Principles of Corporate Finance: Chapter 9 Making Capital Investment Decisions

Suppose a project's operating cash flow is $150. The firm anticipates a $30 investment in bet working capital and $80 in capital spending. What is the project's cash flow? $120 $150 $40 $70

$40

What is the depreciation tax shield if EBIT is $600, depreciation is $1800 and the tax rate is 30 percent? $360 $180 $540 $240

$540

Given the following data, what is the operating cash flow? EBIT = $80 Depreciation= $20 Taxes= $30 $70 $20 $30 $80

$70 (80+20-30)

If a new project requires an investment in net working capital in net working capital when it is launched, then at the end of the project, NWC will be 100% reversed charged against the project again ignored 50% reversed

100% reversed

The rules of depreciating assets for tax purposes are based upon provisions in the : 1989 Sarbanes Oxley Act 1986 IRS Act 1986 SEC Act 1986 Tax Reform Act

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 as depreciation expense increases, income, taxes, and investment cash flows will all increase depreciation expense has no effect on income, taxes, or cash flows as depreciation expense increases, income, taxes, and investment cash flows will all decrease

As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase

Once cash flows have been estimated, which of the following investment criteria can be applied to them? (multiple answers) IRR payback period the constant growth rate dividend growth model YTM NPV

IRR payback period NPV

Cash flows used in project estimation should always reflect: (multiple answers) financing costs after-tax cash flows cash flows when they occur accounting values

after-tax cash flows cash flows when they occur

Side effects from investing in a project refer to cash flows from: (multiple answers) beneficial spillover effects sunk costs opportunity costs erosion effects

beneficial spillover costs erosion effects

Opportunity costs are ______________. benefits gained as a result of accepting a particular project benefits lost due to taking on a particular project the actual expenses incurred by a firm to preserve its market value the actual expenses incurred by a firm to preserve its market share the actual expenses of pursuing a specific project

benefits lost due to taking on a particular project

Which of the following are considered relevant cash flows? (multiple answers) cash flows from sunk costs cash flows from erosion effects when the sales would not otherwise be lost cash inflows from adverse spillover effects cash flows from beneficial spillover effects

cash flows from erosion effects when the sales would not otherwise be lost cash inflows from adverse spillover effects cash flows from beneficial spillover effects

Investment in net working capital arises when (multiple answers) cash is kept for unexpected expenditures inventory is purchased equipment is purchased using long-term debt credit sales are made

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

identify the three main sources of cash flows over the life of a typical project. cash outflows from the investment in plant and equipment at the inception of the project net cash flows from salvage value at the end of the project net cash flows from sales and expenses over the life of the project test marketing expenses that have been classifies as sunk costs

cash outflows from the investment in plant and equipment at the inception of the project net cash flows from salvage value at the end of the project net cash flows from sales and expenses over the life of the project

Which of the following are fixed costs? (multiple answers) cost of equipment rent on a production facility inventory costs net working capital

cost of equipment rent on a production facility

What is net working capital? current assets plus current liabilities current assets minus current liabilities total assets minus total liabilities current liabilities minus current assets

current assets minus current liabilities

The possibility that errors in projected cash flows will lead to incorrect decisions is known as: (multiple answers) forecasting risk guess and bless estimation risk managerial incompetence

forecasting risks estimation risk

sink costs are costs that ___________. cannot be measured have already occurred and are not affected or accepting or rejecting a project will not contribute to profits in the long run even if project is accepted

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. treated as cash outflows spread over the life of the project treated as cash inflows ignored

ignored

Synergy will _________ the sales of existing products. decrease have no effect on increase

increase

The stand-alone principle assumes that evaluation of a project may be based on the project's ______________________ cash flows. differential add-on incremental net

incremental

The difference between a firm's cash flows with a project versus without the project is called __________________. net cash flows incremental cash flows differential cash flows additional cash flows

incremental cash flows

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons: (multiple answers) 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 it impacts products costs

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

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

market value

One of the most important steps in estimating cash flow is to determine the ___________ cash flows. operating relevant specious

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 asses the ____________________ of the cash flow estimates. additivity fungibility reliability principality

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 money spent on advertising to take advantage of opportunities in the market lowering taxes by increasing depreciation expenses

rental income likely to be lost by using a vacant building for an upcoming project

Operating cash flow is a function of : (multiple answers) taxes earnings before interest and taxes initial investment i equipment salvage value of equipment depreciation

taxes earnings before interest and taxes depreciation

Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset? taxes are based on the difference between the book value and the sales price thee 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 purchase price and sales price of the asset

taxes are based on the difference between the book value and the sales price there will be a tax savings if the book value exceeds the sales price book value represents the purchase price minus the accumulated depreciation

A manager has estimated a positive NPV for a project. What could drive this result? (multiple answers) the cash flow estimations are inaccurate management rationality the project is a good investment overly optimistic management

the cash flow estimations are inaccurate the project is a good investment over optimistic management

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 salvage value of the project the operating cash flows from net sales over the life of the project the costs incurred at the inception of the project th sunk costs incurred before the inception of the project

the operating cash flows from net sales over the life of the project

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: Net working capital will be recovered at the end of the project.

true

In a competitive market, positive NPV projects are: uncommon easy to find unlimited

uncommon