Exam 2 Corporate Finance conceptual questions

Increase in credit sales where you did not receive cash

Cash Reduction

Purchase Inventory

Cash Reduction

Operating Cash Flow

EBIT(1-T) + Depreciation

Which one of the following determines the standards and procedures with which audited financial statements are prepared?

Generally Accepted Accounting Principles

Which one of the following characteristics best describes a project that has a low degree of operating leverage?

High variable costs relative to the fixed costs

Would the cash flow still exist if the project does not exist?

If yes do not include in your analysis If no, include it

The top-down approach to computing the operating cash flow:

Ignores noncash expenses

Which one of the following is true according to Generally Accepted Accounting Principles?

Income is recorded based on the realization principle.

Receive Funds from Suppliers

Increase Cash

The free cash flow to the firm is

The amount of cash that could be withdrawn without harming its ability to operate and to produce future cash flows and the cash available for all claimholders in the firm

If Salvage value is less than book value...

The asset is under-depreciated and you over paid in taxes

Which one of the following is classified as a tangible fixed asset?

Computer equipment

Sunk cost - Do not include

Cost incurred in the past and cannot be recovered regardless of whether the project was accepted or not

If Free Cash Flows < 0

Growth opportunities necessitate large investments in fixed assets and large investments need fund raising

Balance Sheet

provides a snapshot of a firm's financial position at one point intime. Summarizes what a firm owns (assets), what a firm owes (liabilities), and the difference between the two (equity)

Net Capital Expenditure

Capital Expenditure - Depreciation

Fixed Asset Purchases

Cash Reduction

Terminal Cash Flow - Cash flow at the end of the period

Includes the salvage value as well as any other cash flow resulting from the termination of the project Get rid of the asset through sale (CAPEX) Assume full recovery of your required NWC investment

Free Cash Flows (NI Method)

Net Income + (1-T)(Interest Expense) + (Depreciation/Amortization) - Capex - Change in Net working capital

Operating Cash Flow

Net income + Depreciation + Interest(1-T)

Increase in Net working capital...

Reduces Cash

If Net working Capital is greater than 0 then...

The cash that will come over the next 12 months exceeds that amount of cash that must be paid over the same period

You would like to know the minimum level of sales that is needed for a project to be accepted based on its net present value. To determine that sales level you should compute the:

financial break-even point

Non-Cash Current Assets

inventory, accounts receivable, and other current assets

Decrease in Net working Capital

releases cash and generates positive cash flows

Which one of the following must be true if a firm had a negative cash flow from assets?

the firm obtained external funding

If Salvage value is more than book value...

The asset is over-depreciated and you paid little in taxes on it

Initial Cash Flow

Purchase of the asset, installation, and shipping cost - This is your year 1 CAPEX Invest in NWC to start the project

Which one of the following financial statements summarizes a firm's revenue and expenses during a period of time?

Income statement

Operating Cash Flows

(Sales - Cost) (1-t) + (Depreciation*t)

does accelerated depreciation or straight line depreciation produce higher cash flows?

Accelerated

Non-Debt Current Liabilities

Accounts payable and other short term non-interest bearing debt

For a corporation that earned positive taxable income, which one of the following statements is correct?

An increase in depreciation expense will increase the operating cash flow.

cash flow from assets

Cash flow from operations - Cash flow used for investments

Free Cash Flows (FCF)

Cash flow to creditors + Cash flow to stockholders

Common stock

Cash stockholders paid to company

Equity

Common stock, preferred stock, and retained earnings

Which one of the following statements related to corporate income taxes is correct?

Corporations pay the same rate of taxes regardless of the amount of taxable income

Increase in inventory

Decreases Cash flows

Increase in sales not yet received

Decreases Cash flows

Key factors for leading to a positive NPV

Degree of competition Potential competition in the market

Operating Cash Flow

EBIT (1-tax rate) + non-cash expenses (ex: depreciation & amortization)

Sale of Fixed Assets

Increase Cash

Cost of goods sold does not reflect true cost

Increases Cash flows

Increase Depreciation and Amortization

Increases Cash flows

Increase in operating expenses

Increases Cash flows

Increase in tax expense

Increases Cash flows

long-term liabilities

Loans and bonds that have a maturity longer than a year

Which one of the following statements concerning net working capital is correct?

Net working capital increases when inventory is sold for cash at a profit.

