Capital Investment Decisions (1/18/24)

c.) increase operating leverage than to decrease it Reason: For all practical purposes, it is easier to increase operating leverage than it is to decrease it.

For all practical purposes, it is easier to _____. a.) break even than it is to lose money b.) decrease operating leverage than to increase it c.) increase operating leverage than to decrease it

a.) should be accepted if there is no capital rationing constraint

A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____. a.) should be accepted if there is no capital rationing constraint b.) it will never cost the firm more than calculated in the cash flow analysis c.) the firm should only accepted if the project has a high payback period

Modified Accelerated Cost Recovery System (MACRS)

A depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

a.) stand-alone

According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm." a.) stand-alone b.) stand-with c.) stand-and-deliver d.) walk-alone

D) Initial investment in inventory to support the project

All of the following are related to a proposed project. Which one should be included in the cash flow at Time 0? A) Annual depreciation tax shield B) Loan obtained to finance the project C) Net working capital recovery D) Initial investment in inventory to support the project

b.) increase Reason: An increase in depreciation expense will increase cash flows because it will decrease taxes paid.

An increase in depreciation expense will ____ cash flows from operations. a.) not affect b.) increase c.) decrease

increase, decrease

As a practical matter, it is easier to _________________ (decrease/increase) operating leverage than it is to ____________________ (decrease/increase) it.

c.) aftertax

Cash flows should always be considered on a(n) ___________ basis. a.) zero-tax b.) before-tax c.) aftertax

d.) Equivalent annual cost

Decreasing which one of the following will increase the acceptability of a project? a.) Sunk costs b.) Salvage value c.) Depreciation tax shield d.) Equivalent annual cost e.) Accounts payable requirement

B) Incremental cash flows

Difference between firm future cash flow with and without a project is referred to as the project's: A) Erosion effects. B) Incremental cash flows. C) Financing cash flows. D) External cash flows

c.) reduce Reason: Erosion will reduce the sales of existing products, resulting in reduction in the cash inflow attributable to the new product.

Erosion will ______ the sales of existing products. a.) increase b.) not affect c.) reduce

d.) ignored Reason: When estimating cash flows from a project, we are only concerned with flows that result from the assets of the project. How we paid for those assets is not relevant.

Interest expenses incurred on debt financing are ______ when computing cash flows from a project. a.) spread over the life of the project b.) treated as cash outflows c.) treated as cash inflows d.) ignored

d.) winner's curse Reason: The winner's curse says that the lowest bidder is the one who underbid the most.

Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the _____. a.) Hamilton's blessing b.) loser's curse c.) winner's blessing d.) winner's curse

Opportunity Costs

Most valuable alternative that is given up if a particular investment is undertaken

c.) net working capital Reason: Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in net working capital are overlooked.

Multiple Choice Question Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ______________ are overlooked. a.) tax rates b.) the cost of capital c.) net working capital d.) investor sentiment

d.) relevant a.) irrelevant Reason: Opportunity costs are relevant costs, because they are costs that could be received if the project were not accepted. b.) intangible Reason: Opportunity costs are not intangible; if the project is rejected, the benefit could still be received. c.) sunk Reason: Opportunity costs are not sunk costs; sunk costs are irrelevant in capital budgeting decisions, because they have already been paid and will not be recovered should the project be rejected. d.) relevant Correct!

Opportunity costs are classified as ______ costs in project analysis. a.) irrelevant b.) intangible c.) sunk d.) relevant

b.) have already occurred and are not affected by accepting or rejecting a project a.) cannot be measured Reason: they can be measured, but they can not be recovered if the project is not accepted. b.) have already occurred and are not affected by accepting or rejecting a project Correct! c.) relate to other projects of the firm Reason: they may relate to other projects of the firm, but they can not be recovered if the project is not accepted. d.) will not contribute to profits in the long run even if a project is accepted Reason: whether or not they will contribute to profits is irrelevant, because they can not be recovered if the project is not accepted.

Sunk costs are costs that ____. a.) cannot be measured b.) have already occurred and are not affected by accepting or rejecting a project c.) relate to other projects of the firm d.) will not contribute to profits in the long run even if a project is accepted

stand

The ________-alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.

first

The ______________ step is to determine whether cash flows are relevant.

recovery

The accelerated cost _____________ system is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

erosion

The cash flows of a new project that come at the expense of a firm's existing projects is called

b.) unequal

The computation of equivalent annual costs is useful when comparing projects with _____ lives. a.) two-year b.) unequal c.) infinite d.) equal

b.) lives Reason: The computation of equivalent annual costs is useful when comparing projects with unequal lives.

