This document contains a 20 question multiple choice quiz on cash flow estimation and risk analysis for a Financial Management course. The questions cover topics such as sensitivity analysis, estimating cash flows, adjusting discount rates for risk, including vs excluding certain costs in cash flow analysis, and scenario analysis. Sample calculations are provided for some questions.

1. UNIVERSITY OF THE EAST
Caloocan Campus
BFM 114 - Financial Management, Part 2
Quiz # 7
Cash Flow Estimation and Risk Analysis
Name: Klea D. Orosa
Date: 03-28-17
MULTIPLE CHOICE
Instruction: Encircle your final answers in this questionnaire. NO ERASURES ALLOWED.
1. First Statement: Sensitivity analysis is a risk analysis technique in which key variables are
changed and the resulting changes in the NPV and IRR are observed.
Second Statement: Sensitivity analysis measures the stand-alone risk of a project by showing
how much the project's NPV is affected by a small change in one of the input variables, such
as sales. Other things held constant, with the independent variable graphed on the
horizontal axis, the steeper the graph of the relationship line, the less risky the project.
a. Only the First Statement is True
b. Only the Second Statement is True
c. Both statements are True
d. None of the statements are True
e. Both statements cannot be determined if true or not
2. First Statement: With the current techniques available, estimating cash flows has become the
easiest step in the analysis of a capital budgeting project.
Second Statement: 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. Only the First Statement is True
b. Only the Second Statement is True
c. Both statements are True
d. None of the statements are True
e. Both statements cannot be determined if true or not
3. First Statement: Suppose a firm is considering production of a new product whose projected
sales include sales that will be taken away from another product the firm also produces. The
lost sales on the existing product are a sunk cost and are not a relevant cost to the new
product.
Second Statement: 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 judgement
is recommended for such projects instead of cash flow analysis.
a. Only the First Statement is True
b. Only the Second Statement is True
c. Both statements are True
d. None of the statements are True
e. Both statements cannot be determined if true or not
4. First Statement: In cash flow estimation, the presence of externalities has no direct cash flow
effects.
Second Statement: Net incremental operating cash flow is calculated by adding back the
change in depreciation to the change in income after taxes.
a. Only the First Statement is True
b. Only the Second Statement is True
c. Both statements are True
d. None of the statements are True
e. Both statements cannot be determined if true or not

2. 5. Risk in a revenue producing project can best be adjusted for by:
a. ignoring it.
b. Adjusting the discount rate upward for increasing risk.
c. Adjusting the discount rate downward for increasing risk.
d. Picking a risk factor equal to the average discount rate.
e. Reducing the NPV by 10 per cent for risky projects.
6. 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.
7. Which of the following statements is correct?
a. If a firm's stockholders are well diversified, we know from theory and from studies of market
behaviour that corporate risk is not important.
b. Undiversified stockholders, including the owners of small businesses, are more concerned about
corporate risk than market risk.
c. Empirical studies of the determinants of required rates of return (k) have found that only market
risk affects stock prices.
d. Market risk is important but does not have a direct effect on stock price because it only affects
beta.
e. Cash flows will only include actual inflows and outflows of a project so that accuracy is assured.
8. Regarding the net present value of a replacement decision, which of the following statements
is false?
a. The present value of the after-tax cost reduction benefits resulting from the new investment is
treated as an inflow.
b. The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment
outlay).
c. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is
treated as an inflow.
d. Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow
at t = 0 (initial investment outlay).
e. An increase in net working capital is treated as an outflow when the project begins (initial
investment outlay) and as an inflow when the project ends (terminal cash flow).
9. Which of the following methods involves calculating an average beta for firms in a similar
business and then applying that beta to determine the beta of its own project?
a. Risk premium method.
b. Pure play method.
c. Accounting beta method.
d. CAPM method.
e. Pure play method and accounting beta method.
10. If a company uses the same discount rate for evaluating all projects, which of the following
results is likely?
a. Accepting poor, high-risk projects.
b. Rejecting good, low-risk projects.
c. Accepting only good, low-risk projects.
d. Accepting no projects.
e. Accepting poor, high-risk projects and rejecting good, low-risk projects.

