Deck 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions

Question 1

Discounting real cash flows at a nominal rate is a serious mistake.

Answer 1

True

Question 2

An asset in the MACRS 5-year class life will have depreciation expense in 6 different years.

Answer 2

True

Question 3

The method of financing a project affects the determination of its cash flows for capital budgeting purposes.

Answer 3

False

Question 4

If a firm sells an asset for more than its value in the IRS's books,the resulting net cash flow will be less than the sales price.

Question 5

Discounting real cash flows with real interest rates provides an overly optimistic idea of a project's value.

Question 6

Sunk costs do not affect the net present value of a project.

Question 7

A project will always generate extra overhead costs.

Question 8

Suppose you finance a project partly with debt.You should neither subtract the debt proceeds from the project's required investment,nor would you recognize the interest and principal payments on the debt as cash outflows.

Question 9

Sunk costs influence capital budgeting decisions only when the sunk costs exceed future cash inflows.

Question 10

Opportunity costs are evaluated for investment decisions at their historical cost.

Question 11

Investments in working capital,just like investments in plant and equipment,result in cash inflows.

Question 12

As a project comes to its end,there is a disinvestment in working capital,which also generates positive cash flow as inventories are sold off and accounts receivable are collected.

Question 13

Accurate capital budgeting analysis depends on total cash flows as opposed to incremental cash flows.

Question 14

Sunk costs remain the same whether or not you accept the project.

Question 15

In project analysis,allocations of overhead should be limited to those that represent additional expense.

Question 16

A reduction in working capital increases cash flows.

Question 17

When a firm makes an investment in working capital,the cash is usually recovered later.

Question 18

Capital budgeting analysis focuses on cash flow as opposed to profits.

Question 19

The present value of the total depreciation tax shield will be higher when an asset uses MACRS than when depreciated straight-line.

Question 20

When you finance a project partly with debt,you should still view the project as if it were all equity-financed,treating all cash outflows required for the project as coming from stockholders,and all cash inflows as going to them.

Question 21

What is the effect on a firm's net working capital if a new project requires a $30,000 increase in inventory,a $10,000 increase in accounts receivable,a $35,000 expenditure on machinery,and a $20,000 increase in accounts payable?

A) −$5,000
B) $10,000
C) $20,000
D) $55,000

Question 22

Which one of the following is least likely to influence the opportunity cost of an asset?

A) Its current market value
B) Alternative uses for the asset
C) The current demand for the asset
D) Its current book value

Question 23

Assume your firm has an unused machine that originally cost $75,000,has a book value of $20,000,and a market value of $25,000.Ignoring taxes,what is the opportunity cost of using this machine?

A) $75,000
B) $25,000
C) $20,000
D) $5,000

Question 24

Cash flow from operations = (revenues − cash expenses)× (1 − tax rate)+ (depreciation × tax rate).

Question 25

Which one of the following changes in working capital is least likely if sales increase?

A) An increase in inventories
B) An increase in accounts payable
C) A decrease in accounts receivable
D) An increase in notes payable

Question 26

Investments in working capital:

A) are simply accounting entries and do not affect NPV.
B) do not matter because the cash is generally recovered when the project ends.
C) increase NPV because they make the project more valuable.
D) reduce project NPV.

Question 27

You are considering the introduction of a new product that will require an investment in new machinery.Which one of these will lower the net present value of that project?

A) A reduction in the firm's total variable costs due to the purchase of the new machine
B) A loss of sales of existing products due to the introduction of the new product
C) The increase in annual depreciation resulting from the asset purchase
D) The sale of the machine after it is fully depreciated

Question 28

The opportunity cost of an asset:

A) should be depreciated annually.
B) should be included in the project cash flows.
C) is typically ignored in capital budgeting.
D) is important only for parcels of land.

Question 29

A project is expected to increase inventory by $17,000,increase accounts payable by $10,000,and decrease accounts receivable by $1,000.What is the project's cash flow from net working capital at time zero?

A) −$8,000
B) $8,000
C) −$6,000
D) $6,000

Question 30

Corporate income statements are designed primarily to show:

A) cash flows during a period.
B) account balances at the end of a period.
C) performance during a period.
D) market values of assets and liabilities.

Question 31

In which of the following cases will a cash investment in net working capital be most likely?

