Deck 10: Cash Flow Estimation

Question 1

To get the operating cash flow, given the net income, we add back ________.

A) cost of goods sold
B) depreciation
C) taxes
D) EBIT

Answer 1

B

Question 2

If the company had a large depreciation expense during the period, the income statement could show a loss for the period, even though the cash account may have grown during the same period.

Answer 2

True

Question 3

A firm can spend its reported profits.

Answer 3

False

Question 4

The projected revenues and costs that form the basis of the potential for a project's acceptance or rejection are estimates of ________.

A) future activity
B) past activity
C) known activity
D) current activity

Question 5

The revenue is $24,000, the cost of goods sold is $12,000, other expenses (from selling and administration) are $6,000, and depreciation is $2,000. What is the EBIT?

A) $12,000
B) $6,000
C) $4,000
D) $2,000

Question 6

The revenue is $25,000, the cost of goods sold is $11,000, other expenses (from selling and administration) are $7,000, and depreciation is $1,000. What is the EBIT?

A) $13,000
B) $7,000
C) $6,000
D) Cannot tell because we do not know the interest paid.

Question 7

Which of the statements below is FALSE?

A) A company could show a loss for the operating period but have generated positive cash flow for the business.
B) Profits are an accounting measure of performance during a specific period of time.
C) To obtain the operating cash flow, given the net income, we add back depreciation and subtract taxes.
D) Cash flow is an accounting measure of performance during a specific period of time.

Question 8

Operating Cash Flow (OCF) = EBIT + Depreciation + Taxes.

Question 9

The EBIT is $20,000, depreciation is $5,000, and taxes are $3,000. What is the operating cash flow (OCF)?

A) $25,000
B) $22,000
C) $14,000
D) $25,000

Question 10

Operating Cash Flow (OCF) is equal to what?

A) EBIT - Depreciation + Taxes
B) EBIT + Depreciation - Taxes
C) EBIT - Depreciation - Taxes
D) EBIT + Depreciation + Taxes

Question 11

________ are an accounting measure of performance during a specific period of time, while ________ is the actual inflow or outflow of money.

A) Profits, cash flow
B) Cash flows, profit
C) Dividends, cash flow
D) Profits, a dividend

Question 12

Most businesses fail because their ________ dries up.

A) net working capital
B) cash flow
C) liabilities
D) tax shield

Question 13

Consider the case of a business that has had a very profitable year and earned a million dollars in profits. Can it distribute a million dollars to its owners (via dividends)?

A) Yes, definitely.
B) Maybe, maybe not.
C) Definitely not.
D) It can certainly distribute over a million dollars.

Question 14

On a corporate income statement interest is paid after taxes are paid.

Question 15

Explain the distinction between profits and cash flow.

Question 16

Explain how to compute an operating cash flow (OCF) from a modified income statement.

Question 17

A major metric of a company's health and its prospects for a long life is how much ________ it can generate.

A) cash flow
B) depreciation
C) tax deferral
D) net income

Question 18

Profits can be defined as an accounting measure of performance during a specific period of time.

Question 19

The ________ are critical to business decisions, business growth, and ultimately business success.

A) risk and timing but not the amount of cash flow
B) the currency denomination of profits
C) risk and profits but not the amount of cash flow
D) timing and amount of cash flow

Question 20

A firm has revenue of $50,000, the cost of goods sold is $23,000, other expenses (from selling and administration) are $14,000, interest expenses are $4,000 and depreciation is $5,000. What is the EBIT?

A) $4,000
B) $8,000
C) $13,000
D) $27,000

Question 21

A firm is considering purchasing an asset that will have a useful life of 10 years and cost $5 million; it will have installation costs of $500,000 and a salvage or residual value of $500,000. What is the annual straight-line depreciation for this asset?

A) $400,000 per year
B) $500,000 per year
C) $600,000 per year
D) $700,000 per year

Question 22

Whenever a new product competes against a company's already existing products and reduces the sales of the other products, net working capital increases occur.

Question 23

________ is the process of "expiring" the cost of a long-term tangible asset over its useful life.

A) Expiration
B) Depreciation
C) Economic recovery
D) Salvaging

Question 24

If four plus five equals ten, that's synergy.

Question 25

________ of a project are those that have already been incurred and cannot be reversed.

A) Erosion costs
B) Opportunity costs
C) Sunk costs
D) Working capital costs

Question 26

Name and describe three issues that can affect the incremental cash flow of a new project.

Question 27

A firm is considering purchasing two assets. Asset L will have a useful life of 20 years and cost $5 million; it will have installation costs of $1 million but no salvage or residual value. Asset S will have a useful life of 8 years and cost $2 million; it will have installation costs of $500,000 and a salvage or residual value of $400,000. Which asset will have a greater annual straight-line depreciation?

