FIN Chapter 9

Which of the following is an example of a sunk cost? Amount needed to build a manufacturing facility. Amount spent on a test market. Interest expense needed to service debt.

Amount spent on a test market.

We only want to consider incremental earnings in the capital budgeting process. Incremental earnings are the: externalities generated from the project. additional sales and costs associated with the project. capital expenditures minus the salvage value of assets.

additional sales and costs associated with the project.

An incremental cash flow valuation considers: previously spent funds. all project cash flows including cannibalization. only the project's cash flows and not cannibalization.

all project cash flows including cannibalization.

In the context of capital budgeting, risk refers to the: chance that the NPV will be greater than zero. degree of variability of the initial investment. degree of variability of the cash inflows.

degree of variability of the cash inflows.

The sale of an ordinary asset for its book value results in: a capital loss. a capital gain. no tax benefit.

no tax benefit.

Most projects will have a decision point where the project can be abandoned or pursued further. The right to make a certain decision is known as a __________ in finance. break-even point real option scenario analysis

real option

Real cash flows are those that include: nominal cash flows. nominal cash flows minus inflation. inflation cash flows.

nominal cash flows minus inflation.

Giancarlo has received an inheritance from his rich uncle and is contemplating the purchase of a Suzuki XL7. In an attempt to make a rational decision, Giancarlo has identified the following cash flow estimates: Negotiated price of new Suzuki XL 7 $24,675 Taxes and fees on a new car purchase $1,732 Proceeds from the trade-in of old car $9,285 Estimated value of the Suzuki XL7 in 5 years $7,285 Estimated value of old car in 5 years $3,572 Estimated annual repair cost on Suzuki XL7 $350 Estimated annual repair cost on old car $925 What would be Giancarlo's initial investment in the Suzuki XL7?

$17,122 Giancarlo's initial investment in the Suzuki XL7 will be $17,122. To arrive at this number you have to include the total out-of-pocket costs for the car and deduct any trade-in value so you can evaluate only incremental cash flows. So, the initial investment = $24,675 + $1,732 - $9,285 = $17,122. If Giancarlo decides to buy this car this will be the amount he will need to complete the transaction.

Which of the following formulas is the correct formula used to calculate incremental earnings? (incremental revenues - incremental costs - depreciation) x (1 - T) (incremental revenues - incremental costs + depreciation) x (1 - T) (incremental revenues - incremental costs - incremental interest expense - depreciation) x (1 -T)

(incremental revenues - incremental costs - depreciation) x (1 - T)

Giancarlo has received an inheritance from his rich uncle and is contemplating the purchase of a Suzuki XL7. In an attempt to make a rational decision, Giancarlo has identified the following cash flow estimates: Negotiated price of new Suzuki XL 7 $24,675 Taxes and fees on a new car purchase $1,732 Proceeds from the trade-in of old car $9,285 Estimated value of the Suzuki XL7 in 5 years $7,285 Estimated value of old car in 5 years $3,572 Estimated annual repair cost on Suzuki XL7 $350 Estimated annual repair cost on old car $925 What would be Giancarlo's operating cash flow in year 5?

-$575 Giancarlo's operating cash flow in year 5 would be -$575. To evaluate his operating cash flows from accepting the project you need to determine the incremental difference. In this case he would have spent $925 but instead spent $350. So his operating cash flows for buying the new car would be $350 - $925 = -$575. The formula is; Replacement cash flows = cash flow for new asset - cash flow for the old asset.

Which of the following cash flows should be included in incremental free cash flows? Capital expenditures necessary to fund the new project. Interest expense generated from debt to finance the project. Stock flotation costs to raise new equity to finance the project.

Capital expenditures necessary to fund the new project.

Which of the following is a relevant opportunity cost that should be considered an incremental cash flow? Lost facility rental income Lost revenue from reduced sales in other products Lost interest income

Lost facility rental income

Which of the following is an example of an externality that will generate relevant cash flows? Overhead assigned to the project from the corporate office. The lost rental income of a facility now used for production. The additional sales revenue of complementary products.

The additional sales revenue of complementary products.

Capital budgeting is the process of: evaluating a firm's investment choices. preparing a statement of cash inflows and outflows. making a cash budget for the firm.

evaluating a firm's investment choices.

Nominal cash flows: have not been adjusted for inflation. include sunk costs as an incremental cash flow. have been adjusted for inflation.

have not been adjusted for inflation.

A common use of break-even analysis is to determine: how many units of sales are needed to cover all costs. the level of cash needed to undertake a project. the point where a project's NPV is equal to the initial outlay.

how many units of sales are needed to cover all costs.

When a business undertakes a new project it will often need to invest additional funds in net working capital to cover items such as: increased inventory levels. higher installation costs. product cannibalization costs.

increased inventory levels.

The relevant cash flows of a project are best described as: incremental cash flows. incidental cash flows. accounting cash flows.

incremental cash flows.

Sunk costs are: any cash outflow associated with a specific project. previous cash outflows not relevant to the project decision. accounting losses on a previous business investment.

previous cash outflows not relevant to the project decision.

A replacement investment is one that: replaces existing assets. refinances an existing asset. excludes relevant costs.

replaces existing assets.

A method for evaluating a project that uses a number of possible values for a given variable, such as cash inflows, to assess its impact on the firm's return is: sensitivity analysis. risk-adjusted discount rate. scenario analysis.

sensitivity analysis.

A statistically based behavioral approach to project analysis that applies predetermined probability distributions is the: certainty equivalent method. simulation method. scenario method.

simulation method.

The tax savings generated due to the ability to expense or depreciate an asset for tax purposes is known as: the depreciation tax shield. modified accelerated cost recovery. depreciation expense.

the depreciation tax shield.