Deck 11: Cash Flow Estimation

Question 1

Land is depreciated:

A) straight line over 27.5 years if they're residential.
B) using MACRS.
C) straight line over 31.5 years for all property.
D) Land is never depreciated.

Answer 1

D

Question 2

Truman University is thinking of opening an evening college. In figuring the cost of such a project, a figure is provided for lighting of parking lots. It is pointed out by the university's finance officer that a city ordinance requires that the parking lots be lighted whether there is an evening college in session or not. Lighting expenses in this case are:

A) opportunity costs.
B) alternative costs.
C) variable costs.
D) side effects.
E) sunk costs.

Answer 2

E

Question 3

The ____ of a resource is its value in its best alternative use and is included in capital budgeting analysis.

A) opportunity cost
B) sunk cost
C) incremental cash flow
D) None of the above

Answer 3

A

Question 4

If a firm sells an asset for less than its book value:

A) there are major tax consequences.
B) the loss is treated as lost depreciation.
C) the loss reduces depreciation expenses.
D) the loss may reduce taxes.

Question 5

When estimating cash flows for capital budgeting projects:

A) interest expenses incurred to finance the project are included.
B) interest expense is considered in the cash flow estimates only if the financing is principally from debt.
C) interest expense is never included in the cash flow estimates.
D) None of the above

Question 6

Depreciation:

A) does not affect cash flows.
B) does not affect profits.
C) is not a cash outflow.
D) is a cash inflow.

Question 7

Which of the following is a cash flow consideration in evaluating a proposed capital project?

A) Incremental overhead effect
B) Basic overheads
C) Financing costs
D) All of the above

Question 8

The determination of net cash flows should never include:

A) changes in depreciation.
B) changes in operating costs.
C) interest charges.
D) a and b only

Question 9

Which of the following is not a cash flow consideration in evaluating a proposed capital project?

A) Increases in net working capital
B) Basic overhead expenses
C) Sales lost from other parts of the company because of the project
D) Foregone depreciation resulting from a replacement machine

Question 10

For which of the following project types is cash flow estimation most difficult?

A) New Venture
B) Replacement
C) Expansion
D) New Market

Question 11

Which of the following is not considered a relevant factor in estimating the incremental cash flows of a proposed capital project?

A) Pre-startup expenditures
B) Financing costs
C) Incremental working capital requirements
D) Taxes on incremental expenses and earnings

Question 12

Which of the following is not used in the development of cash flow estimates for capital projects?

A) Opportunity costs
B) Financing costs
C) Depreciation costs
D) Taxes
E) Overhead costs

Question 13

The dollar amount of interest charges is:

A) always considered in the net cash flow calculation.
B) normally not considered in the net cash flow calculation.
C) always considered as a part of the net investment.
D) None of the above

Question 14

The cost of financing the project is reflected in the ____ in capital budgeting analysis.

A) initial outlay
B) incremental cash flows
C) cost of capital
D) All of the above

Question 15

Which of the following is not a cash flow consideration in evaluating capital budgeting projects?

A) Income taxes on incremental earnings
B) Identifiable incremental overhead
C) Incremental accounting profit (net income)
D) Depreciation

Question 16

Which of the following are (is) generally considered problems associated with cash flow estimation?

A) Uncertainty about the future cash flows
B) The introduction of bias into the estimation of cash flows
C) Uncertainty about the magnitude of fixed cost financing charges
D) a and b

Question 17

The value of resources used in a capital budgeting project should be measured in terms of their:

A) acquisition cost.
B) historical cost.
C) opportunity cost.
D) depreciated cost.

Question 18

Which of the following is a basic principle when estimating a project's cash flows?

A) Cash flows should be measured on a pretax basis.
B) Cash flows should ignore depreciation because it is a non-cash charge.
C) Only direct effects of a project should be included in cash flow calculations.
D) Cash flows should be measured on an incremental basis.

