Fin 3403 Chapter 10 Conceptual Questions

1. The difference between a firm's future cash flows if it accepts a project and that firm's future cash flows if it does not accept the project is referred to as the projects: A. incremental cash flows B. internal cash flows C. external cash flows D. financing cash flows

A. Incremental Cash Flows

21. Changes in the net working capital requirements: 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. only affect the cash flow at time zero and the final year of a project. D. are generally excluded from project analysis due to their irrelevance to the total project. E. reflect only the changes in the current asset accounts.

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

36. The top-down approach to computing the operating cash flow: A. ignores noncash expenses. B. applies only if a project increases sales. C. applies only to cost cutting projects. D. is equal to sales - costs - taxes + depreciation. E. is used solely to compute a bid price.

A. ignored noncash expenses

13. Which one of the following is an example of a sunk cost? A. $1,500 of lost sales because an item was out of stock B. $1,200 paid to repair a machine last year C. $20,000 project that must be forfeited if another project is accepted D. $4,500 reduction in current shoe sales if a store commences selling sandals E. $1,800 increase in comic book sales if a store commences selling puzzles

B. $1,200 paid to repair a machine last year

38. Which one of the following statements is correct concerning bid prices? A. The bid price is the maximum price that a firm should bid. B. A firm can submit a bid that is higher than the computed bid price and still break even. C. A bid price ignores taxes. D. A bid price should be computed based solely on the operating cash flows of the project. E. A bid price should be computed based on a zero percent required rate of return.

B. A firm can submit a bid that is higher than the competed bid price and still break even

7. Which one of the following is the depreciation method which allows accelerated write-offs of property under various lifetime classifications? A. IRR B. ACRS C. AAR D. straight-line to zero E. straight-line to salvage

B. ACRS

41. When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I. differing productive lives II. differing manufacturers III. required replacement at end of economic life IV. differing initial cost A. I and II B. I and III C. I and IV D. II and III E. II and IV

B. I and III

20. All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero? I. purchase of $1,400 of parts inventory needed to support the project II. loan of $125,000 used to finance the project III. depreciation tax shield of $1,100 IV. $6,500 of equipment needed to commence the project A. I and II only B. I and IV only C. II and IV only D. I, II, and IV only E. I, II, III, and IV

B. I and IV only

26. Which one of the following statements is correct? A. Project analysis should only include the cash flows that affect the income statement. B. A project can create a positive operating cash flow without affecting sales. C. The depreciation tax shield creates a cash outflow for a project. D. Interest expense should always be included as a cash outflow when analyzing a project. E. The opportunity cost of a company-owned building that is going to be used in a new project should be included as a cash inflow to the project.

B. a project can create a positive operating cash flow without affecting sales

2. The fact that a proposed project is analyzed on the project's incremental cash flows is the assumption behind which one of the following principles? A. underlying value principle B. stand-alone principle C. equivalent cost principle D. salvage principle E. fundamental principle

B. stand-alone principle

30. The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following? A. depreciation tax shield B. tax due on the salvage value of that asset C. current year's operating cash flow D. change in net working capital E. MACRS depreciation for the current year

B. tax due on the salvage value of that asset

35. 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 a project. E. both taxes and the interest expense are equal to zero.

B. the interest expense is equal to zero

27. A company that utilizes the MACRS system of depreciation: A. will have equal depreciation costs each year of an asset's life. B. will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life. C. can depreciate the cost of land, if it so desires. D. will expense less than the entire cost of an asset. E. cannot expense any of the cost of a new asset during the first year of the asset's life.

B. will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life

28. Morris Motors just purchased some MACRS 5-year property at a cost of $216,000. Which one of the following will correctly give you the book value of this equipment at the end of year 2? Year | Rate 1 20% 2 32% 3 19.20% 4 11.52% 5 11.52% 6 5.76%

B.$216,000 x (1 - .20 - 0.32)

11. Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary A. I and II only B. III and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV

C. I, II, and IV only

33.Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero? A. EBIT + D B. EBIT - T C. NI + D D. (Sales - Costs) x (1 - D) x (1 - T) E. (Sales - Costs) x (1 - T)

C. NI + D

32. Three years ago, Knox Glass purchased a machine for a 3-year project. The machine is being depreciated straight-line to zero over a 5-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the after tax salvage value of that machine? (T represents the relevant tax rate)

C. Sale price + (Book value - Sale price) x T

43. The bid price always assumes which one of the following? A. A project has a one-year life. B. The aftertax net income of the project is zero. C. The net present value of the project is zero. D. Any assets purchased will have a positive salvage value at the end of the project. E. Assets will be depreciated based on MACRS.

C. The net present value of the project is zero

46. Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income. Given this, which one of the following statements is correct? A. As a project, the new machine has a net present value equal to minus one times the machine's purchase price. B. The new machine will have a zero rate of return. C. The new machine will generate positive operating cash flows, at least in the first few years of its life. D. The new machine will create a cash outflow when the firm disposes of it at the end of its life. E. The new machine creates erosion effects.

