CHAPTER 8 Flashcards
Overhead expenses are often allocated to the different business activities for
accounting purposes.
YES
When sales of a new product displace sales of an existing product, the situation
is often referred to as cannibalization.
YES
A capital budget lists the projects and investments that a company plans to
undertake during the coming year.
YES
Income Tax = EBIT × (1 - Tc).
NO
We begin the capital budgeting process by determining the incremental earnings
of a project.
YES
Investments in plant, property, and equipment are directly listed as expense
when calculating earnings.
NO
The opportunity cost of using a resource is the value it could have provided in its
best alternative use.
YES
The marginal corporate tax rate is the tax rate the firm will pay on an incremental
dollar of pre-tax income.
YES
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.
YES
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.
YES
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.
YES
Sunk costs are incremental with respect to the current decision regarding the
project and should be included in its analysis.
NO
Earnings are not cash flows.
YES
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.
NO
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.
YES
Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 - Tc).
YES
As a practical matter, to derive the forecasted cash flows of a project, financial
managers often begin by forecasting earnings.
YES
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.
YES
When evaluating a capital budgeting decision, we generally include interest
expense.
NO
Many projects use a resource that the company already owns.
YES
You consider interest expense when making a capital budgeting decision.
NO
You consider opportunity cost when making a capital budgeting decision.
YES
You consider fixed overhead cost when making a capital budgeting decision.
NO
You consider sunk cost when making a capital budgeting decision.
NO
Money that has been or will be paid regardless of the decision whether or not to proceed with the project is an opportunity cost.
NO
Money that has been or will be paid regardless of the decision whether or not to proceed with the project is a sunk cost.
YES
Since 1997, companies can “carry back” losses for two years and “carry forward”
losses for 20 years.
YES
Net Working Capital = Cash + Inventory + Payables - Receivables.
NO
Earnings do not represent real profits.
YES
Depreciation is not a cash expense paid by the firm.
YES
Depreciation is a method used for accounting and tax purposes to allocate the
original purchase cost of the asset over its life.
YES
Firms often report a different depreciation expense for accounting and for tax
purposes.
YES
Earnings include the cost of capital investments, but do not include non-cash
charges, such as depreciation.
NO
Sometimes the firm explicitly forecast free cash flow over a shorter horizon than
the full horizon of the project or investment.
YES
The firm cannot use its earnings to buy goods, pay employees, fund new
investments, or pay dividends to shareholders.
YES
The depreciation tax shield is the tax savings that results from the ability to
deduct depreciation.
YES
Depreciation expenses have a positive impact on free cash flow.
YES
Free Cash Flow = (Revenues - Costs - Depreciation) × (1 - Tc) - Capital
Expenditures - Change in NWC + Tc × Depreciation.
NO
(1 - Tc) × Depreciation is called the depreciation tax shield.
NO
The incremental effect of a project on the firm’s available cash is the project’s free cash flow.
YES
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.
YES
To evaluate a capital budgeting decision, we must determine its consequences for the firm’s available cash.
YES
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 $650,000 for it. When calculating the NPV of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is 650,000$.
YES
The break-even level of an input is the level for which the investment has an IRR
of zero.
NO
Sensitivity analysis reveals which aspects of the project are most critical when we
are actually managing the project.
YES
When evaluating a capital budgeting project, financial managers should make
the decision that maximizes NPV.
YES
The most difficult part of capital budgeting is deciding how to estimate the cash
flows and the cost of capital.
YES
Scenario analysis considers the effect on NPV of changing multiple project
parameters.
YES
We can use scenario analysis to evaluate alternative pricing strategies for our
project.
YES
Scenario analysis breaks the NPV calculation into its component assumptions
and show how the NPV varies as each one of the underlying assumptions
change.
NO
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.
YES
An exploration of the effect on NPV of changing multiple project parameters is called scenario analysis.
YES