A) Inventory levels will be reduced when the project is introduced.
B) All sales related to the project will be cash sales to a subsidiary.
C) The project will increase inventory more than accounts payable.
D) The project will require additional inventory which will be financed by a supplier.

Question 32

Projects that have negative NPVs should be:

A) depreciated over a longer time period.
B) charged less in overhead costs.
C) discounted using lower rates.
D) rejected or abandoned.

Question 33

If the adoption of a new product will reduce the sales of an existing product,then the project cash flows should:

A) reflect only the sales of the new product.
B) include only the reduction amount.
C) be reduced by the cash that would have been generated by those sales.
D) be adjusted upward by the reduction amount.

Question 34

The rationale for not including sunk costs in capital budgeting decisions is that they:

A) are usually small in magnitude.
B) revert at the end of the investment.
C) have no incremental effect on project cash flows.
D) reduce the project's net present value.

Question 35

When is it appropriate to include sunk costs in the evaluation of a project?

A) Whenever they are relatively large
B) If they improve the project's NPV
C) If they are considered to be overhead costs
D) Never

Question 36

The total depreciation tax shield equals the product of depreciation and the tax rate.

Question 37

A proposed project requires an initial investment of $8,500 in current assets,75% of which will be financed with accounts payable.The project will have:

A) an initial cash outflow of $8,500 at time zero for net working capital.
B) a cash outflow for net working capital at the end of the project.
C) a cash inflow at the end of the project from net working capital.
D) a cash outflow for net working capital every year of the project's life.

Question 38

A firm invests in a 7-year project that requires the purchase of a $135,000 machine tool.This will be depreciated using 5-year MACRS and will have no salvage value.When will this equipment affect the project's tax payments?

A) Every year for 5 years
B) At the time of purchase only
C) Every year for 6 years
D) Every year for 7 years

Question 39

Net working capital is expected to increase by $25,000 in year 5 of a project.If this extra working capital is recovered when the project ends in year 6,what is the effect on the project's net present value,if the cost of capital is 15%?

A) NPV will not be affected because the $25,000 will all be recouped.
B) NPV will increase by $12,429.42.
C) NPV will decrease by $25,000.
D) NPV will decrease by $1,621.23.

Question 40

Which one of these represents a cash outflow for a project?

A) A sunk cost
B) Increase in accounts receivable
C) Depreciation
D) Accrued expenses

Question 41

Which one of the following categories would be least likely to require annual adjustments in a capital budgeting analysis due to the effects of inflation?

A) Sales
B) Expenses
C) Working capital
D) Depreciation expense

Question 42

What is the amount of the annual depreciation tax shield for a firm with $200,000 in net income,$75,000 in depreciation expense,and a 35% marginal tax rate?

A) $26,250
B) $43,750
C) $70,000
D) $75,000

Question 43

Which one of the following would be more apt to make an unacceptable project appear acceptable?

A) Discounting real cash flows with real rates
B) Discounting nominal cash flows with real rates
C) Discounting real cash flows with nominal rates
D) Discounting nominal cash flows with nominal rates

Question 44

The correct method to handle overhead costs in capital budgeting is to:

A) allocate a portion to each project.
B) allocate them to projects with the highest NPVs.
C) ignore all except incremental amounts.
D) ignore them in all cases.

Question 45

When calculating cash flow from operations,one should:

A) subtract depreciation since it represents the cost of replacing worn-out equipment.
B) deduct the depreciation tax shield from after-tax profit.
C) use after-tax profit and ignore depreciation.
D) add depreciation to after-tax profit.

Question 46

Given a positive discount rate,which one of the following changes would increase the NPV of a project?

A) Increasing the firm's opportunity cost of capital
B) Reducing the amount of working capital that is needed.
C) Spreading the total cash inflows over a longer time interval
D) Increasing the project's estimated expenses

Question 47

The likely effect of discounting nominal cash flows with real interest rates will be to:

A) make an investment's NPV appear more attractive.
B) make an investment's NPV appear less attractive.
C) correctly calculate an investment's NPV if inflation is expected.
D) correctly calculate an investment's NPV, regardless of expected inflation.

