Finance – Chapter 9

Identify the three main sources of cash flows over the life of a typical project.A) cash outflows from investment in plant and equipment at the inception of the projectB) net cash flows are sales and expenses over the life of the projectC) test marketing expenses that have been classified as sunk costs.D) net cash flows from salvage value at the end of the project A, B, D
When evaluating cost-cutting proposals, how are operating cash flows affected?A) the decrease in costs decreases operating incomeB) wages are always reduced in cost-cutting endeavorsC) there is an additional depreciation deductionD) the decrease in costs increases operating income C, D
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:A) Hamilton’s blessingB) Winner’s blessingC) winner’s curseD) loser’s curse C.
When analyzing a project, sunk costs _____ incremental cash outflows.are notare are not
opprotunity costs are classified as ___ costs in project analysis.- sunk- intangible- relevant- irrelevant relevant
Side effects from investing in a project refer to cash flows from:- beneficial spillover effects- opportunity costs- erosion effects- sunk costs beneficial spillover effects, erosion effects
sunk costs are costs that ____.- cannot be measured- have already occurred and are not affected by accepting or rejecting a project- will not contribute to profits in the long run even if the project is accepted- relate to other projects of the firm have already occurred and are not affected by accepting or rejecting a project
According to the ____ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a “minifirm”- stand-alone- stand-with-stand-and-deliver- walk-alone stand-alone
When developing cash flows for capital budgeting, it is ____ to overlook important terms.Easyimpossibleraredifficult easy
Operating cash flow is a function of:A) Initial investment in EquipmentB) DepreciationC) Salvage value of EquipmentD) Earnings Before Interest and TaxesE) Taxes B,D, E
Using your personal savings to invest in your business is considered to have an ____ ____ because you are giving up the use of these funds for other investments or uses, such a s vacation or paying off a debt. Opprotunity Cost
If a firm’s current assets are $150,000, its total assets are $320,000, and its current liabilities are $80,000, what is the net working capital? Answer: $150,000 – $80,000 = $70,000
Once cash flows have been estimated, which of the following investment criteria can be applied to them?A) The constant growth dividend discount modelB) Payback periodC) YTMD) IRRE) NPV Answer: payback period, IRR, NPV
Incremental cash flows come about as an ____ consequence of taking a project under consideration. direct
Which of the following are fixed costs?A) net working capitalB) inventory costsC) cost of equipmentD) rent on a production facility C, D
Cash flows should always be considered on a(n) ____ basis.A) zero-taxB) after-taxC) pre-taxD) before-tax after-tax
The first step in estimating cash flow is to determine the ____ cash flows.A) operatingB) speciousC) relevant relevant
Which of the following are considered relevant cash flows? (Select all that apply)A) cash flows from erosion effectsB) cash flows from sunk costsC) cash flows from beneficial spillover effectsD) cash flows from opportunity costs A, C, D
The difference between a firm’s current assets and it’s current liabilities is known as the ____?A) capital structureB) net working capitalC) long-term capitalD) net opportunity capital NWC
Erosion will _____ the sales of existing productsreduceincreasenot affect reduce
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 purchase price and sales price of the assetthere will be a tax savings if the book value exceeds the sales pricetaxes are based on the difference between the book value and sales pricebook value represents the purchase minus the accumulated depreciation there will be a tax savings if the book value exceeds the sales pricetaxes are based on the difference between the book value and sales pricebook value represents the purchase minus the accumulated depreciation
Investment in net working capital arises when ____.cash is kept for unexpected expendituresinventory is purchasedcredit sales are madeequipment is purchased cash is kept for unexpected expendituresinventory is purchasedcredit sales are made
Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ____ are overlooked.investor sentimentNWCthe cost of capitaltax rates NWC
Which of the following is an example of a sunk cost?cost of equipmentsalvage value of equipmenttest marketing expensesbonus to top managment test marketing expenses
An investment project provides cash inflows of $645 per year for eight years.What is the project payback period if the initial cost is $1,800?What is the project payback period if the initial cost is $3,500?What is the project payback period if the initial cost is $5,300? to calculate the payback period, we need to find the time that the project has recovered its initial investment. The cash flows in this problem are an annuity, so the calculation is simpler. If the initial cost is $1,800, the payback period is: Payback = 2 + ($510 / $645) = 2.79 years*There is a shortcut to calculate the payback period when the future cash flows are an annuity. Just divide the initial cost by the annual cash flow. For the $3,500 cost, the payback period is: Payback = $3,500 / $645 = 5.43 years*The payback period for an initial cost of $5,300 is a little trickier. Notice that the total cash inflows after eight years will be: Total cash inflows = 8($645) = $5,160 If the initial cost is $5,300, the project never pays back. Notice that if you use the shortcut for annuity cash flows, you get: Payback = $5,300 / $645 = 8.22 years This answer does not make sense since the cash flows stop after eight years, so again, we must conclude the payback period is never. 0 years*
An investment project has annual cash inflows of $4,100, $5,000, $6,200, and $5,400, for the next four years, respectively. The discount rate is 14 percent. What is the discounted payback period for these cash flows if the initial cost is $6,800? What is the discounted payback period for these cash flows if the initial cost is $8,900? What is the discounted payback period for these cash flows if the initial cost is $11,900? Explanation:When we use discounted payback, we need to find the value of all cash flows today. The value today of the project cash flows for the first four years is: Value today of Year 1 cash flow = $4,100 / 1.14 = $3,596.49Value today of Year 2 cash flow = $5,000 / 1.142 = $3,847.34Value today of Year 3 cash flow = $6,200 / 1.143 = $4,184.82Value today of Year 4 cash flow = $5,400 / 1.144 = $3,197.23 To find the discounted payback, we use these values to find the payback period. The discounted first year cash flow is $3,596.49, so the discounted payback for a $6,800 initial cost is: Discounted payback = 1 + ($6,800 – 3,596.49) / $3,847.34 = 1.83 years For an initial cost of $8,900, the discounted payback is: Discounted payback = 2 + ($8,900 – 3,596.49 – 3,847.34) / $4,184.82 = 2.35 years Notice the calculation of discounted payback. We know the payback period is between two and three years, so we subtract the discounted values of the Year 1 and Year 2 cash flows from the initial cost. This is the numerator, which is the discounted amount we still need to make to recover our initial investment. We divide this amount by the discounted amount we will earn in Year 3 to get the fractional portion of the discounted payback. If the initial cost is $11,900, the discounted payback is: Discounted payback = 3 + ($11,900 – 3,596.49 – 3,847.34 – 4,184.82) / $3,197.23 = 3.08 years –> 1.83–> 2.35–> 3.08
You’re trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $12.5 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,904,300, $1,957,600, $1,926,000, and $1,379,500 over these four years, what is the project’s average accounting return (AAR)? Our definition of AAR is the average net income divided by the average book value. The average net income for this project is: Average net income = ($1,904,300 + 1,957,600 + 1,926,000 + 1,379,500) / 4 = $1,791,850 And the average book value is: Average book value = ($12,500,000 + 0) / 2 = $6,250,000 So, the AAR for this project is: AAR = Average net income / Average book valueAAR = $1,791,850 / $6,250,000AAR = .2867, or 28.67%
An investment project has annual cash inflows of $4,100, $5,000, $6,200, and $5,400, for the next four years, respectively. The discount rate is 14 percent. What is the discounted payback period for these cash flows if the initial cost is $6,800?

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