Chapter 10. MAKING CAPITAL INVESTMENT DECISIONS
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
Operating cash flow is a function of:
-Depreciation -Earnings before interest and taxes -Taxes
The bonus depreciation in 2019 will be:
100%
An increase in depreciation expense will ______ cash flows from operations.
Increase
According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 21 percent?
$2,274
Side effects from investing in a project refer to cash flows from:
-Erosion effects -Beneficial spillover effects
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
-NPV -Payback period -IRR
Identify the three main sources of cash flows over the life of a typical project.
-Net cash flows from sales and expenses over the life of the project. -Net cash flows from salvage value at the end of the project. -Cash outflows from investment in plant and equipment at the inception of the project
Interest expenses incurred on debt financing are ____ when computing cash flows from a project.
Ignored
Which of the following are considered relevant cash flows? (Select all that apply.)
-Cash flows from opportunity costs -Cash flows from beneficial spillover effects -Cash flows from erosion effects
Incremental cash flows come about as a(n) ____ consequence of taking a project under consideration.
Direct
If the tax rate increases, the value of the depreciation tax shield will ____.
Increase
Erosion will ____ the sales of existing products.
Reduce
Opportunity costs are classified as ____ costs in project analysis.
Relevant
The first step in estimating cash flow is to determine the ____ cash flows.
Relevant
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
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?
$8,220
Investment in net working capital arises when ____.
-Cash is kept for unexpected expenditures -Inventory is purchased -Credit sales are made
If a firm's current assets are $150,000, its total assets are $320,000, and its current liabilities are $80,000, what is its net working capital?
$70,000
Sunk costs are costs that ____.
Have already occurred and are not affected by accepting or rejecting a project
What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 21 percent?
$378
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.
What is the equation for estimating operating cash flows using the top-down approach?
OCF= Sales - Costs - Taxes
Operating cash flow is a function of:
-Taxes -Depreciation -Earnings before interest and taxes
When evaluating cost-cutting proposals, how are operating cash flows affected?
-The decrease in costs increases operating income. -There is an additional depreciation deduction.
Which of the following are fixed costs?
-Rent on a production facility -Cost of equipment
The rules for depreciating assets for tax purposes are based upon provisions in the ____.
1986 tax Reform Act
Cash flows should always be considered on a(n) _______________ basis.
After-tax
When analyzing a project, sunk costs ____ incremental cash outflows.
Are not
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.
What is net working capital?
Current assets minus current liabilities
When developing cash flows for capital budgeting, it is ____ to overlook important items.
Easy
True or false: A sunk cost is an example of a relevant incremental cash flow.
False
True or false: Opportunity costs can be ignored when determining the financial feasibility of a project.
False
Net working capital is defined as current assets minus current ____.
Liabilities
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
Using your personal savings to invest in your business is considered to have an ____ opportunity cost because you are giving up the use of these funds for other investments or uses, such as a vacation or paying of a debt.
Opportunity cost
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
Palmer Corp. is choosing between server X and Server Y to replace its current equipment. It has gathered the following information:
Server X: -$80,336.36 Server Y: -$78,859.66
Which one of the following is the equation for estimating operating cash flows using the tax shield approach?
OCF= (Sales - Costs) x (1-Tax rate) + Depreciation x Tax rate