Question 48

A tax shield is equal to the reduction in a firm's:

A) total tax liability resulting from a tax deductible expense.
B) taxable income resulting from depreciation.
C) taxable income resulting from a decrease in long-term debt.
D) net income caused by depreciation.

Question 49

The NPV of an investment proposal becomes negative solely as a result of allocating a portion of the corporation president's salary.It is most likely the case that:

A) the project should be accepted.
B) rejecting the project is the correct decision.
C) the allocation should be postponed until the project is accepted.
D) the salary should be considered an opportunity cost of the project.

Question 50

What effect is likely at the end of the life of a project that required a $20,000 investment in net working capital?

A) The $20,000 must now be paid by the firm.
B) The firm receives a $20,000 cash inflow.
C) Taxable income is reduced by $20,000.
D) No effects are expected because the $20,000 is now a sunk cost.

Question 51

Allocations of overheads should not affect a project's incremental cash flows unless the:

A) project actually changes the total amount of overhead expenses.
B) overhead will not be recovered at the end of the project.
C) overhead is not currently fully allocated to existing projects.
D) accountant is required to allocate costs to this project.

Question 52

Capital budgeting proposals should be evaluated as if the project were financed:

A) entirely by debt.
B) entirely by equity.
C) half by debt and half by equity.
D) with the highest cost source of funds, to be safe.

Question 53

In what manner does depreciation expense affect investment projects?

A) It reduces cash flows by the amount of the depreciation expense.
B) It increases cash flows by the amount of the depreciation expense.
C) It reduces taxable income by the amount of the depreciation expense.
D) It reduces taxes by the amount of the depreciation expense.

Question 54

Your forecast shows $500,000 annually in sales for each of the next 3 years.If your second and third year predictions have failed to incorporate the 3% expected annual inflation,how far off in total dollar sales is your 3-year forecast?

A) $45,450
B) $60,900
C) $52,550
D) $76,250

Question 55

The recovery of an additional investment in working capital is likely to:

A) occur at the end of a project's life.
B) occur at the beginning of a project's life.
C) occur whenever the project first shows a profit.
D) be a sunk cost.

Question 56

Which one of the following methods will provide a correct analysis for capital budgeting purposes?

A) Discounting real cash flows with real rates.
B) Discounting real cash flows with nominal rates.
C) Discounting nominal cash flows with real rates.
D) Discounting nominal cash flows with either real or nominal rates.

Question 57

Changes in net working capital can occur at:

A) the beginning of a project.
B) the end of a project.
C) any time during the life of a project.
D) the beginning of any accounting period.

Question 58

What is the annual depreciation tax shield for a profitable firm in the 30% marginal tax bracket with $100,000 of annual depreciation expense?

A) $10,500
B) $30,000
C) $35,000
D) $65,000

Question 59

What is the operating cash flow for a firm with $500,000 profit before tax,$100,000 depreciation expense,and a 35% marginal tax rate?

A) $260,000
B) $325,000
C) $360,000
D) $425,000

Question 60

Which one of the following would not be expected to affect the decision of whether to undertake an investment?

A) Income tax rates
B) Estimates of future inflation rates
C) Sales reductions in other products caused by this investment
D) Cost of the feasibility study that was conducted for this project

Question 61

The present value of the depreciation tax shield at any given discount rate is:

A) equal for all depreciation methods.
B) higher with MACRS than with straight-line depreciation.
C) higher for the 7-year recovery period than for the 5-year recovery period class.
D) likely to increase annually due to inflation.

Question 62

At a 13% cost of capital,a project's NPV is $100,000 if you invest today.By what amount must the initial cost of the project decrease before you would wish to wait 2 years before investing? Assume all else is held constant.

A) $21,685
B) $26,000
C) $27,690
D) $29,380

Question 63

Methods of accelerated depreciation:

A) allow more total depreciation over the asset's life.
B) decrease the depreciation tax shield.
C) increase the depreciation tax shield.
D) allow assets to be depreciated more rapidly.

Question 64

The opportunity cost of a resource should be considered in project analysis,unless:

A) negative cash flows result from its use.
B) the resource was purchased in a prior time period.
C) the resource has been fully depreciated.
D) the resource has no identifiable market value or alternative use within the firm.

Question 65

A new inventory system will immediately reduce inventory levels by $100,000.If this reduction is permanent and the cost of capital is 13%,how does the net working capital change affect company value?