3. 11. 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 maximise 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. These statements are all false.
12. Which of the following statements is CORRECT?
a. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV
method.
b. A good example of a sunk cost is a situation where a bank opens a new office, and that new office
leads to a decline in deposits of the bank's other offices.
c. A good example of a sunk cost is money that a banking corporation spent last year to investigate
the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to
go forward with the project.
d. If sunk costs are considered and reflected in a project's cash flows, then the project's calculated
NPV will be higher than it otherwise would be.
e. An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore
has been depleted.
13. The CFO of Cicero Industries plans to calculate a new project's NPV by estimating the
relevant cash flows for each year of the project's life (i.e., the initial investment cost, the
annual operating cash flows, and the terminal cash flow), then discounting those cash flows
at the company's overall WACC. Which one of the following factors should the CFO be sure to
INCLUDE in the cash flows when estimating the relevant cash flows?
a. All sunk costs that have been incurred relating to the project.
b. All interest expenses on debt used to help finance the project.
c. The investment in working capital required to operate the project, even if that investment will be
recovered at the end of the project's life.
d. Sunk costs that have been incurred relating to the project, but only if those costs were incurred
prior to the current year.
e. Effects of the project on other divisions of the firm, but only if those effects lower the project's
own direct cash flows.
14. Which of the following factors should be included in the cash flows used to estimate a
project's NPV?
a. Interest on funds borrowed to help finance the project.
b. The end-of-project recovery of any working capital required to operate the project.
c. Cannibalization effects, but only if those effects increase the project's projected cash flows.
d. Expenditures to date on research and development related to the project, provided those costs
have already been expensed for tax purposes.
e. All costs associated with the project that have been incurred prior to the time the analysis is being
conducted.
15. When evaluating a new project, firms should include in the projected cash flows all of the
following EXCEPT:
a. Interest on funds borrowed to help finance the project.
b. The end-of-project recovery of any working capital required to operate the project.
c. Cannibalization effects, but only if those effects increase the project's projected cash flows.
d. Expenditures to date on research and development related to the project, provided those costs
have already been expensed for tax purposes.
e. All costs associated with the project that have been incurred prior to the time the analysis is being
conducted.

4. 16. Collins Inc. is investigating whether to develop a new product. In evaluating whether to go
ahead with the project, which of the following items should NOT be explicitly considered
when cash flows are estimated?
a. The project will utilize some equipment the company currently owns but is not now using. A used
equipment dealer has offered to buy the equipment.
b. The company has spent and expensed for tax purposes $3 million on research related to the new
detergent. These funds cannot be recovered, but the research may benefit other projects that
might be proposed in the future.
c. The new product will cut into sales of some of the firm's other products.
d. If the project is accepted, the company must invest $2 million in working capital. However, all of
these funds will be recovered at the end of the project's life.
e. The company will produce the new product in a vacant building that was used to produce another
product until last year. The building could be sold, leased to another company, or used in the
future to produce another of the firm's products.
17. Which of the following rules is CORRECT for capital budgeting analysis?
a. Only incremental cash flows, which are the cash flows that would result if a project is accepted,
are relevant when making accept/reject decisions.
b. Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the
project's other costs when reaching the accept/reject decision.
c. A proposed project's estimated net income as determined by the firm's accountants, using
generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this
income stream exceeds the project's cost, the project should be accepted.
d. If a product is competitive with some of the firm's other products, this fact should be incorporated
into the estimate of the relevant cash flows. However, if the new product is complementary to
some of the firm's other products, this fact need not be reflected in the analysis.
e. The interest paid on funds borrowed to finance a project must be included in estimates of the
project's cash flows.
18. Which one of the following would NOT result in incremental cash flows and thus should NOT
be included in the capital budgeting analysis for a new product?
a. A new product will generate new sales, but some of those new sales will be from customers who
switch from one of the firm's current products.
b. A firm must obtain new equipment for the project, and $1 million is required for shipping and
installing the new machinery.
c. A firm has spent $2 million on R&D associated with a new product. These costs have been
expensed for tax purposes, and they cannot be recovered regardless of whether the new project is
accepted or rejected.
d. A firm can produce a new product, and the existence of that product will stimulate sales of some of
the firm's other products.
e. A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for
agricultural purposes.
19. Which one of the following would NOT result in incremental cash flows and thus should NOT
be included in the capital budgeting analysis for a new product?
a. Revenues from an existing product would be lost as a result of customers switching to the new
product.
b. Shipping and installation costs associated with a machine that would be used to produce the new
product.
c. The cost of a study relating to the market for the new product that was completed last year. The
results of this research were positive, and they led to the tentative decision to go ahead with the
new product. The cost of the research was incurred and expensed for tax purposes last year.
d. It is learned that land the company owns and would use for the new project, if it is accepted, could
be sold to another firm.
e. Using some of the firm's high-quality factory floor space that is currently unused to produce the
proposed new product. This space could be used for other products if it is not used for the project
under consideration.

