Chapter 9

What approach does the following formula describe? OCF=(Sales-Costs) x (1-T) + Depreciation x T

- The Tax Shied Approach

Capital rationing exists when a company has identified positive NPV projects but can't (or won't) find: ;

- The necessary financing

which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?

- As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase

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

- Asking-what-if question - Scenario analysis

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

The difference between a firm's current assets and its current liabilities is known as the ___

- Net working capital

Which of the following are components of project cash flow?

- Operating cash flow - Capital spending - Change in net working capital

Once cash flows have been estimated, which of the following investments criteria can be applied to them?

- Payback period - IRR - NPV

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

- Real option - Managerial option

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

Which of the following are fixed costs?

- Rent on a production facility - Cost of equipment

Which of the following is an example of an opportunity cost

- Rental income likely to be lost by using a vacant building for an upcoming project

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 the time

When using ____, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to change in that particular variable.

- Sensitivity analysis

In a competitive market, positive NPV projects are:

- Uncommon

If a firm's variable cost per unit estimate used in its base case analysis I $50 per unit and they anticipate the upper and lower bounds to be +/- 10%, what is the worst case for variable cost per unit?

- 1.10 * 50 = $55; the worse case for costs is the higher value

What is the depreciation tax shield if EBIT is $600, depreciation is $1800, and the tax rate is 30% ?

- 1800*1.30= $540

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

- After-tax

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

Which of the following are needed for cash flow estimation?

- Unit sales per period - Variable cost per unit - Selling price per unit

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

- What is he underlying source of value?

The basic approach to evaluating cash flow and NPV estimates involves asking:

- What-if questions

Which of the following are considered relevant cash flows?

- Cash flows from opportunity costs - Cash flows from erosion effects - Cash flows from beneficial spillover effects

Investment in net working capital arises when____

- Credit sales are made - Inventory is purchased - Cash is kept for unexpected expenditures

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

- Direct

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

- Estimation risk - Forecasting risk

Sunk costs are costs that ____

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

Interest expenses incurred on dent financing are ___ when computing cash flows from a project

- Ignore

An increase in depreciation expense will____ cash flows from operation

- Increase

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

- It affect 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

Reasons why NPV is considered a superior capital budgeting technique?

- It considers time value of money - It properly chooses among mutually exclusive projects - It considers all the cash flows

what are the two main drawbacks of sensitivity analysis?

- It may increase the false sense of security among managers if all pessimistic estimates of NVP are positive - It does not consider interaction among variables.

What are the two main benefit of performing sensitivity analysis?

- It reduces a false sense of security by giving a range of values for NPV instead of a single value - It identifies the variable that has the most effect on NPV

Managerial options

- The option to wait - The option to expand - The option to abandon

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

What is an important drawback of traditional NPV analysis

- It ignores managerial options in investment decisions

What are the two main benefits of performing sensitivity analysis?

- It reduces a false sense of security by giving a range of values for NPV instead of a single value - It identifies the variable that has the most effect on NPV

The primary risk in estimation errors is the potential to___

- Make incorrect capital budgeting decisions

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

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

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ____

- Net working capital

Which of the following is true relative to capital rationing?

- Soft rationings is typically internal in that the firm allocates funds to divisions for capital projects - Hard rationing implies the firm is unable to raise funds for projects

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

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 - There will be a tax savings if the book value exceeds the sales price - Book value represents the purchase price minus the accumulated depreciation