Chapter 11. PROJECT ANALYSIS AND EVALUATION

True or false: Opportunity costs are irrelevant costs when doing capital budgeting analysis.

False

A firm with a higher operating leverage will have ____ fixed costs relative to a firm with low operating leverage.

High

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are ____.

Inaccurate

What is the relationship between variable costs and output?

Total variable costs are directly related to the level of output.

True or false: Depreciation expense on a specific asset could be a fixed dollar amount or a variable dollar amount.

True

In a competitive market, positive NPV projects are:

Uncommon

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

Compute net accounting profit based on the following information: sales revenue= $50,000; variable cost= $35,000; fixed costs= $5,000; depreciation expense= $1,000; and tax rate= 21%.

$7,110

Compute the NPV of a project that has the following end-of-year cash flow projections: Year 1= $40,000; Year 2= $50,000,; Year 3= -$22,000. The project requires an initial investment of $75,000 and has a discount rate of 10 percent.

-$13,843

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

Which of the following is a fixed cost for a tire manufacturing business?

-Building rent of $10,000/month -Manager's salary of $98,000/year

When McDonald's decides to build a new restaurant at a particular location, which of the following competitors might also be tempted to locate new facilities in the same area?

-Burger King -Wendy's

Rank each of the following in order from most important to least important as they pertain to project analysis:

1. Cash flow 2. Accounting income

If fixed costs are $3,500 and the operating cash flow is $4,500, then the degree of operating leverage (DOL) is:

1.78

Financial break-even is the sales level that results in:

An NPV of zero

From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage:

As low as possible

Match the scenarios below with "best case", "worst case", or "base case."

Best Case -Sales are $2 million -Net profit margin is 5% Worst Case -Sales are 1 million -Net profit margin is 2% Base Case -Sales are 1.5 million -Net profit margin is 3%

Evans Corporation estimated that the cash flows last year from a particular project would be $40,000, but the actual cash flow turn out to be $37,500. Evans Corporation should:

Not expect cash flow estimates to be exactly right every time.

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 is an example of a sunk cost?

Research and development expense incurred in the past

Capital rationing exists when a company has identified positive NPV projects but can't find:

The necessary financing

Which costs are included in the numerator of the accounting profit break-even point equation?

-Depreciation -Fixed costs

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

-Forecasting risk -Estimation risk

Which of the following are true about depreciation expense?

-It affects cash flows -It affects the accounting profit break-even point -It is a non-cash expense

Which of the following costs relating to a doctor's office are variable costs?

-Lab reports for patients -Medical supplies

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

-NPV considers all the cash flows. -NPV considers time value of money

Which of the following is a legitimate reason for a project to have a positive NPV for Palmer Corporation?

-Palmer has a better product than its competition -Palmer has a better distribution channel than its competition -Palmer can produce the product more cheaply than its competition

Which of the following are examples of fixed costs for a car repair shop performing oil changes and other repairs?

-Salary for the shop manager -Insurance for the shop -Monthly rent for the shop

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

A contribution margin of $35 means that ____.

Each sale of an additional unit will contribute $35 toward paying fixed costs.

If Kellogg's introduces a new brand of cereal, it will most likely lead to ____ in its sales of existing cereals.

Erosion, i.e., a decrease