FN1 Module 5 Past Exam Questions
Multiple Choice Questions
A. Which of the following is necessary for the capital budgeting process?
1) The amount of overhead allocated to the project
2) Interest paid on funds raised to finance the project
3) The timing of the project’s net cash benefits
4) The amount of money spent on research and development
B. Which of the following is not a relevant consideration for evaluating new projects?
1) The change in the firm’s fixed costs
2) The change in the firm’s variable costs
3) The change in the firm’s amortization expense
4) The change in the firm’s tax expense
C. Capital cost allowance (CCA) reduces taxable income because Canada Revenue
Agency considers it an expense, although it is not an actual cash flow. Which of the
following statements about CCA is not true?
1) The half-year rule applies equally to net additions and net dispositions to an
asset class.
2) CCA is important because it reduces taxes payable (by reducing taxable income)
in the years after the purchase of the asset.
3) Assets are grouped into classes with each class having a specific CCA rate set by
Canada Revenue Agency.
4) CCA is calculated based on the unamortized capital cost (UCC) of the asset class,
and without additions or disposals it will continue indefinitely.
D. Which of the following is relevant for determining the net present value (NPV) of
a proposed project?
1) Interest paid on the funds raised to finance the project
2) The amount of money spent on research and development
3) The amount of avoidable overhead costs allocated to the project
4) The amount of otherwise unavoidable overhead costs allocated to the project
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FN1 Module 5 Past Exam Questions
Short Answer Questions
E. Rules important for estimating project cash flows in a capital budgeting analysis
include the following: (1) use actual cash flows, not accounting income and (2) use
incremental cash flows.
Briefly explain why each of these rules is important and relevant for capital budgeting
analysis.
Answer:
Actual cash flows should be used because they are what matter to shareholders.
Dividends are paid and reinvestment is made by the firm from actual cash flows, not
accounting profits. Cash flows differ from accounting profits in several ways, including
the fact that accounting profit includes non-cash expenses such as amortization and may
include the arbitrary allocation of items that may not involve incremental cash flows (for
example, overhead).
Only those cash flows that are incremental to a project are relevant in a capital budgeting
analysis. This then implies that sunk costs should be ignored because they cannot be
reclaimed if the project is not undertaken; sunk costs are not incremental. It also implies
that opportunity costs should be included because the use of resources for the project
means that resources cannot be used elsewhere.
F. State why financing charges are not used in determining operating cash flows
from a project in a capital budgeting analysis.
Answer:
Financing charges associated with financing a particular project are accounted for
through the application of the correct discount rate when evaluating the project.
Thus, if they were (also) used in determining cash flows, financing charges would
be double counted.
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