The computation of equivalent annual costs is useful when comparing projects with unequal _____. a.) initial investments b.) lives c.) salvage values d.) annual cash flows

b.) 1986 Tax Reform Act a.) 1986 SEC Act Reason: The 1986 SEC Act doesn't exist. b.) 1986 Tax Reform Act Correct! c.) 1986 IRS Act Reason: The 1986 Act that reformed taxes is called the 1986 Tax Reform Act. d.) 1986 Sarbanes-Oxley Act Reason: The 2002 Sarbanes-Oxley Act does not deal with depreciation of assets but investor protection from corporate abuses.

The rules for depreciating assets for tax purposes are based upon provisions in the ___. a.) 1986 SEC Act b.) 1986 Tax Reform Act c.) 1986 IRS Act d.) 1986 Sarbanes-Oxley Act

Depreciation Tax Shield

The tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate.

depreciation

To calculate the OCF using the bottom-up approach, add _____________ to net income.

True!

True or False Cash flows should always be considered on an aftertax basis.

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

While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital? a.) It is expected to be recovered by the end of the project's life . b.) It is not at all considered while making capital budgeting decisions. c.) It is treated as sunk cost which will not recovered. d.) It is treated as cash outflow at the end of the project's life.

increase

With cost-cutting proposals, when costs decrease, operating cash flows _________________ (decrease/increase).

Incremental

_____________ cash flows come about as a direct consequence of taking a project under consideration.

Capital Budgeting

allocating and analyzing investment decisions from a firm's perspective

Stand-Alone Principle

assumption that evaluation of project may be based on project incremental cash flows

Net Working Capital

cash needed to fund short-term assets during the project

Sunk Costs

costs already incurred, cannot be removed and should not be included in the investment decision

Side Effects

incremental cash flows include the impact not only on project of interest but impact on others, including erosion, which is when new project cash flows come at expense of existing firm cash flow

a.) There is an additional depreciation deduction. b.) The decrease in costs increases operating income c.) The decrease in costs decreases operating income. Reason: A decrease in costs would increase net income. d.) Wages are always reduced in cost-cutting endeavors. Reason: Wages are not always reduced when costs are cut.

Select all that apply: When evaluating cost-cutting proposals, how are operating cash flows affected? a.) There is an additional depreciation deduction. b.) The decrease in costs increases operating income. c.) The decrease in costs decreases operating income. d.) Wages are always reduced in cost-cutting endeavors.

b.) rent on a production facility d.) cost of equipment a.) net working capital Reason: Net working capital varies with revenues. c.) inventory costs Reason: Inventory costs vary with revenues.

Select all that apply: Which of the following are fixed costs? a.) net working capital b.) rent on a production facility c.) inventory costs d.) cost of equipment

a.) credit sales are made b.) inventory is purchased c.) cash is kept for unexpected expenditures d.) equipment is purchased using long term debt Reason: Equipment is categorized as a fixed asset; neither current assets nor current liabilities are affected by the purchase of equipment.

Select all that apply: Investment in net working capital arises when ___. a.) credit sales are made b.) inventory is purchased c.) cash is kept for unexpected expenditures d.) equipment is purchased using long term debt

c.) OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate

Which one of the following is the equation for estimating operating cash flows using the tax shield approach? a.) OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation b.) OCF = (Sales - Costs) × Tax rate + Depreciation × (1 - Tax rate) c.) OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate d.) OCF = (Sales - Costs) + Deprecation × Tax rate

b.) direct a.) sporadic Reason: Incremental cash flows come about as a direct consequence of taking a project under consideration. b.) direct Correct! c.) indirect Reason: Incremental cash flows come about as a direct consequence of taking a project under consideration.

Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration. a.) sporadic b.) direct c.) indirect

b.) bottom-up

OCF is calculated as net income plus depreciation using the _____ approach. a.) top-down b.) bottom-up c.) accelerated depreciation

a.) benefits lost due to taking on a particular project\ a.) benefits lost due to taking on a particular project Correct! b.) the costs incurred by a firm to preserve its market share Reason: Opportunity costs are not cash flows; rather they are the foregoing of cash flows. c.) the costs of pursuing a specific project Reason: Opportunity costs are benefits lost, rather than direct costs. d.) benefits gained as a result of accepting a particular project Reason: Opportunity costs are benefits lost by accepting a project.

