FIN 357 Chapter 11

A firm with higher operating leverage will have (low/high) fixed costs relative to a firm with low operating leverage.

high

True or false: Ultimately, we are more interested in cash flow than accounting income.

True

In simulation analysis, a combination of _____ analysis and _____ analysis is used.

scenario; sensitivity

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

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

1. NPV considers all the cash flows. 2. NPV considers time value of money.

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

1. estimation risk 2. forecasting risk

Which of the following equations correctly relates OCF to sales volume?

OCF = (P − v) × Q − FC

Suppose Price per Unit is $6, variable cost per unit is $2, fixed costs are $400 and the depreciation allowance per year is $500. The relationship between operating cash flow (OCF) and sales volume (Q) can be expressed as:

OCF = −400 + 4*Q

Which of the following statements is true in the context of comparing accounting profit and present value break-even point?

Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

Which of the following are true about variable costs?

The variable cost per unit may remain constant as the number of units produced increases.

To be considered good, projected cash flows should _____ actual cash flows.

be close to

A firm will start generating positive accounting profits _____.

beyond the break-even sales point

West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately West Corporation lost money on the project. This may have been avoided had they assessed the ______ of the cash flow estimates.

reliability

Corporate managers care about the break-even point because it indicates the level to which _____ can fall before a project will start losing money.

sales

The Omega Division of Alpha Corporation has been allocated $4 million for capital spending but has identified $4.6 million in positive NPV projects. Omega's manager thinks he can convince the company to fund the additional $0.6 million dollars because Omega uses _______ rationing to control overall spending.

soft --- Soft rationing occurs when units in a business are allocated a certain amount of financing for capital budgeting.

The _____ cost is equal to the quantity of output times the cost per unit of output.

variable

The basic approach to evaluating cash flow and NPV estimates involves asking ---- -if questions.

what

An accounting break-even point of 1,000 units means that ____.

when the firm sells 1,000 units, profits will be equal to zero

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.

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

The ____ break-even is the sales level that results in a zero NPV.

financial

As a practical matter, it is easier to (decrease/increase) operating leverage than it is to (decrease/increase) it.

increase; decrease

When using ________ all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable. Multiple choice question.

sensitivity analysis

A firm will start generating profits when ___.

the total number of units sold exceeds the accounting break-even point

True or false: When a business does hard rationing, the firm's DCF analysis breaks down.

true --- When a business does hard rationing, the firm's DCF analysis breaks down and the best course of action is ambiguous.

In a competitive market, positive NPV projects are:

uncommon

____ analysis involves estimating the best-case, worst-case, and base-case cash flows and calculating the corresponding NPVs.

Scenario