C. The new machine will generate positive operating cash flows, at least in the first few years of its life

44. Which one of the following would make a project unacceptable? A. cash inflow for net working capital at time zero B. requiring fixed assets that would have no salvage value C. an equivalent annual cost that exceeds that of an alternative project D. lack of revenue generation E. a depreciation tax shield that exceeds the value of the interest expense

C. an equivalent annual cost that exceeds that of an alternative project

22. Which one of the following is a project cash inflow? Ignore any tax effects. A. decrease in accounts payable B. increase in inventory C. decrease in accounts receivable D. depreciation expense based on MACRS E. equipment acquisition

C. decrease in accounts receivable

39. Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision? A. internal rate of return B. operating cash flow C. equivalent annual cost D. depreciation tax shield E. bottom-up operating cash flow

C. equivalent annual cost

6. Which one of the following best describes pro forma financial statements? A. financial statements expressed in a foreign currency B. financial statements where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales C. financial statements showing projected values for future time periods D. financial statements expressed in real dollars, given a stated base year E. financial statements where all accounts are expressed as a percentage of last year's values

C. financial statements showing projected values for future time periods

10. Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

C. hiring additional employees to handle the increased workload should the firm accept the wreath project

15. Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? A. providing both ketchup and mustard for its customer's use B. repairing the roof of the hot dog stand because of water damage C. selling fewer hot dogs because hamburgers were added to the menu D. offering French fries but not onion rings E. losing sales due to bad weather

C. selling fewer hot dogs because hamburgers were added to the menu

3. Which one of the following costs was incurred in the past and cannot be recouped A. incremental B. side C. sunk D. opportunity E. erosion

C. sunk

5. Which one of the following best described the concept of erosion? A. expensed that have already been injured and cannot be recovered B. change in net working capital related to implementing a new project C. the cash flows of a new project that come at the expense of a firm's existing cash flows D. the alternative that is forfeited when a fixed asset is utilized by a project E. the differences in a firm's cash flows with and without a particular project

C. the cash flows of a new project that come at the expense of a firm's existing cash flows

16. Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product A. I and III only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV

D. II, III, and IV only

8. The depreciation tax shield is best defined as the: A. amount of tax that is saved when an asset is purchased B. tax that is avoided when an asset is sold as salvage C. amount of tax that is due when an asset is sold D. amount of tax that is saved because of the depreciation expense E. amount by which the aftertax depreciation expense lowers net income

D. amount of tax that is saved because of the depreciation expense

23. Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project.

D. can create either a cash inflow or a cash outflow at time zero of a project

45. Decreasing which one of the following will increase the acceptability of a project? A. sunk costs B. salvage value C. depreciation tax shield D. equivalent annual cost E. accounts payable requirement

D. equivalent annual cost

12. The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? A. sunk B. total C. variable D. incremental E. fixed

D. incremental

34. The operating cash flow for a project should exclude which one of the following? A. taxes B. variable costs C. fixed costs D. interest expense E. depreciation tax shield

D. interest expense

4. The option that is foregone so that an asset can be utilized by a specific project is referred to as which of the following? A. salvage value B. wasted value C. sunk cost D. opportunity cost E. erosion

D. opportunity cost

29. Keyser Petroleum just purchased some equipment at a cost of $67,000. What is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5-year property for MACRS? Year | Rate 1 20% 2 32% 3 19.20% 4 11.52% 5 11.52% 6 5.76%

E. $67,000 x 0.32

25. Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to the project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals. A. I and II only B. II and III only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV

E. I, II, III, and IV

42. The equivalent annual cost considers which of the following? I. required rate of return II. operating costs III. need for replacement IV. economic life A. I and II only B. II and IV only C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV

E. I, II, III, and IV

19. Which one of the following will increase a bid price? A. a decrease in the fixed costs B. a reduction in the net working capital requirement C. a reduction in the firm's tax rate D.an increase in the salvage value E. an increase in the required rate of return

E. an increase in the required rate of return

24. The operating cash flow of a cost cutting project: A. is equal to the depreciation tax shield. B. is equal to zero because there is no incremental sales. C. can only be analyzed by projecting the sales and costs for a firm's entire operations. D. includes any changes that occur in the current accounts. E. can be positive even though there are no sales.

E. can be positive even though there are no sales

31. The net book value of equipment will: A. remain constant over the life of the equipment B. vary in response to changes in the market value. C. decrease at a constant rate when MACRS depreciation is used. D. increase over the taxable life of an asset. E. decrease slower under straight-line depreciation than under MACRS.

E. decrease slower under straight-line depreciation than under MACRS

37. Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow? A. erosion effects B. taxes C. fixed expenses D. salaries E. depreciation expense

E. depreciation expense

9. The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following? A. yearly incremental costs B. sunk costs C. opportunity costs D. erosion cost E. equivalent annual cost

E. equivalent annual cost

17. You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the: A. longest life B. highest annual operating cost C. lowest annual operating cost D. highest equivalent annual cost E. lowest equivalent annual cost

E. lowest equivalent annual cost

14. G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? A. opportunity B. fixed C. incremental D.erosion E. sunk

E. sunk

18. The bid price is: A. an aftertax price. B. the aftertax contribution margin. C. the highest price you should charge if you want the project. D. the only price you can bid if the project is to be profitable. E. the minimum price you should charge if you want to earn a target return on investment.

E. the minimum price you should charge if you want to earn a target return on investment

40. The equivalent annual cost method is useful in determining: A. which one of two machines to purchase if the machines are mutually exclusive, have differing lives, and are a one-time purchase. B. the tax shield benefits of depreciation given the purchase of new assets for a project. C. the operating cash flows of a cost-cutting project. D. which one of two investments to accept when the investments have different required rates of return. E. which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

E. which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.