Chapter 9
o Incremental cash flows come about as a(n) _________ consequence of taking a project under consideration Direct Sporadic Indirect
• Direct
o Among 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 The salvage value of the project The sunk costs incurred before the inception of the project The costs incurred at the inception of the project
• The operating cash flows from net sales over the life of the project
o Erosion will _____ the sales of existing products Not affect Increase Reduce
• Reduce
o Which of the following are fixed costs? (2) Net working capital Rent on a production facility Inventory costs Cost of equipment
• Rent of a production facility • Cost of equipment
o 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 Erosion planning Scenario analysis Benefit-cost analysis Opportunity cost analysis
• Sensitivity analysis
o The difference between a firm's cash flows with a project versus without the project is called___________. Incremental cash flows Additional cash flows Net cash flows Differential cash flows
• Incremental cash flows
o Given the following data, what is the operating cash flow? EBIT= $80 Depreciation=$20 Taxes=$30 • $20 • $70 • $80 • $30
o $70
o Suppose a project's operating cash flows is $150. The firm anticipates a $30 investment in net working capital and $80 in capital spending. What is the project's cash flow? $150 $70 $120 $40
• $40
o Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset? (3) Taxes are based on the difference between the book value and the sales price Book value represents the purchase price minus the accumulated depreciation There will be a tax savings if the book value exceeds the sales price Taxes are based on the difference between the purchase price and the sales price of the asset
• Taxes are based on the difference between the book value and the sales price • Book value represents the purchase price minus the accumulated depreciation • There will be a tax savings if the book value exceeds the sales price
o In a competitive market, positive NPV projects are: Unlimited Easy to find Uncommon
• Uncommon
A nine-year project is expected to generate annual revenues of $137,800, variable costs of $82,600, and fixed costs of $11,000. The annual depreciation is $23,500 and the tax rate is 34 percent. What is the annual operating cash flow? $14,301 $13,662 $35,052 $36,506 $37,162
• $37,162
British Metals is reviewing its current accounts to determine how a proposed project might affect the account balances. The firm estimates the project will initially require $81,000 in additional current assets and $57,000 in additional current liabilities. The firm also estimates the project will require an additional $8,000 a year in current assets in each of the first three of the four years of the project. How much net working capital will the firm recoup at the end of the project assuming that all net working capital can be recaptured? $105,000 $24,000 $48,000 $68,000 $81,000
• $48,000
Floral Shoppes has a new project in mind that will increase accounts receivable by $19,000, decrease accounts payable by $4,000, increase fixed assets by $27,000, and decrease inventory by $2,000. What is the amount the firm should use as the initial cash flow attributable to net working capital when it analyzes this project? -$25,000 -$17,000 -$21,000 -$12,000 -$52,000
• -$21,000
o 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 Ignored 50% reversed 100% reversed Charged against the project again
• 100% Reversed
o The primary risk in estimation error is the potential to________ Make managers look bad Make incorrect capital budgeting decisions Delay the launch of a good project
• Make incorrect capital budgeting decisions
o Which of the following techniques will provide the most consistently correct result? Average accounting return Payback Net present value Internal rate of return
• Net present value
A project costs $2.43 million and has no salvage value. Depreciation is straight-line to zero over the five-year life of the project. Sales are projected at 64,000 units per year, price per unit is $73.29, variable cost per unit is $42.93, and fixed costs are $623,000 per year. The tax rate is 35 percent, and the required rate of return is 11percent. What is the sensitivity of NPV to a 100-unit increase in the sales figure? $9,198.40 $8,609.18 $8,097.40 $7,293.48 $7,557.12
• $7,293.48
o The rules for depreciating assets for tax purposes are based upon provisions in the: 1968 Tax Reform Act 1986 Sarbanes-Oxley Act 1986 SEC Act 1986 IRS Act
• 1968 Tax Reform Act
o Which one of the following refers to a method of increasing the rate at which an asset is depreciated? Noncash expense Straight-line depreciation Depreciation tax shield Accelerated cost recovery system Market-based depreciation
• Accelerated cost recovery system
o Cash flow should always be considered on a(n) _________ basis Zero-tax Before-tax Pre-tax After-tax
• After-tax
o 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 investment cash flows will increase Depreciation expense has no effect on income, taxes, or cash flows As depreciation expense increases, income taxes, and investment cash flows will all decrease As depreciation expense increases, income, taxes, and investment cash flows will all increase
• As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase
o Side effects from investing in a project refer to cash flows from: (2) Beneficial spillover effects Opportunity costs Sunk costs Erosion effects
• Beneficial spillover effects • Erosion effects
o Opportunity costs are ________ The actual expenses of pursuing a specific project The actual expenses incurred by a firm to preserve its market share Benefits lost due to taking on a particular project Benefits gained as a result of accepting a particular project
• Benefits lost due to taking on a particular project
o 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? Sensitivity analysis Capital rationing Soft rationing Contingency planning Sunk cost
• Capital rationing
o Which of the following are components of project cash flow? (3) Capital spending Change in net working capital Change in fixed assets Operating cash flow
• Capital spending • Change in net working capital • Operating cash flow
o Which of the following are considered relevant cash flows? (3) Cash flows from beneficial spillover effects Cash flows from erosion effects Cash flows from external costs Cash flows from sunk costs
• Cash flows from beneficial spillover effects • Cash flows from erosion effects • Cash flows from external costs
o Cash flows used in project estimation should always reflect:(2) Financing costs Accounting values Cash flows when they occur After-tax cash flows
• Cash flows when they occur • After-tax cash flows
o Investments in net working capital arises when ________ (3) Cash is kept for unexpected expenditures Credit sales are made Equipment is purchased using long term debt Inventory is purchased
• Cash is kept for unexpected expenditures • Credit sales are made • Inventory is purchased
o 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? Present value of the future income Cost of the remodeling Current market value of the building Initial cost of the building plus the remodeling costs Current market value of the building plus the remodeling costs
• Current market value of the building
o Operating cash flow is a function of: (3) Depreciation Initial investment in equipment Earnings before interest and taxes Salvage value of equipment Taxes
• Depreciation • Earnings before interest and taxes • Taxes
o The possibility that errors in projected cash flows will lead to incorrect decisions is known as: (2) Managerial incompetence Estimation risk Guess and bless Forecasting risk
• Estimation risk • Forecasting risk
o Forecasting risk is best defined as: Reality risk. Value risk. Potential risk. Management risk. Estimation risk.
