Fin 450 chpt 8 hw

If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be

100% reversed.

To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.

True

Synergy will _____ the sales of existing products.

increase

The stand-alone principle assumes that evaluation of a project may be based on the project's ________________ cash flows.

incremental

The difference between a firm's cash flows with a project versus without the project is called ________________.

incremental cash flows

The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its _____ _____.

initial cost

When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ______ rate raised to the nth power.

the discount

Capital rationing exists when a company has identified positive NPV projects but cannot (or will not) find:

the necessary financing

According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."

stand-alone

True or false: Investment in net working capital may arise from the need to cover credit sales.

true

True or false: Net working capital will be recovered at the end of a project.

true

True or false: The measure of average accounting profit is in the numerator of the average accounting return (AAR) formula.

true

The IRR is the discount rate that makes NPV equal to ______

zero

The multiple rates of return problem is the possibility that more than one discount rate may make the net present value of an investment equal to

zero

What is the primary concern of the payback period rule?

How long it takes to recover the initial investment

According to the basic IRR rule, we should:

reject a project if the IRR is less than the required return

One of the most important steps in estimating cash flow is to determine the _________ cash flows.

relevant

Opportunity costs are classified as ____ costs in project analysis.

relevant

Which of the following are fixed costs?

1. cost of equipment 2. rent on a production facility

True or false: In calculating cash flows, you should consider all financing costs.

False

True or false: Operating cash flow is based on the salvage value of equipment. True

False

Investment in net working capital arises when ___.

1. cash is kept for unexpected expenditures 2. credit sales are made 3. inventory is purchased

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

The spreadsheet function for calculating net present value is

=NPV(rate,CF1, ..., CFn) + CF0

True or false: The depreciation tax shield is the depreciation deduction divided by the tax rate.

False

True or false: The payback period takes into consideration the time value of money.

False

Which of the following are considered relevant cash flows?

Cash flows from erosion effects Cash flows from beneficial spillover effects Cash flows from external costs

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

Operating cash flow is a function of:

Depreciation, EBIT, Taxes

In general, NPV is ___.

Equal to zero when the discount rate equals the IRR Negative for Discount Rates above the IRR Positive for Discount Rates below the IRR

True or false: An advantage of the AAR is that it is based on book values, not market values.

False

True or false: Fixed costs cannot be changed over the life of the investment.

False

A(n) ______ project does not rely on the acceptance or rejection of another project.

Independent

The present value of the future cash inflows are divided by the ______ to calculate the profitability index.

Initial investment

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

It considers time value of money. It considers all the cash flows. It considers the riskiness of the project. It properly chooses among mutually exclusive projects

Which of the following are reasons why IRR continues to be used in practice?

It is easier to communicate information about a proposal with an IRR. The IRR of a proposal can be calculated without knowing the appropriate discount rate. Businesspeople prefer to talk about rates of return.

A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?

Market value

In capital budgeting, ______ determines the dollar value of a project to the company.

NPV

Which of the following techniques will provide the most consistently correct result?

Net Present Value

_______ is a measure of how much value is created or added by undertaking an investment.

Net Present Value

Which of the following is the equation for estimating operating cash flows using the tax shield approach?

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

Which of the following are components of project cash flow?

Operating cash flow Change in net working capital Capital spending

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

Project consultation fee

Which of the following is an example of an opportunity cost?

Rental income likely to be lost by using a vacant building for an upcoming project

If the IRR is greater than the _______ ________, we should accept the project.

Required Rate

Which of the following is a disadvantage of the payback period rule?

Requires an arbitrary cutoff point

A manager has estimated a positive NPV for a project. What could drive this result?

The cash flow estimations are inaccurate. The project is a good investment. Overly optimistic management

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

What are the advantages of the payback period method for management?

The payback period method is easy to use. It allows lower level managers to make small decisions effectively. The payback period method is ideal for minor projects.

Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?

The range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. The Excel NPV function is actually a PV function.

Which of the following are weaknesses of the payback method?

Time value of money principles are ignored. Cash flows received after the payback period are ignored. The cutoff date is arbitrary.

True or false: A disadvantage of the AAR is that it does not take into account the time value of money.

True

True or false: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.

True

The internal rate of return is a function of ____.

a project's cash flows

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.

accept

The basic NPV investment rule is:

accept a project if the NPV is greater than zero. reject a project if its NPV is less than zero. if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

Based on the average accounting return rule, a project is _____ if its average accounting return exceeds a target average accounting return.

acceptable

A project should be __________ if its NPV is greater than zero.

accepted

What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC

after tax shield

Cash flows should always be considered on a(n) ___________ basis.

after-tax

Cash flows used in project estimation should always reflect:

after-tax cash flows cash flows when they occur

One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.

arbitrary

The Average Accounting Return is defined as:

average net income/average book value

Side effects from investing in a project refer to cash flows from:

beneficial spillover effects erosion effects

Opportunity costs are ____.

benefits lost due to taking on a particular project

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

Which of the following are fixed costs?

cost of equipment rent on a production facility

Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.

direct

True or false: The discounted cash flow (DCF) valuation estimates future value as the difference between the market price and the cost of the investment.

false

Which of the following is true relative to capital rationing?

hard rationing implies the firm is unable to raise funds for projects soft rationing is typically internal in that the firm allocates funds to divisions for capital projects

Sunk costs are costs that ____.

have already occurred and are not affected by accepting or rejecting a project

Interest expenses incurred on debt financing are ______ when computing cash flows from a project.

ignored

True or false: The depreciation tax shield is the depreciation deduction divided by the tax rate.

it determines the book value of assets which affects net salvage value

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:

it determines the book value of assets which affects net salvage value it affects a firm's annual tax liability it determines taxes owed on fixed assets when they are sold

The payback period can lead to foolish decisions if it is used too literally because:

it ignores cash flows after the cutoff date

The project cash flow equals the project operating cash flow ___________ project change in NWC minus project capital spending.

minus

The discounted cash flow valuation shows that higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.

more

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered _______________.

mutually exclusive

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______________.

net working capital

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

net working capital

Which of the following present problems when using the IRR method?

non-conventional cash flows mutually exclusive projects

One of the flaws of the payback period method is that cash flows after the cutoff date are ___.

not considered in the analysis

The most valuable alternative that is given up if an investment is undertaken is called what?

opportunity cost

The ______ method evaluates a project by determining the time needed to recoup the initial investment.

payback

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

payback period NPV IRR

The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.

payback period; NPV

Given a level of investment in net working capital, that same investment must be______ at some time in the future.

recovered

Erosion will ______ the sales of existing products.

reduce

Internal rate of return (IRR) must be compared to the ________ in order to determine the acceptability of a project.

required return

Estimates of which of the following are needed to prepare pro forma income statements?

selling price per unit variable costs unit sales

The depreciation tax ___________ is the tax savings that results from the depreciation deduction.

shield