4. Corperate Issuers Questions Bank 2023

Question #1 of 7

Question ID: 1469208

Government regulators typically require periodic disclosure of a company's financial
performance for:

A) private companies only.
B) public companies only.
C) both private and public companies.
Explanation
Regulators typically require periodic reporting of financial results for public companies.
Private companies are typically not subject to these requirements.
(Module 28.1, LOS 28.b)

Question #2 of 7

Question ID: 1469206

Under which business structure are profits potentially subject to double taxation?

A) Corporation.
B) General partnership.
C) Limited partnership.
Explanation
Double taxation refers to a situation in which a country taxes corporations' gross earnings
and then taxes net earnings distributed to owners (dividends) as personal income.
Partnership profits are subject to only one level of taxation (they are personal income of
the partners).
(Module 28.1, LOS 28.a)

Question #3 of 7

Question ID: 1469205

In a partnership, a general partner's liability for the obligations incurred by the business:

A) depends on whether the partnership is general or limited.


B) is unlimited.
C) is limited to the amount invested.
Explanation
In either a general partnership or a limited partnership, general partners have unlimited
liability.
(Module 28.1, LOS 28.a)

Question #4 of 7

Question ID: 1469210

Increasing a company's risk exposure in an effort to increase its growth rate is most likely to
be favored by:

A) owners but not lenders.
B) both lenders and owners.
C) neither lenders nor owners.
Explanation
Because the upside for lenders is limited to the promised interest payments and
repayment of principal, they do not benefit from an increased growth rate of the company
and are unlikely to favor actions that increase a company's risk exposure and potential for

default. Because owners have potentially unlimited upside from a company's growth, they
are more likely to favor actions that increase a company's potential growth rate.
(Module 28.1, LOS 28.c)

Question #5 of 7

Question ID: 1469204

The owner's liability for the business obligations of a sole proprietorship:

A) is limited to the amount invested.
B) may be limited or unlimited.
C) is unlimited.
Explanation
A sole proprietorship is legally an extension of the individual who owns and operates it.
The owner has unlimited liability for obligations the business incurs.
(Module 28.1, LOS 28.a)


Question #6 of 7

Question ID: 1469207

A corporation that wishes to raise equity capital and have its shares publicly traded is most

likely to engage in:

A) a management buyout.
B) an initial public offering.
C) a direct listing on an exchange.

Explanation
An initial public offering is a sale of equity shares to the public. Proceeds from the sale
increase the issuer's equity capital. A direct listing does not raise capital. A management
buyout is a method to take a public company private.
(Module 28.1, LOS 28.b)

Question #7 of 7

Question ID: 1469209

Which of the following payments are contractual obligations of a corporation?

A) Interest and principal payments.
B) Interest and common stock dividend payments.
C) Interest, principal, and preferred stock dividend payments.
Explanation
Interest and principal payments to lenders are contractual obligations. A corporation may
distribute dividends to owners but is not required to do so.
(Module 28.1, LOS 28.c)


Question #1 of 13

Question ID: 1463546

In the absence of any ESG-related constraints specified in an investment policy statement, a
portfolio manager is most likely to violate fiduciary duty by using ESG factors to:

A) assess the expected return and risk of potential portfolio investments.
B)

exclude investments with negative ESG characteristics from the investor’s
portfolio.

C) choose among investments with similar risk and return characteristics.
Explanation
Constructing a portfolio based on ESG factors may violate fiduciary duty if doing so
reduces expected returns. Analyzing ESG factors when assessing investment risk or using
ESG factors to choose among otherwise equivalent investments would likely not violate
fiduciary duty.

