Chapter 10 Flashcards
What are incremental cash flows?
The incremental cash flow for project evaluation consist of any and all changes in the firm’s future cash flows that are a direct consequence of taking the project.
Any cash flow that exists regardless of whether or not a project is undertaken is __________.
not relevant
What is the stand-alone principle?
The assumption that evaluation of a project may be based on the project’s incremental cash flows.
What is a sunk cost?
A cost that has already been incurred an cannot be removed and therefore should not be considered in an investment decision.
What is an opportunity cost?
The most valuable alternative that is given up if a particular investment is undertaken.
What is erosion?
The cash flows of a new project that come at the expense of a firm’s existing projects.
Erosion is relevant only when the __________ would not otherwise be lost.
sales
So the firm’s investment in project net working capital closely resembles a _________.
loan
Our goal in project evaluation is to compare the __________ from a project to the __________ that project in order to estimate NPV.
cash flow
cost of acquiring
What are pro forma financial statements?
Financial statements projecting future years’ operations.
To prepare pro forma financial statements, we will need the following:
- unit sales
- selling price per unit
- variable cost per unit
- total fixed costs
- total investment required
While preparing the pro forma financial statement, we do not deduct any __________ because it is a financing expense, not a component of operating cash flow.
interest expense
Cash flow from assets has three components:
- operating cash flow
- capital spending
- changes in net working capital
How do we calculate Project Cash Flow?
Project Cash Flow = Project Operating Cash Flow - Project Change in Net Working Capital - Project Capital Spending
How do we calculate Operating Cash Flow?
Operating Cash Flow = Earnings Before Interest and Taxes (EBIT) + Depreciation - Taxes
Whenever we have an investment in net working capital, that same investment has to be __________.
recovered
How do we calculate Average Accounting Return (AAR)?
AAR = Average Net Income/Average Book Value
What is the accelerated cost recovery system (ACRS)?
A depreciation method under U.S. tax law allowing for the accelerated write-off property under various classifications.
An increase in net working capital (NWC) is a cash __________, so we use a __________ sign to indicate an additional investment that the firm makes in net working capital.
outflow
positive
What is the bottom-up approach?
To project Operating Cash Flow, We start with the accountant’s bottom line (net income) and add back any non-cash deductions such as depreciation. (OCF = Net Income + Depreciation)
The definition of operating cash flow as net income plus depreciation is correct only if there is no __________ subtracted in the calculation of net income.
interest expense
What is the top-down approach?
To project Operating Cash Flow, we start out at the top of the income statement with sales and work our way down to net cash flow by subtracting costs, taxes, and other expenses. (OCF = Sales - Costs - Taxes)
What is the formula for the tax shield approach?
OCF = (Sales - Costs) x (1 - T) + Depreciation x T
What are the two components of the tax-shield approach?
- Calculate the project’s cash flow without depreciation expense
- Depreciation deduction multiplied by the tax rate (T)
What is the depreciation tax shield?
The tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate.
What is the equivalent annual cost (EAC)?
The present value of a project’s costs calculated on an annual basis.
Frank’s is a furniture store that is considering adding appliances to its offerings. What would be the best example of an incremental cash flow related to appliances?
Selling furniture to appliance customers
Changes in the net working capital requirements:
can affect the cash flows of a project every year of the project’s life
A company that utilizes the MACRS system of depreciation will have a greater depreciation tax shield in year ____ than in year ____.
2
1
What is a relevant cash flow?
A relevant cash flow for a project is a change in the firm’s overall future cash flow that comes about as a direct consequence of the decision to take that project.
