FRL 301 Chapter 10 LearnSmart

When analyzing a project, sunk costs _____ incremental cash flows. are are not

are not

When analyzing a project, sunk costs _____ incremental cash outflows. are are not

are not

Operating cash flow is a function of: Depreciation Earnings Before Interest and Taxes Initial Investment in Equipment Salvage Value of Equipment Taxes

(Operating cash flow = EBIT + Depreciation - Taxes) Depreciation Earnings Before Interest and Taxes Taxes

Identify the three main sources of cash flows over the life of a typical 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 - Net cash flows from sales and expenses over the life of the project - Test marketing expenses that have been classified as sunk costs

(Project operating cash flow = Project operating cash flow - Project change in net working capital - Project capital spending) - 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

*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. -There will be tax savings if the book value exceeds the sales price. -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.

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

The rules for depreciating assets for tax purposes are based upon provisions in the _____. 1986 Sarbanes-Oxley Act 1986 SEC Act 1986 Tax Reform Act 1986 IRS Act

1986 Tax Reform Act

According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

Bottom-up approach: (start with the accountant's bottom line (net income) and add back any noncash deductions such as depreciation) OCF = Net income + Depreciation Net income = EBIT - Taxes (correct only if there is no interest expense subtracted in the calculation of net income) OCF = (600 - 600x0.3) + 1,800 = 420 + 1,800 = $2,220

Which of the following are considered relevant cash flows? Cash flows from beneficial spillover effects Cash flows from opportunity costs Cash flows from erosion effects Cash flows from sunk costs

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

Once cash flows have been estimated, which of the following investment criteria can be applied to them? IRR NPV payback period the constant growth dividend discount model YTM

IRR NPV payback period

According to the top-down approach, what is the operating cash flow if sales are $200,000, total cash costs are $190,636, and the tax bill is $1,144?

Top-down approach: (most obvious way) OCF = Sales - Costs - Taxes OCF = 200,000 - 190,636 - 1,144 = $8,220

Cash flows should always be considered on a(n) _____ basis. pre-tax after-tax before-tax zero-tax

after-tax

side effects from investing in a project refer to cash flows from opportunity costs sunk costs beneficial spillover effects erosion effects

beneficial spillover effects erosion effects

What is net working capital? current assets plus current liabilities current liabilities minus current assets total assets minus total liabilities current assets minus current liabilities

current assets minus current liabilities

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

direct

When developing cash flows for capital budgeting, it is _____ to overlook important items rare impossible easy difficult

easy

Sunk costs are costs that _____. -cannot be measured -have already occurred and are not affected by accepting or rejecting a project -will not contribute to profits in the long run even if a project is accepted -relate to other projects of a firm

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

An increase in depreciation expense will _____ cash flows from operations. increase not affect decrease

increase

Investment in net working capital arises when _____. equipment is purchased using long term debt inventory is purchased credit sales are made cash is kept for unexpected expenditures

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

Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in _____ are overlooked. investor sentiment tax rates the cost of capital net working capital

net working capital

The difference between a firm's current assets and its current liabilities is known as the _____. long-term capital net working capital net opportunity capital capital structure

net working capital

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 vacation or paying off a debt.

opportunity cost

Erosion will _____ the sales of existing products. increase reduce not affect

reduce

The first step in estimating cash flow is to determine the _____ cash flows specious relevant operating

relevant

Which of the following are fixed costs? rent on a production facility net working capital cost of equipment inventory costs

rent on a production facility cost of equipment

According to the _____ principle, once the incremental cash flows from a project have identified, the project can be viewed as a "minifirm." walk-alone stand-with stand-and-deliver stand-alone

stand-alone

Opportunity costs are _____. the costs incurred by a firm to preserve its market share benefits gained as a result of accepting a particular project the costs of pursuing a specific project benefits lost due to taking on a particular project

the benefits lost due to taking on a particular project

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. -As depreciation expense increases, income, taxes, and cash flows will all decrease. -As depreciation expense increases, income, taxes, and cash flows will all increase. -Depreciation expense hs no effect on income, taxes, or cash flows.

(Depreciation is a noncash expense. The only cash flow effect of deducting depreciation is to reduce our taxes, a benefit to us.) -As depreciation expense increases, net income and taxes will decrease, while cash flows will increase.

Interest expense inccured on debt financing are _____ when computing cash flows from a project. spread over the life of the project ignored treated as cash outflows treated as cash inflows

(In analyzing a proposed investment, we will _not_ include interest paid or any other financing costs such as dividends or principal repaid because we are interested in the cash flow generated by the assets of the project) ignored

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

OCF = (Sales - Costs) x (1 - T) + Depreciation x T

If the tax rate increases, the value of the depreciation tax shield will _____. not be affected increase decrease

OCF = (Sales - Costs) x (1 - T) + Depreciation x T increase

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

OCF = Sales - Costs - Taxes