Chapter 9 LearnSmart

What is scenario analysis?

it determines the impact on NPV of a set of events relating to a specific scenario.

Suppose a project's operating cash flow is $150, the firm anticipates a $30 investment in net working capital and $80 is capital spending. What is the projects' cash flow?

$40 (150-30-80=40)

Given the following data, what is the operating cash flow? EBIT= $80 Depreciation= $20 Taxes= $30

$70 (80+20-30=70)

Operating cash flow is a function of:

- Taxes - Depreciation - Earnings before interest and taxes (EBIT)

Which of the following are considered relevant cash flows? - cash flows from opportunity costs - cash flows from erosion effects - cash flows from beneficial effects - cash flows from sunk costs

- cash flows from opportunity costs - cash flows from erosion effects - cash flows from beneficial effects

Identify the three main sources of cash flows over the life of a typical project.

- cash outflows from investment in plant and equipment at the inception of the project - net cash flows from sales and expenses over the life of the project - net cash flows from salvage value at the end of the project

Which of the following are fixed costs? - cost of equipment - rent on a production facility - inventory costs - net working capital

- cost of equipment - rent on a production facility

The possibility that errors in projected cash flows will lead to incorrect decisions is known as:

- forecasting risk (estimation risk)

Which of the following is true to capital rationing? - hard rationing is typically a decision made by top management - soft rationing cannot be overcome even if a superior project is found - hard rationing implies a firm is unable to raise funds for projects - soft rationing is typically internal in the firm allocates funds to divisions for capital projects

- hard rationing implies a firm is unable to raise funds for projects - soft rationing is typically internal in the firm allocates funds to divisions for capital projects

Which of the following qualify as "managerial option"? - the option to wait - the option to expand - the option to change the cost of capital - the option to abandon

- the option to wait - the option to expand - the option to abandon

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

What is the key question to ask concerning a project that results in a positive NPV?

What is the underlying source of value?

Accounts recievable and accounts payable are included in project cash flow estimation as part of changes in __________________.

net working capital

To investigate the impact on NPV of a change in one variable, you would employ _________________.

sensitivity analysis

In order to analyze the risk of a project's NPV estimate, we should establish ___________________ for each important estimate variable.

upper and lower bounds

Synergy will ______ the sales of existing products.

increase

Once cash flows have been estimated, which of the following investment criteria can be applied to them? - YTM - the constant growth dividend discount model - NPV - payback period - IRR

- NPV - payback period - IRR

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:

- it affects a firm's annual tax liability - it determines the book value of assets which affects net salvage value - it determines taxes owed on fixed assets when they are sold

A manager has estimated a positive NPV for a project. What could drive that result?

- the project is a good investment - the cash flow estimations are inaccurate - overly optimistic management

Which of the following are needed for cash flow estimation? - unit sales per period - fixed cost per unit - variable cost per unit - selling price per unit

- unit sales per period - variable cost per unit - selling price per unit

If a firm's sales estimate used in its base case analysis is 1,000 units per year and they anticipate the upper and lower bounds to me +/- 15%, what is the "best=case" for units sold per year?

1,150

In the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.

Which of the following techniques will provide the most consistently correct result? - Average accounting return - Net Present Value - Payback - Internal rate of return

Net Present Value

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

The operating cash flows from net sales over the life of the project.

T or F: While preforming sensitivity analysis, we compute NPV several times by changing one input variable at a time.

True

Cash flows should always be considered on a(n) _______________ basis.

after-tax

Cash flows used in project estimation should always reflect:

after-tax flows & cash flows when they occur

When we estimate the best-case , worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

asking what-if questions & scenario analysis

The goals of risk analysis in capital budgeting include:

assessing the degree of financing risk & identifying critical components

Opportunity costs are _________________.

benefits lost due to taking on a particular project

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

cannot be observed

Incremental cash flows come about as a(n) _____________ consequence of taking a project under consideration.

direct

Sunk costs are costs that ________________.

have already occurred and are not affected by accepting or rejecting a project

The stand-alone principle assumes that evaluation of a project may be based on the project's _____________ cash flows.

incremental

The difference between a firm's cash flows with a project versus without the project is called _________________.

incremental cash flows

An option on a real asset rather than a financial asset is known as a:

real option & managerial option

One of the most important steps in estimating cash flows is to determine the ___________ cash flows.

relevant

According to the ____________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm".

stand-alone