FIN 3100 Exam 4
What is a conventional cash flow?
A cash flow that starts at a negative value and grows in one positive direction
What is an unconventional cash flow?
A cash flow that starts at a negative value, grows positively, then goes back to being negative in the future
An increase in assets means what?
A decrease in cash
Which of the below statements is FALSE? A) Erosion results in incremental cash inflows. B) When a company uses its resources for a project, there are opportunity costs. C) Increases in working capital accounts necessary to support a project add upfront costs, but also provide for cost reductions at the end of the project. D) A synergy gain occurs when a new product can be introduced that complements another current product so that sales for this current product increases.
A) Erosion results in incremental cash inflows.
What is the decision rule regarding the payback period method?
Accept if the payback period is less than some preset limit.
What are working capital requirements?
Additional cash flows arising from changes in current assets (such as inventory and receivables) and current abilities (such as accounts payables) that occur as a result of a new project
A decrease in assets means what?
An increase in cash
Are accounts receivable an asset or liability?
Asset
Which of the statements below is TRUE? A) The increase in working capital accounts necessary to support a project also provides for cost increases at the end of the project. B) Decreases in accounts payable constitute a source of cash flow because you are using your suppliers to help finance your business operations. C) An increase in working capital can be brought about by an increase in inventory. D) Decreases in accounts receivables constitute a use of cash flow because you are helping your customers finance their purchases.
C) An increase in working capital can be brought about by an increase in inventory.
Which is NOT a step in the estimation of after-tax cash flow at disposal? A) If selling price equals book value: Selling Price. B) If selling price is greater than book value: Selling Price - Tax on Gain. C) If book value is less than selling price: Selling Price + Tax Credit on Loss. D) If selling price is less than book value: Selling Price + Tax Credit on Loss.
C) If book value is less than selling price: Selling Price + Tax Credit on Loss.
________ is at the heart of corporate finance, because it is concerned with making the best choices about project selection. Short-term budgeting
Capital budgeting
What two things does depreciation affect?
Corporate income tax and capital gains tax
What are synergy and erosion costs?
Costs that arise when a new product or service competes with revenue generated by a current product or service offered by a firm
When 2 projects have the same NPV, what is their corresponding rate known as?
Crossover rate
If an asset's disposal value is less than its ________, a loss on disposal occurs.
Current book value
If an asset's ________ is greater than its current book value, a gain on disposal occurs.
Disposal value
What are some pros of the payback period method?
Easy to understand and useful when liquidity is concerned.
Whenever a new product competes against a company's already existing products and reduces the sales of those products, ________ occur.
Erosion costs
What are sunk costs?
Expenses that have already been incurred, or that will be incurred, regardless of the decision to accept or reject a project
True or False: To be considered acceptable, a project must have an NPV greater than 1.0.
False
A gain on disposal is recognized when the selling price of the asset is ________ the book value.
Greater than
What does higher depreciation mean?
Higher OCF
When would you reject a project using the IRR decision tool?
IRR < Hurdle Rate
When would you accept a project using the IRR decision tool?
IRR > Hurdle Rate
What is the difference between how IRR and NPV are measured?
IRR is measured as a percent, and the NPV is measured in dollars
What are some cons of the payback period method?
Ignores all cash flow after the initial cash outflow has been recovered, ignores the time value of money, and uses an arbitrary cut-off.
________ cash flow is the increase in cash generated by a new project above the current cash flow without the new project.
Incremental
What is the formula for book value?
Initial Value of Equipment - Total Depreciation
What does IRR stand for?
Internal Rate of Return
A loss on disposal is recognized when the selling price of the asset is ________ the book value.
Less than
Are accounts payable an asset or liability?
Liability
What is the NPV decision tool?
Most popular. Discounts all the cash flows from a project back to time 0 using an appropriate discount rate 'r'. Note: Error in book formula as CF0 is negative and doesn't need a negative sign in front. A positive NPV implies that the project is adding value to the firm's bottom line. Therefore, when comparing projects, the higher the NPV, the better.
The crossover rate is the discount rate where both projects have the same ________.
NPV
What does NPV stand for?