• Estimation risk.
o Sunk costs are costs that_______ Relate to other projects of the firm Have already occurred and are not affected by accepting or rejecting a project Will not contribute to profits in the long run even if a project is accepted Cannot be measured
• Have already occurred and are not affected by accepting or rejecting a project
o Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons: (3) It affects a firm's annual tax liability It determines the book value of assets which affect net salvage value It impacts product costs It determines taxes owed on fixed assets when they are sold
• It affects a firm's annual tax liability • It determines the book value of assets which affects net savage value • It determines taxes owed on fixed assets when they are sold
o Which of the following are reasons why NPV is considered a superior capital budgeting technique? (4) It considers time value of money It properly discounts earnings It considers all the cash flows It considers the riskiness of the project It properly chooses among mutually exclusive projects
• It considers time value of money • It considers all the cash flows • It considers the riskiness of the project • It properly chooses among mutually exclusive projects
o The opportunities that a manager has to modify a project once the project has started are called: Sensitivity choices. Managerial options. Scenario adjustments. Restructuring options. Erosion control measures.
• Managerial options.
o A positive NPV exists when the market value of a projects exceeds its cost. Which of these two values is the most difficult to establish? Project cost Market value Both are difficult to establish Both are easy to establish
• Market value
o Identify the three main sources of cash flows over the life of a typical project (3) Net cash flows from salvage value at the end of the project Test marketing expenses that have been classified as sunk costs Net cash flows from sales and expenses over the life of the project Cash outflows from investment in plant and equipment at the inception of the project
• Net cash flows from salvage value at the end of the project • Net cash flows from sales and expenses over the life of the project • Cash outflows from investment in plant and equipment at the inception of the project
o Which of the following is the equation for estimating operating cash flows using the tax shield approach? OCF=(Sales-Costs)*(1-Tax Rate) OCF=(Sales-Costs)+Depreciation OCF=(Sales-costs)*(1-Tax rate)+depreciation*Tax Rate OCF=(Sales-Costs)*Tax Rate+ Depreciation*Tax Rate
• OCF=(Sales-costs)*(1-Tax rate)+depreciation*Tax Rate
o Which one of the following terms refers to the best option that was foregone when a particular investment is selected? Side effect Erosion Sunk cost Opportunity cost Marginal cost
• Opportunity cost
o A manager has estimated a positive NPV for a project. What could drive this result? (3) Management rationality Overly optimistic management The project is a good investment The cash flow estimations are inaccurate
• Overly optimistic management • The project is a good investment • The cash flow estimations are inaccurate
o A pro forma financial statement is a financial statement that: Expresses all values as a percentage of either total assets or total sales. Compares actual results to the budgeted amounts. Compares the performance of a firm to its industry. Projects future years' operating results. Values all assets based on their current market values.
• Projects future years' operating results.
o The tax shield approach to computing the operating cash flow, given a tax-paying firm: Ignores both interest expense and taxes. Separates cash inflows from cash outflows. Considers the changes in net working capital resulting from a new project. Ignores all noncash expenses and their effects. Recognizes that depreciation creates a cash inflow.
• Recognizes that depreciation creates a cash inflow.
o According to the ___________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as the "minifirm" Stand-with Stand-alone Walk-alone Stand-and-deliver
• Stand-alone
o 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): Fixed cost. Forgotten cost. Variable cost. Opportunity cost. Sunk cost.
• Sunk cost
o 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. Credit. Erosion. Opportunity cost. Adjustment.
• Tax Shield
o Which of the following are needed for cash flow estimation? (3) Unit sales per period Variable cost per unit Selling price per unit Fixed cost per unit
• Unit sales per period • Variable cost per unit • Selling price per unit
o 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: is higher than its cost cannot be observed must be determined by the SEC is lower than its cost
• cannot be observed
o One of the most important steps in estimating cash flow is to determine the _________ cash flows Relevant Operating specious
• relevant