Chapter 8

When new product increases the cash flows of existing projects

Synergy (Incremental IRR side effect)

The changes in the firm's future cash flows that are a direct consequence of accepting a project are called: A) Incremental cash flows. B) Stand-alone cash flows. C) Aftertax cash flows. D) Net present value cash flows. E) Erosion cash flows.

A) Incremental cash flows.

Changes in the net working capital: A. can affect the cash flows of a project every year of the project's life. B. only affect the initial cash flows of a project. C. are included in project analysis only if they represent cash outflows. D. are generally excluded from project analysis due to their irrelevance to the total project. E. affect the initial and the final cash flows of a project but not the cash flows of the middle years.

A. can affect the cash flows of a project every year of the project's life.

A project's operating cash flow will increase when the: A. depreciation expense increases. B. sales projections are lowered. C. interest expense is lowered. D. net working capital requirement increases. E. earnings before interest and taxes decreases.

A. depreciation expense increases

One purpose of identifying all of the incremental cash flows related to a proposed project is to: A. isolate the total sunk costs so they can be evaluated to determine if the project will add value to the firm. B. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. C. make each project appear as profitable as possible for the firm. D. include both the proposed and the current operations of a firm in the analysis of the project. E. identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis.

B. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project.

The bottom-up approach to computing the operating cash flow applies only when: A. both the depreciation expense and the interest expense are equal to zero. B. the interest expense is equal to zero. C. the project is a cost-cutting project. D. no fixed assets are required for the project. E. taxes are ignored and the interest expense is equal to zero.

B. the interest expense is equal to zero.

The net working capital of a firm will decrease if there is: A. a decrease in accounts payable. B. an increase in inventory. C. a decrease in accounts receivable. D. an increase in the firm's checking account balance. E. a decrease in fixed assets.

C. a decrease in accounts receivable.

All of the following are anticipated effects of a proposed project. Which of these should be considered when computing the cash flow for the final year of a project? A. operating cash flow and salvage values B. salvage values and net working capital recovery C. operating cash flow, net working capital recovery, salvage values D. net working capital recovery and operating cash flow E. operating cash flow only

C. operating cash flow, net working capital recovery, salvage values

Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped by the end of the project. B. requirements generally, but not always, create a cash inflow at the beginning of a project. C. expenditures commonly occur at the end of a project. D. is frequently affected by the additional sales generated by a new project. E. is the only expenditure where at least a partial recovery can be made at the end of a project.

D. is frequently affected by the additional sales generated by a new project.

The cash flow from a project is computed as the: A. net operating cash flow generated by the project, less any sunk costs and erosion costs. B. sum of the incremental operating cash flow and aftertax salvage value of the project. C. net income generated by the project, plus the annual depreciation expense. D. sum of the incremental operating cash flow, capital spending, and net working capital cash flows incurred by the project. E. sum of the sunk costs, opportunity costs, and erosion costs of the project.

D. sum of the incremental operating cash flow, capital spending, and net working capital cash flows incurred by the project.

Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped by the end of the project. B. requirements generally, but not always, create a cash inflow at the beginning of a project. C. expenditures commonly occur at the end of a project. D. is frequently affected by the additional sales generated by a new project. E. is the only expenditure where at least a partial recovery can be made at the end of a project

D. is frequently affected by the additional sales generated by a new project.

Why does net working capital increase?

Essentially, you are making an investment in working capital (negative cash flow) At end of project - usually assumed to be completely recovered Increases then decreases

*Changes in the firms cash flows that occur as a direct consequence of accepting the project. We are interested in the difference between the cash flows of the firm with the project and the cash flows of the firm without the project.*

Incremental cash flows

Which of the following is incorrect? a. net working capital Appears on the balance sheet b. net working capital Appears on the statement of cash flows c. net working capital Not on the income statement d. net working capital On the income statement

d. net working capital On the income statement

New product reduces the sales and the cash flows of existing products.

erosion (Incremental IRR side effect)

What is net working capital?

is a capital expenditure on fixed assets

Which one of the following will decrease the net working capital of a firm?

making a payment on a long-term debt

For capital budgeting purposes, *allocated cost* should be viewed as a cash outflow of a project only if it is an incremental cost of the project

n/a

Incremental cash flows (side effects, externalities) cannibalism or synergy

n/a

incremental cash flows -opportunity cost -side effects -taxes -inflation Irrelevant -sunk cost

n/a

A cost that already occurred and cannot be changed by the decision to accept or reject the project. *not incremental cash flows, should be ignored*

sunk cost