Chapter 10 Making Capital Investment Decisions
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
Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?
As depreciation expense increases, net income and taxes will decrease, while cash flows will increase.
Which of the following are considered relevant cash flows?
Cash flows from opportunity costs Cash flows from beneficial spillover effects Cash flows from erosion effects
Identify the three main sources of cash flows over the life of a typical project.
Cash outflows from investment in plant and equipment at the inception of the project Net cash flows from sales and expenses over the life of the project. Net cash flows from salvage value at the end of the project
Which one of the following is the equation for estimating operating cash flows using the tax shield approach?
OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
What is the equation for estimating operating cash flows using the top-down approach?
OCF = Sales - Costs - Taxes
Which of the following is an example of an opportunity cost?
Rental income likely to be lost by using a vacant building for an upcoming project
Which of the following is an example of a sunk cost?
Test marketing expenses
Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?
The operating cash flows from net sales over the life of the project
When evaluating cost-cutting proposals, how are operating cash flows affected?
There is an additional depreciation deduction. The decrease in costs increases operating income
Cash flows should always be considered on an aftertax basis.
True
sunk cost
a cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision.
Cash flows should always be considered on a(n) ___ basis.
aftertax
When analyzing a project, sunk costs ____ incremental cash outflows.
are not
When an asset is sold, there will be a tax savings if ___ the value exceeds the sales price.
book
OCF is calculated as net income plus depreciation using the _____ approach.
bottom-up
The computation of equivalent annual costs is useful when comparing projects with unequal _____.
lives
Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ___ are overlooked.
net working capital
To calculate the OCF using the bottom-up approach, add ___ to net income.
depreciation
Operating cash flow is a function of _____.
depreciation taxes earnings before interest and taxes
Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.
direct
When developing cash flows for capital budgeting, it is _____ to overlook important items.
easy
The cash flows of a new project that come at the expense of a firm's existing projects is called ___.
erosion
The ___ step is to determine whether cash flows are relevant.
first
Using your personal savings to invest in your business is considered to have an ___ ___ because you are giving up the use of these funds for other investments or uses, such as a vacation or paying off a debt.
opportunity; cost
To prepare _____ financial statements, we need estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and total fixed costs.
pro forma
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
Investment in net working capital arises when ___.
1. cash is kept for unexpected expenditures 2. credit sales are made 3. inventory is purchased
Which of the following are fixed costs?
1. cost of equipment 2. rent on a production facility
The bonus depreciation in 2019 was ___ percent.
100
The rules for depreciating assets for tax purposes are based upon provisions in the ___.
1986 Tax Reform Act
According to the 2017 Tax Cuts and Jobs Act, bonus depreciation is phased out after _____.
2026
A sunk cost is an example of a relevant incremental cash flow.
False
Opportunity costs can be ignored when determining the financial feasibility of a project.
False
___ cash flows come about as a direct consequence of taking a project under consideration.
Incremental
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.
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
NPV payback period IRR
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 statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
Taxes are based on the difference between the book value and the sales price. There will be a tax savings if the book value exceeds the sales price. Book value represents the purchase price minus the accumulated depreciation.
An increase in depreciation expense will ____ cash flows from operations.
increase
If the tax rate increases, the value of the depreciation tax shield will ______.
increase
Side effects from investing in a project refer to cash flows from _____.
beneficial spillover effects erosion effects
Opportunity costs are ____
benefits lost due to taking on a particular project
With cost-cutting proposals, when costs decrease, operating cash flows ___.
increase
A pro ___ financial statement projects future years' operations.
forma
Sunk costs are costs that ____.
have already occurred and are not affected by accepting or rejecting a project
Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
ignored
As depreciation expense ___, net income and taxes will decrease, while cash flows will ___.
increase; increase
The difference between a firm's current assets and its current liabilities is known as the _____.
net working capital
Erosion will ______ the sales of existing products.
reduce
Opportunity costs are classified as ______ costs in project analysis.
relevant
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
The tax saving that results from the depreciation deduction is called the depreciation tax ___.
shield
A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____.
should be accepted if there is no capital rationing constraint
The ___ -alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.
stand
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
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.
incremental cash flows
the difference between a firm's future cash flows with a project and those without the project
opportunity cost
the most valuable alternative that is given up if a particular investment is undertaken.
When developing cash flows for capital budgeting, it is easy to overlook important items.
true
The computation of equivalent annual costs is useful when comparing projects with _____ lives.
unequal
Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the _____.
winner's curse
The ___ curse says that the lowest bidder is the one who underbid the most.
winners
When analyzing a proposed investment, we ___ include interest paid or any other financing costs.
won't
