BUS ADM 350: Chap. 9
Investment in net working capital arises when ____.
-inventory is purchased -credit sales are made -cash is kept for unexpected expenditures
Estimates of which of the following are needed to prepare pro forma income statements?
-selling price per unit -unit sales -variable costs
If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be
100% reversed
The rules for depreciating assets for tax purposes are based upon provisions in the:
1986 Tax Reform Act
Which one of the following refers to a method of increasing the rate at which an asset is depreciated?
Accelerated cost recovery system
Cash flows should always be considered on a(n) ___________ basis.
After-tax
What is Scenario-Analysis?
Determines the impact on NPV of a set of events relating to a specific scenario.
T/F: In calculating cash flows, you should consider all financing costs.
False
T/F: Taxes are based on the difference between the initial cost and the sales price.
False
T/F: The number of positive NPV projects is unlimited for any given firm.
False
Interest expenses incurred on debt financing are ______ when computing cash flows from a project
Ignored
The stand-alone principle assumes that evaluation of a project may be based on the project's ___________ cash flows.
Incremental
The difference between a firm's cash flows with a project versus without the project is called ________________.
Incremental Cash Flows
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
In the context of capital budgeting, what does sensitivity analysis do?
It examines how sensitive a particular NPV calculation is to changes in underlying assumptions
The primary risk in estimation errors is the potential to __________.
Make incorrect capital budgeting decisions
A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?
Market Value
Capital rationing exists when a company has identified positive NPV projects but cannot (or will not) find:
Necessary Financing
Which of the following techniques will provide the most consistently correct result?
Net Present Value
Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______________.
Net working capital
Which of the following is an example of a sunk cost?
Project consultation fee
Erosion will ______ the sales of existing products.
Reduce
One of the most important steps in estimating cash flow is to determine the _________ cash flows.
Relevant
Opportunity costs are classified as ____ costs in project analysis.
Relevant
To investigate the impact on NPV of a change in one variable, you would employ ________.
Sensitivity Analysis
According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."
Stand-alone
What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC
Tax Shield Approach
T/F: Investment in net working capital may arise from the need to cover credit sales.
True
To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.
True
In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable.
Upper and lower bounds
The basic approach to evaluating cash flow and NPV estimates involves asking:
What-if questions
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
Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.
direct
Sunk costs are costs that ___.
have already occurred and are not affected by accepting or rejecting a project
Sunk costs are costs that ____.
have already occurred and are not affected by accepting or rejecting a project
Synergy will _____ the sales of existing products.
increase
The project cash flow equals the project operating cash flow _____ project change in NWC minus project capital spending.
minus
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
Opportunity costs are ____.
the benefits lost due to taking on a particular project
In a competitive market, positive NPV projects are:
uncommon
An all-equity firm has net income of $112,780, depreciation of $8,750, and taxes of $29,980. What is the firm's operating cash flow?
$121,530
The Corner Shop is considering a new four-year expansion project that requires an initial fixed asset investment of $210,000. The fixed asset will be depreciated straight-line to zero over its four-year life, after which time it will be worthless. The project is estimated to generate $48,000 in annual sales, with costs of $31,000. If the tax rate is 34 percent, what is the OCF for this project?
$29,070
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
Shelton Co. purchased a parcel of land six years ago for $874,500. At that time, the firm invested $146,000 in grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $54,500 a year. The company is now considering building a warehouse on the site as the rental lease is expiring. The current value of the land is $926,000. What value should be included in the initial cost of the warehouse project for the use of this land?
$926,000
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
- IRR -NPV -payback period
The goals of risk analysis in capital budgeting include:
-Assessing the degree of financing risk -Identifying critical components
Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
-Book value represents the purchase price minus the accumulated depreciation. -There will be tax savings if the book value exceeds the sales price. -Taxes are based on the difference between the book value and the sales price.
Cash flows used in project estimation should always reflect:
-Cash flows when they occur -After-tax cash flows
Which of the following are components of project cash flow?
-Change in net working capital -Operating cash flow -Capital spending
The possibility that errors in projected cash flows will lead to incorrect decisions is known as:
-Estimation risk -Forecasting risk
Which of the following is true relative to capital rationing?
-Hard rationing implies the firm is unable to raise funds for projects -Soft Rationing is typically internal in that the firm allocates funds to divisions for capital projects.
Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:
-It affects a firm's annual tax liability -It determines taxes owed on fixed assets when they are sold -It determines the book value of assets which affects net salvage value
Which of the following are reasons why NPV is considered a superior capital budgeting technique?
-It considers the riskiness of the project -It properly chooses among mutually exclusive projects -It considers all the cash flows -It considers time value of money
A manager has estimated a positive NPV for a project. What could drive this result?
-Overly Optimistic management -The project is a good investment -The cash flow estimations are inaccurate
An option on a real asset rather than a financial asset is known as a:
-Real Option -Managerial Option
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
Which of the following qualify as "managerial options"?
-The option to wait -The option to abandon -The option to expand
Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
-There will be a tax savings if the book value exceeds the sales price -Taxes are based on the difference between the book value and the sales price -Book value represents the purchase price minus the accumulated depreciation