BUS ADM 350: Chap. 9

Investment in net working capital arises when ____.

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

Estimates of which of the following are needed to prepare pro forma income statements?

-selling price per unit -unit sales -variable costs

If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be

100% reversed

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

Which one of the following refers to a method of increasing the rate at which an asset is depreciated?

Accelerated cost recovery system

Cash flows should always be considered on a(n) ___________ basis.

After-tax

What is Scenario-Analysis?

Determines the impact on NPV of a set of events relating to a specific scenario.

T/F: In calculating cash flows, you should consider all financing costs.

False

T/F: Taxes are based on the difference between the initial cost and the sales price.

False

T/F: The number of positive NPV projects is unlimited for any given firm.

False

Interest expenses incurred on debt financing are ______ when computing cash flows from a project

Ignored

The stand-alone principle assumes that evaluation of a project may be based on the project's ___________ cash flows.

Incremental

The difference between a firm's cash flows with a project versus without the project is called ________________.

Incremental Cash Flows

Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as:

Incremental cash flows

In the context of capital budgeting, what does sensitivity analysis do?

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

The primary risk in estimation errors is the potential to __________.

Make incorrect capital budgeting decisions

A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish?

Market Value

Capital rationing exists when a company has identified positive NPV projects but cannot (or will not) find:

Necessary Financing

Which of the following techniques will provide the most consistently correct result?

Net Present Value

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______________.

Net working capital

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

Project consultation fee

Erosion will ______ the sales of existing products.

Reduce

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

Relevant

Opportunity costs are classified as ____ costs in project analysis.

Relevant

To investigate the impact on NPV of a change in one variable, you would employ ________.

Sensitivity Analysis

According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."

Stand-alone

What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC

Tax Shield Approach

T/F: Investment in net working capital may arise from the need to cover credit sales.

True

To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.

True

In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable.

Upper and lower bounds

The basic approach to evaluating cash flow and NPV estimates involves asking:

What-if questions

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

cannot be observed

Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.

direct

Sunk costs are costs that ___.

have already occurred and are not affected by accepting or rejecting a project

Sunk costs are costs that ____.

have already occurred and are not affected by accepting or rejecting a project

Synergy will _____ the sales of existing products.

increase

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

minus

The first step in estimating cash flow is to determine the _________ cash flows.

relevant

Opportunity costs are ____.

the benefits lost due to taking on a particular project

In a competitive market, positive NPV projects are:

uncommon

An all-equity firm has net income of $112,780, depreciation of $8,750, and taxes of $29,980. What is the firm's operating cash flow?

$121,530

The Corner Shop is considering a new four-year expansion project that requires an initial fixed asset investment of $210,000. The fixed asset will be depreciated straight-line to zero over its four-year life, after which time it will be worthless. The project is estimated to generate $48,000 in annual sales, with costs of $31,000. If the tax rate is 34 percent, what is the OCF for this project?

$29,070

Broadband, Inc., has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.

$400,000

Shelton Co. purchased a parcel of land six years ago for $874,500. At that time, the firm invested $146,000 in grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $54,500 a year. The company is now considering building a warehouse on the site as the rental lease is expiring. The current value of the land is $926,000. What value should be included in the initial cost of the warehouse project for the use of this land?

$926,000

Once cash flows have been estimated, which of the following investment criteria can be applied to them?

- IRR -NPV -payback period

The goals of risk analysis in capital budgeting include:

-Assessing the degree of financing risk -Identifying critical components

Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?

-Book value represents the purchase price minus the accumulated depreciation. -There will be tax savings if the book value exceeds the sales price. -Taxes are based on the difference between the book value and the sales price.

Cash flows used in project estimation should always reflect:

-Cash flows when they occur -After-tax cash flows

Which of the following are components of project cash flow?

-Change in net working capital -Operating cash flow -Capital spending

The possibility that errors in projected cash flows will lead to incorrect decisions is known as:

-Estimation risk -Forecasting risk

Which of the following is true relative to capital rationing?

-Hard rationing implies the firm is unable to raise funds for projects -Soft Rationing is typically internal in that the firm allocates funds to divisions for capital projects.

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons:

-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

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

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

A manager has estimated a positive NPV for a project. What could drive this result?

-Overly Optimistic management -The project is a good investment -The cash flow estimations are inaccurate

An option on a real asset rather than a financial asset is known as a:

-Real Option -Managerial Option

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

-Scenario Analysis -Asking What-If Questions

Which of the following qualify as "managerial options"?

-The option to wait -The option to abandon -The option to expand

Which of the following 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