Exam 3 11/10 chaps 2&9

Question 1

incremental cash flows

Answer 1

The difference between a firm’s future cash flows with a project and those without the project.

Question 2

The incremental cash flows for project evaluation consist of…

Answer 2

any and all changes in the firm’s future cash flows that are a direct consequence of taking the project.

Question 3

stand-alone principle

Answer 3

The assumption that evaluation of a project may be based on the project’s incremental cash flows.

Question 4

sunk cost

Answer 4

A cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision.

Question 5

opportunity cost

Answer 5

The most valuable alternative that is given up if a particular investment is undertaken.

Question 6

erosion

Answer 6

The cash flows of a new project that come at the expense of a firm’s existing projects.

Question 7

pro forma financial statements

Answer 7

Financial statements projecting future years’ operations.

Question 8

project cash flow=

Answer 8

proj. OCF - proj. change in NWC - proj. capital spending

Question 9

OCF=

Answer 9

earnings before interest and taxes + depreciation - taxes

Question 10

OCF=

tax shield approach

Answer 10

(sales - cost) x (1 - Tc) + (dep x Tc)

Question 11

depreciation tax shield

Answer 11

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

Question 12

total cash flow=

Answer 12

OCF - change in NWC - capital spending

Question 13

cash flow=

Answer 13

cash inflow- cash outflow

Question 14

Accelerated Cost Recovery System (ACRS)

Answer 14

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

Question 15

forecasting risk

Answer 15

The possibility that errors in projected cash flows will lead to incorrect decisions. Also estimation risk.

Question 16

scenario analysis

Answer 16

The determination of what happens to net present value estimates when we ask what-if questions.

Question 17

sensitivity analysis

Answer 17

Investigation of what happens to net present value when only one variable is changed.

Question 18

managerial options

Answer 18

Opportunities that managers can exploit if certain things happen in the future. Also known as “real” options.

Question 19

contingency planning

Answer 19

Taking into account the managerial options implicit in a project.

Question 20

strategic options

Answer 20

Options for future, related business products or strategies.

Question 21

capital rationing

Answer 21

The situation that exists if a firm has positive net present value projects but cannot obtain the necessary financing.

Question 22

soft rationing

Answer 22

The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting.

Question 23

hard rationing

Answer 23

The situation that occurs when a business cannot raise financing for a project under any circumstances.

Question 24

balance sheet

Answer 24

Financial statement showing a firm’s accounting value on a particular date.

Question 25

total value of assets

Answer 25

1. current assets 2. fixed assets - tangible & intangible

Question 26

total value of liabilities and shareholders equity

Answer 26

1. current liabilities 2. long-term debt 3. shareholders' equity

Question 27

assets=

Answer 27

liabilities + shareholders' equity

Question 28

net working capital

Answer 28

Current assets less current liabilities.

Question 29

liquidity

Answer 29

the speed and ease with which an asset can be converted to cash

Question 30

Generally Accepted Accounting Principles (GAAP)

Answer 30

The common set of standards and procedures by which audited financial statements are prepared.

Question 31

income statement

Answer 31

Financial statement summarizing a firm's performance over a period of time.

Question 32

income=

Answer 32

revenues - expenses

Question 33

noncash items

Answer 33

Expenses charged against revenues that do not directly affect cash flow, such as depreciation.

Question 34

average tax rate

Answer 34

Total taxes paid divided by total taxable income.

Question 35

marginal tax rate

Answer 35

Amount of tax payable on the next dollar earned.

Question 36

cash flow from assets

Answer 36

The total of cash flow to creditors and cash flow to stockholders, consisting of the following: operating cash flow, capital spending, and changes in net working capital.

Question 37

operating cash flow

Answer 37

Cash generated from a firm's normal business activities.

Question 38

free cash flow

Answer 38

Another name for cash flow from assets.

Question 39

cash flow to creditors

Answer 39

A firm's interest payments to creditors less net new borrowings.

Question 40

cash flow to stockholders

Answer 40

Dividends paid out by a firm less net new equity raised.

Question 41

net capital spending=

Answer 41

ending fixed assets - beginning fixed assets + depreciation

Question 42

net working capital=

Answer 42

current assets - current liabilities

Question 43

change in NWC=

Answer 43

(current ass 1 - current liab 1) - (current ass 2 - current liab 2)

Question 44

operating cash flow=

Answer 44

net income + change in NWC OR EBIT + depreciation - tax

Question 45

fixed assets sold=

Answer 45

fixed ass 2 - fixed ass 1 - new + depreciation

Question 46

cash flow to creditors=

Answer 46

beg tot liab - end tot liab + interest paid OR interest paid - net new borrowing

Question 47

new net borrowing=

Answer 47

long term debt end - long term debt beg

Question 48

depreciation=

Answer 48

sales - cost - taxable income

Question 49

taxable income=

Answer 49

net income/ (1-0.%)

Question 50

net income=

Answer 50

paid dividends + retained earnings