CFA® Level 1: CFA® Level 1 Exam - Test Prep

CFA® Level 1 Exam

Prev Question Next Question

Question

Which of the following statements is correct?

Answers

A. The rent referred to in the other statement is a sunk cost, and as such it should be ignored.

B. The preceding statement would be true if "upward" were replaced with "downward."

C. The existence of "externalities" reduces the NPV to a level below the value that would exist in the absence of externalities.

D. If one of the assets that would be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the project is not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration.

E. In a capital budgeting analysis where part of the funds used to finance the project are raised as debt, failure to include interest expense as a cost in the cash flow statement when determining the project's cash flows will lead to an upward bias in the NPV.

Show Answer

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E.

The foregone rent is an "opportunity cost" which should be charged to the project under consideration. The cash flows should not take account of interest, because financial costs are dealt with by discounting at the WACC. If interest were deducted to find cash flows, then this cost would be "double counted," and the

NPV would be downward biased. Ignoring interest when determining cash flows produces no bias in the NPV whatever. Note also that externalities can be either positive or negative--they tend to be negative if the new project is a substitute for existing products, but positive if the new project is complementary to the firm's other products.

Prev Question Next Question