FIN 362 - CH 11

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

high

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are ___.

inaccurate

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are _____.

inaccurate

break-even analysis (basic)

minimum sales level

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

operating

scenario analysis (extended)

investigate how different assumptions about the future will impact our estimates - projected CF and hence NPV

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

DOL = 1 + FC/OCF

4 break even measures

I. the general break-even expression II. the accounting break-even point III. the cash break-even point IV. the financial break-even point

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

the general break-even expression

Q = (FC + OCF) / (P - v) -> QP - QV = FC + OCF -> QP = FC + OCF + QV where FC = total fixed costs P = price per unit V = variable cost per unit QP = revenue QV = total variable costs

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

Research and development expense incurred in the past

What is scenario analysis?

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

How to evaluate a project: step 1: base case

Step A. Projected (or pro forma) financial statement. Step B. projected cash flows C. estimate the value of the project

Which of the following is an opportunity cost in the context of a vacant building that a firm currently owns?

The potential rental income lost by using the empty building for a project

sensitivity analysis (extended)

an investigation of what happens to NPV and only one variable is changed.

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 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

We __ consider any interest expense in calculating net income or cash flow from the project.

do not

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

___ analysis determines the impact on NPV of a set of events relating to a specific situation.

scenario

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

scenario

How to evaluate a project

step 1: base case step 2: project analysis

what is scenario analysis?

the determination of what happens to NPV estimates when we ask what-if questions

break-even analysis

tool for analyzing the relationship between sales volume and profitability - sales volume (Q) is usually analyzed more closely than other variables. INTERESTED IN MINIMUM "Q"

If we conclude that a project has a negative NPV when the true NPV is positive, we lose a valuable opportunity.

true

True or false. If we conclude that a project has a negative NPV when the true NPV is positive, we lose a valuable opportunity.

true

how to estimate the value of the project

use DCF valuation: NPV

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

what

sensitivity analysis ex

what happens with the NPV when only unit sales change?

sensitivity analysis (basic)

what if analysis - (one variable) do step A, B, and C for each scenario

scenario analysis (basic)

what if analysis - many variables do step A, B, and C for each scenario

the cash break-even point

*FC & V *when OCF is zero, so cash break-even point is: Q = FC (P - V) -> QP - QV = FC QP = FC + QV

the accounting break-even point

*FC, V & D *When Net income is zero. OFC = D when net income is zero, so break-even point is: Q = (FC + D) / (P - V) -> QP - QV = FC + D QP = FC + QV + D

the financial break-even point

*FINANCE - NPV = 0 *When NPV of project is zero, so financial break-even point is: Q = (FC + OCF) / (P - V)

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

- NPV considers time value of money. - NPV considers all the cash flows

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

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

- increase - decrease

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

How to evaluate a project: step 2: project analysis

1. scenario analysis 2. sensitivity analysis 3. break-even analysis

What is a sunk cost?

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

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

DOL - degree of operating leverage

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are ______.

inaccurate

For all practical purposes, it is easier to _____

increase operating leverage than to decrease it

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