W2 - Online Quiz

Question 1

Multiple Choice

A project proposal shows an accounting profit of £120k per year for 4 years. It also requires an immediate £150k increase in net working capital that will be fully recovered at the end of year 4. Depreciation is £60k per year and the tax rate is 25%. Which statement best describes the correct cash-flow adjustment when applying NPV?

A. Ignore depreciation because it is non-cash; do not adjust for working capital because it is on the balance sheet.

B. Add back depreciation (non-cash) and treat the working-capital increase as a cash outflow now and an inflow in year 4; depreciation affects taxes via a tax shield.

C. Subtract depreciation because it reduces profit; treat the working-capital increase as an inflow because it is an asset.

D. Use accounting profit directly because NPV discounts profits, not cash flows.

Question 2

Multiple Choice

A firm is deciding whether to launch a new product. It will (i) use a warehouse already owned that could be rented out for £40k per year, and (ii) reuse a feasibility study that cost £90k last year. In incremental NPV cash flows, how should these be treated?

A. Include both: the warehouse rental and the feasibility study are cash items.

B. Exclude both: both are sunk costs once incurred.

C. Include the warehouse rental as an opportunity cost; exclude the feasibility study as a sunk cost.

D. Exclude the warehouse rental because no cash is paid; include the feasibility study because it was a real cash outflow.

Question 3

Multiple Choice

A project’s cash flows are forecast in nominal terms with expected inflation of 4% per year. The analyst mistakenly discounts them using a 6% real discount rate. Without changing the nominal cash-flow forecasts, which correction makes the NPV calculation internally consistent?

A. Keep the 6% real rate; inflation is embedded in cash flows so it cancels out automatically.

B. Convert nominal cash flows into real cash flows (remove inflation) and then discount at 6% real.

C. Convert the 6% real discount rate to a nominal rate and discount the nominal cash flows at that nominal rate.

D. Increase the discount rate by 4 percentage points to 10% and discount nominal cash flows at 10%.

Question 4

Multiple Choice

A project will be financed with a specific loan. The analyst proposes to subtract annual interest payments from operating cash flows and then discount at the firm’s WACC. What is the most appropriate principle?

A. Correct: interest is a cash outflow, so it must be deducted before discounting at WACC.

B. Correct only if the project is debt-financed; incorrect if equity-financed.

C. Incorrect: separate investment and financing. Value unlevered project cash flows and discount using a rate consistent with their risk; handle financing effects separately.

D. Incorrect: ignore taxes and discount using the risk-free rate to avoid double counting.

Question 5

Multiple Choice

Two mutually exclusive projects have the following cash flows (t=0, t=1): Project D: -£10,000; +£20,000. Project E: -£100,000; +£115,000. If the cost of capital is 10%, which rule is most reliable and why?

A. Choose D because it has the higher IRR; IRR always dominates NPV when projects are mutually exclusive.

B. Choose D because it has the higher NPV; IRR can be misleading due to scale differences in mutually exclusive choices.

C. Choose D because it pays back faster; payback is superior when capital is scarce.

D. Indifferent because both have positive NPV; any positive-NPV project is acceptable even if mutually exclusive.