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Multiple Choice Questions in relation to Cash Flow Estimation, Real options, Corporate Valuation and Bankrupcy.
Question 1
When evaluating a new project, the firm should consider all of the following factors except:

a. Changes in working capital attributable to the project.
b. Previous expenditures associated with a market test to determine the feasibility of the
project, if the expenditures have been expensed for tax purposes.
c. The current market value of any equipment to be replaced.
d. The resulting difference in depreciation expense if the project involves replacement.
e. All of the statements above should be considered.

Question 2
Which of the following statements is most correct?

a. The rate of depreciation will often affect operating cash flows, even though
depreciation is not a cash expense.
b. Corporations should fully account for sunk costs when making investment decisions.
c. Corporations should fully account for opportunity costs when making investment
decisions.
d. All of the answers above are correct.
e. Answers a and c are correct.

Question 3
Suppose the firm's WACC is stated in nominal terms, but the project's expected cash flows are expressed in real dollars. In this situation, other things held constant, the calculated NPV would

a. Be correct.
b. Be biased downward.
c. Be biased upward.
d. Possibly have a bias, but it could be upward or downward.
e. More information is needed; otherwise, we can make no reasonable statement.

Question 4
Other things held constant, which of the following would increase the NPV of a project being considered?

a. A shift from MACRS to straight-line depreciation.
b. Making the initial investment in the first year rather than spreading it over the first 3
years.
c. A decrease in the discount rate associated with the project.
d. The sale of the old machine in a replacement decision at a capital loss rather than at
book value.
e. An increase in required working capital.

Question 5
A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should

a. Increase the IRR of the asset to reflect the greater risk.
b. Increase the NPV of the asset to reflect the greater risk.
c. Reject the asset, since its acceptance would increase the risk of the firm.
d. Ignore the risk differential if the asset to be accepted would comprise only a small
fraction of the total assets of the firm.
e. Increase the cost of capital used to evaluate the project to reflect the higher risk of the
project.

Question 6
Commodore Corporation is deciding whether it makes sense to invest in a project today, or to postpone this decision for one year. Which of the following statements best describes the issues that Commodore faces when considering this investment timing option?

a. The investment timing option does not affect the expected cash flows and should
therefore have no impact on the project's risk.
b. The more uncertainty about the project's future cash flows the more likely it is that
Commodore will go ahead with the project today.
c. If 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.
d. All of the above statements are correct.
e. None of the above statements is correct.

Question 7
Which of the following are not real options?

a. The option to expand production if the product is successful.
b. The option to buy additional shares of stock if the stock price goes up.
c. The option to expand into a new geographic region.
d. The option to abandon a project.
e. The option to switch sources of fuel used in an industrial furnace.

Question 8
Which of the following is most correct?

a. Real options change the size, but not the risk, of expected cash flows.
b. Real options change the risk, but not the size, of expected cash flows.
c. Real options usually change the cost of capital that should be used to discount the
expected cash flows.
d. Very few projects have real options.
e. Real options are less valuable when the underlying source of risk is high.
Question 9
Clueless Corporation never considers abandonment options or growth options when estimating its optimal capital budget. What impact does this policy have on the company's optimal capital budget?

a. Its estimated capital budget is too small because it fails to consider abandonment and growth options.
b. Its estimated capital budget is too large because it fails to consider abandonment and growth options.
c. Failing to consider abandonment options makes the optimal capital budget too large, but failing to consider growth options makes the optimal capital budget too small, so it is unclear what impact this policy has on the overall capital budget.
d. Failing to consider abandonment options makes the optimal capital budget too small, but failing to consider growth options makes the optimal capital budget too large, so it is unclear what impact this policy has on the overall capital budget.
e. Neither abandonment nor growth options should have an effect on the company's optimal capital budget.

Question 10
Which of the following is NOT a barrier to a hostile takeover?

a. Nonpecuniary benefits.
b. Targeted share repurchases.
c. Shareholder rights provision.
d. Restricted voting rights.
e. Poison pill.

Question 11
Which of the following is not always a way to increase the value of a company?

a. Increase the growth rate of sales.
b. Increase the operating profitability (NOPAT/Sales).
c. Decrease the capital requirement (Capital/Sales).
d. Decrease the weighted average cost of capital.
e. Increase the expected return on invested capital.

Question 12
Which of the following statements is NOT correct?

a. The corporate valuation model can be used even for a company that does not pay
dividends.
b. The corporate valuation model discounts free cash flows by the required return on
equity.
c. The corporate valuation model can be used to find the value of a division.
d. An important step in applying the corporate valuation model is forecasting the pro
forma financial statements.
e. Free cash flows must grow at a constant rate in order to find the horizon, or terminal,
value.

Question 13
Even if a firm's cash flow projections indicate that it will soon be unable to meet scheduled interest payments on its debt, bankruptcy will not begin until the firm actually defaults on a scheduled payment.

a. True
b. False

Question 14
Chapter 7 of the Bankruptcy Act is designed to do which of the following?

a. Provide safeguards against the withdrawal of assets by the owners of the bankrupt
firm.
b. Establish the rules of reorganization for firms with projected cash flows that
eventually will be sufficient to meet debt payments.
c. Allow insolvent debtors to discharge all of their obligations and to start over
unhampered by a burden of prior debt.
d. Answers a and b above.
e. Answers a and c above.

Question 15
Which of the following statements is most correct?

a. The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization plan.
b. The basic doctrine of fairness states that all debt holders must be treated equally.
c. Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the "public interest" is not a relevant concern.
d. While the firm is in bankruptcy, the existing management is always allowed to remain in control of the firm, though the court monitors its actions closely.
e. To a large extent, the decision to dissolve a firm through liquidation or to keep it alive through reorganization depends on a determination of the value of the firm if it is rehabilitated versus the value of its assets if they are sold off individually.

Question 16
What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? 1) Trustees' costs to administer and operate the firm. 2) Common stockholders. 3) General, or unsecured, creditors. 4) Secured creditors who have claim to the proceeds from the sale of a specific property pledged for a mortgage. 5) Taxes due to federal and state governments.

a. 1, 4, 3, 5, 2
b. 5, 4, 1, 3, 2
c. 4, 1, 5, 3, 2
d. 5, 1, 4, 2, 3
e. 1, 5, 4, 3, 2

Question 17
Which of the following statements is most correct?

a. Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
b. Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
c. All bankruptcy petitions are filed by creditors seeking to protect their claims on firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.
d. Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act.
e. "Restructuring" a firm's debt can involve forgiving a certain portion of the debt but does not involve changing the debt's maturity or its contractual interest rate.

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The solution explains some multiple choice questions relating to Cash Flow Estimation, Real options, Corporate Valuation and Bankrupcy

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