Final - Smart Book

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

$540 Tax shield = $1800 x .3 = 540

Operating cash flow is a function of:

- Earnings before interest and taxes - depreciation - taxes

What is a real rate of return?

- It is a percentage change in buying power - It is a rate of return that has been adjusted for inflation

What are reasons why IRR continues to be practiced?

- It is easier to communicate information about a proposal with IRR - Business people like talking about rates of return - It can be calculated without knowing the appropriate discount rate

What are methods of calculating the MIRR of a project?

- Reinvestment Approach - Discounting Approach - The Combination Approach

Which of the following are needed to describe the distribution of stock returns?

- The mean return - The standard deviation of returns

The Ibbotson-Sinquefield data show that over the long-term, _____.

- U.S. T-bills had the lowest risk or variability - long-term corporate bonds had less risk or variability than stocks.

Percentage returns are more convenient than dollar returns because they:

- allow comparison against other investments - apply to any amount invested

What are fixed costs?

- cost of equipment - rent on a production facility

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.

Which of the following presents a when using the IRR method? - mutually exclusive projects - larger cash flow on later projects - a high discount rate - non-conventional cash flows

- mutually exclusive projects - non-conventional cash flows

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

- the project is a good investment - the cash flow estimations are inaccurate - overly optimistic management

Studying market history can reward us by demonstrating that:

- there is a reward for bearing risk - the greater the potential reward is, the greater the risk

The Combination MIRR method is used by the Excel MIRR function and uses which of the following?

-Discounting all negative cash flows to time zero -A financing rate for discounting -A reinvestment rate for compounding -Compounding cash inflows to the end of the project

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

-It allows lower level managers to make small decisions effectively -The payback period method is easy to use -The payback period method is ideal for minor projects (It does not adjust for discount rate)

What 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 refer to talk about rates of return

If a project has multiple internal rates of return, which of the following methods should be used?

-MIRR -NPV

Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926-2011 has revealed as shown in Table 10.10:

1. Small-company common stock 2. Large-company common stocks 3. Long-term corporate bonds 4. Long-term government bonds U.S. Treasury bills

Investment in net working capital arises when ______

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

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

1. it determines the book value of assets which affects net salvage value 2. it determines taxes owed on fixed assets when they are sold 3. it affects a firm's annual tax liability

Which of the following are components of project cash flow?

1. operating cash flow 2. capital spending 3. change in net working capital

Which of the following statement regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?

1. taxes are based on the difference between the book value and the sales price. 2. book value represents the purchase price minus the accumulated depreciation. 3. there will be a tax savings if the book value exceeds the sales price.

If the rate of inflation is 3% and the real rate of return in 9%, the nominal rate is approximately ____

12 %

Suppose you bought 100 shares of Banks & Bower, Inc. for $50 a share. During the year, B&B paid a $0.50 per share dividend. At year end, B&B was selling for $60 a share. What is your total percentage return?

21% (60-50+0.50)/50=21%

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.70%

What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%?

=((80/1.12)+(20/1.12^2))/30=2.91

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

A target average accounting return

Capital ____ is the decision-making process for accepting and rejecting projects

Budgeting

Which of the following is a disadvantage of the Profitability Index?

Cannot rank mutually exclusive projects

Which of the following are ways to make money by investing in stocks?

Capital gains Dividends

Which of the following are weaknesses of the payback method?

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

REDO NUMBER 37

Click from canvas

The Profitability Index is also called the ___ ratio.

Cost-beneift

T/F: An advantage of the AAR is that it is based on book values, not market values

F

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

F

The profitability index is calculated by dividing the PV of the ___ cash inflows by the initial investment.

Future Cash Flows

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because ___.

It defines the business of the firm

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

It ignores cash flows after the cutoff date

The normal distribution is completely described by the ____ and ____

Mean Variance or standard deviation

Which technique will provide the most consistently correct result?

NPV

Multiple IRRs requires you to use

NPV or MIRR

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

(T/F) A project with non-conventional cash flows will produce two or more IRRs

T

(T/F) Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.

T

T/F: A project with non-conventional cash flows will produce two or more IRRs

T

The relationship between nominal rates, real rates and inflation is called:

The Fisher Effect

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

The possibility that errors in projected cash flows will lead to incorrect decisions is known as: 1. forecasting risk 2. estimation risk

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

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, these projects would be considered ___.

mutually exclusive

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

net working capital

Erosion will ____ the sales of existing products

reduce

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

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

reliability

IRR must be compared to the ______ in order to determine the acceptability of a project.

required return

If the IRR is greater than the __________ _________, we should accept the project.

required return

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

stand-alone

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 IRR is the discount rate that makes NPV equal to ______

zero

The PI rule for an independent project is to ___ the project if the PI is greater than 1.

accept

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

accepts

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 an ___ standard.

arbitrary

The dividend yield for a one-year period is equal to the annual dividend amount divided by the _____.

beginning stock price

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

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

direct

The total dollar return on a stock is the sum of the _____ and the _____.

dividends; capital gains

The _____ rate of return is the difference between the rate of return on a risky asset and the risk-free rate of return.

excess

The second lesson from studying capital market history states that the _____ the potential reward, the _____ the risk

greater; greater less; less

The risk-return relationship states that a riskier investment should demand a _______ return.

higher

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

ignored

Dividends are the _____ component of the total return from investing in a stock.

income

An increase in depreciation expense will ___ cash flows from operations

increase