Chapter 10

The changes in a firm's future cash flows that are a direct consequence of accepting a project are called _____ cash flows. a. incremental b. stand-alone c. after-tax d. net present value e. erosion

A incremental

Which of the following statements are correct concerning the analysis of a cost-cutting project that involves the acquisition of fixed assets? I. The costs shown on the pro forma income statement represent a cash inflow. II. The depreciation expense related to the fixed assets will lower the tax expense. III. The project operating cash flow can be computed as sales - taxes + depreciation. IV. Earnings before interest and taxes for the project is computed as depreciation plus the amount of the cost savings. a. I and II only b. III and IV only c. I and III only d. II and IV only e. I, II, and IV only

a. I and II only

Which of the following are correct methods for computing the operating cash flow of a project assuming that the interest expense is equal to zero? I. EBIT + D - T II. EBIT + D +T III. NI + D IV. (Sales - Costs) ´ (T + D) ´ (1-T) a. I and III only b. II and IV only c. II and III only d. I, III, and IV only e. II, III, and IV only

a. I and III only

Bet 'r Bilt Toys just purchased some MACRS 5-year property at a cost of $230,000. Which of the following will correctly give you the book value of this equipment at the end of year 2? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% I. 52 percent of the asset cost II. 48 percent of the asset cost III. 68 percent of 80 percent of the asset cost IV. the asset cost, minus 20 percent of the asset cost, minus 32% of 80% of the asset cost a. II only b. III and IV only c. I and III only d. II and IV only e. I, II, III, and IV

a. II only

Which of the following are examples of erosion? I. the loss of sales due to increased competition in the product market II. the loss of sales because your chief competitor just opened a store across the street from your store III. the loss of sales due to a new product which you recently introduced IV. the loss of sales due to a new product recently introduced by your competitor a. III only b. III and IV only c. I, III and IV only d. II and IV only e. I, II, III, and IV

a. III only

Changes in the net working capital: a. can affect the cash flows of a project every year of the project's life. b. only affect the initial cash flows of a project. c. are included in project analysis only if they represent cash outflows. d. are generally excluded from project analysis due to their irrelevance to the total project. e. affect the initial and the final cash flows of a project but not the cash flows of the middle years.

a. can affect the cash flows of a project every year of the project's life.

The top-down approach to computing the operating cash flow: a. ignores all noncash items. b. applies only if a project produces sales. c. can only be used if the entire cash flows of a firm are included. d. is equal to sales - costs - taxes + depreciation. e. includes the interest expense related to a project.

a. ignores all non cash items.

A pro forma financial statement is one that: a. projects future years' operations. b. is expressed as a percentage of the total assets of the firm. c. is expressed as a percentage of the total sales of the firm. d. is expressed relative to a chosen base year's financial statement. e. reflects the past and current operations of the firm.

a. projects future years' operations.

The book value of an asset will: a. remain constant if the asset is land. b. vary as the market value of the asset varies. c. decrease at a constant rate when MACRS depreciation is used. d. increase over the tax life of the asset. e. decrease faster under straight-line depreciation than under MACRS.

a. remain constant if the asset is land.

A project's operating cash flow will increase when: a. the depreciation expense increases. b. the sales projections are lowered. c. the interest expense is lowered. d. the net working capital requirement increases. e. the earnings before interest and taxes decreases.

a. the depreciation expense increases.

The depreciation method currently allowed under US tax law governing the accelerated write-off of property under various lifetime classifications is called _____ depreciation. a. FIFO b. MACRS c. straight-line d. sum-of-years digits e. curvilinear

b. MACRS

Which one of the following statements is correct concerning bid prices? a. The competitor who wins the bid is the one who submits the highest bid price. b. The winning bid may be at a price that is below break-even especially if there is a related aftermarket for the product. c. A bid price is computed based on 110 percent of a firm's normal required return. d. A bid price should be computed based solely on the operating cash flows of the proposed project. e. A bid price should be computed based on a zero percent required rate of return.

b. The winning bid may be at a price that is below break-even especially if there is a related aftermarket for the product.

One purpose of identifying all of the incremental cash flows related to a proposed project is to: a. isolate the total sunk costs so they can be evaluated to determine if the project will add value to the firm. b. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. c. make each project appear as profitable as possible for the firm. d. include both the proposed and the current operations of a firm in the analysis of the project. e. identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis.

b. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project.

Erosion can be explained as the: a. additional income generated from the sales of a newly added product. b. loss of current sales due to a new project being implemented. c. loss of revenue due to employee theft. d. loss of revenue due to customer theft. e. loss of cash due to the expenses required to fix a parking lot after a heavy rain storm.

b. loss of current sales due to a new project being implemented.

