The discount rate used to value capital investments is often referred to as ____
-the opportunity cost of capital
Since a risky dollar is worth less than a safe one, returns for risky projects must be ________
than those of a risk-free investment.
-Higher
A project has an initial investment of $1.4 million and a present value of cash flows totaling $4
million. What is the project's net present value (NPV)?
-NPV=initial investment + PV of cash flows= -$1.4 million + 4 million = $2.6 million
The rate of return rule states that a firm should invest in any project offering a rate of return that
is higher than the:
-Opportunity cost of capital
The opportunity cost of capital can best be described as:
-the expected rate of return given up by investing in a project rather than in the capital
market
The opportunity cost of capital is determined by the ______ of a project.
-Risk
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107,
and a discount rate of 6%? (Be sure to record the initial investment as a negative number.)
-NPV = -$95 + ($107/1.06) = $5.94
If two projects (investments) A and B are said to be mutually exclusive then we know that the
firm ______________.
-must choose to invest in either A or B, but not both.
The IRR rule specifies that a firm should select any project whose IRR is __________ the firm's
___________.
-higher than; opportunity cost of capital
The rate of return rule states that the rate of return is the discount rate at which NPV:
-equals 0
True or false: IRR is essentially the same as the opportunity cost of capital.
-False: Reason:
One is a return generated by cash flows, the other a measure of risk.
Since a risky dollar is worth less than a safe one, returns for risky projects must be ________
than those of a risk-free investment.
-Higher
Under which of the following situations should the IRR decision rule be avoided?
-selection of mutually exclusive projects
-a project with multiple rates of return
-project NPV does not decline smoothly as discount rate increases
By definition, if the Profitability Index is greater than 0, then ________ .
-net present value (NPV) is greater than 0
The internal rate of return (IRR) is also called the:
-discounted cash flow (DCF) rate of return
A project's IRR measures the _________ whereas the opportunity cost of capital is equal to the
____________.
-profitability of a project; return offered by equivalent-risk investments in the capital
market
In simple cases of capital rationing, the _________ can tell a firm which projects to accept.
-Profitability index
When considering mutually exclusive projects, the project that adds most to shareholder wealth
is the one with:
-the highest NPV
When there is no real capital rationing the preferred valuation metric is
-NPV, because it will favor large projects over small ones.
The correct equation for the Profitability Index (PI) is given by:
-PI = NPV/initial investment
The payback period for a project can best be defined as:
-the length of time before you recover your initial investment
The Internal Rate of Return (IRR) can best be defined as:
-the discount rate at which the NPV equals zero
The limit set on the amount of funds available for investment is referred to as:
-capital rationing
Which capital budgeting decision method finds the present value of each cash flow before
calculating a payback period?
-Discounted payback period
Which of the following are problems that managers may encounter when deciding between
mutually exclusive projects?
-the timing of investments
-when equipment should be replaced
-the choice between short and long-lived equipment
Project A has an initial investment of $10,000 and an NPV of $15,000. Project B has an initial
investment of $100,000 and an NPV of $101,000. Based on the PI (Profitability Index), project
_______ would be selected. Based on the NPV, project _______ would be accepted. Selecting
project ______ will actually maximize shareholder value.
-A; B; B
True or false: the payback rule states that a project should be accepted if its payback period is
greater than a specified cutoff period.
-False
Making the choice to invest today or to postpone that investment to a future date is a choice
between mutually exclusive projects. When making this choice, what is the correct criterion to
use?
-Choose the investment date that produces the highest NPV today.
The ___________ method of project selection asks, "How long must the project last in order to
offer a positive net present value?"
-discounted-payback
The cash flow per period with the same present value as the cost of buying and operating a
machine is called the:
-it is enough simply to compare the NPV of the projects.
Which of the following is the capital investment decision criterion that will always lead
management to make the value-maximizing choice?
-NPV
The single variable of interest for the investment timing problem is
-NPV
Which of the following is the correct definition of the Equivalent Annual Annuity (EAA)?
-A stream of cash flows or payments that have the same present value as a project or
investment's cash flows.
Which of the following are problems that managers may encounter when deciding between
mutually exclusive projects?
-the timing of investments
-the choice between short and long-lived equipment
-when equipment should be replaced
Which two investment criterion methods are most used by firms?
-net present value
-internal rate of return
If choices you make today do not affect future investment opportunities, then
-it is enough simply to compare the NPV of the projects.
To calculate net present value, you need to discount _________.
-Cash flows
The initial cash flow at the start of a project's life is typically
-Negative
The term incremental cash flow can best be defined as:
- cash flow with the project minus firm cash flow without the project
- additional cash flows that will only be earned if the firm proceeds with an investment
Some examples of indirect effects that could affect incremental cash flows would be:
-increased sales of an existing product by release of a complementary product
-release of a product that will generate sales of replacement parts and services in future
years
-cannibalization of existing product sales by introduction of a new product
-loss of existing store sales by locating a new store too close by
When calculating NPV, why are cash flows discounted instead of accounting profits?
