Fina Chp 6
Interest on municipal bonds is ______.
ignored for tax purposes but included as income for FASB accounting
It is appropriate to use the approximate formula for estimating the real interest rate when:
the interest rate and inflation rate are low
True or false: NPV will be the same regardless of whether nominal or real cash flows are used.
true
Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?
The operating cash flows from net sales over the life of the project
The shareholders' books in the US follow the rules of the ____.
Financial Accounting Standards Board (FASB)
____________________ 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
What is the equation for estimating operating cash flows using the top-down approach?
OCF = Sales - Cash costs - Taxes
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?
$200,000 - 190,636 - 1,144 = $8,220
When interest rates and inflation rates are _____, the approximation of the real interest rate becomes _____.
high; poor low; good
The net present value technique does not discount earnings because earnings ___.
do not represent real money
When comparing projects with unequal lives, one should use which of the following methods:
equivalent annual costs
An increase in depreciation expense will ____ cash flows from operations.
increase
If sales are made on credit, net working capital will _____.
increase
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 ____.
increase
Synergy will ______ the sales of existing products.
increase
Buying new cost-cutting equipment affects operating cash flows by:
increasing the depreciation deduction increasing pretax income increasing taxes
___________ expenses incurred on debt financing are ignored when computing cash flows from a project.
interest
The bottom-up approach to calculating OCF starts with:
net income
Under capital budgeting, opportunity costs are cash ______.
outflows
What is the approximate formula for estimating the real interest rate?
Real interest rate = Nominal interest rate - Inflation rate
The computation of equivalent annual costs is useful when comparing projects with unequal _____.
lives
Which of the following is given greater importance in capital budgeting problems in corporate finance?
cash flows
Depreciation × Tax rate represent the depreciation tax _____________.
shield
When using nominal cash flows, the NPV will be _____ when using real cash flows.
the same as
What is an example of an opportunity cost?
Rental income likely to be lost by using a vacant building for an upcoming project
Investment in net working capital arises when ___.
1. cash is kept for unexpected expenditures 2. credit sales are made 3. inventory is purchased
Opportunity costs are classified as:
relevant costs
What is/are true about allocated costs?
These costs are allocated to more than one project. These costs benefit more than one project.
As depreciation ______, operating cash flows will _______.
decrease; decrease increase; increase
The equation for determining the real interest rate has the nominal interest rate in the _____ and the inflation rate in the ______.
numerator; denominator
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
If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, what is the real rate of return?
(1.05/1.02)-1 = 2.94%
At the end of a project, the company sold a machine for $50,000 with a book value of $10,000. Assuming a tax rate of 21%, what is the after tax salvage value?
=0.21*(50,000-10,000) = 84000. Salvage value = 50,000-8400 = 41,600
What correctly describes the relationship between depreciation, income, taxes, and investment cash flows?
As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase.
What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?
Depr. Tax Sheild =Depr. X Tax Rate = $1800 X 30% = $540
_______________ expenses incurred on debt financing are ignored when computing cash flows from a project.
Interest
Identify the three main sources of cash flows over the life of a typical 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 Net cash flows from sales and expenses over the life of the project.
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.
What is the equation for estimating operating cash flows using the tax shield approach?
OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
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?
OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation$600 × (1−.30) + $1,800 = $2,220
What statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
There will be a tax savings if the book value exceeds the sales price. Taxes are based on the difference between the book value and the sales price. Book value represents the purchase price minus the accumulated depreciation.
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 ____ incremental cash outflows.
are not
Allocated costs arise when a specific expenditure ____.
benefits more than one project or division
Discounting is the process of _____.
calculating the present value of either a lump sum or a series of cash flows.
What should be discounted when determining the feasibility of a capital budgeting project(s)?
cash flows
Corporate finance emphasizes _____ while financial accounting emphasizes ______.
cash flows; earnings
Sunk costs are costs that ____.
have already occurred and are not affected by accepting or rejecting a project
When comparing projects with different lives, one should choose the project with the ______ equivalent annual cost.
lower
When bidding for a job, a competing firm can use the NPV approach to determine their bid. Once the bid is submitted, the firm will win the contract for the project if their bid is the:
lowest
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
Under capital budgeting, required working capital is classified as a cash ______.
outflow
Management may look _____ to shareholders and pay _____ tax on reported profit.
profitable; no
What refers to a cash flows purchasing power?
real cash flow
Sometimes when the low bidder wins the bid on a project, it is because they have underbid the project. In other words, the bid they have submitted probably won't even cover the costs of the project. When this happens, the low bidder is said to suffer from the:
winner's curse
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
Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
ignored
As a general rule, when estimating equivalent annual costs, ________ cash flows should be used.
real cash flows should be used because the projects have different lives and inflation could be different in the later periods during which the shorter project is over.
Nominal interest rate - Inflation rate approximates the ________________- interest rate.
real interest rate
Erosion will ______ the sales of existing products.
reduce