Fin 450 LS Ch 8

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

$540

Which of the following are considered relevant cash flows?

-Cash flows from beneficial spillover effects -Cash flows from erosion effects -Cash flows from external costs

Investment in net working capital arises when ___.

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

Which of the following are components of project cash flow?

-change in NWC -capital spending -operating cash flow

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

-it considers the riskiness of the project -it properly chooses among mutually exclusive projects -it considers TVM -it considers all the cash flows

Identify the three 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 & equipment at the inception of the project -net cash flows from salvage value at the end of the project

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

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

Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a 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

Which of the following are needed for cash flow estimation?

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

If a firm's sales estimate used in it base 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

What is the IRR for a project with an initial investment of $500 and subsequent cash inflows of $145 per year for 5 years.

13.82%

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

1986 Tax Reform Act

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%?

2.91

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

9.7%

The spreadsheet function for calculating net present value is ___.

=NPV(rate, CF1, ...,CFn) +CF0

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

A financing rate for discounting A reinvestment rate for compounding Discounting all cash OUTFLOWS to time 0 Compounding cash INFLOWS to the end of the project

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

A target average accounting return

The basic NPV investment rule is:

Accept a project if the NPV is greater than zero Reject a project if the NPV is less than zero If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

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 a(n) ___ standard.

Arbitrary

Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?

As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase

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

Beneficial spillover effects & erosion effects

Opportunity costs are ___.

Benefits lost due to taking on a particular project

Which of the following are reasons why IRR continues to be used in practice?

Businesspeople prefer to talk about rates of return The IRR of a proposal can be calculated without knowing the appropriate discount rate It is easier to communicate information about a proposal with an IRR

Which of the following is a disadvantage of the profitability index?

Cannot rank mutually exclusive projects

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

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

Direct

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

Estimation risk & Forecasting risk

T or F: the number of positive NPV project is unlimited for any given firm

False

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

False

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

Future

Sunk costs are costs that ___.

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

The goals of risk analysis in capital budgeting include:

Identifying critical components & assessing the degree of financing risk

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

Incremental

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

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

What is an important drawback of traditional NPV analysis?

It ignores managerial options in investment decisions

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

Which of the following techniques will provide the most consistently correct result?

NPV

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

NPV & MIRR

In general, NPV is ____.

Negative for discount rates above the IRR Positive for discount rates below the IRR Equal to zero when the discount rate equals the IRR

In capital budgeting, ___ determines the dollar value of a project to the company

Net present value

According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?

Net present value Internal rate of return

Which of the following is the equation for estimating operating cash flows using the tax-shield approach?

OCF= (sales - costs) x Tax Rate + Depreciation x Tax Rate

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 projects' cash flow?

PCF= 150-30-80= $40

The ____ is best suited for decisions on relatively small, minor projects while ___ is more appropriate for large complex projects.

Payback period ; NPV

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

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.

What is scenario analysis?

Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario

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

Sensitivity analysis

Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?

The Excel NPV function is actually a PV function The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign The range of cash flows specified in Excel begins with cashflow #1, not cashflows 0 With the Excel NPV function, Cashflow #0 must be handled outside the NPV function

What approach does the following formula describe? OCF= (sales - costs) x (1-T) + depreciation x T

The Tax Shield Approach

Which of the following are methods of calculating the MIRR of a project?

The discounting approach The reinvestment approach The combination approach

Which of the following qualify as "managerial options?"

The option to wait, the option to abandon, and the option to expand

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

The payback period method is easy to use It allows lower level managers to make small decisions effectively The payback period method is ideal for minor projects

T or F: While performing sensitivity analysis, we compute NPV several times by changing one input variable at a time.

True

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

True

True or False: a project with non-conventional cash flows will produce two or more IRRs.

True

The basic approach to evaluating cash flow and NPV estimates involves asking:

What-if questions

The internal rate of return is a function of ___.

a project's cash flows

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

abandon & expand

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

accept

A project should be ___ if its NPV is greater than zero

accepted

A(n) ____ of the payback period rule is that it is easy to understand

advantage

Cash flows should always be considered on a(n) ___ basis.

after tax

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

asking what-if questions & scenario analysis

The average accounting return is defined as:

average net income/ average book value

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

Which of the following are fixed costs?

cost of equipment or rent on a production facility

Operating cash flow is a function of:

depreciation, earnings before interest and taxes, & taxes

Interest expense 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 difference between a firm's cash flows with a project versus without the project is called ___.

incremental cash flows

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

it affect a firm's annual tax liability & it determines the book value of assets which affect net salvage value, & it determines taxes owed on fixed assets when they are sold.

What are the 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

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

it ignores cash flows after the cutoff date

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

managerial option & real option

A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?

market value

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

net working capital

The NPV is ___ if the required return is less than the IRR, and it is ___ if the required return is greater than the IRR.

positive; negative

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

Opportunity costs are classified as ___ costs in project analysis

relevant

The first step in estimating cash flow is to determine the ___ cash flow

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

If the IRR is greater than the ___ ___,we should accept the project

required return

When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 + ___ rate raised to the nth power.

the discount

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

the necessary financing

In order to analyze the risk of a project's NPV estimate, we should establish ___ for each important estimate variable.

upper and lower bounds

The IRR is the discount rate that makes NPV equal to ___.

zero