FIN CH 9

The goals of risk analysis in capital budgeting include ______.

assessing the degree of financing risk identifying critical components

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 percent reversed.

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

increase

According to the ______ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."

stand-alone

What is the total number of inputs that change at a given time while doing sensitivity analysis?

1

Capital rationing exists when a company has identified positive NPV projects but cannot (or will not) find ______.

the necessary financing

What approach does the following formula describe? OCF = (Sales − Costs) × (1 − TC) + Depreciation × TC

the tax-shield approach

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 all the cash flows. It considers time value of money.

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.

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

True or false: If analysts are overly optimistic about the future, then they may accept a project that realistically has a negative NPV.

True

True or false: Investment in net working capital may arise from the need to cover credit sales.

True

Which of the following are components of project cash flow?

change in net working capital operating cash flow capital spending

Managerial options are taken into consideration in ___ planning.

contingency

Which of the following are fixed costs?

cost of equipment rent on a production facility

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

The primary risk in estimation errors is the potential to ______.

make incorrect capital budgeting decisions

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

real option managerial option

In a competitive market, positive NPV projects are ______.

uncommon

True or false: Operating cash flow is based on the salvage value of equipment.

False

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

IRR payback period NPV

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

OCF = (Sales - Costs) × (1 − Tax rate) + Depreciation × Tax rate

Which of the following 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 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 considered relevant cash flows?

cash flows from beneficial spillover effects cash flows from erosion effects cash flows from external costs

Cash flows used in project estimation should always reflect:

cash flows when they occur. aftertax cash flows.

Investment in net working capital arises when ______.

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

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 percent, What is the "best case" for units sold per year?

1,150

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

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 percent, what is the "worst case" for variable cost per unit?

$55

The project cash flow equals the project operating cash flow project ___ change in NWC minus project capital spending.

minus, -, or less

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

1986 Tax Reform Act.

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.

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

Book value represents the purchase price minus the accumulated depreciation. Taxes are based on the difference between the book value and the sales price. There will be a tax savings if the book value exceeds the sales price.

True or false: In calculating cash flows, you should consider all financing costs.

False

True or false: Sensitivity analysis is helpful because it indicates what we should do regarding forecasting errors.

False

True or false: Taxes are based on the difference between the initial cost and the sales price.

False

True or false: The depreciation tax shield is the depreciation deduction divided by the tax rate.

False

True or false: The number of positive NPV projects is unlimited for any given firm.

False

True or false: The value of managerial options is taken into account when performing conventional NPV analysis.

False

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.

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

Management rationality could drive this result. The cash flow estimations are inaccurate. The project is a good investment.

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.

___ analysis is useful in pinpointing variables that deserve the most attention. (Enter only one word per blank.)

Sensitivity

True or false: Net working capital will be recovered at the end of a project.

True

True or false: To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.

True

True or false: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.

True

Opportunity costs are ______.

benefits lost due to taking on a particular project

What is net working capital?

current assets minus current liabilities

Operating cash flow is a function of:

depreciation. earnings before interest and taxes. taxes.

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

direct

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

erosion effects. beneficial spillover effects.

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

expand abandon

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

forecasting risk estimation risk

Sunk costs are costs that ______.

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

If we find that our estimated NPV is sensitive to a variable that is difficult to forecast, then the degree of forecasting risk is _____.

high

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

ignored

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

The project cash flow equals the project operating cash flow ___ project change in NWC minus project capital spending.

minus, -, or less

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

net present value

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

The most valuable alternative that is given up if an investment is undertaken is called what?

opportunity cost

Which of the following is an example of a sunk cost?

project consultation fee

Given a level of investment in net working capital, that same investment must be ___ at some time in the future.

recovered

Erosion will ______ the sales of existing products.

reduce

One of the most important steps in estimating cash flow is to determine the ______ cash flows.

relevant

Opportunity costs are classified as ______ costs in project analysis.

relevant

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

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

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

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

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

sensitivity

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

sensitivity analysis

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

The depreciation tax ___ is the tax savings that results from the depreciation deduction. (Enter only one word per blank.)

shield

Which of the following qualify as "managerial options"?

the option to expand the option to wait the option to abandon

Estimates of which of the following are needed to prepare pro forma income statements?

unit sales selling price per unit variable costs

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 basic approach to evaluating cash flow and NPV estimates involves asking ______.

what-if questions

True or false: Fixed costs cannot be changed over the life of the investment.

False

In the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.

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

aftertax