Corporate Finance Chapter 9

The project cash flow equals the project operating cash flow _________ project change in NWC minus project capital spending.

minus

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

1. cost of equipment 2. rent on a production facility

To investigate the impact on NPV of a change in one variable, you would employ ______ sensitivity analysis Monte Carlo simulation "what-if" analysis scenario analysis

sensitivity analysis

In a competitive market, positive NPV projects are: uncommon unlimited easy to find

uncommon

Estimates of which of the following are needed to prepare pro forma income statements? unit sales historical trends competitor pricing variable costs selling price per unit

unit sales variable costs selling price per uni

In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable. only minimum values upper and lower bounds average values most likely and least likely values

upper and lower bounds

Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows? -As depreciation expense increases, income, taxes, and investment cash flows will all decrease. -As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase. -Depreciation expense has no effect on income, taxes, or cash flows. -As depreciation expense increases, income, taxes, and investment cash flows will all increase.

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

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

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

The number of positive NPV projects is unlimited for any given firm.

False

Which of the following are reasons why NPV is considered a superior capital budgeting technique? It considers time value of money. It properly discounts earnings. It considers all the cash flows. It properly chooses among mutually exclusive projects It considers the riskiness of the project.

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

What are the two main drawbacks of sensitivity analysis? (Select all that apply) -It does not consider interaction among variables. -It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. -It is easy to compute. -It considers the effects of interactions among variables.

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

What is the total number of inputs that change at a given time while doing sensitivity analysis? All inputs change 0 1

1

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? 1,000 1,015 1,150 850

1,150

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

1986 Tax Reform Act

Which of the following are components of project cash flow? Change in net working capital Operating cash flow Capital spending Change in Fixed assets

Change in net working capital Operating cash flow Capital spending

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

Current assets minus current liabilities

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

Earnings Before Interest and Taxes Taxes Depreciation

True or false: Fixed costs cannot be changed over the life of the investment

False

True or false: Fixed costs cannot be changed over the life of the investment.

False

True or false: Operating cash flow is based on the salvage value of equipment.

False

True or false: Taxes are based on the difference between the initial cost and the sales price.

False

In the context of capital budgeting, what does sensitivity analysis do? -It examines the increase in the cost of a project when the cost of capital increases. -It examines the sensitivity of management to the possibility that a project will be rejected. -It examines the sensitivity of profits to changes in market share. -It examines how sensitive a particular NPV calculation is to changes in underlying assumptions

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

Which of the following techniques will provide the most consistently correct result? Internal Rate of Return Average Accounting Return Payback Net Present Value

Net Present Value

Which of the following is an example of an opportunity cost? -Money spent on advertising to take advantage of opportunities in the market -Lowering taxes by increasing depreciation expenses -Rental income likely to be lost by using a vacant building for an upcoming project

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

What is the difference between scenario analysis and sensitivity analysis? -Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time. -There is no difference between scenario analysis and sensitivity analysis. -Both scenario and sensitivity analysis focus on examining the impact on NPV if one of the underlying variables changes. -Scenario analysis considers only one scenario while sensitivity analysis focuses on interaction among a group of variables.

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

What is scenario analysis -Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario. -Scenario analysis determines the impact on NPV of a change in a single variable. -Scenario analysis determines the probability of occurrence of various future events that could affect the project. -Scenario analysis maps out the various steps involved in the manufacturing process.

Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.

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

Sensitivity Analysis

What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC The Sales and Cost Approach The Depreciation Shield Approach The Tax Shield Approach The Depreciation Approach

The Tax Shield Approach

True or false: If analysts are overly optimistic about the future, then they may accept a project that realistically has a negative NPV.

True

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

True

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

after-tax

Cash flows used in project estimation should always reflect.... -accounting values -after-tax cash flows -cash flows when they occur -financing costs

after-tax cash flows cash flows when they occu

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

benefits lost due to taking on a particular project

If we find that our estimated NPV is sensitive to a variable that is difficult to forecast, then the degree of forecasting risk is ____ high low immeasurable irrelevant

high

Interest expenses incurred on debt financing are ______ when computing cash flows from a project. treated as cash outflows treated as cash inflows spread over the life of the project ignored

ignored

Synergy will _____ the sales of existing products. decrease have no effect on increase

increase

The difference between a firm's cash flows with a project versus without the project is called ________________ additional cash flows incremental cash flows differential cash flows net cash flows

incremental cash flows

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

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

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons: -it determines taxes owed on fixed assets when they are sold -it impacts product costs -it determines the book value of assets which affects net salvage value -it affects a firm's annual tax liability

it determines taxes owed on fixed assets when they are sold it determines the book value of assets which affects net salvage value it affects a firm's annual tax liability

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in _____________ investor sentiment net working capital the cost of capital tax rates

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

The most valuable alternative that is given up if an investment is undertaken is called what? real return expected value sunk cost opportunity cost

opportunity cost

Given a level of investment in net working capital, that same investment must be _________ at some time in the future.

recovered

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

reduce

One of the most important steps in estimating cash flow is to determine the _________ cash flows. operating specious relevant

relevant

Opportunity costs are classified as ____ costs in project analysis intangible irrelevant sunk relevant

relevant

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 reciprocity principality reliability additivity

reliability

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in: rocket science scenario analysis fruitless endeavors asking what-if questions

scenario analysis asking what-if questions

The depreciation tax _________ is the tax savings that results from the depreciation deduction.

shield