Question 19

Raider Productions has to decide whether to build its warehouse in Dallas or Houston. This decision falls into the class of:

A) independent projects.
B) mutually exclusive projects.
C) contingent projects.
D) marginal projects.

Question 20

In estimating the net investment, an outlay that has already been made is known as a(n):

A) sunk cost.
B) cash outflow.
C) opportunity cost.
D) expansion cost.

Question 21

In the evaluation of a capital budgeting project, taxes should be:

A) ignored.
B) treated in the same manner as sunk costs.
C) treated as a cash flow in the period in which they are incurred.
D) None of the above

Question 22

"Mr. Stone, I must say you are making a mistake. I know you have spent $6,000 on research and development to develop this project, but that money must not be used as a negative cash flow of the project." Apparently, Mr. Stone does not understand the concept of:

A) side-effect costs.
B) opportunity costs.
C) sunk costs.
D) variable costs.
E) depreciation not taken.

Question 23

In estimating the cost of a new project, the firm should include:

A) fixed costs.
B) sunk costs.
C) opportunity costs.
D) a and b
E) a and c

Question 24

"We have the space and the staff for this new project. They won't cost us a penny." Such a statement seems to ignore the concept of:

A) sunk costs.
B) costs in other parts of the company.
C) fixed costs.
D) opportunity costs.
E) depreciation not taken.

Question 25

According to the incremental cash flow principle, the firm should include:

A) taxes.
B) interest.
C) dividends.
D) a and b
E) a, b, and c

Question 26

Which of the following are not relevant to the evaluation of a capital budgeting project?

A) Sunk costs
B) Financing costs
C) Inflation effects
D) a and c
E) All of the above

Question 27

In estimating cash flows, the firm should exclude:

A) the interest expense on debt financing.
B) opportunity costs.
C) sunk costs.
D) a and c
E) a, b, and c

Question 28

The most difficult part of the capital budgeting process is:

A) application of evaluation techniques such as NPV or IRR.
B) interpreting the results of the application of NPV or IRR.
C) estimation of the incremental project cash flows.
D) None of the above

Question 29

Which of the following is true of opportunity costs?

A) Not included in initial cash flow
B) Must be estimated and included in the cash flows of the project
C) Similar to sunk costs
D) Should be ignored by the firm
E) Similar to fixed costs

Question 30

According to the incremental cash flow principle, a firm should:

A) include variable costs and fixed costs.
B) exclude variable costs and fixed costs in the project's cash flows.
C) include variable costs and exclude fixed costs in the project's cash flows.
D) include sunk costs in the project's cash flows.
E) exclude opportunity costs in the project's cash flows.

Question 31

In estimating cash flows, the firm should include:

A) effects on other parts of the company.
B) fixed costs.
C) opportunity costs.
D) a and c
E) a, b, and c

Question 32

Which of the following is true of sunk costs?

A) Similar to opportunity costs
B) Not included in initial cash flow
C) Often combined with terminal cash flow
D) Deciding factor in most project decisions
E) Similar to variable costs

Question 33

Sunk costs:

A) cannot be estimated accurately.
B) represent an initial period of cash flow of a capital budgeting project.
C) have been incurred in prior periods.
D) None of the above

Question 34

The sunk costs associated with an asset to be replaced should be:

A) ignored in the valuation of an capital budgeting project.
B) included as an initial period cash outflow in the evaluation of a capital budgeting project.
C) included as a project termination cash outflow in the evaluation of a capital budgeting project.
D) None of the above

Question 35

A vice president of a manufacturing company said: "We own five acres of land next to our own plant. It won't cost us a thing to use that land for our new expansion wing." That vice president does not fully understand the concept of:

A) sunk costs.
B) side-effect costs.
C) fixed costs.
D) opportunity costs.
E) depreciation.

Question 36

Sunk costs are:

A) outlays that have already made and that would not affect future decisions.
B) similar to opportunity costs.
C) fixed costs that must be included in the project's cash flows.
D) variable costs that must be included in the project's cash flows.
E) the deciding factor in most project decisions.