(Module 29.2, LOS 29.e)

Question #2 of 13

Question ID: 1463543

Smith Company's board of directors assigns responsibilities to several committees. The
committee that is most likely to be responsible for establishing the chief executive officer's
compensation package is Smith's:

A) governance committee.
B) remuneration committee.
C) risk committee.
Explanation
Compensation for a company's senior executives is typically a responsibility of a
remuneration or compensation committee.
(Module 29.1, LOS 29.c)

Question #3 of 13

Question ID: 1463544


Responsibilities of a board of directors' nominations committee are least likely to include:

A) recruiting qualified members to the board.
B) evaluating the independence of directors.
C) selecting an external auditor for the company.
Explanation
Selecting an external auditor (subject to shareholder approval) is a responsibility of the
Board's audit committee. (Module 29.1, LOS 29.c)

Question #4 of 13

Question ID: 1463542

Special resolutions that require a supermajority of shareholder votes may be addressed:

A) at either the annual general meeting or an extraordinary general meeting.
B) only at an extraordinary general meeting.
C) only at the annual general meeting.
Explanation
Special resolutions may be voted on at the annual general meeting or at an extraordinary
general meeting that is called specifically to address them. (Module 29.1, LOS 29.c)

Question #5 of 13

Question ID: 1463541

A principal-agent relationship most likely exists between a company's:

A) shareholders and managers.
B) directors and regulators.
C) customers and suppliers.
Explanation
The relationship between shareholders and managers is a principal-agent relationship.
Shareholders, as principals, through the board of directors hire managers, as agents, to
act in the best interests of the shareholders.
(Module 29.1, LOS 29.b)


Question #6 of 13

Question ID: 1463537

The interests of community groups affected by a company's operations are most likely to be
considered in corporate governance under:

A) special interest theory.
B) shareholder theory.
C) stakeholder theory.
Explanation
Community groups may be one of the stakeholder groups considered under stakeholder
theory.
(Module 29.1, LOS 29.a)

Question #7 of 13

Question ID: 1463538

Under shareholder theory, corporate governance is most concerned with managing conflicts
of interest between the firm's managers and its:

A) customers.
B) owners.
C) employees.
Explanation
Under shareholder theory, corporate governance is most concerned with managing
conflicts of interest between the firm's managers and its owners (shareholders).
(Module 29.1, LOS 29.a)

Question #8 of 13

Question ID: 1463547

Environmental, social, and governance (ESG) investing is most accurately described as:

A)

integrating environmental and social considerations into the investment
decision making process.


B)
C)

investing only in companies that promote environmental or social initiatives
favored by an investor.
excluding companies from consideration for investment based on

environmental or social considerations.

Explanation
ESG investing is using environmental, social, and governance factors when making
investment decisions. Investing only in companies that promote environmental or social
initiatives favored by an investor is best described as impact investing. Excluding
companies from consideration for investment based on environmental or social
considerations is best described as negative screening. Impact investing and negative
screening are two of the approaches an investor can use to implement ESG investing.
(Module 29.2, LOS 29.e)

Question #9 of 13

Question ID: 1463545

Risks that may arise from ineffective corporate governance least likely include:

A) reduced default risk.
B) less effective decision making.
C) weaker financial performance.
Explanation
Ineffective corporate governance is likely to increase default risk.

(Module 29.2, LOS 29.d)

Question #10 of 13

Question ID: 1463539

The stakeholders of a company that are least likely to prefer a relatively riskier company

strategy that has the potential for superior company performance are:

A) shareholders.
B) creditors.
C) suppliers.
Explanation


A company's creditors prefer less risk because their potential gains from superior
company performance are limited, while they have significant downside risk from poor
performance that could threaten the company's solvency. Shareholders have the greatest
gains from superior company performance. Suppliers may benefit from superior
performance of a company to which they supply goods and services, but in general they
prefer stable business operations and continuation of their business relationship with the
company.
(Module 29.1, LOS 29.a)

Question #11 of 13

Question ID: 1463536

The stakeholder theory of corporate governance is primarily focused on:

A) the interests of various stakeholders rather than the interests of shareholders.
B)

resolving the competing interests of those who manage companies and other
groups affected by a company’s actions.

