CHAPTER 8

Question 1

Overhead expenses are often allocated to the different business activities for
accounting purposes.

Answer 1

YES

Question 2

When sales of a new product displace sales of an existing product, the situation
is often referred to as cannibalization.

Answer 2

YES

Question 3

A capital budget lists the projects and investments that a company plans to
undertake during the coming year.

Answer 3

YES

Question 4

Income Tax = EBIT × (1 - Tc).

Answer 4

NO

Question 5

We begin the capital budgeting process by determining the incremental earnings
of a project.

Answer 5

YES

Question 6

Investments in plant, property, and equipment are directly listed as expense
when calculating earnings.

Answer 6

NO

Question 7

The opportunity cost of using a resource is the value it could have provided in its
best alternative use.

Answer 7

YES

Question 8

The marginal corporate tax rate is the tax rate the firm will pay on an incremental
dollar of pre-tax income.

Answer 8

YES

Question 9

Overhead expenses are associated with activities that are not directly attributable
to a single business activity but instead affect many different areas of the
corporation.

Answer 9

YES

Question 10

When computing the incremental earnings of an investment decision, we should
include all changes between the firm’s earnings with the project versus without
the project.

Answer 10

YES

Question 11

Because value is lost when a resource is used by another project, we should
include the opportunity cost as an incremental cost of the project.

Answer 11

YES

Question 12

Sunk costs are incremental with respect to the current decision regarding the
project and should be included in its analysis.

Answer 12

NO

Question 13

Earnings are not cash flows.

Answer 13

YES

Question 14

To the extent that overhead costs are fixed and will be incurred in any case, they are incremental to the project and should be included in the capital budgeting analysis.

Answer 14

NO

Question 15

The ultimate goal in capital budgeting is to determine the effect of the decision to take a particular project on the firm’s cash flows.

Answer 15

YES

Question 16

Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 - Tc).

Answer 16

YES

Question 17

As a practical matter, to derive the forecasted cash flows of a project, financial
managers often begin by forecasting earnings.

Answer 17

YES

Question 18

Only include as incremental expenses in your capital budgeting analysis the
additional overhead expenses that arise because of the decision to take on the
project.

Answer 18

YES

Question 19

When evaluating a capital budgeting decision, we generally include interest
expense.

Answer 19

NO

Question 20

Many projects use a resource that the company already owns.

Answer 20

YES

Question 21

You consider interest expense when making a capital budgeting decision.

Answer 21

NO

Question 22

You consider opportunity cost when making a capital budgeting decision.

Answer 22

YES

Question 23

You consider fixed overhead cost when making a capital budgeting decision.

Answer 23

NO

Question 24

You consider sunk cost when making a capital budgeting decision.

Answer 24

NO

Question 25

Money that has been or will be paid regardless of the decision whether or not to proceed with the project is an opportunity cost.

Answer 25

NO

Question 26

Money that has been or will be paid regardless of the decision whether or not to proceed with the project is a sunk cost.

Answer 26

YES

Question 27

Since 1997, companies can “carry back” losses for two years and “carry forward”
losses for 20 years.

Answer 27

YES

Question 28

Net Working Capital = Cash + Inventory + Payables - Receivables.

Answer 28

NO

Question 29

Earnings do not represent real profits.

Answer 29

YES

Question 30

Depreciation is not a cash expense paid by the firm.

Answer 30

YES

Question 31

Depreciation is a method used for accounting and tax purposes to allocate the
original purchase cost of the asset over its life.

Answer 31

YES

Question 32

Firms often report a different depreciation expense for accounting and for tax
purposes.

Answer 32

YES

Question 33

Earnings include the cost of capital investments, but do not include non-cash
charges, such as depreciation.

Answer 33

NO

Question 34

Sometimes the firm explicitly forecast free cash flow over a shorter horizon than
the full horizon of the project or investment.

Answer 34

YES

Question 35

The firm cannot use its earnings to buy goods, pay employees, fund new
investments, or pay dividends to shareholders.

Answer 35

YES

Question 36

The depreciation tax shield is the tax savings that results from the ability to
deduct depreciation.

Answer 36

YES

Question 37

Depreciation expenses have a positive impact on free cash flow.

Answer 37

YES

Question 38

Free Cash Flow = (Revenues - Costs - Depreciation) × (1 - Tc) - Capital
Expenditures - Change in NWC + Tc × Depreciation.

Answer 38

NO

Question 39

(1 - Tc) × Depreciation is called the depreciation tax shield.

Answer 39

NO

Question 40

The incremental effect of a project on the firm’s available cash is the project’s free cash flow.

Answer 40

YES

Question 41

The terminal of continuation value of the project represents the market value (as of the last forecast period) of the free cash flow from the project at all future dates.

Answer 41

YES

Question 42

To evaluate a capital budgeting decision, we must determine its consequences for the firm’s available cash.

Answer 42

YES

Question 43

Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $100,000, however a commercial real estate again has informed you that an outside buyer is interested in purchasing this land and would be willing to pay $650,000 for it. When calculating the NPV of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is 650,000$.

Answer 43

YES

Question 44

The break-even level of an input is the level for which the investment has an IRR
of zero.

Answer 44

NO

Question 45

Sensitivity analysis reveals which aspects of the project are most critical when we
are actually managing the project.

Answer 45

YES

Question 46

When evaluating a capital budgeting project, financial managers should make
the decision that maximizes NPV.

Answer 46

YES

Question 47

The most difficult part of capital budgeting is deciding how to estimate the cash
flows and the cost of capital.

Answer 47

YES

Question 48

Scenario analysis considers the effect on NPV of changing multiple project
parameters.

Answer 48

YES

Question 49

We can use scenario analysis to evaluate alternative pricing strategies for our
project.

Answer 49

YES

Question 50

Scenario analysis breaks the NPV calculation into its component assumptions
and show how the NPV varies as each one of the underlying assumptions
change.

Answer 50

NO

Question 51

The difference between the IRR of a project and the cost of capital tells you how
much error in the cost of capital it would take to change the investment decision.

Answer 51

YES

Question 52

An exploration of the effect on NPV of changing multiple project parameters is called scenario analysis.

Answer 52

YES