Smartbook 9

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.

While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital?

It is expected to be recovered by the end of the project's life.

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.

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

Research and development expense incurred in the past

An increase in depreciation expense will ____ cash flows from operations

increase

If the tax rate increases, the value of the depreciation tax shield will ______.

increase

as depreciation expense _______, taxes and Net Income will decrease while investment cash flows will ___

increases, increase

What is the purpose of accounting profit break-even analysis?

to determine the level of sales at which profits are equal to zero.

If we conclude that a project has a negative NPV when the true NPV is positive, we lose a valuable opportunity.

true

Operating cash flow is a function of _____.

Depreciation, EBIT, Taxes

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 salvage value at the end of the project - Net cash flows from sales and expenses over the life of the project.

What are the two main benefits of performing sensitivity analysis?

-It gives a range of values for NPV instead of a single value, so it gives a more realistic picture. -It identifies the variable that has the most effect on NPV.

What is the total number of inputs that change while doing sensitivity analysis?

1

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

1. IRR 2.NPV 3.payback period

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.

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 cash flows will increase.

What is scenario analysis?

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

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 is an opportunity cost in the context of a vacant building that a firm currently owns?

The potential rental income lost by using the empty building for a project

A firm will start generating positive accounting profits _____.

beyond the break-even sales point

What is net working capital?

current assets minus current liabilities

Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ______________ are overlooked

net working capital

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

net working capital

____________ analysis determines the impact on NPV of a set of events relating to a specific situation

scenario

_____ analysis is the investigation of what happens to NPV when only one variable is changed

sensitivity

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

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 tax saving that results from the depreciation deduction is called the depreciation tax

shield

A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____.

should be accepted if there is no capital rationing constraint

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

true

The basic approach to evaluating cash flow and NPV estimates involves asking _______ -if questions

what

The basic approach to evaluating cash flow and NPV estimates involves asking _____.

what-if questions