A) Asset L has $12,500 more in depreciation per year.
B) Asset L has $37,500 more in depreciation per year.
C) Asset S has $12,500 more in depreciation per year.
D) Asset S has $37,500 more in depreciation per year.

Question 28

Explain why one must be careful when accounting for erosion.

Question 29

Whenever a new product competes against a company''s already existing products and reduces the sales of those products, ________ occur.

A) erosion costs
B) opportunity costs
C) sunk costs
D) working capital costs

Question 30

In terms of revenues and costs for a project, which of the statements below is FALSE?

A) Projected revenues and costs are estimates of future activity.
B) Estimates of revenues and costs begin with operating cash flow of the project.
C) Projected revenues and costs form the basis of the potential for a project's acceptance or rejection.
D) Estimates of revenues and costs begin with sales forecasts and the production costs associated with the sales forecast.

Question 31

Erosion is the additional cash generated by a new project beyond the current cash flow with the addition of a specific new project.

Question 32

The are two main reasons why we need to deal with depreciation. Which of the below is one of these reasons?

A) The gain but not the loss when a capital asset is disposed
B) The loss but not the gain when a capital asset is disposed
C) The tax flow implications from the OCF
D) The tax rate implications from the OCF

Question 33

Managers typically look at the initial outlay for the project as its capital expenditure and determine ________ from this capital expenditure.

A) interest expenses
B) dividends
C) depreciation
D) CEO expenses

Question 34

A firm is considering purchasing two assets. Asset A will have a useful life of 12 years and cost $4 million; it will have installation costs of $300,000 and a salvage or residual value of $400,000. Asset B will have a useful life of 8 years and cost $3.5 million; it will have installation costs of $200,000 and a salvage or residual value of $800,000. Which asset will have a greater annual straight-line depreciation?

A) Asset A has $30,000 more in depreciation per year.
B) Asset A has $37,500 more in depreciation per year.
C) Asset B has $30,000 more in depreciation per year.
D) Asset B has $37,500 more in depreciation per year.

Question 35

Which of the methods below is a way to allocate depreciation?

A) Each year is allocated the amount of cost as determined by the actual estimated usage for that year.
B) Use the government-mandated accelerated depreciation system, which depreciates the capital asset at the minimum accelerated amount allowed each year.
C) Each year is allocated the same amount of cost as determined by the average expected operating cash inflow divided by the number of years of useful life of the machines.
D) Use the government-mandated accelerated depreciation system, which depreciates the capital asset at the maximum accelerated amount allowed each year.

Question 36

________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow of a new project.

A) Cost recovery of divested assets
B) Capital expenditures
C) Sunk costs
D) Opportunity costs

Question 37

A firm is considering purchasing two assets. Asset A will have a useful life of 15 years and cost $3 million; it will have installation costs of $400,000 but no salvage or residual value. Asset B will have a useful life of 6 years and cost $1.3 million; it will have installation costs of $180,000 and a salvage or residual value of $300,000. Which asset will have a greater annual straight-line depreciation?

A) Asset A has $30,000 more in depreciation per year.
B) Asset A has $40,000 more in depreciation per year.
C) Asset B has $30,000 more in depreciation per year.
D) Asset B has $40,000 more in depreciation per year.

Question 38

________ cash flow is the increase in cash generated by a new project above the current cash flow without the new project.

A) Future
B) Current
C) Discounted
D) Incremental

Question 39

Which of the statements below is TRUE?

A) The increase in working capital accounts necessary to support a project also provides for cost increases at the end of the project.
B) An increase in working capital can be brought about by an increase in inventory.
C) Decreases in accounts receivables constitute a use of cash flow because you are helping your customers finance their purchases.
D) Decreases in accounts payable constitute a source of cash flow because you are using your suppliers to help finance your business operations.

Question 40

Which of the below statements is FALSE?

A) Whenever a new product competes against a company's already existing products and reduces the sales of other products, opportunity costs occur.
B) Erosion can provide cost savings.
C) A synergy gain occurs when a new product can be introduced that complements another current product so that sales for this current product increases.
D) Increases in working capital accounts necessary to support a project add upfront costs, but also provide for cost reductions at the end of the project.

Question 41

Which of the statements below is FALSE?

A) Under the modified accelerated cost recovery system (MACRS) system of depreciation, the government classifies all assets into groups that are assigned specific "lives" for the purpose of depreciation.
B) Under the modified accelerated cost recovery system (MACRS) system of depreciation, once the assigned class life is established, an adjustable percentage of the cost is expensed each year as depreciation.
C) Under the modified accelerated cost recovery system (MACRS) system of depreciation, it can be assumed that its assigned life class is the shortest allowable recovery period for allocating the capital expenditure costs and reducing taxes.
D) Depreciation or "expired" costs each year do not reflect cash flows because the actual purchase and installation (outflow of dollars) of the machines have already taken place.

