Which one of the following should be excluded from the cash flows of a project?

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

Ans: True Level: Basic Subject: Financing Costs Type: Concepts

1. 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.

Ans: False Level: Basic Subject: Net Working Capital Type: Concepts

1. 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.

Ans: False Level: Basic Subject: Net Working Capital Type: Concepts

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

Ans: True Level: Basic Subject: Depreciation Tax Shield Type: Concepts

1. The changes in the firm's future cash flows that are a direct consequence of accepting a project are called: A) Incremental cash flows. B) Stand-alone cash flows. C) Aftertax cash flows. D) Net present value cash flows. E) Erosion cash flows.

Ans: A Level: Basic Subject: Incremental Cash Flows Type: Definitions

1. The evaluation of a project based solely on its incremental cash flows is the basis of the: A) Incremental cash flow method. B) Stand-alone principle. C) Dividend growth model. D) Aftertax salvage value analysis. E) Discounted payback method.

Ans: B Level: Basic Subject: Stand-Alone Principle Type: Definitions

1. A cost that has already been paid, or the liability to pay has already been incurred, is a(n): A) Salvage value expense. B) Net working capital expense. C) Sunk cost. D) Opportunity cost. E) Erosion cost.

Ans: C Level: Basic Subject: Sunk Costs Type: Definitions

1. The most valuable investment given up if an alternative investment is chosen is a(n): A) Salvage value expense. B) Net working capital expense. C) Sunk cost. D) Opportunity cost. E) Erosion cost.

Ans: D Level: Basic Subject: Opportunity Costs Type: Definitions

1. The cash flows of a new project that come at the expense of a firm's existing projects are: A) Salvage value expenses. B) Net working capital expenses. C) Sunk costs. D) Opportunity costs. E) Erosion costs.

Ans: E Level: Basic Subject: Erosion Costs Type: Definitions

1. A pro forma financial statement is one that __________________________. A) projects future years' operations B) is expressed as a percentage of the total assets of the firm C) is expressed as a percentage of the total sales of the firm D) is expressed relative to a chosen base year's financial statement E) reflects the past and current operations of the firm

Ans: A Level: Basic Subject: Pro Forma Financial Statements Type: Definitions

1. The cash flow from projects for a company is: A) The net operating cash flow generated by the project, less any sunk costs and erosion costs. B) The sum of the incremental operating cash flow and aftertax salvage value of the project. C) The bottomline net income generated by the project, plus the annual depreciation expense. D) The sum of the incremental operating cash flow, capital spending, and net working capital expenses incurred by the project. E) The sum of the sunk costs, opportunity costs, and erosion costs of the project.

Ans: D Level: Basic Subject: Cash Flow From Projects Type: Definitions

1. The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called (the) _______________________. A) aftertax depreciation savings B) depreciable basis C) depreciation tax shield D) operating cash flow E) aftertax salvage value

Ans: C Level: Basic Subject: Depreciation Tax Shield Type: Definitions

1. The financial statements that reflect the projected results of future years' operations are called _______ statements. A) Incremental B) Pro-forma C) Cash flow D) Net working capital E) Stand-alone

Ans: B Level: Basic Subject: Proforma Financial Statements Type: Definitions

1. Operating cash flow is defined as: A) Earnings before interest and taxes minus depreciation plus taxes. B) The change in net working capital plus depreciation minus taxes. C) Earnings before interest and taxes plus depreciation minus taxes. D) Sales minus costs minus depreciation plus taxes. E) Sales minus variable costs minus fixed costs minus depreciation minus taxes.

Ans: C Level: Basic Subject: Operating Cash Flow Type: Definitions

1. Total cash flow from a project is defined as: A) Operating cash flow minus capital spending minus the change in net working capital. B) Earnings before interest and taxes minus taxes plus depreciation. C) Earnings before interest and taxes plus taxes minus depreciation. D) Operating cash flow minus the change in net working capital plus capital spending. E) Operating cash flow plus depreciation minus capital spending.

