Exam 2 Corporate Finance conceptual questions
Increase in credit sales where you did not receive cash
Cash Reduction
Purchase Inventory
Cash Reduction
Operating Cash Flow
EBIT(1-T) + Depreciation
Which one of the following determines the standards and procedures with which audited financial statements are prepared?
Generally Accepted Accounting Principles
Which one of the following characteristics best describes a project that has a low degree of operating leverage?
High variable costs relative to the fixed costs
Would the cash flow still exist if the project does not exist?
If yes do not include in your analysis If no, include it
The top-down approach to computing the operating cash flow:
Ignores noncash expenses
Which one of the following is true according to Generally Accepted Accounting Principles?
Income is recorded based on the realization principle.
Receive Funds from Suppliers
Increase Cash
The free cash flow to the firm is
The amount of cash that could be withdrawn without harming its ability to operate and to produce future cash flows and the cash available for all claimholders in the firm
If Salvage value is less than book value...
The asset is under-depreciated and you over paid in taxes
Which one of the following is classified as a tangible fixed asset?
Computer equipment
Sunk cost - Do not include
Cost incurred in the past and cannot be recovered regardless of whether the project was accepted or not
If Free Cash Flows < 0
Growth opportunities necessitate large investments in fixed assets and large investments need fund raising
Balance Sheet
provides a snapshot of a firm's financial position at one point intime. Summarizes what a firm owns (assets), what a firm owes (liabilities), and the difference between the two (equity)
Net Capital Expenditure
Capital Expenditure - Depreciation
Fixed Asset Purchases
Cash Reduction
Terminal Cash Flow - Cash flow at the end of the period
Includes the salvage value as well as any other cash flow resulting from the termination of the project Get rid of the asset through sale (CAPEX) Assume full recovery of your required NWC investment
Free Cash Flows (NI Method)
Net Income + (1-T)(Interest Expense) + (Depreciation/Amortization) - Capex - Change in Net working capital
Operating Cash Flow
Net income + Depreciation + Interest(1-T)
Increase in Net working capital...
Reduces Cash
If Net working Capital is greater than 0 then...
The cash that will come over the next 12 months exceeds that amount of cash that must be paid over the same period
You would like to know the minimum level of sales that is needed for a project to be accepted based on its net present value. To determine that sales level you should compute the:
financial break-even point
Non-Cash Current Assets
inventory, accounts receivable, and other current assets
Decrease in Net working Capital
releases cash and generates positive cash flows
Which one of the following must be true if a firm had a negative cash flow from assets?
the firm obtained external funding
If Salvage value is more than book value...
The asset is over-depreciated and you paid little in taxes on it
Initial Cash Flow
Purchase of the asset, installation, and shipping cost - This is your year 1 CAPEX Invest in NWC to start the project
Which one of the following financial statements summarizes a firm's revenue and expenses during a period of time?
Income statement
Operating Cash Flows
(Sales - Cost) (1-t) + (Depreciation*t)
does accelerated depreciation or straight line depreciation produce higher cash flows?
Accelerated
Non-Debt Current Liabilities
Accounts payable and other short term non-interest bearing debt
For a corporation that earned positive taxable income, which one of the following statements is correct?
An increase in depreciation expense will increase the operating cash flow.
cash flow from assets
Cash flow from operations - Cash flow used for investments
Free Cash Flows (FCF)
Cash flow to creditors + Cash flow to stockholders
Common stock
Cash stockholders paid to company
Equity
Common stock, preferred stock, and retained earnings
Which one of the following statements related to corporate income taxes is correct?
Corporations pay the same rate of taxes regardless of the amount of taxable income
Increase in inventory
Decreases Cash flows
Increase in sales not yet received
Decreases Cash flows
Key factors for leading to a positive NPV
Degree of competition Potential competition in the market
Operating Cash Flow
EBIT (1-tax rate) + non-cash expenses (ex: depreciation & amortization)
Sale of Fixed Assets
Increase Cash
Cost of goods sold does not reflect true cost
Increases Cash flows
Increase Depreciation and Amortization
Increases Cash flows
Increase in operating expenses
Increases Cash flows
Increase in tax expense
Increases Cash flows
long-term liabilities
Loans and bonds that have a maturity longer than a year
Which one of the following statements concerning net working capital is correct?
Net working capital increases when inventory is sold for cash at a profit.
