FNAN 250 CHAP 9

Broadband, Inc., has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.

$400,000

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?

$55

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

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

F

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

F

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

F

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

F

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.

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.

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?

NPV

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 scenario analysis?

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

Which of the following qualify as "managerial options"?

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

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

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

Cash flows used in project estimation should always reflect:

after-tax cash flows cash flows when they occur

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

asking what-if questions scenario analysis

The goals of risk analysis in capital budgeting include:

assessing the degree of financing risk identifying critical components

Opportunity costs are ____.

benefits lost due to taking on a particular 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

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

ignored

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

incremental

Opportunity costs are classified as ____ costs in project analysis.

relevant

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

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

the necessary financing

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?

1,150

Which of the following are components of project cash flow?

Change in net working capital Operating cash flow Capital spending

Operating cash flow is a function of:

Depreciation Taxes Earnings Before Interest and Taxes

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

F

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

F

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

IRR NPV payback period

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

Project consultation fee

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.

______________ analysis is useful in pinpointing variables that deserve the most attention.

Sensitivity

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.

T

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

T

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

after-tax

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

Investment in net working capital arises when ___.

cash is kept for unexpected expenditures credit sales are made inventory is purchased

Managerial options are taken into consideration in __________ planning.

contingency

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 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

Synergy will _____ the sales of existing products.

increase

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

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

make incorrect capital budgeting decisions

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

managerial option real option

The project cash flow equals the project operating cash flow________ project change in NWC minus project capital spending

minus

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

net working capital

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

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

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

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

unit sales variable costs selling price per unit

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 basic approach to evaluating cash flow and NPV estimates involves asking:

what-if questions

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

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

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

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

The Tax Shield Approach

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.

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

T

True or false: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.

T

What are the two main drawbacks of sensitivity analysis?

It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. It does not consider interaction among variables.