Question 37

In estimating the cost of a new project, the firm should exclude:

A) opportunity costs.
B) fixed costs.
C) variable costs.
D) alternative costs.
E) b and c

Question 38

In estimating cash flows, the firm should include:

A) changes in working capital.
B) taxes.
C) effects on other parts of the company
D) a and b
E) a, b, and c

Question 39

Working capital to support the demands of a new project must be funded with cash. The assets primarily associated with such working capital requirements include:

A) machinery and equipment.
B) inventory and accounts receivable.
C) land and buildings.
D) All of the above

Question 40

In estimating project cash flows, ____ is generally excluded.

A) dividends
B) effects on other parts of the company
C) proceeds from sales
D) a and b
E) a and c

Question 41

A new replacement machine is being considered that will save $105,000 per year in labor cost and $20,000 on maintenance. The company's marginal tax rate is 34%. The replacement will also generate a tax savings from depreciation of $5,000. Estimate the incremental cash flow for the first year associated with buying the new machine.

A) $87,500
B) $82,500
C) $42,500
D) $51,100

Question 42

Holding all other variables constant, an increase in the cost of equipment at the beginning of the project would affect which of the following?

A) Initial Outlay
B) Incremental cash flows
C) Opportunity costs
D) Both a & b

Question 43

To evaluate a proposed capital project effectively, it is important to understand the fundamental concept of incremental cash flows. Incremental cash flows can be viewed as cash flows:

A) in addition to the company's normal business.
B) separate from the company's normal business.
C) occurring only if the project is undertaken.
D) All of the above

Question 44

There is a capital gain on the sale of an asset for:

A) more than its original cost.
B) more than its book value but less than its original cost.
C) a and b
D) None of the above

Question 45

A capital budgeting project that calls for a replacement decision:

A) normally does not increase the volume of a firm's operations.
B) results in total cash flows that are equal to incremental cash flows.
C) has no initial period cash flows.
D) None of the above

Question 46

Which of the following is true of replacement projects?

A) They generate costs that are planned and directly related to the sales forecast.
B) Their benefits usually come from expected savings.
C) They need not be adjusted for depreciation and taxes.
D) They imply increases in costs and revenues.

Question 47

Holding all other variables constant, which of the following would decrease incremental cash flows for a capital budgeting project?

A) Paying suppliers in 45 days versus 30 days
B) An decrease in depreciation expense
C) An increase in the cost ratio
D) Both a & b
E) All of the above

Question 48

Cash flows that are foregone if the project is undertaken should be included in cash flow estimation. Such a foregone resource is normally referred to as:

A) sunk costs.
B) opportunity costs.
C) resource relinquishment.
D) None of the above

Question 49

The interest rate associated with financing a capital budgeting project:

A) should be included in the estimate of the proposal's incremental cash flows.
B) should be ignored in the evaluation of the capital budgeting project.
C) is reflected in the cost of capital.
D) None of the above

Question 50

Suppose a project involving the introduction of a new product is marginally profitable based on a 6-year cash flow estimate, but becomes much more profitable if two additional years are included in the analysis. How much weight would you assign to the two additional years of cash flows?

A) The two additional years of cash flows should not be considered.
B) The two additional years of cash flows should be treated just like the first six years.
C) The two additional years of cash flows should be treated just like the first six years if management is confident that the product will be viable for eight years.
D) Because the distant future is increasingly uncertain analytical extensions that make a marginal project look good should be considered with substantial skepticism.
E) Both c. and d. may be correct depending on the situation.

Question 51

Most firms choose accelerated depreciation for tax accounting because:

A) reported net income is higher.
B) tax payments are made sooner, resulting in a lower deferred tax liability.
C) operating expenses are correspondingly reduced.
D) income taxes are deferred.

Question 52

When calculating the net cash flow in a project's expected final year:

A) recovery of any working capital invested is disregarded.
B) the after-tax salvage value of project equipment is considered.
C) the remaining principal on any borrowed funds is considered.
D) the sales proceeds from any land associated with the project is disregarded.

