FINA 3310 - ch9

What is net working capital?

Current assets minus current liabilities

What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC

The Tax Shield Approach

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

The cash flow estimations are inaccurate. The project is a good investment. Overly optimistic management

Which of the following qualify as "managerial options"?

The option to wait The option to abandon The option to expand

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

after-tax

Cash flows used in project estimation should always reflect:

after-tax cash flows cash flows when they occur

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

One of the most important steps in estimating cash flow is to determine the _________ cash flows.

relevant

Capital rationing exists when a company has identified positive NPV projects but cannot (or will not) find:

the necessary financing

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

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: If analysts are overly optimistic about the future, then they may accept a project that realistically has a negative NPV.

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

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

100% reversed

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

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 are reasons why NPV is considered a superior capital budgeting technique?

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

What is an important drawback of traditional NPV analysis?

It ignores managerial options in investment decisions.

A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?

Market value

Which of the following techniques will provide the most consistently correct result?

Net Present Value

Identify the three main sources of cash flows over the life of a typical 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 Net cash flows from salvage value at the end of the project

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

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. Taxes are based on the difference between the book value and the sales price. Book value represents the purchase price minus the accumulated depreciation.

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

Which of the following are fixed costs?

cost of equipment rent on a production facility

Investment in net working capital arises when ___.

credits sales are made. cash is kept for unexpected expenditures. inventory is purchased.

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

direct

We underestimate NPV because of the option(s) to ______.

expand abandon

The number of positive NPV projects is unlimited for any given firm.

false

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

false

True or false: In calculating cash flows, you should consider all financing costs.

false

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

false

True or false: Taxes are based on the difference between the initial cost and the sales price.

false

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

false

True or false: The value of managerial options is taken into account when performing conventional NPV analysis.

false

The possibility that errors in projected cash flows will lead to incorrect decisions is known as:

forecasting risk estimation risk

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

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

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

increase

Synergy will _____ the sales of existing products.

increase

The stand-alone principle assumes that evaluation of a project may be based on the project's ________________ cash flows.

incremental

The difference between a firm's cash flows with a project versus without the project is called ________________.

incremental cash flows

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 the taxes owed on fixed assets when they are sold it affects a firm's annual tax liability

The primary risk in estimation errors is the potential to __________.

make incorrect capital budgeting decisions

The project cash flow equals the project operating cash flow ___________ project change in NWC minus project capital spending. Listen to the complete question

minus

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

Which of the following are components of project cash flow?

operating cash flow capital spending change in the net working capital

The most valuable alternative that is given up if an investment is undertaken is called what?

opportunity cost

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

payback period IRR NPV

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

project consultation fee

An option on a real asset rather than a financial asset is known as a:

real option managerial option

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

recovered

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

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

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

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

shield

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

shield

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

Operating cash flow is a function of:

taxes depreciation earnings before interest taxes

In a competitive market, positive NPV projects are:

uncommon

Estimates of which of the following are needed to prepare pro forma income statements?

variable costs selling price per unit unit sales

Which of the following are considered relevant cash flows?

Cash flows from external costs. Cash flows from beneficial spillover effects. Cash flows from erosion effects.