5. 20. Which of the following statements is CORRECT?
a. An example of an externality is a situation where a bank opens a new office, and that new office
causes deposits in the bank's other offices to increase.
b. The NPV method automatically deals correctly with externalities, even if the externalities are not
specifically identified, but the IRR method does not. This is another reason to favor the NPV.
c. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not
specifically identified. However, the payback method does not.
d. Identifying an externality can never lead to an increase in the calculated NPV.
e. An externality is a situation where a project would have an adverse effect on some other part of
the firm's overall operations. If the project would have a favorable effect on other operations, then
this is not an externality.
PART 2: PROBLEMS
Reminders: NO ERASURES ALLOWED. NO SOLUTION NO SCORE.
21. DeVault Services recently hired you as a consultant to help with its capital budgeting process.
The company is considering a new project whose data are shown below. The equipment that
would be used has a 3-year tax life, would be depreciated by the straight-line method over its
3-year life, and would have a zero salvage value. No new working capital would be required.
Revenues and other operating costs are expected to be constant over the project's 3-year life.
What is the project's NPV?
a. $15,740
b. $16,569
c. $17,441
d. $18,359
e. $19,325
22. An all-equity firm is analysing a potential project which will require an initial, after-tax cash
outlay of $50,000 and after-tax cash inflows of $6,000 per year for 10 years. In addition, this
project will have an after-tax salvage value of $10,000 at the end of Year 10. If the risk-free
rate is 6 per cent, the return on an average stock is 10 per cent, and the beta of this project is
1.50, then what is the project's NPV?
a. $13,210
b. $4,905
c. $7,121
d. -$6,158
e. -$12,879
23. Whitney Crane Inc. has the following independent investment opportunities for the coming
year:
Project Cost
Annual Cash
Inflows Life (years) IRR
A $10,000 $11,800 1 .18
B 5,000 3,075 2 15
C 12,000 5,696 3 .20
D 3,000 1,009 4 13
The IRRs for Project A and C, respectively, are:
a. 16 per cent and 14 per cent 10,000=11,800(1+X)^-1
*interpolateb. 18 per cent and 10 per cent
c. 18 per cent and 20 per cent
d. 18 per cent and 13 per cent 12,000=5,696(1-(1+X)^-3/X)
e. 16 per cent and 13 per cent