Ans: A Level: Basic Subject: Total Cash Flow Type: Definitions

1. The equivalent annual cost can be defined as: A) The yearly costs, which are standard in two mutually exclusive projects that have equal lives. B) The net present value of a project divided by the number of years that the project is expected to last. c. The amount of the yearly fixed costs of a project, which remains constant over the life of the project. C) The amount paid each year over the life of a project that has the same net present value as the project. D) The net present value of the yearly fixed costs of a project that is constant over the life of the project.

Ans: D Level: Basic Subject: Equivalent Annual Cost Type: Definitions

1. The depreciation tax shield is defined as: A) [(Sales - costs)(1 - Tc)][(depreciation)(Tc)]. B) Depreciation - taxes. C) (Depreciation)(Tc). D) Net income + depreciation - taxes. E) (Depreciation)(1-Tc)

Ans: C Level: Basic Subject: Depreciation Tax Shield Type: Definitions

1. The reduction in the sale of hamburgers when hot dogs are added to a menu is called the_____ cost. A) Sunk B) Opportunity C) Incremental D) Stand-alone E) Erosion

Ans: E Level: Basic Subject: Erosion Type: Definitions

1. Your company is considering three different methods of producing its product: purchase production equipment, lease production equipment, or contract with a supplier to build the product for them. The methods have differing lives and cash flow streams. You should: A) Choose the method that will least affect the balance sheet of the company. B) Choose the method that maximizes future cash inflows. C) Choose the method that will result in the highest net income. D) Choose the method that minimizes initial cash outflows. E) Choose the method that maximizes firm value.

Ans: E Level: Basic Subject: Project Investment Goals Type: Concepts

1. It is important to identify and use only incremental cash flows in capital investment decisions: A) Because they are the simplest to identify. B) Only when the stand-alone principle fails to hold. C) Because ultimately it is the change in a firm's overall future cash flows that matter. D) To accommodate unforeseen changes that might occur. E) Whenever sunk costs are involved.

Ans: C Level: Basic Subject: Incremental Cash Flows Type: Concepts

1. When we employ ________________ we are evaluating a project on the basis of its incremental cash flows, thereby ignoring the other cash flows of the firm. A) the stand-alone principle B) the equivalence theorem C) the law of one price D) Bell's theorem E) the equivalent annual cost procedure

Ans: A Level: Basic Subject: Stand-Alone Principle Type: Concepts

1. Which of the following is true regarding project evaluation? A) Financing costs must be included in the statement of cash flows because they are not accounted for elsewhere. B) The stand-alone principle calls for evaluation of a project based on its incremental cash flows. C) Changes in NWC are not considered incremental cash flows. D) When fixed assets are sold at the project end, there are usually no tax consequences of the sale. E) Whether straight-line depreciation or CCA is used will have no impact on project NPV.

Ans: B Level: Basic Subject: Project Evaluation Type: Concepts

1. You discover the engine-oil additive your scientists developed three years ago makes a great men's after- shave once diluted properly using certain chemicals. How should you treat the original $125,000 of R&D expenditures that went into developing the engine-oil additive for your present decision regarding whether or not to begin production of the after-shave? A) Treat it as a cash outflow three years ago for the current project; that is, find the future value today of the $125,000 spent three years ago. B) The full $125,000 should be treated as an initial investment today. C) As a cash inflow since the formula has obviously increased in value over the years. D) As an opportunity cost if the formula cannot presently be sold to another manufacturer. E) As a sunk cost since the R&D expenditure has no bearing on today's decision.

Ans: E Level: Basic Subject: Sunk Costs Type: Concepts

1. You are advising a friend who is attempting to decide whether or not to drop one of the courses they are currently enrolled in. If they drop, they will forfeit the money spent on tuition. Which of the following regarding the drop decision is consistent with capital budgeting principles? I. Remaining in the class means you must give up your part-time job. II. The tuition cost for the class was outrageous, $1,000 per credit hour. III. If you drop the class, you can sell the textbook now for $30 at the bookstore. A) I only B) I and II only C) I and III only D) II and III only E) I, II, and III

Ans: C Level: Basic Subject: Sunk Costs Type: Concepts

1. Your company purchased a piece of land five years ago for $150,000 and subsequently added $175,000 in improvements. The current book value of the property is $225,000. There are two options for future use of the land: 1) the land can be sold today for $375,000 on an aftertax basis; 2) your company can destroy the past improvements and build a factory on the land. In consideration of the factory project, what amount (if any) should the land be valued at? A) The present book value of $225,000. B) The aftertax salvage value of $375,000. C) The sales price of $375,000 less the book value of the improvements. D) The original $150,000 purchase price of the land itself. E) The property should be valued at zero since it is a sunk cost.