Net Present Value
The ________ model is usually considered the best of the capital budgeting decision-making models.
Net Present Value (NPV)
Is depreciation a cash flow?
No
Is depreciation treated as a cash flow?
No
Should sunk costs be considered relevant cash flows?
No
What are the three types of cash flows?
Operating cash flows, net capital spending, and change in net working capital
________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow of a new project.
Opportunity costs
The remaining book value when a project is terminated is the ________ minus accumulated depreciation over the life of the project.
Original cost
The ________ method is simple and fast but economically unsound as it ignores all cash flow after the cutoff date and ignores the time-value of money.
Payback period
The ________ model answers one basic question: How soon will I recover my initial investment?
Payback period
The ________ model determines at what point in time cash outflow is recovered by the corresponding future cash inflow.
Payback period
What are the four decision tools?
Payback period, NPV, IRR, and Profitability Index
________ is a modification of NPV to produce the ratio of the present value of the benefits (future cash inflow) to the present value of the costs (initial investment).
Profitability Index (PI)
Which method is designed to give the dollar amount of return for every $1.00 invested in the project in terms of current dollars?
Profitability Index Method
________ are an accounting measure of performance during a specific period of time, while ________ is the actual inflow or outflow of money.
Profits; cash flow
________ of a project are those that have already been incurred and cannot be reversed.
Sunk costs
What is depreciation typically used as?
Tax shield
A financial manager examines concepts such as sunk costs, opportunity costs, and erosion costs to help understand how to estimate the incremental cash flow of a project, which is ________.
The additional money the firm receives from taking on a new project
What are opportunity costs also thought of as?
The best/highest amount you could have earned by taking on another project or opportunity
What is the IRR decision tool?
The discount rate that forces the sum of all the discounted cash flows from a project to equal 0.
What is the payback period decision tool?
The method assumes that all cash outflows occur at the beginning of the project, followed by a stream of inflows. Also assumes that cash inflows occur uniformly over the year.
What is the hurdle rate?
The minimum acceptable rate of return that should be earned on a project, given its riskiness. Same as required return.
The net present value of an investment is ________.
The present value of all benefits (cash inflows) minus the present value of all costs (cash outflows) of the project
The IRR is the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost equals ________.
The present value of the future benefits or cash inflows
The NPV profile of a project is ________.
The project's NPVs at different discount rate
What are two reasons why depreciation should be considered?
The tax-flow implications for operating cash flows and the gain or loss at disposal of a capital asset
Project A has an NPV of $20,000 and a PI of 1.2. Project B has an NPV of $10,000 and a PI of 1.3. Both projects have equal lives. What should the best decision if we are NOT concerned with capital rationing (that is, we are NOT concerned with being short of funds)?
We should accept both projects
When will more taxes be paid?
When depreciation is less
At the end of a project's life, we will recover any initial changes in ________ from the beginning of the project.
Working capital
Should opportunity costs be included as relevant costs?
Yes
Which of the statements below is TRUE of the payback period method? a) It ignores the cash flow after the initial outflow has been recovered. b) It is biased against projects with early-term payouts. c) It focuses on cash flows after the initial outflow has been recovered. d) It incorporates time-value-of-money principles.
a) It ignores the cash flow after the initial outflow has been recovered.
Which of the statements below describes the IRR decision criterion? a) The decision criterion is to reject a project if the IRR exceeds the desired or required return rate. b) The decision criterion is to accept a project if the NPV is positive. c) The decision criterion is to accept a project if the IRR exceeds the hurdle rate or required return rate. d) The decision criterion is to accept a project if the IRR falls below the desired or required return rate.
c) The decision criterion is to accept a project if the IRR exceeds the hurdle rate or required return rate.
Which of the statements below is FALSE? a) If the PI is greater than one, the benefits exceed the costs. b) The profitability index (PI) decision criterion states: if PI < 1.0, reject the project. c) The profitability index (PI) method multiplies the Present Value of Benefits by Present Value of Costs. d) The profitability index (PI) decision criterion states: if PI > 1.0, accept the project.
c) The profitability index (PI) method multiplies the Present Value of Benefits by Present Value of Costs.
