Fina chapter 6

_______________cash flows are the difference between the cash flows of the firm with the project and the cash flows of the firm without the project.

Incremental

Allocated costs must be treated as relevant or incremental costs ______.

only if the costs being allocated are affected by the proposed project

True or false: NPV will be the same regardless of whether nominal or real cash flows are used.

True

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 a vacation or paying off a debt.

opportunity cost

Erosion will ______ the sales of existing products.

reduce

Opportunity costs are classified as Blank______ costs in project analysis.

relevant

Which of the following is an example of an opportunity cost?

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

Which of the following is an example of a sunk cost?

test marketing expenses

It is appropriate to use the approximate formula for estimating the real interest rate when

the interest rate and inflation rate are low

When a firm evaluates a proposal to make an existing facility more cost-effective, the cost savings must be large enough to justify ______.

the necessary capital expenditure

What is the equation for determining the real interest rate?

1+Nominal Interest Rate1+Inflation Rate1+Nominal Interest Rate1+Inflation Rate − 1

If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, what is the real rate of return?

Correct. (1.05/1.02) − 1 = 2.94%.

What is the real interest rate if the nominal annual interest rate is 10 percent and the annual inflation rate is 4 percent?

Correct. (1.10/1.04) − 1 = 5.77%.

How does depreciation affect the operating cash flows?

Depreciation expense reduces the taxable income and taxes, and increases the operating cash flow.

True or false: Discounting involves determining the future value of present cash flow.

False

True or false: Opportunity costs can be ignored when determining the financial feasibility of a project.

False

What is the difference between nominal cash flow and real cash flow?

Nominal cash flow is the actual dollars to be received. Real cash flow refers to the cash flow's purchasing power.

According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

Note that depreciation has already been subtracted in calculating EBIT, so it must be added back. OCF = EBIT − taxes + depreciation, or EBIT(1−t) + depreciation. $600 × (1−0.30)1-0.30 + $1,800 = $2,220.

Which of the following is the equation for estimating operating cash flows using the tax shield approach?

OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate

What is the equation for estimating operating cash flows using the top-down approach?

OCF = Sales − Cash costs − Taxes

What is the approximate formula for estimating the real interest rate?

Real interest rate = Nominal interest rate − Inflation rate

What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?

Tax shield = $1,800 × 0.3 = $540.

Which of the following is (are) true about allocated costs?

These costs are allocated to more than one project. These costs benefit more than one project.

Discounting is the process of ______.

calculating the present value of either a lump sum or a series of cash flows

Which of the following is given greater importance in capital budgeting problems in corporate finance?

cash flows

Corporate finance emphasizes ______, while financial accounting emphasizes ______.

cash flows; earnings

The net present value technique does not discount earnings because earning______.

do not represent real money

When comparing projects with unequal lives, one should use which of the following methods

equivalent annual costs

If the inflation rate increases, the nominal rate of interest will?

increase

If the tax rate increases, the value of the depreciation tax shield will Blank______.

increase

Synergy will ______ the sales of existing products.

increase

As depreciation ______, operating cash flows will ______.

increases; increase decreases; decrease

As a general rule, when estimating equivalent annual costs, ______ cash flows should be used.

real

Nominal interest rate − Inflation rate approximates the______________ interest rate.

real

Which of the following refers to a cash flows purchasing power?

real cash flow

When using nominal cash flows, the NPV will be Blank______ when using real cash flows.

the same as

When using nominal cash flows, the NPV will be_________ when using real cash flows.

the same as

Incremental cash flows of a project are changes in a firm's cash flows that occur as a direct consequence of

accepting a project

When analyzing a project, sunk costs Blank______ incremental cash outflows.

are not

Opportunity costs are_________________.

benefits lost due to taking on a particular project

Buying new cost-cutting equipment affects operating cash flows by___________?

increasing the depreciation deduction increasing pretax income increasing taxes

The computation of equivalent annual costs is useful when comparing projects with unequal

lives

The computation of equivalent annual costs is useful when comparing projects with unequal Blank______. Multiple choice question.

lives

When interest rates and inflation rates are ______, the approximation of the real interest rate becomes ______.

low; good high; poor

When comparing projects with different lives, one should choose the project with the ______ equivalent annual cost.

lower

The bottom-up approach to calculating OCF starts with__________.

net income

The equation for determining the real interest rate has the nominal interest rate in the _____ and the inflation rate in the _____.

numerator; denominator