Finance: Chapter 10 - Making Capital Investment Decisions

operating cash flows the tax shield approach

(sales - cost) * ( 1 - tax rate) + Depreciation * tax rate

Investment in net working capital arises when

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

As depreciation expense __________, net income and taxes will decrease, while cash flows will __________

-increases -increase

Other things to watch out in investments:

-interested only in measuring cash flow -always interested in after tax cash flow because taxes are definitely cash outflow

Operating cash flows

EBIT + Depreciation - Taxes

Taxes =

EBIT x tax rate

While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital?

It is expected to be recovered by the end of the project's life.

When evaluating cost-cutting proposals, how are operating cash flows affected?

-There is an additional depreciation deduction. -The decrease in costs increases operating income.

The bonus depreciation in 2019 was _____ percent.

100

According to the 2017 Tax Cuts and Jobs Act, bonus depreciation is phased out after

2026

Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?

As depreciation expense increases, net income and taxes will decrease, while cash flows will increase

When an asset is sold, there will be a tax savings if the _____ value exceeds the sales price

book

cash flow

cash inflow - cash outflow or operating cash flow - change in NWC

operating cash flows the top down approach

sales - cost - taxes

A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____

should be accepted if there is no capital rationing constraint

stand-alone principle

the assumption that evaluation of a project may be based on the project's incremental cash flows

incremental cash flows

the difference between a firm's future cash flows with a project and those without the project, direct consequence

opportunity cost

the most desirable alternative given up as the result of a decision

Side effects from investing in a project refer to cash flows from

beneficial spillover effects erosion effects

Operating cash flow =

earnings before interest and taxes + depreciation - taxes

to prepare pro forma financial statements we need:

estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and total fixed cost

The tax saving that results from the depreciation deduction is called the depreciation tax

shield

Which of the following are considered relevant cash flows?

-Cash flows from opportunity costs -Cash flows from erosion effects -Cash flows from beneficial spillover effects

Identify the three main sources of cash flows over the life of a typical 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. -Net cash flows from salvage value at the end of the project

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

-IRR -payback period -NPV

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

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

erosion

the cash flows of a new project that come at the expense of a firms existing projects, in this case cash flows from the new line should be adjusted downward to reflect lost profits on other lines

equivalent annual cost

the present value of a project's costs calculated on an annual basis

depreciation tax shield

the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate

consequence to stand-alone principle

will be evaluating the proposed project purely on its own merits, in isolation from any other activities or projects

Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the

winner's curse

EBIT

Sales - Costs - Depreciation

Which of the following is an example of a sunk cost

Test marketing expenses

Opportunity costs are

benefits lost due to taking on a particular project

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

skunk cost

a cost that has already been paid and cannot be recovered

Accelerated Cost Recovery System (ACRS)

a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications

incremental cash flows for project evaluation consist of

any and all changes in the firms future cash flows that are a direct consequence of taking the project

pro forma financial statements

financial statements projecting future years' operations, easy convenient means of summarizing much of the relevant information for a project

in analyzing a proposed investment we will not include interest paid or any other

financing costs such as dividends or principal repaid because we are interested in the cash flow generated by the assets of the project

An increase in depreciation expense will ____ cash flows from operations.

increase

With cost-cutting proposals, when costs decrease, operating cash flows

increase

What is a relevant cash flow for a project?

is a change in the firm's overall future cash flow that comes about as a direct consequence of the decision to take the project

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

lives

operating cash flow bottom up approach

net income + depreciation

any cash flow that exists regardless of whether or not a project is undertaken is

not relevant

total cash flow =

operating cash flow - change in NWC - capital spending

Erosion will ______ the sales of existing products

reduce

what the stand-alone principle says is that

once we have determined the incremental cash flows from undertaking a project, we can view that project as a kind of minifirm with its own future revenues and costs its own assets and own cash flows

project cash flow =

project operating cash flow - project change in networking capital - project capital spending