C) increasing the value a company.

Explanation
Resolving the conflicting interests of both shareholders and other stakeholders is the
focus of corporate governance under stakeholder theory. Shareholders are among the
groups whose interests are considered under stakeholder theory.
(Module 29.1, LOS 29.a)

Question #12 of 13

Question ID: 1463540

The stakeholder group that typically prefers the greatest amount of business risk is:

A) directors.
B) shareholders.
C) senior managers.
Explanation


Compared to the other two groups, shareholders have the greatest potential gains from
riskier strategies and can diversify their holdings across firms in order to reduce the
influence of company specific risk. While senior managers can gain from company
outperformance, they typically prefer less risk than shareholders because managers' risk
of poor company performance on the value of their options and on their careers cannot
be easily diversified away.

(Module 29.1, LOS 29.a)

Question #13 of 13

Question ID: 1463548

Thematic investing is most accurately described as:

A)

identifying the best companies in each sector with respect to environmental
and social factors.

B) considering a single environmental or social factor when selecting investments.
C)

excluding companies or sectors from consideration for investment based on
environmental and social factors.

Explanation
Thematic investing refers to selecting investments with a view to a specific environmental,
social, or governance factor. Identifying the best companies in each sector with respect to
environmental and social factors is referred to as best-in-class investing. Excluding
companies or sectors from consideration for investment based on environmental and
social factors is referred to as negative screening.

(Module 29.2, LOS 29.f)


Question #1 of 6

Question ID: 1469215

A firm is least likely to reduce its capital needs by adopting which of the following business
models?

A) Asset-light.
B) Bundling.
C) Pay-in-advance.
Explanation
Bundling is a pricing strategy for multiple products. Firms that rent or lease major assets
(an asset-light model) or receive cash before providing goods or services (a pay-in-advance
model) tend to have less need for capital than firms that own fixed assets or do not collect
cash in advance.
(Module 30.1, LOS 30.b)

Question #2 of 6

Question ID: 1469214

Nebrid Company describes itself as a B2B firm. This means that Nebrid:

A) is a marketplace for buyers and sellers.
B) provides both inbound and outbound logistics.
C) sells its products or services to other businesses.
Explanation
B2B businesses are those that sell their products to other businesses.
(Module 30.1, LOS 30.a)

Question #3 of 6
An example of macro risk that companies may face is:

A) exchange-rate risk.
B) ESG risk.

Question ID: 1469216


C) capital investment risk.
Explanation
Macro risks include economic factors such as exchange-rate changes. ESG risk and capital
investment risk are examples of firm-specific risks.
(Module 30.1, LOS 30.c)

Question #4 of 6

Question ID: 1469213

Debrin Company uses a tiered pricing strategy. Debrin is most likely to:

A) offer a discount for buying a large number of units.
B) charge higher prices during peak times of day.
C)

set a temporarily low price until it builds market share and scales up
production.

Explanation
Tiered pricing refers to setting prices based on a customer's volume of purchases.
(Module 30.1, LOS 30.a)

Question #5 of 6

Question ID: 1469211

Binder Company describes itself as a direct sales business. In terms of its business model,
this refers to Binder's:

A) channel strategy.
B) product or service.
C) pricing strategy.
Explanation
A channel strategy describes how a company will sell and deliver its product or service,
such as selling directly to customers (direct sales) or through intermediaries such as
retailers.
(Module 30.1, LOS 30.a)


Question #6 of 6

Question ID: 1469212

Redbin Software publishes a multiplayer video game. Redbin allows users to download the
basic software at no charge and makes enhanced features available at various prices.
Redbin's pricing strategy is best described as:

A) hidden revenue.
B) penetration.
C) freemium.
Explanation
Freemium pricing refers to providing a basic product at no cost and selling or unlocking
increased functionality for a price.
(Module 30.1, LOS 30.a)

Question #1 of 25

Question ID: 1463558

If two projects are mutually exclusive, a company:

A) can accept either project, but not both projects.
B) must accept both projects or reject both projects.
C) can accept one of the projects, both projects, or neither project.
Explanation
Mutually exclusive means that out of the set of possible projects, only one project can be
selected. Given two mutually exclusive projects, the company can accept one of the
projects or reject both projects, but cannot accept both projects.

