Question

1) Suppose that you calculate the NPV of a project, and obtain a value of $100 million dollars. After completing your analysis, you find out that the corporate tax rate will change from 40% to 30%. If nothing else changes, what is the effect of this tax change on the NPV you had calculated? Assume that your company has no debt.

a) The new NPV will be lower than $100

b) The new NPV will be higher than $100

c) Since taxes affect many things, it is not possible to tell.

d) The NPV will not change. Taxes do not affect the value of a project.

e) There is too little information to make a forecast.

2) Assume you are considering buying a machine to increase production and sales of a certain product.

Which of the following effects should NOT be considered in the capital budgeting analysis?

a) Last year a marketing consulting firm charged you $500,000 to forecast future sales of your product.

b) Increased sales of this product will cause a reduction in sales in another one of your firm's products.

c) The money invested in this machine could alternatively be used to do research and development of a new product, so if you buy the machine, you will not be able to build and market this new product.

d) The machine requires an additional investment for its installation, and it would require an increase in NOWC.

e) All of these effects have to be considered.

3) Assume a new project requires an initial investment of $10 million dollars, with ensuing cash flows of $2, $4 and $5 million in years 1, 2 and 3. Assuming the company's WACC is 10%, which of the following statements is true?

a) The firm should reject the project, as the IRR is lower than the WACC.

b) The firm should accept the project, as the IRR is higher than the WACC.

c) The firm should accept the project, as the NPV is positive.

d) The firm should accept the project, as the NPV is negative.

e) None of these statements are true.

4) Assume a new project requires an initial investment of $6 million dollars, with ensuing cash flows of $1, $3 and $5 million in years 1, 2 and 3. Assuming the company's WACC is 10%, which of the following statements is true?

a) The firm should accept the project, as the IRR is lower than the WACC.

b) The firm should reject the project, as the IRR is higher than the WACC.

c) The firm should accept the project, as the NPV is positive.

d) The firm should reject the project, as the NPV is negative.

e) None of these statements are true.

Answer 1

1)

Tax rates will have inverse impact on NPV. If tax rates increase, tax expense will increase and project cash flows will decrease and if tax rates decrease, project cash flows will increase.

Hence, correct option is B.