Deck 10: Making Capital Investment Decisions

Question 1

Incremental costs should be included in the analysis of a project

Answer 1

True

Question 2

Sunk costs are considered cash flows of a project.

Answer 2

False

Question 3

An offer to purchase the patent rights would normally be included in the final cash flow of a project that entailed the development and sale of a new product.

Answer 3

True

Question 4

An increase in taxes is an example of an incremental cash flow.

Question 5

You build a Taco Bell just down the street from your McDonalds franchise would likely NOT cause erosion.

Question 6

For the purpose of performing capital budgeting analysis, cash flows must be incremental.

Question 7

The loss of sales due to a new product which you recently introduced is an example of erosion.

Question 8

You begin selling coffee in new, small-sized pouches alongside your regular-sized coffee cans would likely NOT cause erosion.

Question 9

A decrease in the cost of goods sold is an example of an incremental cash flow.

Question 10

To fully understand the effects of a proposed project, total cash flows should be developed as part of the project's pro forma statements.

Question 11

The recovery of the money spent for inventory related to the project would normally be included in the final cash flow of a project that entailed the development and sale of a new product.

Question 12

Interest expense causes operating cash flow to differ from net income.

Question 13

Sunk costs should be included in the analysis of a project.

Question 14

The loss of sales due to increased competition in the product market is an example of erosion.

Question 15

Selling existing equipment at 10% less than book value would create a source of cash.

Question 16

For the purpose of performing capital budgeting analysis, cash flows must be after-tax.

Question 17

The loss of sales due to a new product recently introduced by your competitor is an example of erosion.

Question 18

A gas station owner expands floor space to make room for a convenience store would likely NOT cause erosion.

Question 19

The money spent to obtain a patent on the new product design would normally be included in the final cash flow of a project that entailed the development and sale of a new product.

Question 20

An increase in accounts receivable is an example of an incremental cash flow.

Question 21

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will have to sell all of the inventory related to the project at a price at least equal to the cost.

Question 22

Depreciation causes operating cash flow to differ from net income.

Question 23

Opportunity costs should be included in the analysis of a project.

Question 24

A company owns a building that is totally paid for. This building has been sitting idle for the past three years. Now the company is trying to analyze a project that would include the use of this building. Therefore, the current market value of the building should be included in that analysis.

Question 25

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will have to sell all of the project's fixed assets at a price at least equal to the book value of the assets

Question 26

The money spent to advertise the new product would normally be included in the final cash flow of a project that entailed the development and sale of a new product.

Question 27

The correct formula for computing the operating cash flow of a project is EBIT + D + T.

Question 28

The cash flows of a project should include the related changes in the fixed assets.

Question 29

Assume project X requires additions to net working capital in each year of its life, all to be recovered at the end. In this case, the present value of the net working capital recovery will exceed the total dollar outlays on net working capital.

Question 30

A company owns a building that is totally paid for. This building has been sitting idle for the past three years. Now the company is trying to analyze a project that would include the use of this building. Therefore, the insurance paid on the building over the past three years should be included in that analysis.

Question 31

Taxes causes operating cash flow to differ from net income.

Question 32

The cash flows of a project should include the related changes in the tax account.

Question 33

A decrease in net working capital is an example of an incremental cash flow.

Question 34

Pro forma statements for a proposed project should be compiled on a stand-alone basis.

Question 35

Fixed costs causes operating cash flow to differ from net income.

Question 36

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will have to pay all of the project's suppliers in full.

Question 37

A new project is expected to have the following effects on the financial statements of a firm. The effect of a decrease in accounts receivable should be included in the net working capital requirements for the project.

Question 38

A company owns a building that is totally paid for. This building has been sitting idle for the past three years. Now the company is trying to analyze a project that would include the use of this building. Therefore, the cost to survey the lot to construct a drainage pond required for the project should be included in that analysis?

Question 39

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will have to collect all of the accounts receivables related to the project.

Question 40

Opportunity costs are considered cash flows of a project.

Question 41

A new project is expected to have the following effects on the financial statements of a firm. The effect of an increase in inventory should be included in the net working capital requirements for the project.

Question 42

The bottom-up approach is used for calculating OCF, if the only information from the statement of comprehensive income items known to you are net income and depreciation.

Question 43

A new project is expected to have the following effects on the financial statements of a firm. The effect of an increase in the depreciation expense should be included in the net working capital requirements for the project.

Question 44

The proper formula of project cash flow is operating cash flow - additions to net working capital - capital spending.

Question 45

The cash flows of a project should include the related changes in accounts payable.

Question 46

The top-down approach is used for calculating OCF, if the only information from the statement of comprehensive income items known to you are net income and depreciation.

Question 47

To fully understand the effects of a proposed project, operating cash flows should be developed as part of the project's pro forma statements.

Question 48

The bottom-up approach for calculating project operating cash flow does not require you to add back noncash deductions such as depreciation.