6. 24. Klott Company encounters significant uncertainty with its sales volume and price in its
primary product. The firm uses scenario analysis in order to determine an expected NPV,
which it then uses in its budget. The base case, best case, and worst case scenarios and
probabilities are provided in the table below. What is Klott's expected NPV, standard
deviation of NPV, and coefficient of variation of NPV?
Probability of
Outcome
Unit Sales
Volume
Sales
Price
NPV
(In Thousands)
Worst case 0.30 6,000 $3,600 -$6,000
Base case 0.50 10,000 4,200 +13,000
Best case 0.20 13,000 4,400 +28,000
a. Expected NPV = $35,000; σNPV = 17,500; CVNPV = 2.0. -6000 (.30) -1800
b. Expected NPV = $35,000; σNPV = 11,667; CVNPV = 0.33. 13000 (.50) 6500
c. Expected NPV = $10,300; σNPV = 12,083; CVNPV = 1.17. 28000 (.20) 5600
d. Expected NPV = $13,900; σNPV = 8,476; CVNPV = 0.61. 10300
e. Expected NPV = $10,300; σNPV = 13,900; CVNPV = 1.35. 12083/10300=1.17
25. Kasper Film Co. is selling off some old equipment it no longer needs because its associated
project has come to an end. The equipment originally cost $22,500, of which 75% has been
depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%.
What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note
that if the equipment's final market value is less than its book value, the firm will receive a
tax credit as a result of the sale.
a. $5,558
b. $5,850
c. $6,143
d. $6,450
e. $6,772
26. Weston Clothing Company is considering manufacturing a new style of shirt, whose data are
shown below. The equipment to be used would be depreciated by the straight-line method
over its 3-year life and would have a zero salvage value, and no new working capital would
be required. Revenues and other operating costs are expected to be constant over the
project's 3-year life. However, this project would compete with other Weston's products and
would reduce their pre-tax annual cash flows. What is the project's NPV?
Cost of capital 10.0%
Pre-tax cash flow reduction for other products (cannibalization) $5,000
Investment cost (depreciable basis) $80,000
Straight-line deprec. rate 33.333%
Sales revenues, each year for 3 years $67,500
Annual operating costs (excl. deprec.) $25,000
Tax rate 35.0%
a. $3,636
b. $3,828
c. $4,019
d. $4,220
e. $4,431

7. 27. Alabama Pulp Company (APC) can control its environmental pollution using either ‘Project
Old Tech’ or ‘Project New Tech.’ Both will do the job, but the actual costs involved with
Project New Tech, which uses unproved, new state-of-the-art technology, could be much
higher than the expected cost levels. The cash outflows associated with Project Old Tech,
which uses standard proven technology, are less risky--they are about as uncertain as the
cash flows associated with an average project. APC's required rate of return for average risk
projects is normally set at 12 per cent, and the company adds 3 per cent for high risk projects
but subtracts 3 per cent for low risk projects. The two projects in question meet the criteria
for high and average risk, but the financial manager is concerned about applying the normal
rule to such cost-only projects. You must decide which project to recommend, and you should
recommend the one with the lower PV of costs. What is the PV of costs of the better project?
Cash Outflows
Years 0 1 2 3 4
Project New Tech 1,500 315 315 315 315
Project Old Tech 600 600 600 600 600
a. 2,521 315(1-(1.09)^-4/.09)
b. 2,399 -1020.51+-1500=-2520
c. 2,457 600(1-(1.12)^-4/.12)
d. 2,543 -1822.41+-600=-2422.40
e. 2,422 *.12-.03=.09
28. Century Roofing is thinking of opening a new warehouse, and the key data are shown below.
The company owns the building that would be used, and it could sell it for $100,000 after
taxes if it decides not to open the new warehouse. The equipment for the project would be
depreciated by the straight-line method over the project's 3-year life, after which it would be
worth nothing and thus it would have a zero salvage value. No new working capital would be
required, and revenues and other operating costs would be constant over the project's 3-
year life. What is the project's NPV?
Project cost of capital (r) 10.0%
Opportunity cost $100,000
Net equipment cost (depreciable basis) $65,000
Straight-line deprec. rate for equipment 33.333%
Sales revenues, each year $123,000
Operating costs (excl. deprec.), each year $25,000
Tax rate 35%
a. $10,521
b. $11,075
c. $11,658
d. $12,271
e. $12,885
29. McLeod Inc. is considering an investment that has an expected return of 15% and a standard
deviation of 10%. What is the investment's coefficient of variation?
a. 0.67 ER .15
SD .10
.10/.15
CV= .67
b. 0.73
c. 0.81
d. 0.89
e. 0.98