Which one of the following statements concerning net working capital is correct?

Net working capital may be a negative value.

From the valuation perspective you focus on...

Non-cash Current assets, and non-debt Current liabilities

Projected cash flows are ___________ to equal actual cash flows

Not likely, we do not think the value that we calculated to be the actual cash flows it is much more accurate to if we averaged the cash flows from a certain time period

Project CF

Operating CF - Increase in Net Working Capital - Project Capital Spending

Retained earnings

Portion of earnings that have been saved rather than paid out as dividends

Forecasting risk

Projections with errors built in to account for the possibility that errors in projected cash flows will lead to incorrect decisions

Investment/Project Examples

Purchase of new assets Replacement of assets Introduction of new product line Expansion of an existing product line Buying out other firms

A decrease in which one of the following will increase the accounting break-even quantity? Assume straight-line depreciation is used and ignore taxes.

Sales price per unit

Examples of alternative use

Selling an asset Renting or leasing an asset Use resource elsewhere in the business

Which one of the following best illustrates erosion as it relates to a snack stand located on the beach?

Selling fewer cookies because ice cream was added to the menu

Does accelerated depreciation or straight line depreciation produce higher net income?

Straight line

Financing Costs - Do not include

Such as interest expense or dividends of principal repaid

Income statement

Summarizes a firm's revenues or expenses over a given period of time

A project that has a payback period exactly equal to the project's life is operating at:

The accounting break-even point

If Free Cash Flows > 0

The firm is generating more cash than is required and the firm must pay out cash to security holders or add to the existing cash balance

Assume you graph a project's net present value given various sales quantities. Which one of the following statements is correct regarding the resulting function?

The slope of the function measures the sensitivity of the net present value to a change in sales quantity.

A new project will require an initial investment of $250,000. Using the company's required rate of return of 13 percent, the project's NPV is $900. Should the project be accepted? Why or why not?

Yes; It will earn an annual return of 13 percent, plus an additional $900 in present value dollars.

Current asset

asset that has a life of less than one year - cash, accounts receivable, Inventory (raw material, finished good)

Fixed asset

asset with long-term use or value - lives exceeding one year

Assume a profitable, tax-paying company uses the bottom-up approach to compute operating cash flow. An increase in which one of the following items will result in an increase in operating cash flow?

depreciation expense

Cash flow to stockholders

dividends paid - net new equity raised

The CFO of Shelby & Muhammad receives frequent capital funding requests from the firm's division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is:

facing hard rationing.

Cash flow to creditors

interest paid - net new borrowing

Shareholders' equity:

represents the residual value of a firm.

Combining scenario analysis with sensitivity analysis can yield a crude form of _____ analysis.

simulation

Free Cash Flow (EBIT Method)

EBIT (1-tax rate) + non-cash expenses (ex: depreciation & amortization) - Capital Expenditure - Change in Net Working Capital

Externalities (Cannibalization) - Include

Effects of a project on cash flows in other parts of the firm. Can be positive or negative and should be included as part of the project's incremental cash flows

Opportunity Cost - Include

Is the revenues forgone from not using the resource on its next best alternative use

Current liabilities

Liabilities that needed to be paid off within a year - accounts payable, notes payable, short term debt, and portions of long term debt that are due within the year

The cash flow that is available for distribution to a corporation's creditors and stockholders is called the:

cash flow from assets.

The cash flow related to interest payments less any net new borrowing is called the:

cash flow to creditors

Incremental Cash flow

cash flow with project - cash flow without project

Net Working Capital

current assets - current liabilities

Operating leverage is the degree of dependence a firm places on its:

fixed costs

As the degree of sensitivity of a project to a single variable rises, the:

greater is the importance of accurately predicting the value of that variable.

As of 2018, firms can take a "bonus" depreciation deduction of 100 percent of the cost of an eligible asset in the year the asset was purchased. If a firm elects to take the bonus depreciation instead of using MACRS depreciation, the project's Year 1 operating cash flow will _______ in the amount of ________.

increase; the depreciation expense times the tax rate

Webster Iron Works started a new project last year. As it turns out, the project has been operating at its accounting break-even level of output and is now expected to continue at that level over its lifetime. Given this information, you know that the project:

is operating at a higher level than if it were operating at its cash break-even level.

Variable costs can be defined as the costs that:

vary directly with sales