50 Multiple Choice Business – Finance Questions

1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.

The relatively well posed project with promises of great future pay offs must be examined closely nevertheless to determine its true profitability. As such, the Super Project’s NPV must be calculated, however before we proceed we must acknowledge the relevant cash flows. The project incurred an expense of testing the market. This expense, however, must not be included in our cash flow analysis because it can be considered a sunk cost. This expense is required for ‘taking a temperature’ of the market and will not be recovered. Other sources of cash flow include:

2. Use the projections provided in the case to compute the incremental cash flows for the PCB project. Provide a reasonable estimate for cash flows after 2009 as well.

Moreover, Robert Gates’ estimation of the price increase (2.0%) differs from the information provided in the case (1.7%). This overestimates revenue and thereby FCF. To make better projections for the firms’ FCF, Robert Gates would also have to consider the opportunity cost of alternative investments, the risk exposure throughout the project and operational risks after three years.

b) The decision to invest in projects increases the shareholders value of the company. This is consistent with the growth and from the NPV criteria, positive NPV of projects increases the shareholder's value.

Project A: This project is new to your company. You do not feel confident in estimating the project costs using internal resources. There are other companies that have done this type of work. Yet you still want the most accurate estimates possible.

a) Apply the coefficient-of-variation decision criterion to these alternatives to find out which is preferred by the angel investor, assuming that he/she is risk-averse.

a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?

Capital budgeting decisions involve investments requiring large cash outlays at the beginning of the life of the project and commit the firm to a particular course of action over a relatively long period of time. As such, they are costly and difficult to reverse, both because of: (1) their large cost and (2) the fact that they involve fixed assets, which cannot be liquidated easily.

"a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what

later in the project life. With a NPV of less than -$810,000, Scenario 6 is the project with the

These two decisions and the net pay off would be influenced by two key uncertainties viz. whether

a) When the machine was bought for Lift-Off productions the cost has been calculated; and

5. The project is assumed to end in year 4. Do you think that this is realistic? Can you estimate the value of the project’s operating cash flows beyond year 4? State any assumptions you made.

Mutually exclusive projects are another situation for which NPV must extend its approach. In such projects, the chosen project is usually one which results in the greatest positive NPV because this will produce the greatest addition to shareholders’ wealth. In the case of mutually exclusive investments, ranking becomes crucial as only