FIN 357 Chapter 11: Project Analysis and Evaluation

True or false: Ultimately, we are more interested in cash flow than accounting income.

True

The situation that occurs when a business cannot raise financing for a project under any circumstances is called _________ rationing.

hard

A firm with higher operating leverage will have ______ fixed costs relative to a firm with low operating leverage.

high

For all practical purposes, it is easier to _____.

increase operating leverage than to decrease it

As a practical matter, it is easier to (decrease/increase) operating leverage than it is to (decrease/increase) it.

increase, decrease

The possibility that errors in projected cash flows will lead to incorrect decisions is called _______, or estimation, risk.

forecasting

A firm with higher operating leverage will have (low/high) fixed costs relative to a firm with low operating leverage.

high

An accounting break-even point of 2,000 means the firm ____.

will start generating profits if it sells more than 2,000 units

___________ analysis involves estimating the best-case, worst-case, and base-case cash flows and calculating the corresponding NPVs.

scenario

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

An accounting break-even point of 1,000 units means that ____.

when the firm sells 1,000 units, profits will be equal to zero

Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $1,000,000. 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.

1,000,000

Rank each of the following in order from most important to least important as they pertain to project analysis:

1. cash flow 2. accounting income

When McDonald's decides to build a new restaurant at a particular location, which of the following competitors might also be tempted to locate new facilities in the same area?

Burger King Wendy's

Suppose Price per Unit is $6, variable cost per unit is $2, fixed costs are $400 and the depreciation allowance per year is $500. The relationship between operating cash flow (OCF) and sales volume (Q) can be expressed as:

OCF = (P - v) * Q - FC OCF = (6-2) * Q - 400

Which of the following equations correctly relates OCF to sales volume?

OCF = (P − v) × Q − FC

Which of the following statements is true in the context of comparing accounting profit and present value break-even point?

Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect

Which of the following is an example of a sunk cost?

Research and development expense incurred in the past

What is the purpose of accounting profit break-even analysis?

To determine the level of sales at which profits are equal to zero

What is the relationship between variable costs and output?

Total variable costs are directly related to the level of output

Financial break-even is the sales level that results in _____.

an NPV = 0

From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage _____.

as low as possible

To be considered good, projected cash flows should _____ actual cash flows.

be close to

A firm will start generating positive accounting profits _____.

beyond the break-even sales point

The _____ is the percentage change in operating cash flow relative to the percentage change in quantity sold.

degree of leverage

West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately West Corporation lost money on the project. This may have been avoided had they assessed the ______ of the cash flow estimates.

reliability

In a simulation, the average NPV and the spread of NPVs around the average are determined by _____.

repeated random drawings

Corporate managers care about the break-even point because it indicates the level to which _____ can fall before a project will start losing money.

sales

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

The Omega Division of Alpha Corporation has been allocated $4 million for capital spending but has identified $4.6 million in positive NPV projects. Omega's manager thinks he can convince the company to fund the additional $0.6 million dollars because Omega uses _______ rationing to control overall spending.

soft

The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting is called _________ rationing.

soft

Capital rationing exists when a company has identified positive NPV projects but can't find _____.

the necessary financing

The ___________ - cost is equal to the quantity of output times the cost per unit of output.

variable

The basic approach to evaluating cash flow and NPV estimates involves asking _______-if questions.

what

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

what-if questions

Which of the following is the correct equation for the degree of operating leverage?

DOL = 1 + (FC / OCF)

True or false: When a business does hard rationing, the firm's DCF analysis breaks down.

True

In simulation analysis, a combination of _____ analysis and _____ analysis is used.

scenario; sensitivity

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

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

NPV considers TVM NPV considers all cash flows

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 _________ break-even is the sales level that results in a zero NPV.

financial

Which costs are included in the numerator of the accounting profit break-even point equation?

fixed costs; depreciation

Evans Corporation estimated that the cash flows last year from a particular project would be $40,000, but the actual cash flow turned out to be $37,500. Evans Corporation should _____.

not expect cash flow estimates to be exactly right every time

The degree to which a firm or project relies on fixed costs is called the __________ leverage.

operating

___________ value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

present

A firm will start generating profits when ___.

the total number of units sold exceeds the accounting break-even point

Corporate managers care about the break-even point because it indicates the level _____.

to which sales can fall before a project will start losing money

In a competitive market, positive NPV projects are:

uncommon

A situation in which a firm has positive NPV projects but cannot find the necessary financing is called capital ___________.

rationing

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

estimation risk or forecasting risk

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.