-using accounting profits gives an inaccurate NPV
-income statements do not track cash flows
-accounting profits do not recognize project investment expenditures as they occur
A sunk cost is irreversible; sunk costs
-do not affect NPV and should be ignored.
Andersen Corp will undertake a project that will produce cash flows of $50,000 in year 1,
$60,000 in year 2, $70,000 in year 3, $75,000 in year 4 and $68,000 in year 5, what is the present
value of those cash flows if Andersen's required rate of return on the project is 15 percent?
-Reason:
50000/(1.15) +
60000/(1.15)2 +
70000/(1.15)3 +
75000/(1.15)4 +
68000/(1.15)5 =
$211,562.53
Incremental cash flow is equal to:
-cash flow with project - cash flow without project
Which of the following are characteristics of sunk costs?
-they do not affect the project NPV
-they are past and irreversible cash outflows
-managers are often influenced by sunk costs
An opportunity cost arises in a project whenever:
-the project uses an existing asset that could have been sold or put to productive use
elsewhere
A benefit or cash flow foregone as a result of an action is called:
-Opportunity Cost
The term incremental cash flow can best be defined as:
-cash flow with the project minus firm cash flow without the project
-additional cash flows that will only be earned if the firm proceeds with an investment
Some examples of indirect effects that could affect incremental cash flows would be:
-loss of existing store sales by locating a new store too close by
-release of a product that will generate sales of replacement parts and services in future –
years
-increased sales of an existing product by release of a complementary product
-cannibalization of existing product sales by introduction of a new product
Which of the following are commonly made mistakes that managers make in regard to working -
capital and forecasting project cash flows?
-forgetting that working capital may change during the life of the project
-forgetting about working capital entirely
-forgetting that working capital is recovered at the end of the project
A sunk cost is irreversible; sunk costs
-do not affect NPV and should be ignored
Which of the following statements about nominal versus real cash flows are correct?
- real cash flows must be discounted by a real discount rate
- nominal cash flows must be discounted by a nominal discount rate
Which of the following is true of a project's terminal cash flow?
-it may include recovery of working capital investment
-it may be due to final cleanup or recovery costs
-it may be positive or negative
-It may be due to the sale of a project asset
By keeping costs such as interest and principal payments on debt out of project cash flows, you
are following a fundamental principle of corporate finance known as the separation of
investment and ___________ decisions.
-Financing
The term incremental cash flow can best be defined as:
-additional cash flows that will only be earned if the firm proceeds with an investment
-cash flow with the project minus firm cash flow without the project
The difference between the nominal discount rate and the real discount rate is ________.
-Expected inflation
The Tax Cuts and Jobs Act allows companies to take bonus depreciation sufficient to write off
what percent of investment immediately?
-100%
Cash flows from capital investments + operating cash flows + cash flows from changes in
working capital =
-Total cash flow
True or false: Financing costs like interest and principal payments on borrowed funds must be
included in the incremental cash flows for the project.
-False: Reason:
-Financing costs are not included in a project's incremental cash flows because the
investment decision needs to be separated from the financing decision. The project should
be treated as if it were all-equity financed when calculating cash flows.
Smith Industries plans to sell an asset at the end of a 5 year project for $250,000. The book value
of the asset at that time will be $125,000. The marginal tax rate is 35 percent. How much tax will
Smith pay on the sale, and what will be its net proceeds (cash inflow)?
-Reason:!
-Tax = (250000 - 125,000) x0.35= 43750; Net proceeds = 250000 – 43750
Bonus depreciation is a temporary provision of the Tax Cuts and Jobs Act. It is scheduled to be
phased-out starting in!
-2023
Which of the items below are the elements which must be included in the calculation of
a project's total cash flow?
-operating cash flow
-cash flow from capital investments
-cash flows from changes in working capital
The initial capital investment is a cash outflow at the start of the project that includes
which of the following types of outflows:
-any investment in fixed assets required by the project
-investments in research and marketing required for the project
A project generates revenues of $5,000, costs of $3,000 and taxes of $700. What is the
project's operating cash flow?
-$5,000 - $3000 - $700 = $1300
Which of the following will correct the effect of depreciation?
-Operating Cash Flow = (Revenues - cash expenses) X (1- tax rate) + (tax rate X
deprecation)
-Operating Cash Flow = After-tax profit + depreciation
-Operating Cash Flow = Net Income + depreciation
At the end of a project, a firm's investment has a salvage value of $4 million. The firm
will pay taxes of $.5 million on the sale of the equipment from the investment. What is
the net cash flow to the firm?
-Reason:!