Ans: B Level: Basic Subject: Opportunity Costs Type: Concepts

1. Which of the following would likely NOT cause erosion? I. A gas station owner expands floor space to make room for a convenience store. II. You begin selling coffee in new, small-sized pouches alongside your regular-sized coffee cans. III. You build a Taco Bell just down the street from your McDonalds franchise. A) I only B) I and II only C) III only D) I and III only E) II and III only

Ans: A Level: Basic Subject: Erosion Type: Concepts

1. There may be a bias against accepting capital budgeting projects if A) Cash outflows are underestimated. B) The discount rate is underestimated. C) Opportunity costs are not accounted for. D) Inflation in cash inflow estimation is ignored. E) Sunk costs are excluded.

Ans: D Level: Basic Subject: Inflation Type: Concepts

1. Which of the following statements regarding cash flow is correct? A) Cash flow measures changes in the firm's cash account. B) Cash flow should be recognized only when it has accrued according to GAAP practices. C) In evaluating capital budgeting decisions, cash flows should be valued on a pretax basis for consistency's sake. D) Aftertax cash flow is usually identical to accounting profits when accrual accounting is used for financial statement purposes. E) Incremental cash flows should include opportunity costs but ignore sunk costs.

Ans: E Level: Basic Subject: Cash Flows Type: Concepts

1. Which of the following statements is NOT accurate regarding pro forma financial statements? A) In order to construct pro forma statements you generally forecast unit sales first. B) Pro forma statements are generally prepared for more than one year in advance. C) Pro forma statements merely represent the best current estimate of the future. D) Pro forma statements need only be prepared when applying for a bank loan. E) It is important that pro forma statements be as accurate as possible.

Ans: D Level: Basic Subject: Pro Forma Statements Type: Concepts

1. Which of the following is a proper definition of project cash flow? I. EBIT + D - Taxes - additions to net working capital II. Operating cash flow - additions to net working capital - capital spending III. Operating cash flow - additions to net working capital + recoveries of net working capital IV. Sales - costs - taxes - project capital spending A) I only B) I, II, and III only C) II only D) II and III only E) I, II, III, and IV

Ans: C Level: Basic Subject: Project Cash Flow Type: Concepts

1. Which of the following statements regarding operating cash flows is accurate? A) To evaluate changes in OCF you need to look at both the balance sheet and income statement. B) Changes in OCF will occur when cost of goods sold changes, all else the same. C) Changes in OCF result directly from changes in financing D) OCF for a project can be found by subtracting depreciation from project net income. E) An increase in depreciation will cause a decrease in OCF, all else the same.

Ans: B Level: Basic Subject: Operating Cash Flow Type: Concepts

1. If a company making only cash sales is considering allowing customer credit, then __________. A) sales will likely decrease B) the change will result in a source of funds C) receivables will likely increase D) net working capital will decrease if funding needs are met with long-term liabilities E) expenses will fall due to monthly billings and collection efforts

Ans: C Level: Basic Subject: Receivables Type: Concepts

1. Which of the following would be considered a use of funds? I. An increase in receivables II. An increase in payables III. An increase in inventory IV. An increase in sales A) I and III only B) I and IV only C) II and III only D) II and IV only E) I, III, and IV only

Ans: A Level: Basic Subject: Use Of Funds Type: Concepts

1. If a firm moves into a higher tax bracket, one would expect its depreciation tax shield to be which of the following, all else the same? A) More valuable. B) Less valuable. C) Unchanged, since depreciation doesn't change. D) Unchanged, because changes in tax rates don't matter once a project is in place. E) It is impossible to tell how it will change, if at all, without more information.

