Chapter 13

Question 1

what are incramental CF’s

Answer 1

company’s cash flows with the project - company’s cash flows without the project

Question 2

what is the most important and difficult step in capital budgeting

Answer 2

estimating a proposals relevant cash flows

Question 3

for capital budgeting purposes is a projects net cash flows or its accounting income relevent

Answer 3

net cash flows

Question 4

How are asset purchases treated differently for cash flows vs. accounting income

Answer 4

accounting: the purchase of fixed assets is not a deduction from accounting income

cash flows: the purchase of a fixed asset is a negative cash flow

Question 5

How are non cash purchases treated differently for cash flows vs. accounting income

Answer 5

accounting: subtract non cash charges

cash flows: add them back in

Question 5

how do changes in net operating working capital affect cash flows

Answer 5

will be added to cash flows

Question 6

how do interest expense get accounted for in cash flows vs. accounting income

Answer 6

accounting: interest expenses are subtracted

cash flows: interest not subtracted

Question 7

what are expansion projects

Answer 7

when a firm makes an investment in a new facility

Question 8

what is a replacement project

Answer 8

when a firm replaces existing assets, generally to reduce costs

Question 9

what are sunk costs

Answer 9

an outlay that has already occurred or had been committed and hence is not affected by the decision under consideration

Question 10

what are opportunity costs

Answer 10

the cash flows that could be generated from assets the firm already owns

Question 11

what are externalitites

Answer 11

the effects of a project on other parts of the firm or on the environment

Question 12

what does negative within-firm externalities mean

Answer 12

• the new business eats into current business
• the loss of CF should be considered

Question 13

what does positive within-firm externalities mean

Answer 13

a new project can be complementary to an old one

Question 14

what are environmental externalities

Answer 14

cost to meet environmental regulations and maintain goodwill

Question 15

incremental cash flows four categories

Answer 15

• initial costs
• operating cash flows over project life
• changes in net working capital
• terminal year cash flows

Question 16

What are the three ways to measure stand-alone risk also known as uncertainty of CF

Answer 16

• sensitivity analysis
• scenario analysis
• Monte Carlo simulation

Question 17

what is a sensitivity analysis

Answer 17

percentage change in NPV that results from a given percentage change in an input variable when other inputs are held at their expected values

Question 18

what do steeper sensitivity lines show

Answer 18

greater risk

Question 19

what is scenario analysis

Answer 19

shows what would happen to the project NPV if several of the inputs turn out to be better or worse than expected

Question 20

what does the coefficient variation measure in a scenario analysis

Answer 20

measure the amount of risk per dollar of NPV

-company stand-alone risk

Question 21

what is a simulation analysis

Answer 21

a probability of NPV is based on sample of simulated values

Question 22

what do sensitivity, scenario and simulation analyses all ignore

Answer 22

diversification, they only measure standalone risk

Question 23

What is a real option

Answer 23

traditional capital budgeting theory that assumes that a project is like a roulette wheel.

Question 24

what are types of real options?

Answer 24

1. investment timing option (wait until more information is available)
2. growth options
3. abandonment options
4. flexibility options