FIN 3414 - Chapter 8

If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, What is the real rate of return?

2.94% (1.05/1.02) - 1 = 2.94%

Which of the following is given greater importance in capital budgeting problems in corporate finance?

Cash flows

Which of the following are considered relevant cash flows?

Cash flows from erosion effects Cash flows from opportunity costs Cash flows from synergy effects

According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

$2,220 OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation $600 × (1-.30)1-.30 + $1,800 = $2,220

According to the bottom-up approach, what is the OCF if EBIT is $1,100, depreciation is $2,500, and the tax rate is 35 percent?

$3,215 OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation $1,100 × (1-.35)1-.35 + $2,500 = $3,215

How does depreciation affect the operating cash flows?

Depreciation expense reduces the taxable income and taxes, and increases the operating cash flow.

The rules for depreciating assets for tax purposes are based upon provisions set forth in

IRS Publication 946.

Which of the following are true about allocated costs?

These costs are allocated to more than one project. These costs benefit more than one project.

Opportunity costs are

benefits lost due to taking on a particular project.

Side effects from investing in a project refer to cash flows from

erosion effects. synergy effects.

Assets in the five-year MACRS class are depreciated over ____ years.

five

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

If the inflation rate increases, the nominal rate of interest will

increase

The computation of equivalent annual costs is useful when comparing projects with unequal

lives

The actual dollars to be received or paid out is referred to as a

nominal cash flow.

The equivalent annual cost approach

puts costs on a per-year basis. is useful when comparing projects with different useful lives.

For capital budgeting, the investment in working capital is assumed to be

recovered at the end of the project.

Opportunity costs are classified as ____ costs in project analysis.

relevant

All real estate is depreciated

straight-line basis

The stockholders' books in the U.S. follow the rules of the

Financial Accounting Standards Board (FASB).

What is the equation for estimating operating cash flows using the top-down approach?

OCF = Sales - Costs - Taxes

What are the two sets of accounting books?

Tax books Stokholders' books

Which of the following is an example of a sunk cost?

Test marketing expenses

Corporate finance techniques generally include the use of ______ while financial accounting stresses ______ numbers.

cash flows; income

For capital budgeting, opportunity costs are treated as

cash outflows.

Allocated costs arise when a specific expenditure

benefits more than one project or division.

What is the difference between nominal cash flow and real cash flow?

Nominal cash flow is the actual dollars to be received. Real cash flow refers to the cash flow's purchasing power.