FIN 320 chap 9
16) A decrease in the sales of a current project because of the launching of a new project is A) cannibalization. B) a sunk cost. C) an overhead expense. D) irrelevant to the investment decision.
Answer: A
9.2 Forecasting Incremental Earnings 1) When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process.
Answer: FALSE
9.3 Determining Incremental Free Cash Flow 1) To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings. T/F
Answer: FALSE
18) The difference between scenario analysis and sensitivity analysis is: A) Scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is based upon net present value (NPV). B) Only sensitivity analysis allows us to change our estimated inputs of our net present value (NPV) analysis. C) Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters. D) Only scenario analysis breaks the net present value (NPV) calculation into its component assumptions.
C) Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters.
Use the figure for the question(s) below. 2) A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. The assumptions regarding which parameter should be scrutinized most carefully in the estimation process? A) units sold B) sales price C) cost of goods D) cost of capital
C) cost of goods
9.1 The Capital Budgeting Process 1) A capital budget lists the potential projects a company may undertake in future years.T/F
Answer: FALSE
6) The EBIT breakeven point can be calculated using which of the following formulas? A) (Units Sold × Sale Price) — (Units Sold × Cost per unit) — SG&A — Depreciation = 0 B) (Units Sold × Sale Price) + (Units Sold × Cost per unit) — SG&A — Depreciation = 0 C) (Units Sold × Sale Price) — (Units Sold × Cost per unit) + SG&A + Depreciation = 0 D) (Units Sold × Sale Price) + (Units Sold × Cost per unit) + SG&A — Depreciation = 0
A) (Units Sold × Sale Price) — (Units Sold × Cost per unit) — SG&A — Depreciation = 0
21) Which of the following will cause the EBIT Break-Even for sales to increase? A) A decrease in the sales price. B) A decrease in depreciation expense. C) A decrease in selling, general, and administrative expenses. D) A decrease in the number of units sold.
A) A decrease in the sales price.
15) Which of the following statements is FALSE? A) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero. B) The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital. C) When evaluating a capital budgeting project, financial managers should make the decision that maximizes net present value (NPV). D) Sensitivity analysis reveals which aspects of the project are most critical when we are actually managing the project.
A) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero.
4) Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why? A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs. B) No, because the cost of the movie was not recoverable and would have been lost whatever action he took. C) No, because going to see the movie means that the product of his initial investment was realized as originally planned. D) No, because he incurred no further costs by going to see the movie.
A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
3) A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. How should the $20 million best be considered? A) as a sunk cost B) as an opportunity cost C) as a fixed overhead expense D) as a capital cost
A) as a sunk cost
2) Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking? A) option to delay B) option to expand C) option to abandon D) option to switch
A) option to delay
19) An exploration of the effect of changing multiple project parameters on net present value (NPV) is called A) scenario analysis. B) internal rate of return (IRR) analysis. C) accounting break-even analysis. D) sensitivity analysis.
A) scenario analysis.
5) Which of the following formulas will correctly calculate Net Working Capital? A) Cash + Inventory + Receivables + Payables B) Cash + Inventory + Receivables - Payables C) Cash + Inventory - Receivables + Payables D) Cash - Inventory + Receivables + Payables
B) Cash + Inventory + Receivables - Payables
5) Which of the following statements regarding real options is NOT correct? A) Real options should only be exercised when they increase the NPV of a project. B) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date. C) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date. D) Real options build greater flexibility into a project and thus increase its net present value (NPV).
B) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date
4) A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard? A) option to delay B) option to expand C) option to abandon D) option to switch
B) option to expand
3) After research into where to place a new restaurant, Burger Billies, a small fast-food chain, plans to open a new store near a small college. The anticipated customer base is students attending the college. They learn that a major fast food chain will be opening a franchise within the college, which leads the owners of Burger Billies to revise their estimate of sales to one below the break-even point. Which of the following is most likely the best real option for Burger Billies to take with regard to the proposed restaurant site? A) option to delay B) option to expand C) option to abandon D) option to switch
C) option to abandon
Use the figure for the question(s) below. 5) The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true? A) The net present value (NPV) of the project increases with increased cost of goods sold. B) The project should not be undertaken if the predicted cost of goods sold is less than $110. C) The net present value (NPV) of the project will be positive if the cost of good sold is greater than $110. D) If the good costs $110 to make, the net present value (NPV) of the project will be zero.