Which one of the following statements concerning net working capital is correct?
Net working capital may be a negative value.
From the valuation perspective you focus on...
Non-cash Current assets, and non-debt Current liabilities
Projected cash flows are ___________ to equal actual cash flows
Not likely, we do not think the value that we calculated to be the actual cash flows it is much more accurate to if we averaged the cash flows from a certain time period
Project CF
Operating CF - Increase in Net Working Capital - Project Capital Spending
Retained earnings
Portion of earnings that have been saved rather than paid out as dividends
Forecasting risk
Projections with errors built in to account for the possibility that errors in projected cash flows will lead to incorrect decisions
Investment/Project Examples
Purchase of new assets Replacement of assets Introduction of new product line Expansion of an existing product line Buying out other firms
A decrease in which one of the following will increase the accounting break-even quantity? Assume straight-line depreciation is used and ignore taxes.
Sales price per unit
Examples of alternative use
Selling an asset Renting or leasing an asset Use resource elsewhere in the business
Which one of the following best illustrates erosion as it relates to a snack stand located on the beach?
Selling fewer cookies because ice cream was added to the menu
Does accelerated depreciation or straight line depreciation produce higher net income?
Straight line
Financing Costs - Do not include
Such as interest expense or dividends of principal repaid
Income statement
Summarizes a firm's revenues or expenses over a given period of time
A project that has a payback period exactly equal to the project's life is operating at:
The accounting break-even point
If Free Cash Flows > 0
The firm is generating more cash than is required and the firm must pay out cash to security holders or add to the existing cash balance
Assume you graph a project's net present value given various sales quantities. Which one of the following statements is correct regarding the resulting function?
The slope of the function measures the sensitivity of the net present value to a change in sales quantity.
A new project will require an initial investment of $250,000. Using the company's required rate of return of 13 percent, the project's NPV is $900. Should the project be accepted? Why or why not?
Yes; It will earn an annual return of 13 percent, plus an additional $900 in present value dollars.
Current asset
asset that has a life of less than one year - cash, accounts receivable, Inventory (raw material, finished good)
Fixed asset
asset with long-term use or value - lives exceeding one year
Assume a profitable, tax-paying company uses the bottom-up approach to compute operating cash flow. An increase in which one of the following items will result in an increase in operating cash flow?
depreciation expense
Cash flow to stockholders
dividends paid - net new equity raised
The CFO of Shelby & Muhammad receives frequent capital funding requests from the firm's division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is:
facing hard rationing.
Cash flow to creditors
interest paid - net new borrowing
Shareholders' equity:
represents the residual value of a firm.
Combining scenario analysis with sensitivity analysis can yield a crude form of _____ analysis.
simulation
Free Cash Flow (EBIT Method)
EBIT (1-tax rate) + non-cash expenses (ex: depreciation & amortization) - Capital Expenditure - Change in Net Working Capital
Externalities (Cannibalization) - Include
Effects of a project on cash flows in other parts of the firm. Can be positive or negative and should be included as part of the project's incremental cash flows
Opportunity Cost - Include
Is the revenues forgone from not using the resource on its next best alternative use
Current liabilities
Liabilities that needed to be paid off within a year - accounts payable, notes payable, short term debt, and portions of long term debt that are due within the year
The cash flow that is available for distribution to a corporation's creditors and stockholders is called the:
cash flow from assets.
The cash flow related to interest payments less any net new borrowing is called the:
cash flow to creditors
Incremental Cash flow
cash flow with project - cash flow without project
Net Working Capital
current assets - current liabilities
Operating leverage is the degree of dependence a firm places on its:
fixed costs
As the degree of sensitivity of a project to a single variable rises, the:
greater is the importance of accurately predicting the value of that variable.
As of 2018, firms can take a "bonus" depreciation deduction of 100 percent of the cost of an eligible asset in the year the asset was purchased. If a firm elects to take the bonus depreciation instead of using MACRS depreciation, the project's Year 1 operating cash flow will _______ in the amount of ________.
increase; the depreciation expense times the tax rate
Webster Iron Works started a new project last year. As it turns out, the project has been operating at its accounting break-even level of output and is now expected to continue at that level over its lifetime. Given this information, you know that the project:
is operating at a higher level than if it were operating at its cash break-even level.
Variable costs can be defined as the costs that:
vary directly with sales