Opportunity costs are ____. a.) benefits lost due to taking on a particular project b.) the costs incurred by a firm to preserve its market share c.) the costs of pursuing a specific project d.) benefits gained as a result of accepting a particular project

a.) taxes c.) earnings before interest and taxes d.) depreciation b.) salvage value of equipment Reason: Salvage value of the equipment is not an operating cash flow. e.) initial investment in equipment Reason: Initial investment is not an operating cash flow.

Select all that apply Operating cash flow is a function of _____. a.) taxes b.) salvage value of equipment c.) earnings before interest and taxes d.) depreciation e.) initial investment in equipment

c.) NPV d.) IRR e.) payback period Reason: Once cash flows have been estimated, capital budgeting methods such as NPV can be applied to them.

Select all that apply: Once cash flows have been estimated, which of the following investment criteria can be applied to them? a.) the constant growth dividend discount model b.) YTM c.) NPV d.) IRR e.) payback period

Erosion

The cash flows of a new project that come at the expense of a firm's existing projects.

c.) relevant a.) operating Reason: While determining the operating cash flows is important, it is not the first step. b.) specious Reason: The first step is to determine whether cash flows are relevant. c.) relevant Correct!

The first step in estimating cash flow is to determine the _________ cash flows. a.) operating b.) specious c.) relevant

Opportunity Cost

The most valuable alternative that is given up if a particular investment is undertaken.

Equivalent Annual Cost (EAC)

The present value of a project's costs calculated on an annual basis.

True

True or False When developing cash flows for capital budgeting, it is easy to overlook important items.

tax

Using the top-down approach, OCF is calculated by subtracting costs and _______________ from sales.

c.) Current assets minus current liabilities

What is net working capital? a.) Current assets plus current liabilities b.) Current liabilities minus current assets c.) Current assets minus current liabilities d.) Total assets minus total liabilities

a.) OCF = Sales - Costs - Taxes b.) OCF = (Sales - Costs) X (1-T) + Depreciation X T Reason: This answer gives the equation for the tax shield approach. c.) OCF = Net Income + Depreciation Reason: This answer gives the equation for the bottom-up approach.

What is the equation for estimating operating cash flows using the top-down approach? . a.) OCF = Sales - Costs - Taxes b.) OCF = (Sales - Costs) X (1-T) + Depreciation X T c.) OCF = Net Income + Depreciation d.) OCF = Sales - Costs

Pro Forma Financial Statements

What type of financial statements projecting future years' operations?

working

When a firm finances new investments, it may set up accounts payable with suppliers, but the balance that the firm must supply is called the investment in net capital.

won't

When analyzing a proposed investment, we ____________ (will/won't) include interest paid or any other financing costs.

c.) easy Reason: When developing cash flows for capital budgeting, it is easy to overlook important items.

When developing cash flows for capital budgeting, it is _____ to overlook important items. a.) impossible b.) rare c.) easy d.) difficult

b.) Tax shield approach

Which approach to estimating the operating cash flows uses the following equation? OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate a.) Top-down approach b.) Tax shield approach c.) Bottom-up approach

b.) Test marketing expenses a.) Bonus to top management Reason: The bonus to top management is only paid if it is a function of the project and the project is accepted, and therefore its cost is not a sunk cost. b.) Test marketing expenses Correct! c.) Salvage value of equipment Reason: The salvage value of the equipment will only be received if the project is accepted; therefore it is not a sunk cost. d.) Cost of new equipment Reason: The equipment will not be purchased if the project is rejected, and therefore its cost is not a sunk cost.

Which of the following is an example of a sunk cost? a.) Bonus to top management b.) Test marketing expenses c.) Salvage value of equipment d.) Cost of new equipment

Incremental Cash Flows

difference between a firm's future cash flows with and without project

b.) Differing lives and planned replacement at end of life

Assume you are considering two mutually exclusive machines and need to select one for a cost-cutting project. Which one of these sets of characteristics best indicates the use of the equivalent annual cost method of analysis? a.) Differing costs with no replacement at end of life b.) Differing lives and planned replacement at end of life c.) Differing lives with no replacement at end of life d.) Differing manufacturers and differing operating costs e.) Differing required returns with no replacement at end of life

e.) Equivalent annual cost

The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following? a.) Yearly incremental costs b.) Sunk costs c.) Opportunity costs d.) Annuitized erosion cost e.) Equivalent annual cost

b.) net working capital

The difference between a firm's current assets and its current liabilities is known as the _____. a.) long-term capital b.) net working capital c.) net opportunity capital d.) capital structure

e.) costs of research conducted to identify equipment choices.

The equivalent annual cost considers all of the following except the: a.) required rate of return. b.) operating costs. c.) need for replacement. d.) economic life. e.) costs of research conducted to identify equipment choices.