D) If the good costs $110 to make, the net present value (NPV) of the project will be zero.
17) Which of the following statements is FALSE? A) We can use scenario analysis to evaluate alternative pricing strategies for our project. B) Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters. C) The difference between the internal rate of return (IRR) of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. D) Scenario analysis breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as each one of the underlying assumptions changes.
D) Scenario analysis breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as each one of the underlying assumptions changes.
16) Which of the following statements is FALSE? A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our net present value (NPV) analysis for the project. B) To compute the net present value (NPV) for a project, you need to estimate the incremental cash flows and choose a discount rate. C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty. D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
9) The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project's net present value (NPV). Which of the following best describes what type of analysis the manager is performing? A) scenario analysis B) sensitivity analysis C) break-even analysis D) EBIT-break even analysis
A) scenario analysis
22) Which of the following is an example of *cannibalization*? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local university's mascot. C) A basketball manufacturer adds basketball hoops to its product line. D) A convenience store begins selling pre-paid cell phones.
Answer: A
6) Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product? A) the fluctuations in the cost of capital over the period in question B) the sales of a new product will typically accelerate, plateau, and ultimately decline over time C) the prices of technology products generally fall over time D) competition tends to reduce profit margins over time in most industries
Answer: A
10) Which of the following factors that a manager should bear in mind when estimating a project's revenues and costs is NOT correct? A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition. B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product. C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline. D) Prices and costs tend to rise with the general level of inflation in the economy.
Answer: B
14) Which of the following statements is FALSE? A) Many projects use a resource that the company already owns. B) When evaluating a capital budgeting decision, we generally include interest expense. C) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
Answer: B
15) Which of the following costs would you consider when making a capital budgeting decision? A) sunk cost B) opportunity cost C) interest expense D) fixed overhead cost
Answer: B
5) Which of the following best defines incremental earnings? A) cash flows arising from a particular investment decision B) the amount by which a firm's earnings are expected to change as the result of an investment decision C) the earnings arising from all projects that a company plans to undertake in a fixed timespan D) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision
Answer: B
13) Which of the following statements is FALSE? A) We begin the capital budgeting process by determining the incremental earnings of a project. B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pretax income. C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings. D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.
Answer: C
3) How does the capital budgeting process begin? A) by analyzing alternate projects B) by evaluating the net present value (NPV) of each project's cash flows C) by compiling a list of potential projects D) by forecasting the future consequences for the firm of each potential project
Answer: C
6) Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile? A) They do not tell how the decision affects the firm's reported profits from an accounting perspective. B) They are not easily predicted from historical financial statements of a firm and its competitors. C) These earnings are not actual cash flows. D) They do not show how the firm's earnings are expected to change as the result of a particular decision.
Answer: C
4) What is the ultimate goal of the capital budgeting process? A) to determine how the consequences of making a particular decision affects the firm's revenues and costs B) to list the projects and investments that a company plans to undertake in the future C) to forecast the consequences of a list of future projects to the firm D) to determine the effect of the decision to accept or reject a project on the firm's cash flows
Answer: D
2) An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation. T/F?
Answer: FALSE
2) Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV). T/F
Answer: FALSE
9.6 Real Options in Capital Budgeting 1) A real option is the obligation to take a particular business action. T/F
Answer: FALSE
2) Interest and other financing-related expenses are excluded when determining a project's unlevered net income.
Answer: TRUE
2) The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital. T/F
Answer: TRUE
9.4 Other Effects on Incremental Free Cash Flows 1) Firms should use the most accelerated depreciation scheme allowable. T/F?
Answer: TRUE
9.5 Analyzing the Project 1) The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital. T/f
Answer: TRUE
20) An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called A) scenario analysis. B) internal rate of return (IRR) analysis. C) accounting break-even analysis. D) sensitivity analysis.
D) sensitivity analysis.
3) Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings? A) adding depreciation B) subtracting all non-cash expenses C) subtracting increases in Net Working Capital D) subtracting depreciation expenses from taxable earnings
D) subtracting depreciation expenses from taxable earnings
5) An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor? A) the amount obtained by renting the sixth floor B) the cost of refurbishing the new space to be occupied by the Human Resources Department C) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces D) the cost of the research into the feasibility of renting the sixth floor
D) the cost of the research into the feasibility of renting the sixth floor