(Module 31.1, LOS 31.b)

Question #2 of 25

Question ID: 1463553

One of the basic principles of capital allocation is that:

A) opportunity costs should be excluded from the analysis of a project.
B) decisions are based on cash flows.
C) projects should be analyzed on a pre-tax basis.
Explanation
Key principles of the capital allocation process are:
1. Decisions are based on cash flows, not accounting income.
2. Cash flows are based on opportunity costs.
3. The timing of cash flows is important.

4. Cash flows are analyzed on an after-tax basis.
5. Financing costs are reflected in the project's required rate of return.
(Module 31.1, LOS 31.b)

Question #3 of 25

Question ID: 1463560


A company is considering a $10,000 project that will last 5 years.
Annual after tax cash flows are expected to be $3,000
Cost of capital = 9.7%
What is the project's net present value (NPV)?

A) +$1,460.
B) -$1,460.
C) +$11,460.
Explanation

Calculate the PV of the project cash flows
N = 5, PMT = -3,000, FV = 0, I/Y = 9.7, CPT → PV = 11,460

Calculate the project NPV by subtracting out the initial cash flow
NPV = $11,460 – $10,000 = $1,460

(Module 31.2, LOS 31.c)

Question #4 of 25

Question ID: 1463561

A firm is reviewing an investment opportunity that requires an initial cash outlay of $336,875
and promises to return the following irregular payments:
Year 1: $100,000
Year 2: $82,000
Year 3: $76,000
Year 4: $111,000
Year 5: $142,000
If the required rate of return for the firm is 8%, what is the net present value of the
investment?

A) $64,582.
B) $99,860.
C) $86,133.


Explanation
To determine the net present value of the investment, given the required rate of return,
we can discount each cash flow to its present value, sum the present value, and subtract
the required investment.
Year

Cash Flow

PV of Cash flow at 8%

0

–336,875.00

–336,875.00

1

100,000.00

92,592.59

2

82,000.00

70,301.78

3

76,000.00

60,331.25

4

111,000.00

81,588.31

5

142,000.00

96,642.81

Net Present Value

64,581.74

(Module 31.2, LOS 31.c)

Question #5 of 25

Question ID: 1463551

Which of the following steps is least likely to be a step in the capital allocation process?

A) Arranging financing for capital projects.
B) Conducting a post-audit to identify errors in the forecasting process.
C) Forecasting cash flows and analyzing project profitability.
Explanation
Arranging financing is not one of the administrative steps in the capital budgeting process.
The four administrative steps in the capital budgeting process are:
1. Idea generation
2. Analyzing project proposals
3. Creating the firm-wide capital budget
4. Monitoring decisions and conducting a post-audit

(Module 31.1, LOS 31.b)

Question #6 of 25

Question ID: 1463569

Should a company accept a project that has an IRR of 14% and an NPV of $2.8 million if the
cost of capital is 12%?

A) No, based on the NPV and the IRR.
B) Yes, based on the NPV and the IRR.
C) Yes, based only on the NPV.
Explanation
The project should be accepted on the basis of its positive NPV and its IRR, which exceeds
the cost of capital.
(Module 31.2, LOS 31.c)

Question #7 of 25

Question ID: 1463571

Garner Corporation is investing $30 million in new capital equipment. The present value of
future after-tax cash flows generated by the equipment is estimated to be $50 million.
Currently, Garner has a stock price of $28.00 per share with 8 million shares outstanding.
Assuming that this project represents new information and is independent of other
expectations about the company, what should the effect of the project theoretically be on
the firm's stock price?

