Chapter 6

The changes in a firm's future cash flows that are a direct consequence of accepting a project are called _____ cash flows. A. incremental B. stand-alone C. opportunity D. net present value E. erosion

A. incremental

Interest rates or rates of return on investments that have been adjusted for the effects of inflation are called _____ rates. A. real B. nominal C. effective D. stripped E. coupon

A. real

Which one of these is an example of erosion that should be included in project analysis? A. The anticipated loss of current sales when a new product is launched. B. The expected decline in sales as a new product ages. C. The reduction in your sales that occurs when a competitor introduces a new product. D. The sudden loss of sales due to a major employer in your community implementing massive layoffs. E. The reduction in sales price that will most likely be required to sell inventory that has aged.

A. The anticipated loss of current sales when a new product is launched.

A project's operating cash flow will increase when the: A. depreciation expense increases. B. sales projections are lowered. C. interest expense is lowered. D. net working capital requirement increases. E. earnings before interest and taxes decreases.

A. depreciation expense increases.

A project which is designed to improve the manufacturing efficiency of a firm but will generate no additional sales revenue is referred to as a(n) _____ project. A. sunk cost B. opportunity C. cost-cutting D. revenue-cutting E. revenue-generating

C. cost-cutting

Changes in the net working capital: A. can affect the cash flows of a project every year of the project's life. B. only affect the initial cash flows of a project. C. are included in project analysis only if they represent cash outflows. D. are generally excluded from project analysis due to their irrelevance to the total project. E. affect the initial and the final cash flows of a project but not the cash flows of the middle years.

A. can affect the cash flows of a project every year of the project's life.

The top-down approach to computing the operating cash flow: A. ignores all noncash items. B. applies only if a project produces sales. C. can only be used if the entire cash flows of a firm are included. D. is equal to Sales −Costs −Taxes + Depreciation. E. includes the interest expense related to a project.

A. ignores all noncash items.

The depreciation method currently allowed under U.S. tax law governing the accelerated write-off of property under various lifetime classifications is called _____ depreciation. A. FIFO B. MACRS C. straight-line D. sum-of-years digits E. curvilinear

B. MACRS

One purpose of identifying all of the incremental cash flows related to a proposed project is to: A. isolate the total sunk costs so they can be evaluated to determine if the project will add value to the firm. B. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. C. make each project appear as profitable as possible for the firm. D. include both the proposed and the current operations of a firm in the analysis of the project. E. identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis.

B. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project.

Erosion can be explained as the: A. additional income generated from the sales of a newly added product. B. loss of current sales due to a new project being implemented. C. loss of revenue due to employee theft. D. loss of revenue due to customer theft. E. loss of cash due to the expenses required to fix a parking lot after a heavy rain storm.

B. loss of current sales due to a new project being implemented.

The bottom-up approach to computing the operating cash flow applies only when: A. both the depreciation expense and the interest expense are equal to zero. B. the interest expense is equal to zero. C. the project is a cost-cutting project. D. no fixed assets are required for the project. E. taxes are ignored and the interest expense is equal to zero.

B. the interest expense is equal to zero.

The pro forma income statement for a cost reduction project: A. will reflect a reduction in the sales of the firm. B. will generally reflect no incremental sales. C. has to be prepared reflecting the total sales and expenses of the entire firm. D. cannot be prepared due to the lack of any project related sales. E. will always reflect a negative project operating cash flow.

B. will generally reflect no incremental sales.

Toni's Tools is comparing machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. These machines should be compared using: A. net present value only. B. both net present value and the internal rate of return. C. their equivalent annual costs. D. the depreciation tax shield approach. E. the replacement parts approach.

C. their equivalent annual costs.

The net working capital of a firm will decrease if there is: A. a decrease in accounts payable. B. an increase in inventory. C. a decrease in accounts receivable. D. an increase in the firm's checking account balance. E. a decrease in fixed assets.

C. a decrease in accounts receivable.

The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called the: A. aftertax depreciation savings. B. depreciable basis. C. depreciation tax shield. D. operating cash flow. E. aftertax salvage value.

C. depreciation tax shield.

Sunk costs include any cost that: A. will change if a project is undertaken. B. will be incurred if a project is accepted. C. has previously been incurred and cannot be changed. D. will be paid to a third party and cannot be refunded for any reason whatsoever. E. will occur if a project is accepted and once incurred, cannot be recouped.

C. has previously been incurred and cannot be changed.

The cash flows of a project should: A. be computed on a pretax basis. B. include all sunk costs and opportunity costs. C. include all incremental and opportunity costs. D. be applied to the year when the related expense or income is recognized by GAAP. E. include all financing costs related to new debt acquired to finance the project.

