Finance ch 9

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 -Net cash flows from salvage value at the end of the project -Cash outflows from investment in plant and equipment at the inception of the project

What is the total number of inputs that change at a given time while doing sensitivity analysis?

1

If a firm's variable cost per unit estimate used in its base case analysis is $50 per unit and they anticipate the upper and lower bounds to be +/- 10%, What is the "worst case" for variable cost per unit?

1.10 × $50 = $55; The worst case for costs is the higher value.

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%, What is the "best case" for units sold per year?

1.15 × 1,000 = 1,150

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 considered relevant cash flows?

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

Which of the following are components of project cash flow?

Change in net working capital Operating cash flow Capital spending

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

Direct

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

Project consultation fee

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

false

Sunk costs are costs that ____.

have already occurred and are not affected by accepting or rejecting a project

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

The goals of risk analysis in capital budgeting include:

identifying critical components assessing the degree of financing risk

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

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

make incorrect capital budgeting 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

The project cash flow equals the project operating cash flow .................................. project change in project capital spending.

minus

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

opportunity cost

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

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

the necessary financing

In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable.

upper and lower bounds

Operating cash flow is a function of:

Taxes Depreciation Earnings Before Interest and Taxes

Opportunity costs are ____.

benefits lost due to taking on a particular project

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

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

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

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.

What is an important drawback of traditional NPV analysis?

It ignores managerial options in investment decisions.

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

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

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

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

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 scenario analysis?

Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.

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

The Tax Shield Approach

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

Which of the following qualify as "managerial options"?

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

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

abandon expand

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

after tax

Managerial options are taken into consideration in ....... planning.

contingency

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

erosion effects beneficial spillover effects

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

estimation risk forecasting risk

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

false

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

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

One of the most important steps 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 are fixed costs?

rent on a production facility cost of equipment

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

sensitivity

To investigate the impact on NPV of a change in one variable, you would employ ________.

sensitivity analysis

The depreciation tax.................... is the tax savings that results from the depreciation deduction.

sheild

Which of the following is true relative to capital rationing?

soft rationing is typically internal in that the firm allocates funds to divisions for capital projects hard rationing implies the firm is unable to raise funds for projects