A) The stock price will increase to $30.50.
B) The stock price will increase to $34.25.
C) The stock price will remain unchanged.
Explanation
In theory, a positive NPV project should provide an increase in the value of a firm's shares.
NPV of new capital equipment = $50 million - $30 million = $20 million

Value of company prior to equipment purchase = 8,000,000 × $28.00 =
$224,000,000
Value of company after new equipment project = $224 million + $20 million =
$244 million
Price per share after new equipment project = $244 million / 8 million = $30.50
Note that in reality, changes in stock prices result from changes in expectations more than
changes in NPV.

(Module 31.3, LOS 31.e)


Question #8 of 25

Question ID: 1463563

Fisher, Inc., is evaluating the benefits of investing in a new industrial printer. The printer will
cost $28,000 and increase after-tax cash flows by $7,000 during each of the next four years
and $6,000 in each of the two years after that. The internal rate of return (IRR) of the printer
project is closest to:

A) 11.8%.
B) 11.6%.
C) 12.0%.
Explanation
CF0 = –$28,000; CF1 = $7,000; F1 = 4; CF2 = $6,000; F2 = 2; CPT → IRR = 11.6175%.
(Module 31.2, LOS 31.c)

Question #9 of 25

Question ID: 1463559

Lincoln Coal is planning a new coal mine, which will cost $430,000 to build. The mine will
bring cash inflows of $200,000 annually over the next seven years. It will then cost $170,000
to close down the mine in the following year. Assume all cash flows occur at the end of the
year. Alternatively, Lincoln Coal may choose to sell the site today. If Lincoln has a 16%
required rate of return, the minimum price they should accept for the property is closest to:

A) $326,000.
B) $310,000.
C) $318,000.
Explanation


The key is first identifying this as a NPV problem. The minimum price the company should
accept for selling the property is the net present value of the mine if the company built
and operated it.
Next, the year of each cash flow must be property identified; specifically: CF0 = –430,000;
CF1-7 = +$200,000; CF8 = –$170,000.
Entering these values into the cash flow worksheet:
CF0 = –430,000; C01 = 200,000; F01 = 7; C02 = –170,000; F02 = 1; I = 16; CPT NPV =
325,858.76
(Module 31.2, LOS 31.c)

Question #10 of 25

Question ID: 1463550

With respect to capital investments, the greatest amount of detailed analysis is typically
required when deciding whether to:

A) address safety-related concerns.
B) replace a functioning machine with a newer model to reduce costs.
C) introduce a new product or develop a new market.
Explanation
Introducing a new product or entering a new market involves sales and expense
projections that can be highly uncertain, and therefore require the greatest degree of
detailed analysis. Addressing safety or regulatory concerns or replacing old machinery
typically involve less uncertainty and do not require the same depth of analysis as
developing a new product or entering a new market.
(Module 31.1, LOS 31.a)

Question #11 of 25

Question ID: 1463573

Polington Aircraft Co. just announced a sale of 30 aircraft to Cuba, a project with a net
present value of $10 million. Investors did not anticipate the sale because government
approval to sell to Cuba had never before been granted. The share price of Polington should
theoretically:

A)

not necessarily change because new contract announcements are made all the
time.


B)
C)

increase by the project NPV divided by the number of common shares

outstanding.
increase by the NPV × (1 – corporate tax rate) divided by the number of
common shares outstanding.

Explanation
Since the sale was not anticipated by the market, the share price should rise by the NPV of
the project per common share. NPV is already calculated using after-tax cash flows.

(Module 31.3, LOS 31.e)

Question #12 of 25

Question ID: 1463552

Financing costs for a capital project are:

A) subtracted from estimates of a project’s future cash flows.
B) subtracted from the net present value of a project.
C) captured in the project’s required rate of return.
Explanation
Financing costs are reflected in a project's required rate of return. Project specific
financing costs should not be included as project cash flows. The firm's overall weighted
average cost of capital, adjusted for project risk, should be used to discount expected
project cash flows.

