Chapter 8 Flashcards
(26 cards)
4)The ultimate goal of the capital budgeting process is to ________.
A. determine how the consequences of making a particular decision affects the firm’s revenues and
costs
B. determine the effect of the decision to accept or reject a project on the firm’s cash flows
C. forecast the consequences of a list of future projects for the firm
D. list the projects and investments that a company plans to undertake in the future
B
Interest and other financing related expenses are excluded when determining a project’s unlevered net income.
T
Which of the following statements is FALSE?
A.
As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
B.
When evaluating a capital budgeting decision, we generally include interest expense.
C.
Many projects use a resource that the company already owns.
D.
Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.
B
Which of the following would you NOT consider when making a capital budgeting decision?
A.
the opportunity to lease out a warehouse instead of using it to house a new production line
B.
the cost of a marketing study completed last year.
C.
the additional taxes a firm would have to pay in the next year
D.
the change in direct labor expense due to the purchase of a new machine
B
A decrease in the sales of a current project because of the launching of a new project is
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Part 1
A.
a sunk cost.
B.
an overhead expense.
C.
irrelevant to the investment decision.
D.
cannibalization.
D
A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. The $20 million should best be considered ________.
A.as a capital cost
B.as an opportunity cost
C.as a sunk cost
D.as a fixed overhead expens
C
Capital budgeting is the process of allocating funds to the firm’s investment projects.
F. Capital Budgeting: is a processs that a firm analyzes projects and decides which ones to accepts
The ultimate goal of capital budgeting is to determine the effect of a project on the
firm’s cash flows and the consequences of accepting or rejecting a project for the firm’s
value.
T
How does the capital budgeting process begin?
A) by analyzing alternate projects
B) by evaluating the net present value (NPV) of each project’s cash flows
C) by compiling a list of potential projects
D) by forecasting the future consequences for the firm of each potential project
E) by calculating the incremental earnings of a project
C. It begins lists the projects and investment that a firm analyzes projects and decides which ones to accept
4) What is the ultimate goal of the capital budgeting process?
A) to determine how the consequences of making a particular decision affects the firms
revenues and costs
B) to list the projects and investments that a company plans to undertake in the future
C) to forecast the consequences of a list of future projects to the firm
D) to determine the effect of the decision to accept or reject a project on the firms cash
flows
E) to calculate the incremental earnings of a project
D
5) Which of the following best defines incremental earnings?
A) cash flows arising from a particular investment decision
B) the amount by which a firm’s earnings are expected to change as the result of an
investment decision
C) the earnings arising from all projects that a company plans to undertake in a fixed
timespan
D) the net present value (NPV) of earnings that a firm is expected to receive as the result
of an investment decision
E) the increase in cash flows resulting from a new product
B
Which of the following best describes why the predicted incremental earnings arising
from a given decision are not sufficient in and of themselves to determine whether that
decision is worthwhile?
A) They do not tell how the decision affects the firm’s reported profits from an accounting
perspective.
B) They are not easily predicted from historical financial statements of a firm and its
competitors.
C) These earnings are not actual cash flows.
D) They do not show how the firm’s earnings are expected to change as the result of a
particular decision.
E) They do not tell us how profits change from an accounting perspective.
C
When evaluating the effectiveness of an improved manufacturing process we should
evaluate the total sales and costs generated by this process.
F
Cameron Industries is purchasing a new chemical vapour depositor in order to make
silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered
and installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to have a working life of six years. Which of these
activities will be reported as an operating expense?
A) the delivery and install cost only
B) the cost of the depositor only
C) the redesign of the plant only
D) the delivery and install cost and the cost of the depositor
E) the install cost only
C. Operating Expenses: conduct a market survey, develop a prototype, or launch an ad campaign
Why does capital budgeting focus on incremental revenues and costs, instead of the
projected total revenues and costs of the firm?
Since the goal is to evaluate how the project will change the cash flows of the
firm, we must ignore any sales and costs that are using existing firm resources.
How do we handle interest expense when making a capital budgeting decision?
We do not generally include interest expense when making capital budgeting
decisions
Incremental Earnings Forecast
– Pro Forma Statement
– Taxes and Negative Incremental EBIT
– Interest Expense
+ Unlevered Net Income
- Pro Forma Statement: financial statement forecasting table used by estimated number
-Unleverd Net Income: forcast in project we assume that we do not need to borrow money –> do not nedd to include interest in pro forma statement
The cash flow effect from a change in Net Working Capital is always equal in size and
opposite in sign to the changes in Net Working Capital.
T
Which of the following best describes Net Working Capital?
A) A long-term investment that generates consistent cash flows.
B) A short-term investment that maximizes cash flow for immediate use.
C) A short-term investment that ties up cash flow that could be used elsewhere.
D) A financial metric used to measure a company’s long-term profitability.
C
An increase in NWC causes___in Free cash flow
decrease
- If AR increase, NWC increase -> decrease cash
- If AP increase, NWC decrease -> increase cash
What does the term “Depreciation Tax Shield” refer to in financial accounting?
A) A tax incentive provided to companies for making capital investments.
B) A tax credit for the depreciation of assets over time.
C) Tax savings resulting from the ability to deduct depreciation expenses.
D) A tax benefit for companies that experience asset appreciation.
C.
Marginal Corporation Tax RRate x Depreciation
The most difficult part of the capital budgeting process is accurately estimating cash
flows and cost of capital.
T
The manufacturer of a brand of kitchen knives is investigating the likely effects that an
increase in the cost of the raw materials required to make these knives will have on the
the cost of manufacturing the knives, the selling price of the knives, the number of knives
that will then be sold, and the project’s net present value (NPV). Which of the following
best describes what type of analysis the manager is performing?
A) scenario analysis
B) sensitivity analysis
C) break-even analysis
D) EBIT-break even analysis
E) EPS analysis
A.
Scenario Analysis: – A capital budgeting tool that determines how the NPV
varies as a number of the underlying assumptions
are changed simultaneously
15) The difference between scenario analysis and sensitivity analysis is:
A) Scenario analysis is based upon the internal rate of return (IRR) and sensitivity
analysis is based upon net present value (NPV).
B) Only sensitivity analysis allows us to change our estimated inputs of our net present
value (NPV) analysis.
C) Scenario analysis considers the effect on net present value (NPV) of changing multiple
project parameters.
D) Only scenario analysis breaks the net present value (NPV) calculation into its
component assumptions.
E) Sensitivity analysis allows for variations in many of the underlying assumptions
simultaneously.
C
