Chapter 9: Making Capital Investment Decisions
The possibility that errors in projected cash flows will lead to incorrect decisions is known as:
estimation risk forecasting risk
If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be
100% reversed.
2. To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.
2. True
3. True or false: Investment in net working capital may arise from the need to cover credit sales.
3. True
8. True or false: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.
8. True
What are the two main benefits of performing sensitivity analysis?
It identifies the variable that has the most effect on NPV. It reduces a false sense of security by giving a range of values for NPV instead of a single value
Which of the following techniques will provide the most consistently correct result?
Net Present Value
Which of the following is an example of a sunk cost?
Project consultation fee
Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
Taxes are based on the difference between the book value and the sales price. Book value represents the purchase price minus the accumulated depreciation. There will be a tax savings if the book value exceeds the sales price.
What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC
The Tax Shield Approach
A manager has estimated a positive NPV for a project. What could drive this result?
The project is a good investment. Overly optimistic management The cash flow estimations are inaccurate.
Cash flows should always be considered on a(n) ___________ basis.
after-tax
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
Cash flows used in project estimation should always reflect:
cash flows when they occur after-tax cash flows
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 goals of risk analysis in capital budgeting include:
identifying critical components assessing the degree of financing risk
Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
ignored
Synergy will _____ the sales of existing products
increase
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
Investment in net working capital arises when ___.
inventory is purchased credit sales are made cash is kept for unexpected expenditures
Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:
it determines taxes owed on fixed assets when they are sold it determines the book value of assets which affects net salvage value it affects a firm's annual tax liability
The primary risk in estimation errors is the potential to __________.
make incorrect capital budgeting decisions
:The project cash flow equals the project operating cash flow_______ project change in NWC minus project capital spending.
minus
The project cash flow equals the project operating cash flow project change in NWC minus project capital spending.
minus
Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______________.
net working capital
.Erosion will ______ the sales of existing products.
reduce
One of the most important steps in estimating cash flow is to determine the _________ cash flows.
relevant
Opportunity costs are classified as ____ costs in project analysis.
relevant
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:
scenario analysis asking what-if questions
Estimates of which of the following are needed to prepare pro forma income statements?
selling price per unit variable costs unit sales
Scenario analysis considers a combination of factors for each scenario while ____________ analysis focuses on only one variable at a time.
sensitivity
Scenario analysis considers a combination of factors for each scenario while ____________analysis focuses on only one variable at a time.
sensitivity
_____________ analysis is useful in pinpointing variables that deserve the most attention.
sensitivity
To investigate the impact on NPV of a change in one variable, you would employ ________.
sensitivity analysis
In a competitive market, positive NPV projects are:
uncommon
In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable
upper and lower bounds
In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable.
upper and lower bounds
The basic approach to evaluating cash flow and NPV estimates involves asking:
what-if questions
Broadband, Inc., has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.
$400,000
1. True or false: In calculating cash flows, you should consider all financing costs.
1. False
The rules for depreciating assets for tax purposes are based upon provisions in the:
1986 Tax Reform Act
5. True or false: Taxes are based on the difference between the initial cost and the sales price.
5. False
6. The number of positive NPV projects is unlimited for any given firm.
6. False
7. True/False:The number of positive NPV projects is unlimited for any given firm.
7. False
Which of the following are components of project cash flow?
Operating cash flow Capital spending Change in net working capital
Which of the following are reasons why NPV is considered a superior capital budgeting technique?
It properly chooses among mutually exclusive projects It considers all the cash flows. It considers the riskiness of the project. It considers time value of money.
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
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
NPV payback period IRR
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 is the equation for estimating operating cash flows using the tax shield approach?
OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
4. True or false: Taxes are based on the difference between the initial cost and the sales price.
4. False
What is the difference between scenario analysis and sensitivity analysis?
Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time.
What is scenario analysis?
Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.
A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?
Market value
When using _______________, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.
sensitivity analysis