Question 49

To fully understand the effects of a proposed project, a recap of net working capital requirements should be developed as part of the project's pro forma statements.

Question 50

The cash flows of a project should include the related changes in the long-term debt.

Question 51

The proper formula of project cash flow is operating cash flow - additions to net working capital + recoveries of net working capital

Question 52

The top-down approach for calculating project operating cash flow does not require you to add back noncash deductions such as depreciation.

Question 53

Assume that over the life of project X, net working capital is maintained at an amount equal to the initial investment. If so, net working capital doesn't need to be included in the NPV computation, since the outflow at time zero is exactly (as we generally assume) offset by an equal inflow at the end of the project's life.

Question 54

To fully understand the effects of a proposed project, the statement of comprehensive income should be developed as part of the project's pro forma statements.

Question 55

A company owns a building that is totally paid for. This building has been sitting idle for the past three years. Now the company is trying to analyze a project that would include the use of this building. Therefore, the property taxes paid on the building over the past three years should be included in that analysis.

Question 56

Taxes are considered cash flows of a project.

Question 57

The correct formula of project cash flow is sales - costs - taxes - project capital spending.

Question 58

A new project is expected to have the following effects on the financial statements of a firm. The effect of a reduction in accounts payable should be included in the net working capital requirements for the project.

Question 59

The proper formula of project cash flow is EBIT + D - Taxes - additions to net working capital

Question 60

To reflect the costs associated with a project accurately, the analyst should exclude interest expenses in the computation of operating cash flows.

Question 61

The tax-shield approach is used for calculating OCF, if the only information from the statement of comprehensive income items known to you are net income and depreciation.

Question 62

The EAC method for evaluating projects applies when the projects are mutually exclusive.

Question 63

In a cost-cutting proposal the reduction in costs has the same effect as an increase in sales.

Question 64

A company is evaluating the replacement of the office copier. The cost of the maintenance contract on the new copier should be considered in that evaluation.

Question 65

A company is evaluating the replacement of the office copier. The costs of repairs made today on the existing copier should be considered in that evaluation.

Question 66

Louie's Leisure Products is considering a project which will require the purchase of $1.4 million in new equipment. The equipment belongs in a 20% CCA class. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. Annual sales from this project are estimated at $1.2 million. Net working capital equal to 20% of sales will be required to support the project. All of the net working capital will be recouped at the end of the project. The firm desires a minimal 14% rate of return on this project. The tax rate is 34%.

What is the present value of the net working capital changes associated with the project?
The project is expected to last 7 years.

A) -$144,087
B) -$95,913
C) $0
D) $144,087
E) $184,837

Question 67

Lottie's Boutique needs to maintain 20% of its sales in net working capital. Lottie's is considering a 3-year project which will increase sales from their current level of $110,000 to $130,000 the first year and $145,000 a year for the following two years. What amount should be included in the project analysis for the last year of the project in regards to the net working capital?

A) -$35,000
B) -$7,000
C) $0
D) $7,000
E) $35,000

Question 68

EAC is used to evaluate mutually exclusive projects with different lives if the projects are expected to be continuously replicated.

Question 69

Buildings can be depreciated for tax purposes.

Question 70

Given the following information and assuming a CCA rate of 20%, what is the NPV of this project? Initial investment = $400,000; life = five years; before-tax cost savings = $150,000 per year; salvage value = $30,000 in year 5; tax rate = 34%; discount rate = 14%.

A) -$149,841
B) -$33,117
C) $0
D) $19,800
E) $27,428

Question 71

Machinery and equipment can be depreciated for tax purposes.

Question 72

The tax-shield approach for calculating project operating cash flow does not require you to add back noncash deductions such as depreciation.

Question 73

A company is evaluating the replacement of the office copier. The selling price of the existing copier should be considered in that evaluation.

Question 74

Setting the bid price requires finding the point at which project NPV is zero.

Question 75

A decrease in the corporate tax rate decreases the value of the depreciation tax shield, all else equal.

Question 76

The EAC method for evaluating projects applies when the projects will be replaced more or less indefinitely.

Question 77

You are considering investing in a piece of equipment to implement a cost-cutting proposal. The pre-tax cost reduction is expected to equal $41.67 for each of the three years of the project's life. The equipment has an initial cost of $125 and belongs in a 20% CCA class. Assume a 34% tax bracket, a discount rate of 15%, and a salvage value of zero.

If the equipment is sold to another company at the end of year 3 for $20, what is the NPV?

A) -$33.56
B) -$28.91
C) $0
D) $28.91
E) $33.56

Question 78

Land can be depreciated for tax purposes.

Question 79

The EAC method for evaluating projects applies when the projects have different economic lives.

Question 80

A company is evaluating the replacement of the office copier. The balance due on the current lease, which will be payable even if the copier is returned should be considered in that evaluation.