Which of the following statements describes the most appropriate treatment of cash flows in capital
budgeting?
A Interest costs are included in the project's cash flows to reflect financing costs.
B A project is evaluated using its incremental cash flows on an after- tax basis.
C Sunk costs and externalities should not be included in the cash flow estimates. - Correct AnswersB is
correct. All of the incremental cash flows arising from a project should be analyzed on an after- tax basis.
C is incorrect. Only sunk costs should be ignored in a project's cash flow estimation, but not any
externalities. Sunk costs cannot be recovered once they have been incurred. Externalities (both positive
and negative ones) are the effects of an investment decision on other things beside the investment
itself; they should therefore be included in the cash flow estimation.
A is incorrect. Financing costs like interest costs are excluded from calculations of operating cash flows.
The financing costs are reflected in the required rate of return for an investment project. If financing
costs are included, we would be double- counting these costs.
Which of the following best allows a board of directors to act in the interest of the company and
shareholders?
A Independent board members are selected from outside the industry.
B Internal directors provide monitoring of the firm's management.
C The board has the authority to select and terminate senior management. - Correct AnswersC is
correct. The board has a duty to make decisions in the best interest of the company and shareholders. It
reviews management's performance in executing the strategy set by the board. In order to ensure
strong execution of the strategy, the board must have the authority to select and terminate senior
management.
A is incorrect. At least some independent members should have industry expertise.
B is incorrect. External directors should provide monitoring within the firm.
, Risk management is most likely the process by which an organization:
A minimizes its exposure to potential losses.
B adjusts its risk to a predetermined level.
C maximizes its risk- adjusted return. - Correct AnswersB is correct. An organization with a strong
competitive position can recover from losses more easily than one with a weaker competitive position.
Therefore, an organization's risk tolerance should reflect its competitive position. An organization's size
does not define the risk sources it faces or the relative losses it can absorb, so it should not be reflected
in its risk tolerance. Neither the risk sources affecting an organization nor the size of the losses an
organization can absorb are a function of its perception of market stability.
A is incorrect because a minimum risk position may not be optimal for the organization.
C is incorrect because a high risk- adjusted return may require a level of risk taking that is beyond the
organization's capacity to absorb.
A good risk governance process would most likely:
A provide guidance on the size of the largest acceptable loss for the organization.
B provide different risk targets for each unit within the organization.
C be a bottom- up process that reflects the current risk exposures of all parts of the organization. -
Correct AnswersA is correct. A quality risk governance process takes a top- down approach and is
charged with risk oversight for the entire organization. It should operate on an enterprise- wise basis
rather than viewing each unit in isolation. It will determine the organization's risk tolerance and provide
a sense of the maximum loss the organization can absorb.
B is incorrect because a good risk governance process looks at the enterprise as a whole rather than
viewing individual units in isolation.
C is incorrect because a risk governance process is a top- down process.
budgeting?
A Interest costs are included in the project's cash flows to reflect financing costs.
B A project is evaluated using its incremental cash flows on an after- tax basis.
C Sunk costs and externalities should not be included in the cash flow estimates. - Correct AnswersB is
correct. All of the incremental cash flows arising from a project should be analyzed on an after- tax basis.
C is incorrect. Only sunk costs should be ignored in a project's cash flow estimation, but not any
externalities. Sunk costs cannot be recovered once they have been incurred. Externalities (both positive
and negative ones) are the effects of an investment decision on other things beside the investment
itself; they should therefore be included in the cash flow estimation.
A is incorrect. Financing costs like interest costs are excluded from calculations of operating cash flows.
The financing costs are reflected in the required rate of return for an investment project. If financing
costs are included, we would be double- counting these costs.
Which of the following best allows a board of directors to act in the interest of the company and
shareholders?
A Independent board members are selected from outside the industry.
B Internal directors provide monitoring of the firm's management.
C The board has the authority to select and terminate senior management. - Correct AnswersC is
correct. The board has a duty to make decisions in the best interest of the company and shareholders. It
reviews management's performance in executing the strategy set by the board. In order to ensure
strong execution of the strategy, the board must have the authority to select and terminate senior
management.
A is incorrect. At least some independent members should have industry expertise.
B is incorrect. External directors should provide monitoring within the firm.
, Risk management is most likely the process by which an organization:
A minimizes its exposure to potential losses.
B adjusts its risk to a predetermined level.
C maximizes its risk- adjusted return. - Correct AnswersB is correct. An organization with a strong
competitive position can recover from losses more easily than one with a weaker competitive position.
Therefore, an organization's risk tolerance should reflect its competitive position. An organization's size
does not define the risk sources it faces or the relative losses it can absorb, so it should not be reflected
in its risk tolerance. Neither the risk sources affecting an organization nor the size of the losses an
organization can absorb are a function of its perception of market stability.
A is incorrect because a minimum risk position may not be optimal for the organization.
C is incorrect because a high risk- adjusted return may require a level of risk taking that is beyond the
organization's capacity to absorb.
A good risk governance process would most likely:
A provide guidance on the size of the largest acceptable loss for the organization.
B provide different risk targets for each unit within the organization.
C be a bottom- up process that reflects the current risk exposures of all parts of the organization. -
Correct AnswersA is correct. A quality risk governance process takes a top- down approach and is
charged with risk oversight for the entire organization. It should operate on an enterprise- wise basis
rather than viewing each unit in isolation. It will determine the organization's risk tolerance and provide
a sense of the maximum loss the organization can absorb.
B is incorrect because a good risk governance process looks at the enterprise as a whole rather than
viewing individual units in isolation.
C is incorrect because a risk governance process is a top- down process.