Ans: A Level: Basic Subject: Depreciation Tax Shield Type: Concepts

1. Which of the following can be depreciated for tax purposes? I. Machinery and equipment II. Land III. Buildings A) I only B) I and II only C) I and III only D) II and III only E) I, II, and III

Ans: C Level: Basic Subject: Depreciation Type: Concepts

1. A taxable gain occurs when an asset is sold for more than its book value. For capital budgeting purposes, the taxes on the sale ____________________________. A) are treated as a reduction in cash and added to operating cash flow B) are treated as a noncash event similar to depreciation C) are treated as a reduction in cash and deducted from the book value of the asset D) are treated as a reduction in cash and deducted from the taxable gain E) are treated as a reduction in cash and are deducted from the sale price

Ans: E Level: Basic Subject: Salvage Value Type: Concepts

1. Your firm sells a machine it purchased two years ago. The selling price was approximately 50% less than the book value of the machinE) As a result of this transaction, your firm has a tax benefit: A) in the amount of the tax rate multiplied by the difference between the selling price and the original purchase price B) in the amount of the tax rate multiplied by the difference between the selling price and the book value C) that is available in the current year only D) that is only available for certain types of assets as defined by the CCRA E) that depends on the composition of the CCA pool to which the asset belongs

Ans: E Level: Basic Subject: Taxes Type: Concepts

1. Which of the following describes the "bottom-up" approach to defining operating cash flow? A) EBIT + D - Taxes B) NI + D C) (S-C) (1 - TC) + DTc D) S - C - Taxes E) NI + D - taxes

Ans: B Level: Basic Subject: Operating Cash Flow Type: Concepts

1. Which of the following describes the "top-down" approach to defining operating cash flow? A) EBIT + D - Taxes B) S - C - Taxes + D C) (S - C) (1 - TC) + DTc D) S - C - Taxes E) NI + D

Ans: D Level: Basic Subject: Operating Cash Flow Type: Concepts

1. Which of the following describes the "tax shield" approach to defining operating cash flow? A) EBIT + D - Taxes B) NI + D C) (S - C) (1 - TC) + DTc D) S - C - Taxes E) EBIT + DTc

Ans: C Level: Basic Subject: Operating Cash Flow Type: Concepts

1. You are considering a new project which will require an initial build up of raw materials inventory. The expected life of the project's equipment is seven years. If all goes as you expect, you will replace the equipment at the end of the seven years. If not, you will terminate the project. You currently believe there is a 50-50 chance of either occurrence. How should you treat the raw material inventory in year seven of your present analysis and why? A) Treat half of it as a cash inflow because there is a 50% chance the project will terminate then B) Treat it as a cash outflow because it is expected that the machines will be replaced C) Treat it as a cash inflow because the replacement of the machines becomes a new capital budgeting decision at that point D) Treat it as both a cash inflow and outflow, net effect zero E) Treat half as a cash inflow in year seven, but also treat only half as a cash outflow at the beginning of the project

Ans: C Level: Basic Subject: Inventory Type: Concepts

1. When considering mutually exclusive investment projects with different lives that will be replaced once they terminate, it is best to evaluate them using _________________________. A) the discounted payback rule B) the profitability index rule C) the equivalent annual cost rule D) the internal rate of return rule E) the net present value rule

Ans: C Level: Basic Subject: Equivalent Annual Cost Type: Concepts

1. The EAC method for evaluating projects applies when which of the following project characteristics exist? I. The projects are mutually exclusive. II. The projects have different economic lives. III. The projects will be replaced more or less indefinitely. A) III only B) I and II only C) I and III only D) II and III only E) I, II, and III

Ans: E Level: Basic Subject: Equivalent Annual Cost Type: Concepts

1. Two types of batteries are being considered for use in electric golf carts. Burnout brand has a three year life, while Longlasting brand has a five year life. You must choose between the two batteries and you expect to continually replace the brand you ultimately choose. You should: A) Take the option with the greater NPV. B) Take the option with the lower NPV. C) Take the option with the greater EAC. D) Take the option with the smaller EAC. E) Take the option with the lowest accounting break-even.

Ans: D Level: Basic Subject: Equivalent Annual Costs Type: Concepts

1. When you set the project NPV equal to zero in calculating a bid price you are: A) Going to earn zero net income on the project. B) Appropriately including opportunity costs in your analysis. C) Certain to be the low bidder since, if any firm does bid lower, they will be bidding based on a negative NPV project. D) Assured of earning your firm's highest possible IRR. E) Finding the price at which you expect to create zero wealth for your shareholders.