8. 30. Brandt Enterprises is considering a new project that has a cost of $1,000,000, and the CFO
set up the following simple decision tree to show its three most likely scenarios. The firm
could arrange with its work force and suppliers to cease operations at the end of Year 1
should it choose to do so, but to obtain this abandonment option, it would have to make a
payment to those parties. How much is the option to abandon worth to the firm?
a. $55.08
b. $57.98
c. $61.03
d. $64.08
e. $67.29
31 - 35.
Choose only 2 questions to answer. Use a separate sheet for your answers.
 How will you use the concepts of Financial Management in your daily life?
 If you are going to invest in the future, are you going to invest for stocks, bonds or other type
of an investment? Why are you going to choose this option?
 Are you going to diversify your investments? Explain.
 In today’s global economic situation where the future is uncertain/unpredictable, do you
believe investing in the Philippines is still wise? Why or why not?
 How will you explain to a normal person about the stock market?
God Bless and Good Luck to your Departmental Exams! :)

9.  How will you use the concepts of Financial Management in your daily life?
I will use financial management in my life through investing in financial security that
some bank offered. Through FM it will help me to read the pulse of changing market and
the riskiness of it.
 If you are going to invest in the future, are you going to invest for stocks, bonds or other type
of an investment? Why are you going to choose this option?
I will invest in insurance investment, based on insurance broker at the bank it is the best
substitute for time deposits for it will give you higher return plus no worry about having
loss for they will introduce you to the companies who are already stable in the market in
case of crisis in the market the insurance company will be the one to full out all the
investment and reinvest it to other partnered companies.
 Are you going to diversify your investments? Explain.
Yes, it’s better to divers the money you have in the bank than let it sleep it on saving acct
and earn nothing. Instead I will seek consultation or advice at the bank who knows well
than I do on what are the other ways that I can do to earn more money through
investments.
In today’s global economic situation where the future is uncertain/unpredictable, do you
believe investing in the Philippines is still wise? Why or why not
Yes, I do believe it’s still wise to invest as long as you know where, who are you
transacting with and don’t be afraid to seek advice to the expert in that field for they will
give you lots of knowledge and strategy in what is the best choice to do.
 How will you explain to a normal person about the stock market?
Based on my experience whenever my tito’s whose working aboard asked me about it
they are so curious about what it is and how it is. Explains it through basic level wherein
they can understand it and give them the knowledge of pros & cons about the investment,
sharing them your own experience about it and how to have it. Give them information
that is understandable and avoid using confusing words (jargon). Eventually it will help
them to start their own.

10.  How will you use the concepts of Financial Management in your daily life?
I will use financial management in my life through investing in financial security that
some bank offered. Through FM it will help me to read the pulse of changing market and
the riskiness of it.
 If you are going to invest in the future, are you going to invest for stocks, bonds or other type
of an investment? Why are you going to choose this option?
I will invest in insurance investment, based on insurance broker at the bank it is the best
substitute for time deposits for it will give you higher return plus no worry about having
loss for they will introduce you to the companies who are already stable in the market in
case of crisis in the market the insurance company will be the one to full out all the
investment and reinvest it to other partnered companies.
 Are you going to diversify your investments? Explain.
Yes, it’s better to divers the money you have in the bank than let it sleep it on saving acct
and earn nothing. Instead I will seek consultation or advice at the bank who knows well
than I do on what are the other ways that I can do to earn more money through
investments.
In today’s global economic situation where the future is uncertain/unpredictable, do you
believe investing in the Philippines is still wise? Why or why not
Yes, I do believe it’s still wise to invest as long as you know where, who are you
transacting with and don’t be afraid to seek advice to the expert in that field for they will
give you lots of knowledge and strategy in what is the best choice to do.
 How will you explain to a normal person about the stock market?
Based on my experience whenever my tito’s whose working aboard asked me about it
they are so curious about what it is and how it is. Explains it through basic level wherein
they can understand it and give them the knowledge of pros & cons about the investment,
sharing them your own experience about it and how to have it. Give them information
that is understandable and avoid using confusing words (jargon). Eventually it will help
them to start their own.