(Module 31.1, LOS 31.b)

Question #13 of 25

Question ID: 1463570

An investment is purchased at a cost of $775,000 and returns $300,000 at the end of years 2
and 3. At the end of year 4 the investment receives a final payment of $400,000. The IRR of
this investment is closest to:

A) 8.65%.
B) 9.45%.
C) 13.20%.


Explanation
Cf0 = -775,000, C01 = 0, F01 = 1, C02 = 300,000, F02 = 2, C03 = 400,000, F03 = 1; IRR =
8.6534.
(Module 31.2, LOS 31.c)

Question #14 of 25

Question ID: 1463554

The CFO of Axis Manufacturing is evaluating the introduction of a new product. The costs of
a recently completed marketing study for the new product and the possible increase in the
sales of a related product made by Axis are best described (respectively) as:

A) opportunity cost; externality.
B) externality; cannibalization.
C) sunk cost; externality.
Explanation
The study is a sunk cost, and the possible increase in sales of a related product is an
example of a positive externality.
(Module 31.1, LOS 31.b)

Question #15 of 25

Question ID: 1463565

If the calculated net present value (NPV) is negative, which of the following must be correct.
The discount rate used is:

A) greater than the internal rate of return (IRR).
B) less than the internal rate of return (IRR).
C) equal to the internal rate of return (IRR).
Explanation
When the NPV = 0, this means the discount rate used is equal to the IRR. If a discount rate
is used that is higher than the IRR, the NPV will be negative. Conversely, if a discount rate
is used that is lower than the IRR, the NPV will be positive.

(Module 31.2, LOS 31.c)


Question #16 of 25

Question ID: 1463567

An analyst has gathered the following data about a company with a 12% cost of capital:
Project P

Project Q

Cost

$15,000

$25,000

Life

5 years

5 years

Cash inflows $5,000/year $7,500/year
If the projects are independent, what should the company do?

A) Accept both Project P and Project Q.
B) Accept Project P and reject Project Q.
C) Reject both Project P and Project Q.
Explanation
Project P: N = 5; PMT = 5,000; FV = 0; I/Y = 12; CPT → PV = 18,024; NPV for Project A =
18,024 – 15,000 = 3,024.
Project Q: N = 5; PMT = 7,500; FV = 0; I/Y = 12; CPT → PV = 27,036; NPV for Project B =
27,036 – 25,000 = 2,036.
For independent projects the NPV decision rule is to accept all projects with a positive
NPV. Therefore, accept both projects.

(Module 31.2, LOS 31.c)

Question #17 of 25

Question ID: 1463555

The effects that the acceptance of a project may have on other firm cash flows are best
described as:

A) pure plays.
B) externalities.
C) opportunity costs.
Explanation


Externalities refer to the effects that the acceptance of a project may have on other firm
cash flows. Cannibalization is one example of an externality.

(Module 31.1, LOS 31.b)

Question #18 of 25

Question ID: 1463557

Which of the following is least relevant in determining project cash flow for a capital
investment?

A) Tax impacts.
B) Sunk costs.
C) Opportunity costs.
Explanation
Sunk costs are not to be included in investment analysis. Opportunity costs and the
project's impact on taxes are relevant variables in determining project cash flow for a
capital investment. (Module 31.1, LOS 31.b)

Question #19 of 25

Question ID: 1463566

As the director of capital budgeting for Denver Corporation, an analyst is evaluating two
mutually exclusive projects with the following net cash flows:
Year Project X Project Z
0

-$100,000 -$100,000

1

$50,000

$10,000

2

$40,000

$30,000

3

$30,000

$40,000

4

$10,000

$60,000

If Denver's cost of capital is 15%, which project should be chosen?

A) Project X, since it has the higher IRR.
B) Project X, since it has the higher net present value (NPV).


