FRL 3000: Ch 10 Smartbook: Making Capital Investment Decisions

Select all that apply Which of the following are fixed costs? Multiple select question. cost of equipment net working capital inventory costs rent on a production facility

cost of equipment rent on a production facility

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

direct Reason: Incremental cash flows come about as a direct consequence of taking a project under consideration.

With cost-cutting proposals, when costs decrease, operating cash flows ____________ (decrease/increase).

Blank 1: increase

Using the top-down approach, OCF is calculated by subtracting costs and _________ from sales.

Blank 1: taxes or tax

Sunk costs are costs that ____.

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

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

relevant

Opportunity costs are classified as:

relevant costs

The bonus depreciation in 2019 was _____ percent.

100

Which approach to estimating the operating cash flows uses the following equation? OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate

Tax shield approach

True or false: A sunk cost is an example of a relevant incremental cash flow.

False Reason: The decision to accept or reject a project is not affected by sunk costs because they will not be recovered if the project is rejected. As such, sunk costs are not incremental costs.

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

ignored Reason: When estimating cash flows from a project, we are only concerned with flows that result from the assets of the project. How we paid for those assets is not relevant.

If the tax rate increases, the value of the depreciation tax shield will ______.

increase Reason: If the tax rate increases, the value of the depreciation tax shield will increase; the relationship is multiplicative.

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

A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____.

should be accepted if there is no capital rationing constraint

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

Test marketing expenses Reason: The equipment will not be purchased if the project is rejected, and therefore its cost is not a sunk cost.; The bonus to top management is only paid if it is a function of the project and the project is accepted, and therefore its cost is not a sunk cost.; The salvage value of the equipment will only be received if the project is accepted; therefore it is not a sunk cost.

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

aftertax

The -alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.

Blank 1: stand

Select all that apply Operating cash flow is a function of _____. Multiple select question. taxes initial investment in equipment earnings before interest and taxes salvage value of equipment depreciation

taxes earnings before interest and taxes depreciation Reason: Initial investment is not an operating cash flow. Reason: Salvage value of the equipment is not an operating cash flow.

The computation of equivalent annual costs is useful when comparing projects with _____ lives.

unequal

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

1986 Tax Reform Act Reason: The 1986 SEC Act doesn't exist. Reason: The 1986 Act that reformed taxes is called the 1986 Tax Reform Act. Reason: The 2002 Sarbanes-Oxley Act does not deal with depreciation of assets but investor protection from corporate abuses.

According to the 2017 Tax Cuts and Jobs Act, bonus depreciation is phased out after _____.

2026

Select all that apply Which of the following are considered relevant cash flows? (Select all that apply.) Multiple select question. Cash flows from opportunity costs Cash flows from sunk costs Cash flows from beneficial spillover effects Cash flows from erosion effects

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

Select all that apply Which of the following are considered relevant cash flows? (Select all that apply.) Multiple select question. Cash flows from sunk costs Cash flows from opportunity costs Cash flows from beneficial spillover effects Cash flows from erosion effects

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

What is net working capital?

Current assets minus current liabilities

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

True or false: Cash flows should always be considered on an aftertax basis.

True

When analyzing a project, sunk costs ____ incremental cash outflows.

are not

Select all that apply Side effects from investing in a project refer to cash flows from _____. Multiple select question. beneficial spillover effects opportunity costs sunk costs erosion effects

beneficial spillover effects erosion effects Reason: Opportunity costs are not side effects; they are direct costs of accepting the project.; Reason: Sunk costs are not side effects; they have already occurred and will not be recovered if the project is rejected.

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

increase Reason: An increase in depreciation expense will increase cash flows because it will decrease taxes paid.

Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the _____.

winner's curse Reason: The winner's curse says that the lowest bidder is the one who underbid the most.

When analyzing a proposed investment, we _________ (will/won't) include interest paid or any other financing costs.

won't

Opportunity costs are ____.

benefits lost due to taking on a particular project Reason: Opportunity costs are not cash flows; rather they are the foregoing of cash flows.; Opportunity costs are benefits lost by accepting a project.; Opportunity costs are benefits lost, rather than direct costs.

When an asset is sold, there will be a tax savings if the ____________ value exceeds the sales price.

book

OCF is calculated as net income plus depreciation using the _____ approach.

bottom-up

A pro _________ financial statement projects future years' operations.

Blank 1: forma

To calculate the OCF using the bottom-up approach, add ____________ to net income.

