Fina Chp 6

Interest on municipal bonds is ______.

ignored for tax purposes but included as income for FASB accounting

It is appropriate to use the approximate formula for estimating the real interest rate when:

the interest rate and inflation rate are low

True or false: NPV will be the same regardless of whether nominal or real cash flows are used.

true

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

The shareholders' books in the US follow the rules of the ____.

Financial Accounting Standards Board (FASB)

____________________ cash flows are the difference between the cash flows of the firm with the project and the cash flows of the firm without the project.

Incremental

What is the equation for estimating operating cash flows using the top-down approach?

OCF = Sales - Cash costs - Taxes

According to the top-down approach, what is the operating cash flow if sales are $200,000, total cash costs are $190,636, and the tax bill is $1,144?

$200,000 - 190,636 - 1,144 = $8,220

When interest rates and inflation rates are _____, the approximation of the real interest rate becomes _____.

high; poor low; good

The net present value technique does not discount earnings because earnings ___.

do not represent real money

When comparing projects with unequal lives, one should use which of the following methods:

equivalent annual costs

An increase in depreciation expense will ____ cash flows from operations.

increase

If sales are made on credit, net working capital will _____.

increase

If the inflation rate increases, the nominal rate of interest will ______.

increase

If the tax rate increases, the value of the depreciation tax shield will ____.

increase

Synergy will ______ the sales of existing products.

increase

Buying new cost-cutting equipment affects operating cash flows by:

increasing the depreciation deduction increasing pretax income increasing taxes

___________ expenses incurred on debt financing are ignored when computing cash flows from a project.

interest

The bottom-up approach to calculating OCF starts with:

net income

Under capital budgeting, opportunity costs are cash ______.

outflows

What is the approximate formula for estimating the real interest rate?

Real interest rate = Nominal interest rate - Inflation rate

The computation of equivalent annual costs is useful when comparing projects with unequal _____.

lives

Which of the following is given greater importance in capital budgeting problems in corporate finance?

cash flows

Depreciation × Tax rate represent the depreciation tax _____________.

shield

When using nominal cash flows, the NPV will be _____ when using real cash flows.

the same as

What is an example of an opportunity cost?

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

Investment in net working capital arises when ___.

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

Opportunity costs are classified as:

relevant costs

What is/are true about allocated costs?

These costs are allocated to more than one project. These costs benefit more than one project.

As depreciation ______, operating cash flows will _______.

decrease; decrease increase; increase

The equation for determining the real interest rate has the nominal interest rate in the _____ and the inflation rate in the ______.

numerator; denominator

True or false: Discounting involves determining the future value of present cash flow.

False

True or false: Opportunity costs can be ignored when determining the financial feasibility of a project.

False

If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, what is the real rate of return?

(1.05/1.02)-1 = 2.94%

At the end of a project, the company sold a machine for $50,000 with a book value of $10,000. Assuming a tax rate of 21%, what is the after tax salvage value?

=0.21*(50,000-10,000) = 84000. Salvage value = 50,000-8400 = 41,600

What correctly describes the relationship between depreciation, income, taxes, and investment cash flows?

As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase.

What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

Depr. Tax Sheild =Depr. X Tax Rate = $1800 X 30% = $540

_______________ expenses incurred on debt financing are ignored when computing cash flows from a project.

Interest

Identify the three main sources of cash flows over the life of a typical project.

Net cash flows from salvage value at the end of the 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.

What is the difference between nominal cash flow and real cash flow?

Nominal cash flow is the actual dollars to be received. Real cash flow refers to the cash flow's purchasing power.

What is the equation for estimating operating cash flows using the tax shield approach?

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

According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation$600 × (1−.30) + $1,800 = $2,220

What statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?

There will be a tax savings if the book value exceeds the sales price. Taxes are based on the difference between the book value and the sales price. Book value represents the purchase price minus the accumulated depreciation.

Incremental cash flows of a project are changes in a firm's cash flows that occur as a direct consequence of ____.

accepting a project

When analyzing a project, sunk costs ____ incremental cash outflows.

are not

Allocated costs arise when a specific expenditure ____.

benefits more than one project or division

Discounting is the process of _____.

calculating the present value of either a lump sum or a series of cash flows.

What should be discounted when determining the feasibility of a capital budgeting project(s)?

cash flows

Corporate finance emphasizes _____ while financial accounting emphasizes ______.

cash flows; earnings

Sunk costs are costs that ____.

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

When comparing projects with different lives, one should choose the project with the ______ equivalent annual cost.

lower

When bidding for a job, a competing firm can use the NPV approach to determine their bid. Once the bid is submitted, the firm will win the contract for the project if their bid is the:

lowest

Using your personal savings to invest in your business is considered to have an ________________________ because you are giving up the use of these funds for other investments or uses, such as, a vacation or paying off a debt.

opportunity cost

Under capital budgeting, required working capital is classified as a cash ______.

outflow

Management may look _____ to shareholders and pay _____ tax on reported profit.

profitable; no

What refers to a cash flows purchasing power?

real cash flow

Sometimes when the low bidder wins the bid on a project, it is because they have underbid the project. In other words, the bid they have submitted probably won't even cover the costs of the project. When this happens, the low bidder is said to suffer from the:

winner's curse

When a firm evaluates a proposal to make an existing facility more cost effective, the cost savings must be large enough to justify:

the necessary capital expenditure

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

ignored

As a general rule, when estimating equivalent annual costs, ________ cash flows should be used.

real cash flows should be used because the projects have different lives and inflation could be different in the later periods during which the shorter project is over.

Nominal interest rate - Inflation rate approximates the ________________- interest rate.

real interest rate

Erosion will ______ the sales of existing products.

reduce