FIN 3309 Anderson Chap 9

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

$540

If a firm's variable cost per unit estimate used in its base case analysis is $50 per unit and they anticipate the upper and lower bounds to be +/- 10%, what is the "worst case" for variable cost per unit?

$55

Given the following info, what is the OCF? EBIT = $80 Depreciation = $20 Taxes = $30

$70

If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be:

100% reversed

Equation for estimating operating cash flows using the tax shield approach:

OCF = (Sales - Costs) x (1-Tax Rate) + Depreciation x Tax Rate

T or F: Net working capital will be recovered at the end of a project.

True

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

direct

Sunk costs are costs that:

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

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

ignored

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

increase

Synergy will _____ the sales of existing products.

increase

The stand-alone principle assumes that evaluation of a project may be based on the project's _________ cash flows.

incremental

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

net working capital

The difference between a firm's current assets and its current liabilities is known as the ____.

net working capital

Opportunity costs are classified as ____ costs in project analysis.

relevant

The first step in estimating cash flow is to determine the _______ cash flows.

relevant

What is an example of an opportunity cost?

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

To investigate the impact on NPV of a change in one variable, you would employ ______.

sensitivity analysis

Example of a sunk cost:

test marketing expenses

Capital rationing exists when a company has identified positive NPV projects but can't (or won't) find:

the necessary financing

In a competitive market, positive NPV projects are:

uncommon

Cash flows used in project estimation should always reflect:

-after-tax cash flows -cash flows when they occur

The goals of risk analysis in capital budgeting include:

-assessing the degree of financing risk -identifying critical components

Example of fixed costs:

-cost of equipment -rent on a production facility

Investment in networking capital arises when:

-credit sales are made -cash is kept for unexpected expenditures -inventory is purchased

Side effects from investing in a project refer to cash flows from:

-erosion effects -beneficial spillover effects

The possibility that errors in projected cash flows will lead to incorrect decisions are know as:

-estimating risk -forecasting risk

What are two main drawbacks of sensitivity analysis?

-it does not consider interaction among variables -it may increase the false sense of security among managers if all pessimistic estimates of NPV are positive

What are the two main benefits of performing sensitivity analysis?

-it identifies the variable that has the most effect on NPV -it reduces a false sense of security by giving a range of values for NPV instead of a single value

Identify 3 main sources of cash flows over the life of a typical project:

-net cash flows from sales and expenses over the life of the project -cash outflows from investment in plant and equipment at the inception of the project -net cash flows from salvage value at the end of the project

Once cash flows have been estimated, which of the following investment criteria can be applied to them?

-payback period -IRR -NPV

An option on a real asset rather than a financial asset is known as a:

-real option -managerial option

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

-scenario analysis -asking what-if questions

What is an important drawback of traditional NPV analysis?

It ignores managerial options in investment decisions.

What technique will provide the most consistency correct result?

Net Present Value

What is the difference between scenario analysis and sensitivity analysis?

Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time.

When using _____, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.

Sensitivity Analysis

Opportunity costs are ____.

benefits lost due to taking on a particular project

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

Suppose a project's operating cash flow is $150. The firm anticipates a $30 investment in net working capital and $80 in capital spending. What is the project's cash flow?

$40

Broadband Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.

$400,000

We underestimate NPV because of the option(s) to ______.

-expand -abandon

what is true relative to capital rationing?

-soft rationing is typically internal in that the firm allocates funds to divisions for capital projects -hard rationing implies the firm is unable to raise funds for projects

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

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

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

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

What is needed for cash flow estimation:

-variable cost per unit -unit sales per period -selling price per unit

If a firm's sales estimate used in its base case analysis is 1,000 units per year and they anticipate the upper and lower bounds to be +/- 15%, what is the "best case" for units sold per year?

1,150

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

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