C. include all incremental and opportunity costs.

Tax shield refers to a reduction in taxes created by: A. a reduction in sales. B. an increase in interest expense. C. noncash expenses. D. a project's incremental expenses. E. opportunity costs.

C. noncash expenses.

All of the following are anticipated effects of a proposed project. Which of these should be considered when computing the cash flow for the final year of a project? A. operating cash flow and salvage values B. salvage values and net working capital recovery C. operating cash flow, net working capital recovery, salvage values D. net working capital recovery and operating cash flow E. operating cash flow only

C. operating cash flow, net working capital recovery, salvage values

The salvage value of an asset creates an aftertax cash flow in an amount equal to the: A. sales price of the asset. B. sales price minus the book value. C. sales price minus the tax due based on the sales price minus the book value. D. sales price plus the tax due based on the sales price minus the book value. E. sales price plus the tax due based on the book value minus the sales price.

C. sales price minus the tax due based on the sales price minus the book value.

A cost that has already been paid, or the liability to pay has already been incurred, is a(n): A. salvage value expense. B. net working capital expense. C. sunk cost. D. opportunity cost. E. erosion cost.

C. sunk cost.

The increase you realize in buying power as a result of owning an investment is referred to as the _____ rate of return. A. inflated B. realized C. nominal D. real E. risk-free

D. real

The book value of an asset is primarily used to compute the: A. annual depreciation tax shield. B. amount of cash received from the sale of an asset. C. amount of tax saved annually due to the depreciation expense. D. amount of tax due on the sale of an asset. E. change in depreciation needed to reflect the market value of the asset.

D. amount of tax due on the sale of an asset.

For a profitable firm, an increase in which one of the following will increase the operating cash flow? A. employee salaries B. office rent C. building maintenance D. depreciation E. equipment rental

D. depreciation

Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped by the end of the project. B. requirements generally, but not always, create a cash inflow at the beginning of a project. C. expenditures commonly occur at the end of a project. D. is frequently affected by the additional sales generated by a new project. E. is the only expenditure where at least a partial recovery can be made at the end of a project.

D. is frequently affected by the additional sales generated by a new project.

The most valuable investment given up if an alternative investment is chosen is a(n): A. salvage value expense. B. net working capital expense. C. sunk cost. D. opportunity cost. E. erosion cost.

D. opportunity cost.

The cash flow from a project is computed as the: A. net operating cash flow generated by the project, less any sunk costs and erosion costs. B. sum of the incremental operating cash flow and aftertax salvage value of the project. C. net income generated by the project, plus the annual depreciation expense. D. sum of the incremental operating cash flow, capital spending, and net working capital cash flows incurred by the project. E. sum of the sunk costs, opportunity costs, and erosion costs of the project.

D. sum of the incremental operating cash flow, capital spending, and net working capital cash flows incurred by the project.

You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) _____ cost. A. opportunity B. fixed C. incremental D. sunk E. relevant

D. sunk

Which one of the following should be excluded from the analysis of a project? A. erosion costs B. incremental fixed costs C. incremental variable costs D. sunk costs E. opportunity costs

D. sunk costs

A company which uses the MACRS system of depreciation: A. will have equal depreciation costs each year of an asset's life. B. will expense the largest percentage of the cost during an asset's first year of life. C. can depreciate the cost of land, if it so desires. D. will write off the entire cost of an asset over the asset's class life. E. cannot expense any of the cost of a new asset during the first year of the asset's life.

D. will write off the entire cost of an asset over the asset's class life.

Assume a firm has no interest expense or extraordinary items. Given this, the operating cash flow can be computed as: A. EBIT - Taxes. B. EBIT × (1 - Tax rate) + Depreciation × Tax rate. C. (Sales - Costs) × (1 - Tax rate). D. EBIT - Depreciation + Taxes. E. Net income + Depreciation.

E. Net income + Depreciation.

The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost. A. incremental B. sunk C. opportunity D. erosion E. equivalent annual

E. equivalent annual

A decrease in a firm's current cash flows resulting from the implementation of a new project is referred to as: A. salvage value expenses. B. net working capital expenses. C. sunk costs. D. opportunity costs. E. erosion costs.

E. erosion costs.

The pretax salvage value of an asset is equal to the: A. book value if straight-line depreciation is used. B. book value if MACRS depreciation is used. C. market value minus the book value. D. book value minus the market value. E. market value.

E. market value.

The equivalent annual cost method is useful in determining: A. the annual operating cost of a machine if the annual maintenance is performed versus when the maintenance is not performed as recommended. B. the tax shield benefits of depreciation given the purchase of new assets for a project. C. operating cash flows for cost-cutting projects of equal duration. D. which one of two machines to acquire given equal machine lives but unequal machine costs. E. which one of two machines to purchase when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

E. which one of two machines to purchase when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.