Ans: E Level: Basic Subject: Bid Price Type: Concepts

1. In setting the bid price, the firm seeks the price that will cause the project to "breakeven" in a financial sense. The lowest acceptable bid price results in all of the following EXCEPT: A) AAR = required return B) NPV = 0 C) Discounted payback = the life of the project D) IRR = required return E) PI = 1

Ans: A Level: Basic Subject: Financial Breakeven Type: Concepts

1. Which of the following is true? I. Setting the bid price requires finding the point at which project NPV is zero. II. In a cost-cutting proposal the reduction in costs has the same effect as an increase in sales. III. EAC is used to evaluate mutually exclusive projects with different lives if the projects are expected to be continuously replicated. A) III only B) I and II only C) I and III only D) II and III only E) I, II, and III

Ans: E Level: Basic Subject: Special Cases In Capital Budgeting Type: Concepts

1. Billie Jo sent a letter inquiring about the cost of a piece of equipment for a project she is considering. The cost of the stamp to mail this letter is an example of a(n) _____ cost. A) Opportunity B) Relevant C) Erosion D) Sunk E) Incremental

Ans: D Level: Basic Subject: Sunk Cost Type: Concepts

1. Project cash flows will increase when: A) Capital spending for the project increases. B) The inventory requirements for a project increase. C) The depreciation associated with a project decreases. D) The projected sales resulting from the project increase. E) The incremental change in accounts payable decreases.

Ans: D Level: Basic Subject: Project Cash Flow Type: Concepts

1. Which one of the following is the correct method for computing the net cash flow on the sale of a piece of equipment? (Assume that the equipment was the only asset in its CCA pool) A) (Book value - selling price)(1-T) B) (Book value - selling price)(T) C) (Selling price)(T) D) (Selling price - book value)(1-T) E) (Selling price - book value)(T)

Ans: D Level: Basic Subject: Cash Flow On Sale Of Asset Type: Concepts

1. 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. Which of the following costs should be included in that analysis? I. The property taxes paid on the building over the past three years II. The insurance paid on the building over the past three years III. The current market value of the building IV. The cost to survey the lot to construct a drainage pond required for the project A) I and II only B) III and IV only C) I, II, and III only D) I, II, and IV only E) I, II, III, and IV

Ans: B Level: Intermediate Subject: Relevant Cost Type: Concepts

1. Which one of the following would be considered a use of cash? A) Sale of fully depreciated equipment B) A decrease in accounts receivable C) Sale of inventory at cost D) Reduction in accounts payable E) Product sale at a price in excess of cost

Ans: D Level: Basic Subject: Use Of Cash Type: Concepts

1. Which of the following are considered cash flows of a project? I. Taxes II. Financing costs III. Sunk costs IV. Opportunity costs A) I and II only B) I and IV only C) III and IV only D) II and IV only E) I, II, and IV only

Ans: B Level: Basic Subject: Relevant Costs Type: Concepts

1. For a new project, a company plans to invest $15,000 in inventory, $8,000 in accounts receivable and $150,000 in fixed assets with a salvage value of $44,000. Accounts payable will increase by $13,000 when the project starts. Assets are depreciated straight line to zero over the 4-year life of the project. Taxes are 35%. Which one of the following statements is correct concerning the cash flow in year 4? A) $15,000 is a cash outflow from inventory. B) The cash flow from the salvage value is equal to $44,000 multiplied by 35%. C) $13,000 is a cash inflow from accounts payable. D) The net salvage value is a cash outflow. E) $8,000 is a cash inflow from accounts receivable.

