Unit 4 Chapter 6

Proper treatment of inflation in NPV calculations involves: I) discounting nominal cash flows by the nominal discount rate; II) discounting real cash flows by the real discount rate; III) discounting nominal cash flows by the real discount rate

1 &2 only

The NPV value obtained by discounting nominal cash flows using the nominal discount rate is the same as the NPV value obtained by discounting: I) real cash flows using the real discount rate; II) real cash flows using the nominal discount rate III) nominal cash flows using the real discount rate

1 only

Working capital is a frequent source of errors in estimating project cash flows. These errors include: I) forgetting about working capital entirely; II) forgetting that working capital may change during the life of the project; III) forgetting that working capital is recovered at the end of the project; IV) forgetting to depreciate working capital

1,2 &3

For the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project

1. the consequent reduction in sales of the company's existing gasoline models(i.e., incidental effects). 2. the value of tools that will be transferred to the project from the company's existing plants instead of being sold. 3. the expenditure on new plants and equipment

T/F A financial analyst should include interest and dividend payments when calculating a project's cash flows.

False

T/F By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.

False

T/F Opportunity costs should not be included in project analysis, as they are missed opportunities.

False

T/F The rule for comparing machines with different lives is to select the machine with the greatest equivalent annual cost (EAC).

False

The equivalent annual cash-flow technique is primarily used whenever the lives of two different projects are the same.

False

Within the MACRS system of depreciation, most industrial equipment falls into the ten- and fifteen-year classes.

False

The principal short-term assets are:

I) cash; II) accounts receivable; III) inventories;

sunk cost

Money that a firm has already spent, or committed to spend regardless of whether a project is taken

The current market value of a previously purchased machine proposed for use in a project is an example of a:

Opportunity Cost

For the case of an electric car project, which of the following costs or cash flows should be categorized as incremental when analyzing whether to invest in the project?

Tax savings resulting from the depreciation charges

opportunity cost.

The cost of a resource that may be relevant to an investment decision even when no cash changes hand

T/F A financial analyst can use the equivalent annual cash-flow approach to determine the year in which an existing machine can be profitably replaced with a new machine.

True

T/F Depreciation expense acts as a tax shield in reducing taxes.

True

T/F Most large U.S. corporations keep two separate sets of books, one for stockholders and one for the Internal Revenue Service.

True

T/F Sunk costs are bygones, i.e., they are unaffected by the decision to accept or reject a project. They should therefore be ignored.

True

T/F When calculating cash flows, one should consider them on an incremental basis.

True

T/F When evaluating projects with positive NPV but different life spans, the proper technique to employ is the equivalent annual cash-flow approach.

True

T/F Working capital is one of the most common sources of mistakes in estimating project cash flows.

True

When calculating cash flows, one should consider all incidental effects.

True

Working capital is needed for additional investment within a project and should be included within cash-flow estimates.

True

You should replace a machine when the EAC of continuing to operate it exceeds the EAC of the new machine.

True

Which of the following countries allows firms to keep two separate sets of books, one for the stockholders and one for the tax authorities like the Internal Revenue Service? I) U.S.; II) Japan; III) France

US only

Investment in inventories includes investment in: I) raw material; II) work-in-progress; III) finished goods

all 3

When Honda develops a new engine the incidental effects might include the following: I) demand for replacement parts; II) profits from the sale of repair services III) offer modified or improved versions of the new engine for other uses

all 3

Important points to remember while estimating the cash flows of a project are: I) Only cash flow is relevant. II) Always estimate cash flows on an incremental basis. III) Be consistent in the treatment of inflation.

all 3 are correct

Germany allows firms to choose the following depreciation methods: I) straight-line method; II) declining-balance method

both

Preferably, a financial analyst estimates cash flows for a project as:

cash flows after taxes.

If the discount rate is stated in nominal terms then—order to calculate the NPV in a consistent manner—the project requires that:

cash flows be estimated in nominal terms.

If the discount rate is stated in real terms then—order to calculate the NPV in a consistent manner—the project requires that:

cash flows be estimated in real terms.

A reduction in the sales of existing products caused by the introduction of a new product is an example of:

incidental effects.

When a firm has the opportunity to add a project that will utilize excess factory capacity (that is currently not being used), which costs should be used to help determine if the added project should be undertaken?

incremental costs

Accountants do not depreciate investment in net working capital because:

it is recovered during, or at the end of the project, thus is not a depreciating asset.

An analyst wishes to determine the value of resources used by a proposed project. Which values should the analyst use to approximate opportunity costs?

market values

Net working capital is best represented as:

short-term assets - short-term liabilities

Costs incurred as a result of past, irrevocable decisions and irrelevant to future decisions are called:

sunk costs.

One should consider net working capital (NWC) in project cash flows because:

typically, firms must invest cash in short-term assets to produce finished goods.