Question 53

When a firm sells an asset for ____, it realizes a capital gain and must pay income taxes on it.

A) book value
B) less than book value
C) more than book value
D) any amount

Question 54

The initial outlay calculation for an asset replacement decision normally includes any:

A) after-tax salvage value of the old asset.
B) an initial buildup in net working capital.
C) interest expense.
D) a and b

Question 55

Certain expenditures associated with a project should not be included in capital budgeting cash flows. Such expenditures, referred to as sunk costs, might include:

A) the cost of an existing resource that will no longer be available for other uses.
B) a costly market study previously undertaken to determine the viability of the project.
C) Both a and b
D) Neither a nor b

Question 56

Sale of an asset for less than book value creates a loss which reduces the company's taxes by an amount equal to ____ times ____.

A) one-half the loss, the company's marginal tax rate
B) the loss, one minus the company's marginal tax rate
C) one-half the loss, one minus the company's marginal tax rate
D) the loss, the company's marginal tax rate

Question 57

The initial outlay calculation for an ____ project normally includes ____.

A) asset expansion; pretax proceeds from the sale of the old asset
B) asset replacement; pretax proceeds from the sale of the old asset
C) asset expansion; after-tax proceeds from the sale of the old asset
D) asset replacement; after-tax proceeds from the sale of the old asset

Question 58

In terms of the capital budgeting process, net cash flows are:

A) the net cash outlays required to place a project in service.
B) the funds invested in additional assets.
C) incremental changes in a firm's cash flow.
D) the outlays that have already been made.

Question 59

How should managers deal with subjective cash flow estimates (e.g. claiming positive cash flows for improved customer satisfaction related to better product quality)?

A) Cash flows that cannot be verified should be excluded.
B) A range of estimates should be considered, and the estimate that best justifies the project should be selected.
C) A range of estimates should be considered, and the lowest end of the range should be selected.
D) Subjective estimates should be included only if they are directly related to the project and are reasonable and conservative.
E) Only subjective estimates relating to product quality should be considered.

Question 60

There is neither a gain nor a loss on the sale of a depreciable asset for an amount exactly equal to its:

A) acquisition cost.
B) tax book value.
C) opportunity cost.
D) historical cost.

Question 61

Which of the following is considered a relevant cash flow?

A) A market feasibility study already performed prior to the project
B) Interest expense associated with financing the project
C) Initial cost of hiring and training employees
D) Both b & c
E) All of the above

Question 62

MACRS is:

A) a government program to assist small businesses in capital budgeting.
B) a system of accelerated depreciation that companies are free to use or not for financial purposes.
C) a system of accelerated depreciation dictated by the government for tax purposes.
D) the Mandatory Accounting Credit and Reserve System.

Question 63

If a depreciable asset is sold:

A) there is no tax consequence.
B) the sale price minus the book value is added to the firm's income and is taxed at the firm's long term capital gain tax rate.
C) the sale price is added to the firm's income and is taxed at the firm's marginal tax rate.
D) the sale price minus the book value is added to the firm's income and is taxed at the firm's marginal tax rate.
E) the sale price minus the book value is added to the firm's income and is taxed at the firm's average tax rate.

Question 64

Holding all other variables constant, which of the following would DECREASE annual after-tax cash flows on a project?

A) A decrease in depreciation expense
B) A decrease in the savings projected due to the project's improving product quality
C) A decrease in interest expense
D) Both a & b
E) All of the above

Question 65

According to the Modified Accelerated Cost Recovery System (MACRS), which assets are classified as a 5-year asset?

A) Computers
B) Industrial equipment
C) Trucks
D) Manufacturing tools
E) a and c

Question 66

As a financial person you would be concerned because marketing analyses frequently: I. Overstate NPV by using the wrong interest rate.
II) Are biased in favor of the projects they propose and estimate unrealistic cash flows.
III) Choose projects in areas that the firm knows nothing about.

