Ch. 12 exam (BUSFIN 3220)

(quantitative or qualitative analysis) corporate risk

qualitative

the price that the company receives for a fixed asset at the end of the project

salvage value

(true or false) Sunk costs are cash outlays a company has made in the past, and they can't be recovered whether the new project goes forward or not. Thus, you don't include these costs in the project's capital budgeting analysis.

true

(true or false) While an opportunity cost is not an actual cash outlay, this cost must be added to the project's costs when you calculate its net present value.

true

(true or false) externalities can be positive & negative

true

assume all CFs occur at the (beginning/end) of the year

end

what is the most common type of negative externality?

environmental externality

(true or false) Positive externalities on a project are called complements

true

NPV is higher with (straight line/accelerated) depreciation

accelerated

(base, worst, or best case scenario) analysis in which all of the input variables are set at their most likely values

base-case

the situation when a new project reduces cash flows that the firm would otherwise have had

cannibalization

what are negative externalities called?

cannibalization

what are positive externalities called?

complements

(what type of risk) considers the firm's diversification, but not stockholder diversification

corporate risk

(what type of risk) measured by a project's effect on uncertainty about the firm's expected future returns

corporate risk

if the salvage value is (same/different) than the book value of the asset then there is a tax effect

different

effect on the firm or the environment that are not reflected in the projects CFs

externalities

(true or false) An opportunity cost is an amount that a firm would receive if it does not make a given investment. An example would be the purchase price from a building that a firm owns and could sell if it does not make an investment that would call for the use of the building. Opportunity costs should not be reflected in a capital budgeting analysis.

false

(True or false) An opportunity cost represents the best return a company could get on an asset it already owns. It is the cost of losing out on something if you greenlight the project, so you want to include this cost in the capital budgeting analysis.

true

(True or false) depreciation is a non-cash expense

true

(True or false) replacement chain & EAA approach ALWAYS result in the same decision

true

what are the three types of externalities?

1. negative within firm 2. positive within firm 3. environmental

what are the three ways to measure stand-alone risk?

1. sensitivity analysis 2. scenario analysis 3. Monte Carlo simulation

you have to pay taxes if the salvage value is (<,>) book value

>

____ represents the net amount of cash available for all investors after considering necessary investments in capital expenditures & NOWC

FCF

why do we have to consider changes in NOWC separately?

GAAP requires revenue & COGS be recorded when sale is made not when cash is received

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) risk analysis technique in which probable future events are simulated on computer, generating estimated rates of return & risk indexes

Monte Carlo simulation

NPV of a project is equal to the (PV/FV) of the FCFs

PV

when in the tax on a salvage value a positive cash flow? - SV > BV - SV < BV

SV < BV

(base, worst, or best case scenario) all input variables set at their best reasonably forecasted values

best-case

(true or false) Sunk costs are the costs associated with "the road not taken". They represent the alternative cost of an asset if that asset were not already owned by the firm; therefore, these costs should be included in the capital budgeting analysis.

false

(true or false) sunk costs are relevant in the capital budgeting analysis & should be incorporated in the NPV calculation

false

the greater the risk = the (lower/higher) the cost of capital

higher

analysis of cash flows should only include _________ investments

incremental

CFs that will occur if & only if the firm takes on the project

incremental CFs

if assets can be redeployed or sold easily, the project may be (less/more) risky than otherwise thought

less

(what type of risk) measured by its effect on the firm's beta coefficient

market risk

(what type of risk) most relevant but most difficult to estimate

market risk

(what type of risk) the riskiness of the project as seen by a well-diversified stockholder

market risk

if the project has the potential for a lawsuit, it is (less/more) risky than previously thought

more

larger the range = steeper the variable's slope = (less/more) sensitive the NPV is to changes in the variable

more

should dividends be included in the analysis of cash flows ?

no

should financing effects be included in cash flows?

no

should interest expenses be included in the analysis of cash flows?

no

How is NOWC recovered?

once a project is complete, an increase/decrease in NOWC must be offset in the final year

is there always a tax on salvage value?

only if SV> book value

why is depreciation relevant if it is a non-cash expense?

only relevant b/c it affects taxes

(pay taxes or receive money) salvage value > book value

pay taxes

(quantitative or qualitative analysis) market risk

qualitative

(quantitative or qualitative analysis) stand alone risk

quantitative

(pay taxes or receive money) salvage value < book value

receive money

approach that assumes that each project can be repeated as may times as necessary to reach a common life

replacement chain approach

the cost of capital appropriate for a project, given the riskiness of that project

risk-adjusted cost of capital

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) allows us to change more than one variable at a time & incorporate the probabilities of changes in the key variables

scenario analysis

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) risk analysis technique in which bad & good sets of financial circumstances are compared with a most likely, or base-case situation

scenario analysis

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) % change in NPV resulting from a given % change in an input variable, other things held constant

sensitivity analysis

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) change one variable at a time

sensitivity analysis

(sensitivity analysis ,scenario analysis, or Monte Carlo simulation) most commonly used type of risk analysis

sensitivity analysis

(what type of risk) measured by variability of the projects expected returns

stand alone

(what type of risk) a projects risk assuming that it is the only asset the firm has & the firm is the only stock in each investor's portfolio

stand alone risk

(what type of risk) diversification is ignored

stand alone risk

a cash outlay that has already been incurred & cannot be recovered regardless of whether the project is accepted or rejected

sunk cost

(true or false) Opportunity costs and sunk costs are tricky when analyzing capital budgeting projects. In summary, for a correct capital budgeting analysis, opportunity costs must be included in the analysis while sunk costs should be ignored—the money is gone whether the project is undertaken or not.

true

(true or false) A project's incremental cash flow is the difference between the firm's cash flow if it accepts the project versus if it rejects the project. Thus, if a project has an initial cost of $1 million in Year 1 and no other costs or revenues, then the incremental cash flow in that year will be -$1 million.

true

(true or false) A sunk cost is a cost that has been incurred and cannot be recovered regardless of whether a project is accepted or rejected. Sunk costs should not/ be reflected in a capital budgeting analysis.

true

(true or false) Cannibalization is a negative externality that reduces the cash flow in another part of the same company.

true

(true or false) Effects of a project on other parts of the firm or the environment are called externalities.

true

(true or false) Externalities can be either negative or positive but they should be correctly accounted for in a project's cash flows when evaluating that project.

true

(true or false) In some instances, replacements add capacity as well as lower operating costs. When this is the case, sales revenues would be increased; and if that led to an increase in net operating working capital, that number would be shown as a Time 0 expenditure along with its recovery at the end of the project's life. These changes would, of course, be reflected in the differential cash flows for the analysis.

true

(true or false) almost all of the CFs in a replacement project are incremental

true

(base, worst, or best case scenario) all input variables seta t their worst reasonably forecasted values

worst-case

if the new product line decreases the sales of the firm's other lines, would this affect the analysis?

yes this is an externality