A) Company value increases by $100,000.
B) NPV increases by $13,000.
C) Company value will not change.
D) Company value increases by $769,231.

Question 66

What is the undiscounted cash flow in the final year of an investment,assuming $10,000 after-tax cash flows from operations,$1,000 from the sale of a fully depreciated machine,a $2,000 investment in working capital,and a 35% tax rate?

A) $8,450
B) $12,600
C) $12,650
D) $14,000

Question 67

Why is accelerated depreciation often favored for the corporation's set of tax books?

A) It increases the total depreciation tax shield over the project's life.
B) It reduces the total amount of taxes paid over the project's life.
C) It increases net accounting profits over the project's life.
D) It allows the depreciation tax savings to be realized earlier.

Question 68

Which one of the following statements regarding depreciation is correct?

A) The depreciation tax shield adjusts annually with the level of inflation.
B) The real amount of annual depreciation is fixed, thus the higher the rate of inflation, the higher the depreciation tax shield.
C) Tax law allows accelerated depreciation to be used for tax purposes.
D) MACRS can be used for accounting purposes but not for tax purposes.

Question 69

Which of the following correctly adjusts for depreciation when calculating a project's operating cash flow?

A) (revenues − cash expenses) × (1 − tax rate) + (tax rate × depreciation).
B) pretax profit + depreciation tax shield.
C) after-tax profit − depreciation.
D) ignore depreciation since it is not a cash flow.

Question 70

An investment today of $25,000 promises to return $10,000 annually for the next 3 years.What is the real rate of return on this investment if inflation averages 6% annually during the period?

A) 3.49%
B) 9.78%
C) 4.84%
D) 6.38%

Question 71

Under the MACRS:

A) all assets are depreciated over 5 years.
B) depreciable percentages decline throughout the asset's class life.
C) straight-line depreciation percentages are doubled.
D) assets are assumed to be purchased and sold midyear.

Question 72

When a depreciable asset is ultimately sold,the sales price is:

A) fully taxable.
B) nontaxable.
C) nontaxable only if accelerated depreciation was used.
D) taxable to the extent that the sales price exceeds book value.

Question 73

If inflation is forecast to increase,which of the company's following cash flows is most likely to change?

A) The depreciation tax shield.
B) Labor costs.
C) Costs of raw materials purchased on a fixed price contract.
D) Interest payments on its long-term debt.

Question 74

When the real rate of interest is less than the nominal rate of interest,then:

A) disinflation must be occurring.
B) investment returns cannot increase the purchasing power of an investment.
C) nominal cash flows should be discounted with real rates.
D) the rate of inflation must be positive.

Question 75

The modified accelerated cost recovery system (MACRS)allows an increase:

A) in total depreciation over the asset's life.
B) in annual depreciation during earlier years.
C) in real but not nominal depreciation expense.
D) in the asset's depreciable cost basis.

Question 76

The statement "We've got too much invested in that project to pull out now" possibly illustrates the need to:

A) switch to an accelerated method of depreciation.
B) recognize sunk costs.
C) reduce net working capital assigned to the project.
D) reduce discount rates to improve NPV.

Question 77

A project costs $12,800 and is expected to provide a real cash inflow of $10,000 at the end of each of years 1 through 5.Calculate the net present value of this project if inflation is expected to be 4% in each year and the firm employs a nominal discount rate of 10.76%.

A) $33,522.30
B) $28,756.79
C) $33,294.07
D) $26,311.15

Question 78

A new project requires an increase in both current assets and current liabilities of $125,000 each.What is the overall impact on the net working capital investment?

A) An increase of zero
B) An increase of $125,000
C) An increase of $250,000
D) An increase of $62,500, when averaged over the life of the project

Question 79

The primary difficulty in the allocation of overhead costs to prospective projects is that the:

A) allocation will reduce the project's NPV.
B) discount rate is unknown.
C) costs may not represent an incremental expense.
D) expenses may have been previously allocated.

Question 80

A firm plans to purchase a $50,000 asset that will be depreciated straight-line over a 5-year life to a zero salvage value.What is the present value of the resulting depreciation tax shield if the tax rate is 35% and the discount rate is 10%?

A) $10,866.67
B) $13,267.75
C) $17,500.00
D) $37,908.18