A) I, II, and III
B) II and III
C) I and III
D) I and II

Question 67

Which of the following is true of the accelerated depreciation?

A) It makes companies pay more taxes in the early years of an asset's life.
B) It allows companies to charge more depreciation in the early years of an asset's life.
C) It lets companies show higher book profits in the short run even when the cash flows are lower.
D) It defers most of the depreciation charge towards the later years of an asset's life.

Question 68

What type of benefits is hard to quantify and lead to favorable biases when estimated by people who want project approval?

A) Objective benefits
B) Opportunity benefits
C) Subjective benefits
D) Sunk benefits

Question 69

An example of an opportunity cost is:

A) an idle plant that could be sold if it is not used for the new project.
B) the cost of incremental working capital.
C) the cost of a market study done last year.
D) a and b

Question 70

Holding all other variables constant, which of the following would DECREASE the Net Working Capital investment required on a project?

A) Allowing customers a shorter time to pay for purchases
B) Taking a longer time to pay suppliers
C) Reducing inventory levels
D) Both a & c
E) All of the above

Question 71

An increase in sales may lead to:

A) a decrease in receivables.
B) a decrease in working capital.
C) an increase in fixed assets.
D) an increase in payables.

Question 72

Many capital projects require increases in net working capital. Which of the following would be included in the net working capital requirements of a capital project?

A) Machinery and equipment
B) Accounts receivable and accounts payable
C) Long term debt
D) Fixed assets net of depreciation
E) All of the above would be included in net working capital requirements.

Question 73

Inaccurate cash flow estimates originate from several sources. The most significant of these is:

A) estimating errors made by unbiased financial analysts.
B) estimating errors made by unbiased managers in the departments proposing projects.
C) unintentionally biased estimates made by impartial financial analysts.
D) errors due to the biases of managers in the departments proposing projects.

Question 74

The depreciation permitted for tax purposes is generally:

A) the same as economic depreciation.
B) different from economic depreciation.
C) not tax deductible.
D) tax deductible at the firm's average tax rate.
E) b and d

Question 75

Which of the following capital budgeting techniques might not consider the terminal value of a project?

A) Net Present Value
B) Internal Rate of Return
C) Profitability Index
D) Payback Period

Question 76

Which of the following issues related to a new venture will affect the terminal value calculation?

A) The magnitude of the cash flow at the end of the detailed forecast period
B) Aggressive assumptions about growth in the long run
C) The generation of substantial revenues in the last years of the detailed forecast period
D) Changing economic conditions that affect long term growth prospects
E) All of the above

Question 77

Tribune Company purchases an inventory of paper for $1,000 on credit. All other working capital items remain the same. The change in net working capital that results from this transaction is:

A) $1,000.
B) $2,000.
C) zero.
D) $4,000.
E) $5,400.

Question 78

The Modified Accelerated Cost Recovery System (MACRS) is often used by companies to calculate depreciation expense for tax purposes. Which of the following is most correct?

A) MACRS allows greater tax deductions related to depreciation earlier in the life of an asset than straight line depreciation does.
B) MACRS uses the half-year convention in calculating depreciation expense.
C) MACRS always depreciates the value of an asset down to zero (as opposed to a salvage value) if the asset is held long enough by the company.
D) Even though depreciation is a non-cash expense, the use of MACRS can improve the profitability of a project as compared to the same project using straight line depreciation.
E) All of the above are correct.

Question 79

There's a strong argument that terminal values based on infinite projections shouldn't be used in capital budgeting because of the uncertainty of the distant future. This position maintains that if a project can't be justified in a reasonably long time, it shouldn't be undertaken. The time frame associated with this argument is usually about:

A) 5 years.
B) 10 years.
C) 20 years.
D) None of the above

Question 80

Terminal value assumptions can lead to bad capital budgeting decisions because:

A) the mathematics are tricky and difficult to understand.
B) almost any project can be made to look good with an aggressive terminal value assumption.
C) nothing lasts forever.
D) almost all growth assumptions are unreasonable.