Corporate Finance Chapter 9 Flashcards
Corporate Finance Chapter 9
The correct method to handle overhead costs in capital budgeting is to
A) ignore them in all cases.
B) ignore all except identifiable incremental amounts.
C) allocate a portion to each project.
D) allocate them to projects with the highest NPVs.
B) ignore all except identifiable incremental amounts.
When the real rate of interest is less than the nominal rate of interest, then:
A) inflation must be added to the nominal rate.
B) nominal flows should be discounted with real rates.
C) inflation is expected to occur.
D) investment returns do not increase purchasing power
C
New projects or products can have an indirect effect on the firm as well as a direct effect. Which of
the following appears to be an indirect effect of launching a new product?
A) additional working capital is required.
B) sales of our similar product will decline.
C) the sales force will need to be increased.
D) additional machinery must be purchased.
C) the sales force will need to be increased.
A cost should be considered sunk when it:
A) is replaced by costs that are not yet sunk. B) produces no additional sales revenues.
C) is fully depreciated. D) has no effect on future flows
D) has no effect on future flows
Which of the following methods will provide a correct analysis for capital budgeting purposes?
A) discounting real cash flows with nominal rates.
B) discounting real cash flows with real rates.
C) discounting nominal cash flows with real rates.
D) all of the above methods will provide similar results.
B) discounting real cash flows with real rates.
The “recovery” of an additional investment in working capital is assumed to:
A) be a sunk cost.
B) occur at the end of the project’s life.
C) occur whenever the project first shows a profit.
D) occur at the beginning of the project’s life.
B) occur at the end of the project’s life.
The value of a proposed capital budgeting project depends upon the:
A) increase in total sales produced.
B) total cash flows produced.
C) accounting profits produced.
D) incremental cash flows produced.
D) incremental cash flows produced.
Which of the following statements regarding investment in working capital is incorrect?
A) working capital is recovered at the end of the project.
B) the working capital may change during the life of the project.
C) investment in working capital, unlike investment in plant and equipment, represents a positive
cash flow.
D) the cash flow is measured by the change in working capital, not the level of working capital
C) investment in working capital, unlike investment in plant and equipment, represents a positive
Working capital will affect incremental cash flows if:
A) current liabilities change more than current assets.
B) inventory changes from previous levels.
C) current assets change more than current liabilities.
D) net working capital changes from previous levels
D) net working capital changes from previous levels
The additional inventory investment that is often required for new projects can be partially
funded by:
A) reducing accounts receivable.
B) increasing accounts payable.
C) decreasing equipment purchases.
D) switching to accelerated depreciation methods
B) increasing accounts payable.
Your forecast shows $500,000 annually in sales for each of the next three years. If your second and third year predictions have failed to incorporate 5 percent expected annual inflation, how
far off in total dollars is your three-year forecast?
500,000 + 500,000 * 1.05 + 500,000 * (1.05)2 – 500,000 * 3
= $76,250
An investment today of $25,250 promises to return $10,250 annually for the next 3 years. What is
the real rate of return on this investment if inflation averages 6% annually during the period?
Using a financial calculator:
n = 3, PV = −$25,250, PMT = $10,250, FV = $0,
CPT i/Y = 10.540% (nominal)
Real return = (1.10540 ÷ 1.06) − 1 = 4.28%
For a 6-year project that costs $106,000, has annual revenues of $52,400, and annual costs of $15,600, calculate Annual Cash Flow and NPV. Assume the investment can be depreciated for tax purposes straight-line over 6 years, the corporate tax rate is 21%, and the discount rate is 14%
Annual cash flow = (revenues−costs)×(1−tax rate)+(tax rate×depreciation)
= (52,400 − 15,600) × (1 − 0.21) + (0.21 × 106,000 ÷ 6)
= $32,782
Using the financial calculator,
CF0 = -106,000, CF1 = 32,782, F01= 6, I/Y = 14
NPV = $21,478.30
Calculate a cash flow in the final year of an investment, assuming $26,000 after-tax cash flows from operations, $2,600 from the sale of machine, a $3,600 investment in working capital, and a 21% tax rate.
Note that taxes have already been deducted from the cash flows from operations and are included
as a liability in working capital. Therefore, the tax should only be subtracted from the sale of the machine.
Cash flow=26,000 + 3,600 + 2,600×(1−21%) = $31,654
