current techniques available, estimating cash flows has become the easiest step in the analysis of a capital budgeting project. a. True b. False (13.1) Cash flow estimation Answer: a Diff: E 3 . Estimating project cash flows is considered the most important and the most difficult step in the capital budgeting process. Both the number of variables and the interdepartmental nature of the process contribute to the difficulty of estimating cash flows. a. True b. False (13.1) Cash flow estimation Answer: b Diff: E 4 . Although it is difficult to make accurate forecasts, the initial outlays and subsequent costs of large projects are forecast with great accuracy, but revenues are more uncertain and large errors are not uncommon. a. True b. False (13.1) Incremental cash flows Answer: a Diff: E 5 . Net incremental cash flow is calculated by adding back the change in depreciation to the change in net income. a. True b. False Chapter 13: Capital Budgeting: Cash Flows and Risk Page 1
(13.3) Externalities Answer: b Diff: E 6 . In cash flow estimation, the presence of externalities has no direct cash flow effects. a. True b. False (13.3) Externalities Answer: b Diff: E 7 . Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this, they should be excluded from the financial analyses. a. True b. False (13.4) Relevant cash flows Answer: b Diff: E 8 . 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 relevant in the analysis. a. True b. False (13.4) Relevant cash flows Answer: a Diff: E 9 . 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 (13.4) Relevant cash flows Answer: b Diff: E 10 . When calculating the cash flows for a project, you should include interest payments. a. True b. False (13.4) Net operating working capital Answer: b Diff: E 11 . Changes in net operating working capital do not need to be considered in capital budgeting cash flow analysis as long as the nominal (undiscounted) values of the changes are identical in each time period. a. True b. False Page 2 Chapter 13: Capital Budgeting: Cash Flows and Risk
(13.4) Depreciation cash flows Answer: b Diff: E 12 . The primary advantage of accelerated depreciation over straight-line depreciation is that the total, undiscounted, depreciation tax savings over the life of the project are greater when an accelerated depreciation method is used. a. True
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