C) Neither project.
Explanation
NPV for Project X = -100,000 + 50,000 / (1.15)1 + 40,000 / (1.15)2 + 30,000 / (1.15)3 + 10,000
/ (1.15)4
= -100,000 + 43,478 + 30,246 + 19,725 + 5,718 = -833
NPV  for Project Z = -100,000 + 10,000 / (1.15)1 + 30,000 / (1.15)2 + 40,000 / (1.15)3 + 60,000
/ (1.15)4
= -100,000 + 8,696 + 22,684 + 26,301 + 34,305 =  -8,014
Reject both projects because neither has a positive NPV.

(Module 31.2, LOS 31.c)

Question #20 of 25

Question ID: 1463549

Which of the following types of capital investments are most likely to generate little to no
revenue?

A) Going concern projects.

B) Regulatory projects.
C) New product or market development.
Explanation
Mandatory regulatory or environmental projects may be required by a governmental
agency or insurance company and typically involve safety-related or environmental
concerns. The projects typically generate little to no revenue, but they accompany other
new revenue producing projects and are accepted by the company in order to continue
operating.
(Module 31.1, LOS 31.a)

Question #21 of 25

Question ID: 1463564


The estimated annual after-tax cash flows of a proposed investment are shown below:
Year 1: $10,000
Year 2: $15,000
Year 3: $18,000
After-tax cash flow from sale of investment at the end of year 3 is $120,000
The initial cost of the investment is $100,000, and the required rate of return is 12%. The net
present value (NPV) of the project is closest to:

A) $19,113.
B) $63,000.
C) -$66,301.
Explanation
10,000 / 1.12 = 8,929
15,000 / (1.12)2 = 11,958
138,000 / (1.12)3 = 98,226

NPV = 8,929 + 11,958 + 98,226 − 100,000 = $19,113
Alternatively: CFO = -100,000; CF1 = 10,000; CF2 = 15,000; CF3 = 138,000; I = 12; CPT → NPV
= $19,112.

(Module 31.2, LOS 31.c)

Question #22 of 25

Question ID: 1463556

Johnson's Jar Lids is deciding whether to begin producing jars. Johnson's pays a consultant
$50,000 for market research that concludes Johnson's sales of jar lids will increase by 5% if it
also produces jars. In choosing the cash flows to include when evaluating a project to begin
producing jars, Johnson's should:

A)
B)

exclude the cost of the market research and include the effect on the sales of
jar lids.
include both the cost of the market research and the effect on the sales of jar
lids.


C)

include the cost of the market research and exclude the effect on the sales of jar
lids.

Explanation

Sunk costs should be excluded from cash flows, as they are costs that cannot be avoided
even if the project is not undertaken. Externalities, such as positive or negative effects of
accepting a project on sales of the company's existing products, should be included in the
cash flows. (Module 31.1, LOS 31.b)

Question #23 of 25

Question ID: 1463568

Jack Smith, CFA, is analyzing independent investment projects X and Y. Smith has calculated
the net present value (NPV) and internal rate of return (IRR) for each project:
Project X: NPV = $250; IRR = 15%
Project Y: NPV = $5,000; IRR = 8%
Smith should make which of the following recommendations concerning the two projects?

A) Accept Project X only.
B) Accept Project Y only.
C) Accept both projects.
Explanation
The projects are independent, meaning that either one or both projects may be chosen.
Both projects have positive NPVs, therefore both projects add to shareholder wealth and
both projects should be accepted.
(Module 31.2, LOS 31.c)

Question #24 of 25

Question ID: 1463572

The effect of a company announcement that they have begun a project with a current cost
of $10 million that will generate future cash flows with a present value of $20 million is most

likely to:

A) increase value of the firm’s common shares by $10 million.
B) increase the value of the firm’s common shares by $20 million.
C) only affect value of the firm’s common shares if the project was unexpected.