-Net cash flow= salvage value - tax on gain= $4 million - $.5 million = $3.5 million
Which of the following forecasted components of project cash flow should be adjusted
directly to change with inflation from year to year?
-Revenue and expenses
Which of the following statements about working capital is correct?
-a project may have WC outflows early, changing to inflows as WC is recovered
Which of the following formulas can be used to ensure that depreciation is not included
in a project's operating cash flows?
-Operating cash flow = revenues - cash expenses – taxes
-Operating cash flow = (revenues - cash expenses) x (1-tax rate) + (tax rate x
depreciation)
-Operating cash flow = after-tax profit + depreciation
True or false: project discounted cash flow analysis assumes that cash flows occur at
the end of the year even though they are actually spread through the year as sales and
expenses actually occur.
-True
If the cost of an input it $1,000,000 this year; if you project inflation to be 3% annually, what
would be an appropriate forecast for the cost of that input in year 4?
-Cost x inflation + 1M x 1.03 x 1.03 x 1.03 x 1.03= 1,125,508
A project generates a net profit of $1.8 million and depreciation of $200,000. What is the
project's operating cash flow?
-$2M Reason:!
-Operating cash flow = net profit + depreciation = $2 million
Which of the following will correct the effect of depreciation?
-Operating Cash Flow = Net Income + depreciation
-Operating Cash Flow = (Revenues - cash expenses) X (1- tax rate) + (tax rate X
deprecation)
-Operating Cash Flow = After-tax profit + depreciation
A firm's capital budget is generally drawn up on a _____ basis.
-Annual
Unbiased cash flow forecasts are often difficult to obtain due to ________, which,
despite causing higher projected cash flows, can also increase effort, commitment, and
persistence from employees.
-Over optimism
Sensitivity analysis!consists of which of the following activities?
-Change the forecast of one cash flow variable at a time to observe effect on NPV
Project analysis given different combinations of variables is called:
"
- scenario analysis
Which of the following is a solution to the problem of inconsistency in project forecasts?
-Provide managers with a common set of economic and firm-specific indicators
upon which to base forecasts
The analysis of the level of sales at which the project breaks even is:
-Break even analysis
Obtaining unbiased cash flow forecasts can be difficult because senior managers
sometimes increase the ____________ for capital expenditures.
-Hurdle rate
Which of the following accurately describes the!accounting break-even point?
-The level of sales at which total revenues equal total costs
-The level of sales at which profits are zero
Managers ask "what if" questions related to the factors that can increase or reduce
project cash flows because ________.
-changes in cash flows change NPV and may change the acceptability of a
project
The make-or-break variable most commonly used in break-even analysis is ________;
however, _______ can also be used to help a firm understand the break-even point.
-sales volume; costs
The _______ break-even point is the level of sales at which profits are zero, or,
equivalently, at which total revenues equal total costs.
-accounting
Which of the following best describes the!NPV break-even point?
-The level of project sales at which the NPV turns from negative to positive
A firm is said to have high!operating leverage!if:
-Fixed costs are high relative to variable costs
Real options include the option to (choose 4):
-expand
-postpone
-modify
-abandon
Which of the following accurately describes the!accounting break-even point?
-The level of sales at which total revenues equal total costs
-The level of sales at which profits are zero
Which of the following statements is true?
-A higher initial investment requires a higher level of sales to achieve NPV break
even
-A higher firm tax rate means higher sales are required to achieve NPV break
even
-A higher project depreciation means lower sales are required to achieve NPV
break-even
The real option to expand helps to mitigate which of the following project risks faced by
a firm?
-The risk of making a large initial investment in full production for a project with
uncertain cash flows.
What can management do to help ensure that they have a real option to abandon a
project while maintaining a positive NPV?
-Use project assets that are tangible and have a high value in secondhand
markets.
A firm with high operating leverage will see that _____ changes in sales will lead to
_______ changes in profits.
-Small, large
It may make sense to time the decision to implement small positive NPV projects if their
input prices are highly!"
-Blank 1: volatile,!variable,!erratic,!or unpredictable
Options to invest in, modify, postpone, or dispose of a capital investment project are
known as:
-Real options
A firm that is able to vary its output mix as demand changes is said to have:
-flexible production facilities
The _______ break-even point is the level of sales at which profits are zero, or,
equivalently, at which total revenues equal total costs.
-Accounting
A diagram of sequential decisions and possible outcomes that managers use to decide
whether to expand is called a:
-Decision tree
When considering the option to abandon, it is important to recognize that tangible
assets are!"
-Easier
The timing real option is really an option to _________.
-wait until the firm has additional information about project success before
investing
When manufacturers realize they are dependent on a single source of raw materials,
they may seek out!"
-flexible
Which of the following accurately describes the!accounting break-even point?
-The level of sales at which profits are zero
-The level of sales at which total revenues equal total costs