Question 42

MACRS allocates the same amount of cost each period as determined by the total initial cost divided by the number of years of useful life of the machines.

Question 43

The ________ a capital asset is not part of the MACRS and is ignored for depreciation expense.

A) salvage value of
B) dividends paid from
C) inventory from
D) straight-line value of

Question 44

A firm is considering purchasing an asset that will cost $5 million. Other depreciable costs include $800,000 in installation costs. If the asset is classified in the 5-year class, what is the annual depreciation for years 1, 3, and 6 for this asset, using the fixed depreciation percentages given by MACRS? (The percentages are 20.00%, 19.20%, 5.76%, and 8.93%, respectively.)

A) $1,856,000, $1,113,600, and $334,080 for years 1, 3, and 6, respectively
B) $1,160,000, $1,113,600, and $334,080 for years 1, 3, and 6, respectively
C) $1,160,000, $1,113,600, and $668,160 for years 1, 3, and 6, respectively
D) $5,800,000, $1,160,000, and $1,113,600 for years 1, 3, and 6, respectively

Question 45

The advantage of MACRS over straight-line depreciation is that you can write off more of your capital costs in the ________ years.

A) first
B) last
C) later
D) earlier

Question 46

The advantage of ________ over ________ depreciation is that you can write off more of your capital costs in the earlier years.

A) straight-line depreciation over the modified accelerated cost recovery system
B) straight-line depreciation over straight-line deductions.
C) MACRS over straight-line depreciation
D) MACRS over straight-line deductions

Question 47

Briefly describe straight-line depreciation.

Question 48

The advantage of straight-line over MACRS depreciation is that you can write off ________.

A) more of your total capital costs
B) your capital costs in fewer years
C) a larger percentage of your capital costs earlier
D) None of the above

Question 49

A firm is considering purchasing an asset that will have a useful life of 8 years and cost $5.5 million; it will have installation costs of $90,000 and a salvage or residual value of $1,600,000. What is the annual straight-line depreciation for this asset?

A) $400,000 per year
B) $422,000 per year
C) $498,750 per year
D) $530,450 per year

Question 50

When a depreciable asset is sold, a tax gain or tax loss on disposal is calculated, based on the book value of the asset at the time of disposal. If a ________ has occurred, ________ are incurred.

A) gain, tax reductions
B) gain, taxes
C) gain, tax credits
D) loss, taxes

Question 51

When a depreciable asset is sold, a tax gain or tax loss on disposal is calculated, based on the ________ of the asset at the time of disposal.

A) book value only
B) market value only
C) difference in book and market values
D) difference in market value and salvage value

Question 52

When a depreciable asset is sold, a tax gain or tax loss on disposal is calculated, based on the book value of the asset at the time of disposal. If a ________ has occurred, a ________ is recorded.

A) gain, tax credit
B) gain, tax reduction
C) loss, tax credit
D) loss, tax increase

Question 53

Briefly describe MACRS depreciation.

Question 54

The current book value of an asset serves as the basis for determining the gain or loss ________.

A) at retention
B) at book value
C) at market value
D) at disposal

Question 55

Termination is the process of "expiring" the cost of a long-term tangible asset over its useful life.

Question 56

The annual straight-line depreciation expense is the total value (cost plus installation) minus any anticipated salvage value divided by the number of years of service (life) of the machine.

Question 57

A firm is considering purchasing an asset that will cost $1 million. Other depreciable costs include $100,000 in installation costs. If the asset is classified in the 3-year class, what is the annual depreciation for each year for this asset using the fixed depreciation percentages given by MACRS? (The percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively.)

A) $366,667, $366,667, $366,667 and $0 for years 1, 2, 3, and 4, respectively
B) $275,000, $275,000, $275,000, and $275,000 for years 1, 2, 3, and 4, respectively
C) $366,630, $488,950, $162,910, and $81,510 for years 1, 2, 3, and 4, respectively
D) $366,630, $488,950, $81,510, and $81,510 for years 1, 2, 3, and 4, respectively

Question 58

MACRS stands for modified accelerated cost recovery system and classifies the "life" of every asset for use in determining the depreciation cost for each year.

Question 59

The accelerated write-off of capital costs in MACRS provides a taxable expense that reduces taxes at a faster rate than with straight-line. Therefore, according to ________ concepts, we can surmise that bigger tax cuts in the earlier years and lower tax cuts in the later years are better than a steady tax cut each year.

