Finance Chapter 12

Bruce Moneybags owns several restaurants and hotels near a local interstate. One restaurant, Beef and More, originally cost $1.8 million, is currently fully paid for, but needs modernized. Bruce is trying to decide whether to accept an offer and sell Beef and More, as is, for the offer price of $1.1 million or renovate the restaurant himself. The projected renovation cost is $1.3 million. The restaurant would need to be shut down completely during the renovation which would cause an aftertax net loss of $90,000 in today's dollars. The estimated present value of the cash inflows from the renovated restaurant is $3.2 million. When analyzing the renovation project, what cost, if any, should be included for the current restaurant?

1.1 million

scenario analysis asks questions such as

What is the best outcome that should reasonably be expected?

a proposed project will increase a firm's accounts payables. this increase is generally

a cash inflow at time zero and a cash outflow at the end of the project

Lake City Plastics currently produces plastic plates and silverware. The company is considering expanding its product offerings to include plastic serving trays. All of the following are relevant costs to this project with the exception of:

a percentage of the current operating overhead

Which one of the following refers to a method of increasing the rate at which an asset is depreciated?

accelerated cost recovery system

Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best fits the situation facing the firm?

capital rationing

The pro forma income statements for a proposed investment should include all of the following except:

changes in net working capital

CrossTown Builders is considering remodeling an old building it currently owns. The building was purchased ten years ago for $1.2 million. Over the past ten years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $1.9 million. The company is considering remodeling the building into industrial-type apartments at an estimated cost of $1.6 million. The estimated present value of the future income from these apartments is $4.1 million. Which one of the following defines the opportunity cost of the remodeling project?

current market value of the building

Which one of the following will increase the operating cash flow as computed using the tax shield approach?

decrease in fixed costs

Nu Tek is comprised of four separate operating divisions. For this year, the firm has decided to allocate capital funds using a soft rationing approach. Which one of the following applies to this situation?

division managers should expect to be treated equally, at least initially, in the capital distribution process

Which one of the following terms is most commonly used to describe the cash flows of a new project that are simply an offset of reduced cash flows for a current project?

erosion

forecasting risk is best defined as

estimation risk

Flo is considering three mutually exclusive options for the additional space she plans to add to her specialty women's store. The cost of the expansion will be $148,000. She can use this additional space to add children's clothing, an exclusive gifts department, or a home decor section. She estimates the present value of the cash inflows from these projects are $121,000 for children's clothing, $178,000 for exclusive gifts, and $145,000 for decorator items. Which option(s), if any, should she accept?

exclusive gifts only

Dismal Outlook is unable to obtain financing for any new projects under any circumstances. This company is faced with:

hard rationing

the operating cash flows of a project

include erosion effects

which of the following create cash inflows from net working capital

increase in accounts payable and decrease in inventory

Assume an all-equity firm has positive net earnings. The operating cash flow of this firm:

increases when the tax rate decreases

Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as:

incremental cash flows

the ability to delay an investment

is valuable provided there are conditions under which the investment will have a positive net present value

Which one of the following is a correct value to use if you are conducting a best-case scenario analysis?

lowest expected value for fixed costs

The opportunities that a manager has to modify a project once the project has started are called:

managerial options

contingency planning focuses on the

managerial options implicit in a project

ignoring the option to wait

may underestimate the net present value of a project.

Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of five years.

money spent last month repairing a damaged front fender

Ed owns a store that caters primarily to men. Each of the answer options represents an item related to a planned store expansion. Each of these items should be included in the expansion analysis with the exception of the cost:

of the blueprints that have been drawn of the expansion area

Firm A uses straight-line depreciation. Firm B uses MACRS depreciation. Both firms bought $75,000 worth of equipment last year that has a tax life of 5 years. The 5-year MACRS percentage rates, starting with Year 1, are: 20, 32, 19.2, 11.52, 11.52, and 5.76. Both firms have a marginal tax rate of 34 percent and identical operating cash flows except for the depreciation effects. Given this, you know the:

operating cash flow of Firm A is greater than that of Firm B for Year 3.

Which one of the following terms refers to the best option that was foregone when a particular investment is selected?

opportunity cost

Turner Industries started a new project three months ago. Sales arising from this project are significantly less than anticipated. Given this, which one of the following is management most apt to implement?

option to abandon

Which one of these has the least potential to increase the net present value of a proposed investment? Assume the project has a positive net present value in at least one set of circumstances.

option to discontinue a project at the end of its intended life

a pro forma financial statement is a financial statement that

projects future years operating results

Scenario analysis is best described as the determination of the:

reasonable range of project outcomes

The tax shield approach to computing the operating cash flow, given a tax-paying firm:

recognizes that depreciation creates a cash inflow

the net working capital invested in a project is generally

recouped at the end of the project

Jamie is analyzing the estimated net present value of a project under various conditions by revising the sales quantity, sales price, and the cost estimates. The type of analysis that Jamie is doing is best described as:

scenario analysis

helps determine the reasonable range of expectations for a project's anticipated outcome.

scenario analysis

Kate is analyzing a proposed project to determine how changes in the sales quantity would affect the project's net present value. What type of analysis is being conducted?

sensitivity analysis

helps identify the variable within a project that presents the greatest forecasting risk.

sensitivity analysis

Northern Companies has three separate divisions. Each year, the company determines the amount it can afford to spend in total for capital expenditures and then allocates one-third of that amount to each division. This allocation process is called:

soft rationing

Which one of the following principles refers to the assumption that a project will be evaluated based on its incremental cash flows?

stand alone principle

Which one of the following refers to the option to expand into related businesses in the future?

strategic option

Weston Steel purchased a new coal furnace six years ago at a cost of $2.2 million. Last year, the government changed the emission requirements and this furnace cannot meet those standards. Thus, the company can no longer use the furnace, nor has it been able to locate anyone willing to purchase the furnace. Given the current situation, the furnace is best described as which type of cost?

sunk

A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as a(n):

sunk cost

The analysis of a new project should exclude:

sunk costs

The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation:

tax shield

The Corner Market has decided to expand its retail store by building on a vacant lot it currently owns. This lot was purchased four years ago at a cost of $299,000, which the firm paid in cash. To date, the firm has spent another $38,000 on land improvements, all of which was also paid in cash. Today, the lot has a market value of $329,000. What value should be included in the analysis of the expansion project for the cost of the land?

the current market value of the land

The Shoe Box is considering adding a new line of winter footwear to its product lineup. When analyzing the viability of this addition, the company should include all of the following in its analysis with the exception of:

the research and development costs to produce the current winter footwear samples

when a firm faces hard rationing

there will be no available funds for capital expenditures

Thrill Rides is considering adding a new roller coaster to its amusement park. The addition is expected to increase its overall ticket sales. In particular, the company expects to sell more tickets for its current roller coaster and experience extremely high demand for its new coaster. Sales for its boat ride are expected to decline but food and beverage sales are expected to increase significantly. All of the following are side effects associated with the new roller coaster with the exception of the:

ticket sales for the new coaster