Finance Ch. 8-9

stand-alone

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

reject a project if the IRR is less than the required return

According to the basic IRR rule, we should:

net working capital

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

increase

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

the necessary financing

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

after-tax cash flows cash flows when they occur

Cash flows used in project estimation should always reflect:

more

Higher cash flows earlier in a project's life are _____ valuable than higher cash flows later on.

Net cash flows from salvage value at the end of the project. Cash outflows from investment in plan and equipment at the inception of the project Net cash flows from the sales and expenses ove the life of the project.

Identify the three main sources of cash flows over the life of a typical project.

mutually exclusive

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, these projects would be considered _____.

1,150 = 1,000 x 1.15

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?

$55 as 1.1 x 50 = 55

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?

MIRR NPV

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

Net Present Value

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

upper and lower bounds

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

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

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

ignored

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

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

Investment in net working capital arises when _____.

payback period; NPV

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

accept a project if the NPV is greater than zero. reject a project if its NPV is less than zero. if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference.

The basic NPV investment rule is:

incremental cash flows

The difference between a firm's cash flows with a project versus without the project is called _____.

assessing the degree of financing risk identifying critical components

The goals of risk analysis in capital budgeting include:

a project's cash flows

The internal rate of return is a function of _____.

1986 Tax Reform Act

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

=NPV(CF1, ..., CFn) + CFO

The spreadsheet function for calculating net present value is:

True

True or false: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.

True

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

reliability

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.

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

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

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

What are the two main benefits of performing sensitivity analysis?

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

What are the two main drawbacks of sensitivity analysis?

It ignores managerial options in investment decisions.

What is an important drawback of traditional NPV analysis?

Current assets minus current liabilities

What is net working capital?

9.7%

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

NPV = -95 + (107/1.06) = $5.94

What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?

$540 = 1,800 x .3

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

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

What is the difference between scenario analysis and sensitivity analysis?

What is the underlying source of value?

What is the key question to ask concerning a project that results in a positive NPV?

2.91

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%?

Operating cash flow Change in net working capital Capital spending

Which of the following are components of project cash flow?

Cash flows from opportunity costs Cash flows from beneficial spillover effects Cash flows from erosion effects

Which of the following are considered relevant cash flows?

cost of equipment rent on a production facility

Which of the following are fixed costs?

The Reinvestment Approach The Discounting Approach The Combination Approach

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

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

Which of the following are needed for cash flow estimation?

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

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

It considers all the cash flows. It considers time value of money. It properly chooses among mutually exclusive projects It considers the riskiness of the project.

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

Time value of money principles are ignored. Cash flows received after the payback period are ignored. The cutoff date is arbitrary.

Which of the following are weaknesses of the payback method?

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

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

Cannot rank mutually exclusive projects

Which of the following is a disadvantage of the Profitability Index?

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

Which of the following is an example of an opportunity cost?

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

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

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

Which of the following qualify as "managerial options"?

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

it ignores cash flows after the cutoff date

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

***relevant

***One of the most important steps in estimating cash flow is to determine the _____ cash flows

Mutually exclusive projects non-conventional cash flows

*Which of the following present problems when using the IRR method?

The project is a good investment The cash flow estimations are inaccurate Overly optimistic management

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

It defines the business of the firm

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because _____.

IRR payback period NPV

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

not considered in the analysis

One of the flaws of the payback period method is that cash flows after the cutoff date are _____.

benefits lost due to taking on a particular project.

Opportunity costs are _____.

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

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?

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

Sunk costs are costs that _____.

increase

Synergy will _____ the sales of existing products.

average net income/average book value

The Average Accounting Return is defined as:

zero

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

accept

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

what-if questions

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

accepts

The payback period rule _____ a project if it has a payback period that is less than or equal to a particular cutoff date.

estimation risk forecasting risk

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

initial investment

The present value of the future cash inflows are divided by the _____ to calculate the profitability index.

scenario analysis asking what-if questions

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

cannot be observed

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:

internal rate of return 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?