Blank 1: depreciation

Opportunity costs are classified as ______ costs in project analysis.

relevant

_________ cash flows come about as a direct consequence of taking a project under consideration.

Blank 1: Incremental

Select all that apply Once cash flows have been estimated, which of the following investment criteria can be applied to them? Multiple select question. payback period the constant growth dividend discount model YTM NPV IRR

payback period NPV IRR Reason: not the constant growth dividend discount model bc Reason: Once cash flows have been estimated, capital budgeting methods such as NPV can be applied to them. not YTM bc Reason: Once cash flows have been estimated, capital budgeting methods such as NPV can be applied to them.

To prepare _____ financial statements, we need estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and total fixed costs.

pro forma

Erosion will ______ the sales of existing products.

reduce Reason: Erosion will reduce the sales of existing products, resulting in reduction in the cash inflow attributable to the new produce.

When analyzing a proposed investment, we ___________ (will/won't) include interest paid or any other financing costs.

Blank 1: won't

True or false: When developing cash flows for capital budgeting, it is easy to overlook important items.

True Reason: When developing cash flows for capital budgeting, it is easy to overlook important items.

______________ cash flows come about as a direct consequence of taking a project under consideration.

Blank 1: Incremental

The cash flows of a new project that come at the expense of a firm's existing projects is called _____________. (Enter one word per blank.)

Blank 1: erosion or erosions

The ________ step is to determine whether cash flows are relevant.

Blank 1: first

While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital?

It is expected to be recovered by the end of the project's life.

Select all that apply Identify the three main sources of cash flows over the life of a typical project. Multiple select question. Net cash flows from salvage value at the end of the project Net cash flows from sales and expenses over the life of the project. Test marketing expenses that have been classified as sunk costs 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 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 Reason: NOT Test marketing expenses that have been classified as sunk costs Reason: Sunk costs are not included in project cash flows. They will not be recovered if the project is rejected.

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

The operating cash flows from net sales over the life of the project Reason: While salvage value is difficult to forecast, it is not of primary importance. Reason: While these costs are important, they are easier to determine since they occur immediately. Reason: Sunk costs are not included in the project analysis.

Select all that apply Investment in net working capital arises when ___. Multiple select question. cash is kept for unexpected expenditures equipment is purchased using long term debt credit sales are made inventory is purchased

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

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 cash flows will increase.

With cost-cutting proposals, when costs decrease, operating cash flows __________________. (decrease/increase).

Blank 1: increase

As depreciation expense _________________ (decreases/increases), net income and taxes will decrease, while cash flows will _______________(decrease/increase).

Blank 1: increases Blank 2: increase

Using your personal savings to invest in your business is considered to have an _______________ ______________ because you are giving up the use of these funds for other investments or uses, such as a vacation or paying off a debt.

Blank 1: opportunity Blank 2: cost

The accelerated cost ____________ system is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

Blank 1: recovery

The tax saving that results from the depreciation deduction is called the depreciation tax __________.

Blank 1: shield

The ___________ curse says that the lowest bidder is the one who underbid the most.

Blank 1: winner's, winner, or winners

When a firm finances new investments, it may set up accounts payable with suppliers, but the balance that the firm must supply is called the investment in net ___________ capital.

Blank 1: working

Select all that apply Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset? Multiple select question. Book value represents the purchase price minus the accumulated depreciation. Taxes are based on the difference between the purchase price and sales price of the asset. 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.

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. Reason: Taxes are based on the difference between the book value (cost - accumulated depreciation) and sales price of the asset.

Which one 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

What is the equation for estimating operating cash flows using the top-down approach?

OCF = Sales - Costs - Taxes NOT OCF = Net Income + Depreciation Reason: This answer gives the equation for the bottom-up approach. The top-down approach is OCF = Sales - Costs - Taxes NOT OCF = (Sales - Costs) X (1-T) + Depreciation X T Reason: This answer gives the equation for the tax shield approach. The top-down approach is OCF = Sales - Costs - Taxes

Select all that apply When evaluating cost-cutting proposals, how are operating cash flows affected? Multiple select question. The decrease in costs decreases operating income. Wages are always reduced in cost-cutting endeavors. There is an additional depreciation deduction. The decrease in costs increases operating income.

There is an additional depreciation deduction. The decrease in costs increases operating income. Reason: Wages are not always reduced when costs are cut. Reason: A decrease in costs would increase net income.

When developing cash flows for capital budgeting, it is _____ to overlook important items.

easy

The computation of equivalent annual costs is useful when comparing projects with unequal _____.

lives

Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ______________ are overlooked.

net working capital

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

net working capital Reason: The difference between a firm's current assets and its current liabilities is known as the net working capital. Capital structure is the way in which assets are financed on the right hand side of the balance sheet. Reason: The difference between a firm's current assets and its current liabilities is known as the net working capital, which is short term by its nature.