Chapter 10 Making capital investment decisions

Question 1

estimates the critical input in a net present value anlysis

Answer 1

cash flow

Question 2

a change in the firms overalll future cash flow that cocmes about as a direct consequence of the decision to accept that project

Answer 2

a relevant cash flow

Question 3

the difference between a firms future cash flows without a project

Answer 3

incremental cash flows

Question 4

consists of any and all changed in the firms 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

Answer 4

incremental cash flows

Question 5

the assumption that evaluation of a project may be based on the projects incremental cash flows
(only the incremental cash flows of that specific project)

Answer 5

stand alone principle

Question 6

a cost that has already been incurred and cannot be removed and therfore should not be considered in an investment decision
- a cost we have already paid or have already incurred the liability to pay
- the firm will have to pay this cost no matter what

Answer 6

sunk cost

Question 7

the most valuable alternative that is given up if a particular investment is undertaken
- it is not an out of pocket cost, but, rather, a benefit foregone

Answer 7

opportunity cost

Question 8

the cash flows of a new project that come at the expense of a firms existing projects
- negative impact on the cash flows of an existing product from the introduction of a new product

Answer 8

erosion

Question 9

• covers initial investment, expenses
• supplied by the firm at the beginning of a project and recoverd by the firm at the end of the project

Answer 9

net working capital

Question 10

in analyzing a proposed investment, do not include interest paid or any other financing costs

Answer 10

financing costs

Question 11

financial statements projecting future years operations

Answer 11

pro forma financial statements

Question 12

a cash outflow that will occur regardless of the level of sales

Answer 12

fixed cost

Question 13

is not deducted in calculating operating cash flow

Answer 13

interest expense

Question 14

Cash flow from assets (projected cash flow) has 3 components

Answer 14

1. Project operating cash flow
2. project change in net working capital
3. Project capital spending

Question 15

is a noncash deduction, so it has cash flow consequences only because it influences taxes

Answer 15

accounting depreciation

Question 16

a depreciation method under US tax law allowing for the accelerated write off of property under varius classifications

Answer 16

accelerated cost recovery system (ACRS)
(instituted in 1981)

Question 17

Modified ACRS

Answer 17

MACRS
(enacted by the tax reform act of 1986)

Question 18

• book value at the end of the project life equals zero
• need to know the lifespan of the asset or project
• depreciation expense is the same in each year

Answer 18

Straight line depreciation

Question 19

the difference between market value and book value is _____ ______ and must be _______ when the asset is sold
- effectively the asset was overdepreciated and too little taxes were paid

Answer 19

excess depreciation
recaptured

Question 20

if the book value exceeds the market value, the difference is treated as a _____ for tax purposes

Answer 20

loss

Question 21

the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate

Answer 21

depreciation tax shield

Question 22

the present value of a projects costs calculated n an annual basis

Answer 22

equivalent annual cost (EAC)

Question 23

utilize the EAC approach only when both of the following circumstances exist

Answer 23

1. the possibilities under evaluation have different economic lives
2. indefinite need (planned replacement at end of life)

Question 24

when utilizing the EAC approach which possibility do we choose

Answer 24

the possibility with the smallest EAC