Ans: E Level: Intermediate Subject: Cash Flows Type: Concepts

1. Which of the following cause operating cash flow to differ from net income? I. Interest expense II. Taxes III. Depreciation IV. Fixed Costs A) I and II only B) I and III only C) II and III only D) I, II, and IV only E) I, III, and IV only

Ans: B Level: Basic Subject: Operating Cash Flow Type: Concepts

1. A company is evaluating the replacement of the office copier. Which of the following should be considered in that evaluation? I. The balance due on the current lease, which will be payable even if the copier is returned. II. The cost of the maintenance contract on the new copier. III. The costs of repairs made today on the existing copier. IV. The selling price of the existing copier. A) I and II only B) II and III only C) II and IV only D) I, II, and IV only E) II, III, and IV only

Ans: C Level: Basic Subject: Relevant Cost Type: Concepts

1. Which of the following would normally be included in the final cash flow of a project that entailed the development and sale of a new product? I. The money spent to advertise the new product II. The money spent to obtain a patent on the new product design III. The recovery of the money spent for inventory related to the project IV. An offer to purchase the patent rights A) I and III only B) II and IV only C) III and IV only D) I and IV only E) II, III, and IV only

Ans: C Level: Intermediate Subject: Cash Flows Type: Concepts

1. Which one of the following statements is true concerning project analysis? A) Net present value is the best method to use when analyzing cost saving projects involving equipment that will be replaced at the end of the project and the options available have different project lives. B) The internal rate of return is the best method of analysis when the projects under consideration are cost cutting projects with negative cash flows for all time periods. C) The internal rate of return is the best method of analysis when two or more cost cutting projects, with differing initial costs, are being compared because the method incorporates the time value of money concept. D) No matter the circumstances, net present value is always considered to be the best method of analysis as it considers all relevant cash flows and incorporates the time value of money theory. E) For cost cutting proposals where a decision is being made between two or more pieces of equipment with differing lives, the equivalent annual cost method is considered superior to the net present value method if the equipment is to be replaced at the end of its life.

Ans: E Level: Intermediate Subject: Project Analysis Type: Concepts

1. Your company may introduce a new line of tennis shoes. You have been given the following projections: sales = 35,000 units @ $40 per unit; variable costs = $25 per unit; fixed costs = $125,000 per year; initial investment = $1,000,000; interest expense = $50,000 per year; project life = 10 years. What is the net income for this project in the third year if the corporate tax rate is 34%? You may assume that the CCA rate on the initial investment is 30%, the half-year rule applies, and the appropriate discount rate of 12%. A) $62, B) $113, C) $198, D) $264, E) $297,

Ans: B Level: Basic Subject: Net Income Type: Problems

1. A project requires the purchase of machinery for $40,000. The machinery belongs in a 20% CCA class and will have a salvage value of $4,000 at the end of the 4 year project. It will require a net working capital investment of $5,000 up-front. The The firm has a tax rate of 34% and a required return of 10%. The project generates after-tax operating income of $10,000. What is the project's NPV? A) -$2, B) $ C) $1, D) $2, E) $2,

Ans: B Level: Basic Subject: Net Present Value Type: Problems

1. You purchase a machine for $22,000 which belongs in a 30% CCA class. What is the present value of the CCA tax shield on the machine if it is sold at the end of the third year for $6,000, your tax rate is 34%, and the appropriate discount rate is 15%? A) $1, B) $3, C) $5, D) $5, E) $6,

Ans: D Level: Basic Subject: PVCCATS Type: Problems

1. The equipment required for a four year project costs $60,000 and belongs in a 20% CCA class. The project generates after-tax operating income of $13,750 and the fixed assets will be sold for $7,000 at the termination of the project. If the firm has a tax rate of 34% and a required return of 10%, what is the NPV? A) $ B) $1, C) $1, D) $2, E) $2,

Ans: A Level: Basic Subject: Net Present Value Type: Problems

1. The machinery required for a three year project costs $20,000, belongs in a 15% CCA class, and will require a net working capital investment of $5,000 up-front. The project generates after-tax operating income of $11,500. The fixed assets will be sold for $2,000 at the end of the project. If the firm has a tax rate of 34% and a required return of 10%, what is the project NPV? A) $10, B) $11, C) $12, D) $13, E) $15,

Ans: C Level: Basic Subject: Net Present Value Type: Problems

Which of the following should be excluded from the cash flows of a project?

Which one of the following is excluded from the cash flow from assets?

Which of the following is not included in finding the operating cash flow?

Which of the following items would not be included in cash flow from investing?