FIN Ch 10

The ________-alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.

stand

Cash Flow Algorithm

Cash Flow = Cash Inflow - Cash Outflow

While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital?

It is expected to be recovered by the end of the project's life.

Cash flows should always be considered on an after-tax basis. True or False?

True

Which of the following are fixed costs? A) cost of equipment B) inventory costs C) rent on a production facility D) net working capital

cost of equipment rent on a production facility

Investment in net working capital arises when ___. A) equipment is purchased using long-term debt B) credit sales are made C) inventory is purchased D) cash is kept for unexpected expenditures

credit sales are made inventory is purchased cash is kept for unexpected expenditures

Pro Forma Financial Statements

Financial statements projecting future years' operations. To prepare these statements, we will need estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and the total fixed costs.

The cash flows of a new project that come at the expense of a firm's existing projects is called ________ .

erosion

Interest expenses incurred on debt financing are ______ when computing cash flows from a project.

ignored

An increase in depreciation expense will ____ cash flows from operations.

increase

The rules for depreciating assets for tax purposes are based upon provisions in the ___.

1986 Tax Reform Act

Stand-Alone Principle

The assumption that evaluation of a project may be based on the project's incremental cash flows

Erosion

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

When evaluating cost-cutting proposals, how are operating cash flows affected? A) The decrease in costs increases operating income. B) Wages are always reduced in cost-cutting endeavors. C) There is an additional depreciation deduction. D) The decrease in costs decreases operating income.

The decrease in costs increases operating income. There is an additional depreciation deduction.

With cost-cutting proposals, when costs decrease, operating cash flows ________.

increase

The accelerated cost ________ system is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

recovery

Opportunity costs are classified as ______ costs in project analysis.

relevant

The ________ curse says that the lowest bidder is the one who underbid the most.

winner's

When analyzing a proposed investment, we ________ include interest paid or any other financing costs.

won't

When a firm finances new investments, it may set up accounts payable with suppliers, but the balance that the firm must supply is called the investment in net _________ capital.

working

Opportunity Cost

The most valuable alternative given up if a particular investment is undertaken.

Unit sales are 8,000 in year 1 and 9,000 in year 2. Revenue per unit is $180. NWC starts out at $50,000 and rises to 15% of sales. What is the change in cash flow for the NWC balance at the end of year 2? A) $9,000 B) $12,000 C) $25,000 D) $27,000 E) $54,000

$27,000 Calculation Steps: 1. Calculate total revenue for years. So, Year 1 $1,440,000 Year 2 $1,620,000 2. Next calculate NWC rise of 15% Year 1 1440000 x .15 = 216000 Year 2 1620000 x .15 = 243000 3. Subtract year 2 from year 1 243000 - 216000 = 27,000 change in NWC for year 2

Opportunity costs are ____.

benefits lost due to taking on a particular project

OCF is calculated as net income plus depreciation using the _____ approach.

bottom-up

The Top-down Approach Calculation

OCF = Sales - Costs - Taxes

________ cash flows come about as a direct consequence of taking a project under consideration.

Incremental

Sunk Cost

A cost that has already been incurred and that cannot be removed and therefore should not be considered in an investment decision.

Once cash flows have been estimated, which of the following investment criteria can be applied to them? A) IRR B) NPV C) the constant growth dividend discount model D) YTM E) payback period

IRR NPV payback period

The Tax Shield Calculation

OCF = (Sales - Costs) x (1 - Tc) + Depreciation x Tc Where Tc is the corporate tax rate.

The Bottom-up Approach Calculation

OCF = Net income + Depreciation - Taxes

What is the equation for estimating operating cash flows using the top-down approach?

OCF = Sales - Costs - Taxes

When considering Net Working Capital, a project will generally need all of the following, except: A) Some cash on hand to pay any expenses that arise. B) An initial investment in inventories and accounts receivables. C) Some financing in the form of accounts payable. D) A balance that represents the investment in net working capital. E) Only long-term assets to get the project started.

Only long-term assets to get the project started.

What are the three components of the project cash flow?

Project Cash Flow = Project Operating Cash Flow - Project Change in NWC - Project Capital Spending

Project Cash Flow

Project Operating Cash Flow Project Change in Net working capital Project Capital Spending

Incremental Cash Flow

The difference between a firm's future cash flows with a project and those without a project.

Modified Accelerated Cost Recovery System (MACRS) Classes

Three-year - Equipment used in research Five-year - Autos, computers Seven-year - Most industrial equipment

To calculate the OCF using the bottom-up approach, add ________ to net income.

depreciation

When developing cash flows for capital budgeting, it is _____ to overlook important items.

easy

The ________ step is to determine whether cash flows are relevant.

first

Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ______________ are overlooked.

net working capital

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

net working capital

The computation of equivalent annual costs is useful when comparing projects with _____ lives.

unequal

Poplar products is evaluating a piece of machinery. The cost of the machinery is $1,700,000. The machinery will be depreciated over five years. At the end of the project, the equipment will be worth 25% of its original value. The tax rate is 35%. What is the after-tax proceeds at the end of the project? A) $106,250 B) $276,250 C) $148,750 D) $425,000 E) $595,000

$276,750 Calculation Steps: 1. Multiply machinery cost by the future worth % 1,700,000 x .25 = 425,000 2. Next, multiply future worth by the tax rate 425,000 x (1 - .35) = 276,250

Alternative Definitions of Operating Cash Flow

The Bottom-up Approach The Top-down Approach The Tax Shield Approach

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

direct

Which approach to estimating the operating cash flows uses the following equation? OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate

Tax-Shield Approach

Which of the following is an example of a sunk cost? A) Salvage value of equipment B) Bonus to top management C) Test marketing expenses D) Cost of new equipment

Test marketing expenses

Phantom Corporation purchased equipment for $50,000, four years ago. The accumulated depreciation to date is $41,360. If they were able to sell the equipment today for $20,000, what would be the amount of tax due? Assume the company is in the 34% tax bracket. A) $1,931 B) $3,862 C) $8,640 D) $10,000 E) $11,360

$3,862 Calculation steps: 1. Subtract accumulated depreciation from original purchase price $50,000 - $41,360 = $8,640 book value remaining 2. Subtract book value from sale price today. $20,000 - $8,640 = $11,360 taxable income 3. Multiply taxable income by the tax rate $11,360 x .34 = $3,862.40