28: Uses of Capital

Question 1

Capital allocation is the process planning _____ on assets where the _____ to the firm are expected to be greater than 1 years

Answer 1

planning expenditures based on cash flows

Question 2

Making good capital allocation decisions must be consistent with the manager’s primary goal of:

Answer 2

maximizing shareholder value

Question 3

Are interest costs included in the estimate of the incremental cash flows from an investment?

Answer 3

No. Costs to finance the investment are taken into account when the cash flows are discounted at the appropriate cost of capital;
including interest costs in the cash flows would result in double-counting the cost of debt

Question 4

Sunk costs _____ be included in the analysis

Answer 4

Should not, these costs are not affected by the accept/reject decision because they cannot be avoided

Question 5

the effects of acceptance of a project may have on other firm cash flows

Answer 5

externatilites

Question 6

A common example of a ____ externality is cannibalization, which occurs when:

Answer 6

negative externality because the new project takes sales from an existing one

Question 7

Cash flows are based on:

Answer 7

opportunity costs

Question 8

Cash flows are analyzed on an ______ basis

Answer 8

after tax
the impacts of taxes must be considered when analyzing all capital allocation projects

Question 9

Financing costs, like interest payments, are reflected in the project’s:

Answer 9

required rate of return (discount rate) & therefore should not be included in the cash flows

Question 10

The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the:

Answer 10

opportunity cost of capital

Question 11

IRR is the discount rate that makes the net present value equal to zero

Answer 11

IRR is the discount rate to make PV inflows = PV outflows

Question 12

When comparing ROIC and cost of capital, if all projects have a positive NPV, ROIC is ____ cost of capital, and these projects are providing return that is greater than ______

Answer 12

Since all projects have a positive NPV, they are all providing a return that is greater than the opportunity cost of capital.
Therefore, the ROIC > cost of capital

Question 13

____ is a direct measure of the expected change in firm value from undertaking a project

Answer 13

NPV

Question 14

____ is related to share value; and should cause a proportionate increase in a company’s stock price, of _____/shares outstanding, but other factors are related

Answer 14

NPV
NPV per shares outstanding

Question 15

IRR shows the return on _____

Answer 15

each dollar invested as a percentage

Question 16

When dealing with mutually exclusive projects, the most reliable decision rule is:

Answer 16

NPV

Question 17

The value of a company is the value of its _____ plus the ______ of all of its future investments

Answer 17

existing investments + net present values

Question 18

The internal rate of return method assumes that the cash flows from a project are reinvested at the project’s ____; the net present value (NPV) method assumes that cash flows are reinvested at _____.

Answer 18

IRR
the cost of capital

Question 19

used to identify systematic errors in the forecasting process and improve operations is which step of the capital allocation process?

Answer 19

conducting post audit (last step)

Question 20

For independent projects the NPV decision rule is to:
For mutually exclusive projects the NPV decision rule is to:

Answer 20

accept all projects with a positive NPV
accept the project with the highest NPV

Question 21

When the NPV = 0, this means the discount rate used is _____ IRR

Answer 21

cost of capital = IRR

Question 22

changing the inputs into a production process:
option to sell:
option to increase capacity:

Answer 22

flexibility option
abandonment
expansion

Question 23

IRR analysis will yield ____ accept/reject decision for a single project compared to NPV

Answer 23

the same

Question 24

NPV is the preferred method, but should be used especially when there are ____ IRR

Answer 24

multiple project IRRs

Question 25

Unconventional cash flows where the sign of the cash flows change more than once cause:

Answer 25

multiple IRR

Conventional cash flows= 1 IRR

Question 26

NPV will = IRR for projects:

Answer 26

for independent projects with conventional cash flows

Question 27

Conflict between the NPV and IRR decision rules can arise when evaluating mutually exclusive projects with conventional cash flows because:

Answer 27

1) the scale of investments may differ and/or 2) the timing of the cash flows may differ