The evaluation of a project based solely on its incremental cash flows is the basis of the: a. incremental cash flow method. b. stand-alone principle. c. dividend growth model. d. after-tax salvage value analysis. e. discounted payback method.

b. stand-alone principle

The bottom-up approach to computing the operating cash flow applies only when: a. both the depreciation expense and the interest expense are equal to zero. b. the interest expense is equal to zero. c. the project is a cost-cutting project. d. no fixed assets are required for the project. e. taxes are ignored and the interest expense is equal to zero.

b. the interest expense is equal to zero.

The pro forma income statement for a cost reduction project: a. will reflect a reduction in the sales of the firm. b. will generally reflect no incremental sales. c. has to be prepared reflecting the total sales and expenses of a firm. d. cannot be prepared due to the lack of any project related sales. e. will always reflect a negative project operating cash flow.

b. will generally reflect no incremental sales.

Which one of the following will decrease net working capital of a firm? a. a decrease in accounts payable b. an increase in inventory c. a decrease in accounts receivable d. an increase in the firm's checking account balance e. a decrease in fixed assets

c. a decrease in accounts receivable

A project which is designed to improve the manufacturing efficiency of a firm but will generate no additional sales is referred to as a(n) _____ project. a. sunk cost b. opportunity c. cost-cutting d. revenue-cutting e. revenue-generating

c. cost-cutting

The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called the: a. after-tax depreciation savings. b. depreciable basis. c. depreciation tax shield. d. operating cash flow. e. after-tax salvage value.

c. depreciation tax shield

Sunk costs include any cost that: a. will change if a project is undertaken. b. will be incurred if a project is accepted. c. has previously been incurred and cannot be changed. d. is paid to a third party and cannot be refunded for any reason whatsoever. e. will occur if a project is accepted and once incurred, cannot be recouped.

c. has previously been incurred and cannot be changed.

The cash flows of a project should: a. be computed on a pre-tax basis. b. include all sunk costs and opportunity costs. c. include all incremental costs, including opportunity costs. d. be applied to the year when the related expense or income is recognized by GAAP. e. include all financing costs related to new debt acquired to finance the project.

c. include all incremental costs, including opportunity costs.

Tax shield refers to a reduction in taxes created by: a. a reduction in sales. b. an increase in interest expense. c. noncash expenses. d. a project's incremental expenses. e. opportunity costs.

c. noncash expenses.

The salvage value of an asset creates an after-tax cash inflow to the firm in an amount equal to the: a. sales price of the asset. b. sales price minus the book value. c. sales price minus the tax due based on the sales price minus the book value. d. sales price plus the tax due based on the sales price minus the book value. e. sales price plus the tax due based on the book value minus the sales price.

c. sales price minus the tax due based on the sales price minus the book value.

A cost that has already been paid, or the liability to pay has already been incurred, is a(n): a. salvage value expense. b. net working capital expense. c. sunk cost. d. opportunity cost. e. erosion cost.

c. sunk cost

Which one of the following is an example of an incremental cash flow? a. the annual salary of the company president which is a contractual obligation b. the rent on a warehouse which is currently being utilized c. the rent on some new machinery that is required for an upcoming project d. the property taxes on the currently owned warehouse which has been sitting idle but is going to be utilized for a new project e. the insurance on a company-owned building which will be utilized for a new project

c. the rent on some new machinery that is required for an upcoming project.

Toni's Tools is comparing machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. These machines should be compared using: a. net present value only. b. both net present value and the internal rate of return. c. their effective annual costs. d. the depreciation tax shield approach. e. the replacement parts approach.

c. their effective annual costs.

The cash flows of a project should include the related changes in which of the following accounts? I. taxes II. accounts payable III. fixed assets IV. long-term debt a. I and II only b. III and IV only c. I and III only d. I, II, and III only e. I, II, III, and IV

d. I, II, and III only

All of the following are anticipated effects of a proposed project. Which of these should be included in the initial project cash flow related to net working capital? I. an inventory decrease of $5,000 II. an increase in accounts receivable of $1,500 III. an increase in fixed assets of $7,600 IV. a decrease in accounts payable of $2,100 a. I and II only b. I and III only c. II and IV only d. I, II, and IV only e. I, II, III, and IV

d. I, II, and IV only

Which of the following should be included in the analysis of a project? I. sunk costs II. opportunity costs III. erosion costs IV. incremental costs a. I and II only b. III and IV only c. II and IV only d. II, III, and IV only e. I, II, and IV only

d. II, III, and IV only

Which one of the following statements is correct? a. Project analysis should only include the cash flows which affect the income statement. b. A project can create a positive cash flow from operations without affecting the sales level of a firm. c. For the majority of projects that increase sales, there will be a cash outflow related to net working capital that occurs at the end of the project. d. Interest expense should always be included as a cash outflow when analyzing a project. e. The opportunity cost of a company-owned building that is going to be used in a new project should be included as a cash inflow to the project.

d. Interest expense should always be included as a cash outflow when analysing a project.

