Finance 342 Chapter 9 Concept Questions

The Tax Cuts and Jobs Act allows companies to take bonus depreciation sufficient to write off what percent of investment immediately?

100%

By keeping costs such as interest and principal payments on debt out of project cash flows, you are following a fundamental principle of corporate finance known as the separation of investment and ___________ decisions.

Financing

A project generates a net profit of $1.8 million and depreciation of $200,000. What is the project's operating cash flow?

$2 million Reason: Operating cash flow = net profit + depreciation = $2 million

At the end of a project, a firm's investment has a salvage value of $4 million. The firm will pay taxes of $.5 million on the sale of the equipment from the investment. What is the net cash flow to the firm?

$3.5 Million Reason: Net cash flow= salvage value - tax on gain= $4 million - $.5 million = $3.5 million

A project generates revenues of $1.4 million, cash expenses of $1 million, and taxes of $100,000. What is the operating cash flow?

$300,000 Reason: Operating cash flow = revenues - cash expenses - taxes = $1.4 million - $1 million - $100,000 = $300,000

Smith Industries plans to sell an asset at the end of a 5 year project for $250,000. The book value of the asset at that time will be $125,000. The marginal tax rate is 35 percent. How much tax will Smith pay on the sale, and what will be its net proceeds (cash inflow)?

$43,750; $206,250 Explanation: Tax = (250000 - 125,000) x0.35= 43750; Net proceeds = 250000 - 43750 = $206,250

Which of the following are true regarding the inclusion of working capital in project cash flows?

-invested working capital is recovered by the end of the project -recovery of working capital is a cash inflow -investment in working capital is a cash outflow -investment in working capital may change over the life of the project

The initial capital investment is a cash outflow at the start of the project that includes which of the following types of outflows

-investments in research and marketing required for the project -any investment in fixed assets required by the project

Bonus depreciation is a temporary provision of the Tax Cuts and Jobs Act. It is scheduled to be phased-out starting in

2023

The initial cash flow at the start of a project's life is typically

Negative

The initial capital investment in a project requires a ______ cash flow. The salvage value from a project involves a ________ cash flow.

Negative / Positive

Which of the following will correct the effect of depreciation?

Operating Cash Flow = After-tax profit + depreciation Operating Cash Flow = Net Income + depreciation Operating Cash Flow = (Revenues - cash expenses) X (1- tax rate) + (tax rate X deprecation)

Which of the following formulas can be used to ensure that depreciation is not included in a project's operating cash flows?

Operating cash flow = (revenues - cash expenses) x (1-tax rate) + (tax rate x depreciation) Operating cash flow = revenues - cash expenses - taxes Operating cash flow = after-tax profit + depreciation

Land that is used for a manufacturing facility could also be sold. The _________ cost equals the cash that could be realized from selling the land now instead of using it for the manufacturing facility.

Opportunity

Land that is used for a manufacturing facility could also be sold. The ____ cost equals the cash that could be realized from selling the land now instead of using it for the manufacturing facility.

Oppotunity

A benefit or cash flow foregone as a result of an action is called

an opportunity cost

Incremental cash flow is equal to

cash flow with project - cash flow without project

The cash flows brought about at the end of a project are called ________ and ________ be included in a project's cash flow forecasts.

terminal cash flows; should

An opportunity cost arises in a project whenever:

the project uses an existing asset that could have been sold or put to productive use elsewhere

Cash flows from capital investments + operating cash flows + cash flows from changes in working capital =

total cash flow

The term incremental cash flow can best be defined as:

- Cash flow with the project minus firm cash flow without the project - Additional cash flows that will only be earned if the firm proceeds with an investment

If the cost of an input it $1,000,000 this year; if you project inflation to be 3% annually, what would be an appropriate forecast for the cost of that input in year 4?

$1,125,508

A project generates revenues of $5,000, costs of $3,000 and taxes of $700. What is the project's operating cash flow?

$1,300 Rationale: $5000 - $3,000 - $700 = $1,300

Which of the following are commonly made mistakes that managers make in regard to working capital and forecasting project cash flows?

- forgetting that working capital may change during the life of the project - forgetting about working capital entirely - forgetting that working capital is recovered at the end of the project

Which of the following is true of a project's terminal cash flow?

- it may include recovery of working capital investment - it may be positive or negative - It may be due to the sale of a project asset - it may be due to final cleanup or recovery costs

Which of the following statements about nominal versus real cash flows are correct?

- nominal cash flows must be discounted by a nominal discount rate - real cash flows must be discounted by a real discount rate

Which of the items below are the elements which must be included in the calculation of a project's total cash flow?

- operating cash flow - cash flow from capital investments - cash flows from changes in working capital

Some examples of indirect effects that could affect incremental cash flows would be:

- release of a product that will generate sales of replacement parts and services in future years - cannibalization of existing product sales by introduction of a new product - increased sales of an existing product by release of a complementary product - loss of existing store sales by locating a new store too close by

Which of the following are characteristics of sunk costs?

- they do not affect the project NPV - they are past and irreversible cash outflows - managers are often influenced by sunk costs

When calculating NPV, why are cash flows discounted instead of accounting profits?

-Income statements do not track cash flows. -Accounting profits do not recognize project investment expenditures as they occur. -Using accounting profits gives an inaccurate NPV.

Some examples of opportunity costs that should be included in project analysis are

-Skilled employees who are moved from an existing project to the new project causing a loss in the existing project -The market price of an asset that is committed to the project when it could have been sold for cash

To calculate net present value, you need to discount _________.

Cash Flows

True or False: Financing costs like interest and principal payments on borrowed funds must be included in the incremental

False

True or False: Indirect effects on cash flows may be positive or negative

True

True or False: Indirect effects on cash flows may be positive or negative.

True

True or false: project discounted cash flow analysis assumes that cash flows occur at the end of the year even though they are actually spread through the year as sales and expenses actually occur.

True

Which of the following statements about working capital is correct?

a project may have WC outflows early, changing to inflows as WC is recovered

A sunk cost is irreversible; sunk costs

do not affect NPV and should be ignored.

The difference between the nominal discount rate and the real discount rate is

expected inflation

Which of the following forecasted components of project cash flow should be adjusted directly to change with inflation from year to year?

revenue / expenses

A project's operating cash flow can be calculated using which of the following equations

revenues - costs - taxes

A project's operating cash flow can be calculated using which of the following equations:

revenues - costs - taxes

When calculating NPV, the proper time to record investment expenditures is:

when they occur