A) time-value of money
B) depreciation and sunk costs
C) depreciation and opportunity costs
D) interest rate

Question 60

________ costs each year do not reflect cash flow because the actual purchase and installation (outflow of dollars) of the asset have already taken place.

A) Depreciation
B) Sunk
C) Opportunity
D) Working Capital

Question 61

Anthony, Ltd. purchases a machine for $15,000. This machine qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Anthony has a tax rate of 33%. If the machine is sold at the end of four years for $4,000, what is the cash flow from disposal?

A) $3,535.36
B) $3,408.22
C) $2,592.00
D) $1,408.00

Question 62

Book value is the original cost of an asset plus the accumulated depreciation.

Question 63

A gain on disposal is recognized when the selling price of the asset is ________ the book value.

A) greater than
B) equal to
C) less than
D) greater than or equal to

Question 64

Benson Co. purchases an asset for $6,000. This asst qualifies as a seven-year recovery asset under MACRS. Benson has a tax rate of 30%. The seven-year expense percentages for years 1, 2, 3, 4, 5, and 6 are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, and 8.93%, respectively. If the asset is sold at the end of six years for $2,000, what is the cash flow from disposal?

Question 65

When computing the total cash outflow needed to start a project we must include ________.

A) any change in net income
B) any change in working capital
C) any change in dividends
D) any change in earnings

Question 66

Which is NOT a step in the estimation of after-tax cash flow at disposal?

A) If selling price is greater than book value: Selling Price - Tax on Gain.
B) If selling price is less than book value: Selling Price + Tax Credit on Loss.
C) If book value is less than selling price: Selling Price + Tax Credit on Loss.
D) If selling price equals book value: Selling Price.

Question 67

A loss on disposal is recognized when the selling price of the asset is ________ the book value.

A) greater than
B) equal to
C) less than
D) less than or equal to

Question 68

Baldwin Co. purchases an asset for $50,000. This asset qualifies as a five-year recovery asset under MACRS, with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Baldwin has a tax rate of 35%. If the asset is sold at the end of four years for $5,000, what is the after-tax cash flow from disposal?

A) $3,535.36
B) $3,408.22
C) $2,592.00
D) $6274.00

Question 69

Which of the statements below is FALSE?

A) The current book value of an asset serves as the basis for determining the gain or loss at disposal.
B) Book value is the original cost of the asset plus the accumulated depreciation.
C) A gain on disposal is recognized when the selling price of the asset is greater than the book value.
D) A loss on disposal is recognized when the selling price of the asset is less than the book value.

Question 70

To project the appropriate anticipated cash flow for a project, we must put all cash flow knowledge together. This includes ________ of the incremental cash flow.

A) both the amount and timing
B) the amount
C) the timing
D) the amount but not the time

Question 71

We assume no ________ costs for a project if a competitor is also introducing a competing product.

A) sunk
B) buyback
C) erosion
D) corrosion

Question 72

Fully depreciated assets have a positive book value, and so any proceeds from sale at disposal are taxable gains.

Question 73

The current book value of an asset serves as the basis for determining the gain or loss at disposal.

Question 74

If the selling price of an asset at disposal is greater than its book value, then the after-tax cash flow is the selling price minus the tax on the gain.

Question 75

Fully depreciated assets ________ , and so any proceeds from sale at disposal are taxable gains.

A) always have a market value of zero
B) have a positive book value
C) have a negative market value
D) have a book value of zero

Question 76

Bacon Signs Inc., purchases a machine for $70,000. This machine qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%, etc. The firm has a tax rate of 40%. If the machine is sold at the end of two years for $50,000, what is the cash flow from disposal?

A) $50,000
B) $43,440
C) $39,875
D) $33,600

Question 77

If the selling price of an asset at disposal is less than its book value, then the after-tax cash flow is the selling price minus the tax on the gain.

Question 78

Winston Co. purchases an asset for $60,000. This asset qualifies as a seven-year recovery asset under MACRS. Winston has a tax rate of 30%. The seven-year fixed depreciation percentages for years 1, 2, 3, 4, 5, and 6 are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, and 8.93%, respectively. If the asset is sold at the end of six years for $10,000, what is the cash flow from disposal?

Question 79

Churchill Ltd. purchases an asset for $150,000. This asset qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Churchill has a tax rate of 35%. If the asset is sold at the end of four years for $40,000, what is the cash flow from disposal?

A) $36,089
B) $35,072
C) $34,931
D) $33,678

Question 80

The tax rules for depreciation recapture are much more ________ than a simplified approach for disposal.

A) basic
B) complicated
C) easy
D) shortened