The book value of an asset is primarily used to compute the: a. annual depreciation tax shield. b. amount of cash received from the sale of an asset. c. amount of tax saved annually due to the depreciation expense. d. amount of tax due on the sale of an asset. e. change in depreciation needed to reflect the market value of the asset.

d. amount of tax due on the sale of an asset.

An increase in which one of the following will increase the operating cash flow? a. employee salaries b. office rent c. building maintenance d. equipment depreciation e. equipment rental

d. equipment depreciation.

The stand-alone principle advocates project analysis which is focused on _____ costs. a. sunk b. total c. variable d. incremental e. fixed

d. incremental

Net working capital: a. can be ignored in project analysis because any expenditure is normally recouped by the end of the project. b. requirements generally, but not always, create a cash inflow at the beginning of a project. c. expenditures commonly occur at the end of a project. d. is frequently affected by the additional sales generated by a new project. e. is the only expenditure where at least a partial recovery can be made at the end of a project.

d. is frequently affected by the additional sales generated by a new project.

The most valuable investment given up if an alternative investment is chosen is a(n): a. salvage value expense. b. net working capital expense. c. sunk cost. d. opportunity cost. e. erosion cost.

d. opportunity cost.

The cash flow from projects for a company is computed as the: a. net operating cash flow generated by the project, less any sunk costs and erosion costs. b. sum of the incremental operating cash flow and after-tax salvage value of the project. c. net income generated by the project, plus the annual depreciation expense. d. sum of the incremental operating cash flow, capital spending, and net working capital expenses incurred by the project. e. sum of the sunk costs, opportunity costs, and erosion costs of the project.

d. sum of the incremental operating cash flow, capital spending, and net working capital expenses incurred by the project.

You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) _____ cost. a. opportunity b. fixed c. incremental d. sunk e. relevant

d. sunk

A company which uses the MACRS system of depreciation: a. will have equal depreciation costs each year of an asset's life. b. will expense the cost of nonresidential real estate over a period of 7 years. c. can depreciate the cost of land, if they so desire. d. will write off the entire cost of an asset over the asset's class life. e. cannot expense any of the cost of a new asset during the first year of the asset's life.

d. will write off the entire cost of an asset's class life.

Will Do, Inc. just purchased some equipment at a cost of $650,000. What is the proper methodology for computing the depreciation expense for year 3 if the equipment is classified as 5-year property for MACRS? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a. $650,000 * (1-.20) * (1-.32) * (1-.192) b. $650,000 * (1-.20) * (1-.32) c. $650,000 * (1+.20) * (1+.32) * (1+.192) d. $650,000 * (1-.192) e. $650,000 * .192

e. $650,000 * .192

Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to a project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals. a. I and II only b. II and III only c. I, II, and IV only d. II, III, and IV only e. I, II, III, and IV

e. I, II, III, and IV

Which of the following are examples of an incremental cash flow? I. an increase in accounts receivable II. a decrease in net working capital III. an increase in taxes IV. a decrease in the cost of goods sold a. I and III only b. III and IV only c. I and IV only d. I, III, and IV only e. I, II, III, and IV

e. I, II, III, and IV

The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost. a. incremental b. sunk c. opportunity d. erosion e. equivalent annual

e. equivalent annual

The cash flows of a new project that come at the expense of a firm's existing projects are called: a. salvage value expenses. b. net working capital expenses. c. sunk costs. d. opportunity costs. e. erosion costs.

e. erosion cost

The pre-tax salvage value of an asset is equal to the: a. book value if straight-line depreciation is used. b. book value if MACRS depreciation is used. c. market value minus the book value. d. book value minus the market value. e. market value.

e. market value

The equivalent annual cost method is useful in determining: a. the annual operating cost of a machine if the annual maintenance is performed versus when the maintenance is not performed as recommended. b. the tax shield benefits of depreciation given the purchase of new assets for a project. c. operating cash flows for cost-cutting projects of equal duration. d. which one of two machines to acquire given equal machine lives but unequal machine costs. e. which one of two machines to purchase when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

e. which one of two machines to purchase when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.