FIN3403 Quiz Ch7-9

An increase in depreciation expense will ______ cash flows from operations.

increase (Because depreciation is not a cash expense, its only effect is to decrease taxes paid, thereby increasing cash flows from operations.)

Select all that apply 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

Select all that apply 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. - Book value represents the purchase price minus the accumulated depreciation. - Taxes are based on the difference between the book value and the sales price.

Select all that apply The goals of risk analysis in capital budgeting include ______.

- identifying critical components - assessing the degree of financing risk

Select all that apply According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the United States and Canada?

- internal rate of return (IRR) - net present value (NPV)

Select all that apply Which of the following are methods of calculating the MIRR of a project?

- the reinvestment approach - the discounting approach - the combination approach

The spreadsheet function for calculating net present value is ______.

=NPV(rate,CF1, ..., CFn) + CF0

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.

Which 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 difference between scenario analysis and sensitivity analysis?

Scenario analysis considers a combination of factors for each scenario, while sensitivity analysis focuses on only one variable at a time.

What is an important drawback of traditional NPV analysis?

What is an important drawback of traditional NPV analysis?

A project should be ______ if its NPV is greater than zero.

accepted

West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately, West Corporation lost money on the project. This may have been avoided had they assessed the ______ of the cash flow estimates.

reliability

The trading of existing shares occurs in the ______ market.

secondary

Select all that apply What are the advantages of the payback period method for management?

- It allows lower-level managers to make small decisions effectively. - The payback period method is ideal for minor projects. - The payback period method is easy to use.

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

In a competitive market, positive NPV projects are ______.

uncommon

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

Opportunity costs are ______.

benefits lost due to taking on a particular project

A person who brings buyers and sellers together is called a(n) ______.

broker

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.

Managerial options are taken into consideration in _____ planning.

contingency

The profitability index is also called the ______ ratio.

cost-benefit

What is net working capital?

current assets minus current liabilities

All else constant, the dividend yield will increase if the stock price ______.

decreases

Incremental cash flows come about as a(n) ______ consequence of taking a project under consideration.

direct

The constant growth model assumes that ______.

dividends change at a constant rate

A PE ratio that is based on estimated future earnings is known as a ______ PE ratio.

forward

The ______ can be interpreted as the capital gains yield.

growth rate

The value of a firm is derived using the firm's ______ rate and its ______ rate.

growth; discount

If we find that our estimated NPV is sensitive to a variable that is difficult to forecast, then the degree of forecasting risk is _____.

high

Interest expenses incurred on debt financing are ______ when computing cash flows from a project.

ignored (In order to separate the investment from the financing of that investment, you must ignore any costs associated with financing.)

Synergy will ______ the sales of existing products.

increase

The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its ______.

initial cost

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______.

net working capital

The difference between a firm's current assets and its current liabilities is known as the ______.

net working capital

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

one vote per share held

The fundamental business of the New York Stock Exchange is to attract ______.

order flow

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

project consultation fee

Internal rate of return (IRR) must be compared to the ______ in order to determine the acceptability of a project.

required return

When using ______, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.

sensitivity analysis

The depreciation tax ______ is the tax savings that results from the depreciation deduction. (Enter only one word per blank.)

shield

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 IRR is the discount rate that makes NPV equal to ______.

zero

Select all that apply What are the two main benefits of performing sensitivity analysis?

- It identifies the variable that has the most effect on NPV. - It reduces a false sense of security by giving a range of values for NPV instead of a single value.

Select all that apply Which of the following are reasons why IRR continues to be used in practice?

- It is easier to communicate information about a proposal with an IRR. - The IRR of a proposal can be calculated without knowing the appropriate discount rate. - Businesspeople prefer to talk about rates of return.

Select all that apply Which of the following are reasons why NPV is considered a superior capital budgeting technique?

- It properly chooses among mutually exclusive projects. - It considers all the cash flows. - It considers the riskiness of the project. - It considers time value of money.

Select all that apply Once cash flows have been estimated, which of the following investment criteria can be applied to them?

- NPV - IRR - payback period

Select all that apply A benchmark PE ratio can be determined using:

- a company's own historical PEs. - the PEs of similar companies.

Select all that apply The NYSE differs from the Nasdaq primarily because the NYSE has ______.

- a physical location - a face-to-face auction market

Select all that apply Which of the following are components of project cash flow?

- capital spending - operating cash flow - change in net working capital

Which of the following are fixed costs?

- cost of equipment - rent on a production facility

Select all that apply The possibility that errors in projected cash flows will lead to incorrect decisions is known as ______.

- estimation risk - forecasting risk

Select all that apply Which of the following present problems when using the IRR method?

- nonconventional cash flows - mutually exclusive projects

How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime.

An increase in the size of the first cash inflow will decrease the payback period, all else held constant.

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.

Which of the following represents the valuation of stock using a zero growth model?

Dividend/Discount rate = D/R

Which one of the following is true about dividend growth patterns?

Dividends may grow at a constant rate.

True or false: Common stock has a set maturity.

False

True or false: Daily stock prices can only be found by looking up the stock in newspapers.

False

True or false: Fixed costs cannot be changed over the life of the investment.

False

True or false: Operating cash flow is based on the salvage value of equipment.

False

True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.

False

True or false: The depreciation tax shield is the depreciation deduction divided by the tax rate.

False (The depreciation tax shield is the depreciation deduction times the tax rate.)

True or false: A PE ratio that is based on estimated future earnings is called a regressive PE ratio.

False (called a forward PE ratio.)

True or false: A disadvantage of the AAR is that it does not take into account the time value of money.

True

True or false: Investment in net working capital may arise from the need to cover credit sales.

True

True or false: Net working capital will be recovered at the end of a project.

True

True or false: 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

True or false: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.

True

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered ______.

mutually exclusive

The NPV is ______ if the required return is less than the IRR, and it is ______ if the required return is greater than the IRR.

positive; negative

Given a level of investment in net working capital, that same investment must be ______ at some time in the future.

recovered

The first step in estimating cash flow is to determine the ______ cash flows.

relevant

True or false: Sensitivity analysis is helpful because it indicates what we should do regarding forecasting errors.

False

Select all that apply 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.

Select all that apply A manager has estimated a positive NPV for a project. What could drive this result?

- The project is a good investment. - The cash flow estimations are inaccurate. - Overly optimistic management could drive this result.

Select all that apply Which of the following are cash flows to investors in stocks?

- capital gains - dividends

Select all that apply Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:

- it determines the book value of assets which affects net salvage value - it determines taxes owed on fixed assets when they are sold - it affects a firm's annual tax liability

Select all that apply An option on a real asset rather than a financial asset is known as a _____.

- managerial option - real option

Select all that apply Preferred stock has preference over common stock in the:

- payment of dividends. - distribution of corporate assets.

Select all that apply 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

If a firm's sales estimate used in its base-case analysis is 1,000 units per year and they anticipate the upper and lower bounds to be ± 15 percent, What is the "best case" for units sold per year?

1,150

True or false: The payback period takes into consideration the time value of money.

False

The two most important stock markets in the United States are the New York Stock Exchange and ______.

Nasdaq

______ is a measure of how much value is created or added by undertaking an investment.

Net present value

Match the following terms relating to stock valuation. Instructions

P1: Price in one year D1: Next expected dividend R: Discount rate P0: Price today D0: Dividend just paid

The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.

accepts

Based on the average accounting return rule, a project is ______ if its average accounting return exceeds a target average accounting return.

acceptable

Cash flows should always be considered on a(n) ______ basis.

aftertax