Deck 10: Making Capital Investment Decisions

Question 1

A decrease in the cost of goods sold is an example of an incremental cash flow.

Answer 1

True

Question 2

Selling existing equipment at 10% less than book value would create a source of cash.

Answer 2

True

Question 3

You build a Taco Bell just down the street from your McDonalds franchise would likely NOT cause
erosion.

Answer 3

False

Question 4

To fully understand the effects of a proposed project, total cash flows should be developed as part
of the project's pro forma statements.

Question 5

The loss of sales due to a new product which you recently introduced is an example of erosion.

Question 6

You begin selling coffee in new, small-sized pouches alongside your regular-sized coffee cans
would likely NOT cause erosion.

Question 7

The loss of sales due to increased competition in the product market is an example of erosion.

Question 8

An increase in accounts receivable is an example of an incremental cash flow.

Question 9

The recovery of the money spent for inventory related to the project would normally be included in
the final cash flow of a project that entailed the development and sale of a new product.

Question 10

For the purpose of performing capital budgeting analysis, Cash flows must be incremental.

Question 11

Sunk costs are considered cash flows of a project.

Question 12

Incremental costs should be included in the analysis of a project

Question 13

The loss of sales due to a new product recently introduced by your competitor is an example of
erosion.

Question 14

For the purpose of performing capital budgeting analysis, Cash flows must be after-tax.

Question 15

A gas station owner expands floor space to make room for a convenience store would likely NOT
cause erosion.

Question 16

Interest expense causes operating cash flow to differ from net income.

Question 17

An offer to purchase the patent rights would normally be included in the final cash flow of a project
that entailed the development and sale of a new product.

Question 18

Sunk costs should be included in the analysis of a project.

Question 19

An increase in taxes is an example of an incremental cash flow.

Question 20

The money spent to obtain a patent on the new product design would normally be included in the
final cash flow of a project that entailed the development and sale of a new product.

Question 21

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will
have to pay all of the project's suppliers in full.

Question 22

A new project is expected to have the following effects on the financial statements of a firm. The
effect of a decrease in accounts receivable should be included in the net working capital
requirements for the project.

Question 23

Depreciation causes operating cash flow to differ from net income.

Question 24

Opportunity costs should be included in the analysis of a project.

Question 25

The cash flows of a project should include the related changes in the tax account.

Question 26

A company owns a building that is totally paid for. This building has been sitting idle for the past
three years. Now the company is trying to analyze a project that would include the use of this
building. Therefore, the cost to survey the lot to construct a drainage pond required for the project
should be included in that analysis?

Question 27

The cash flows of a project should include the related changes in the fixed assets.

Question 28

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will
have to collect all of the accounts receivables related to the project.

Question 29

A decrease in net working capital is an example of an incremental cash flow.

Question 30

A company owns a building that is totally paid for. This building has been sitting idle for the past
three years. Now the company is trying to analyze a project that would include the use of this
building. Therefore, the insurance paid on the building over the past three years should be included
in that analysis.

Question 31

Fixed Costs causes operating cash flow to differ from net income.

Question 32

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will
have to sell all of the inventory related to the project at a price at least equal to the cost.

Question 33

Opportunity costs are considered cash flows of a project.

Question 34

Pro forma statements for a proposed project should be compiled on a stand-alone basis.

Question 35

The correct formula for computing the operating cash flow of a project is EBIT + D + T.

Question 36

Taxes causes operating cash flow to differ from net income.

Question 37

A company owns a building that is totally paid for. This building has been sitting idle for the past
three years. Now the company is trying to analyze a project that would include the use of this
building. Therefore, the current market value of the building should be included in that analysis.

Question 38

If a firm wishes to recapture 100% of its net working capital investment in a project, the firm will
have to sell all of the project's fixed assets at a price at least equal to the book value of the assets

Question 39

The money spent to advertise the new product would normally be included in the final cash flow of
a project that entailed the development and sale of a new product.

Question 40

Assume project X requires additions to net working capital in each year of its life, all to be
recovered at the end. In this case, the present value of the net working capital recovery will exceed
the total dollar outlays on net working capital.

Question 41

To fully understand the effects of a proposed project, operating cash flows should be developed as
part of the project's pro forma statements.

Question 42

Taxes are considered cash flows of a project.

Question 43

A new project is expected to have the following effects on the financial statements of a firm. The
effect of a reduction in accounts payable should be included in the net working capital
requirements for the project.

Question 44

To fully understand the effects of a proposed project, the statement of comprehensive income
should be developed as part of the project's pro forma statements.

Question 45

To reflect the costs associated with a project accurately, the analyst should exclude interest
expenses in the computation of operating cash flows.

Question 46

The proper formula of project cash flow is operating cash flow - additions to net working capital +
recoveries of net working capital

Question 47

To fully understand the effects of a proposed project, a recap of net working capital requirements
should be developed as part of the project's pro forma statements.

Question 48

The top-down approach is used for calculating OCF, if the only information from the statement of
comprehensive income items known to you are net income and depreciation.

Question 49

The correct formula of project cash flow is sales - costs - taxes - project capital spending.

Question 50

The proper formula of project cash flow is EBIT + D - Taxes - additions to net working capital

Question 51

A new project is expected to have the following effects on the financial statements of a firm. The
effect of an increase in inventory should be included in the net working capital requirements for the
project.

Question 52

The bottom-up approach is used for calculating OCF, if the only information from the statement of
comprehensive income items known to you are net income and depreciation.

Question 53

The top-down approach for calculating project operating cash flow does not require you to add
back noncash deductions such as depreciation.

Question 54

A new project is expected to have the following effects on the financial statements of a firm. The
effect of an increase in the depreciation expense should be included in the net working capital
requirements for the project.

Question 55

Assume that over the life of project X, net working capital is maintained at an amount equal to the
initial investment. If so, net working capital doesn't need to be included in the NPV computation,
since the outflow at time zero is exactly (as we generally assume) offset by an equal inflow at the
end of the project's life.

Question 56

The proper formula of project cash flow is operating cash flow - additions to net working capital -
capital spending.

Question 57

A company owns a building that is totally paid for. This building has been sitting idle for the past
three years. Now the company is trying to analyze a project that would include the use of this
building. Therefore, the property taxes paid on the building over the past three years should be
included in that analysis.

Question 58

The cash flows of a project should include the related changes in the long-term debt.

Question 59

The bottom-up approach for calculating project operating cash flow does not require you to add
back noncash deductions such as depreciation.

Question 60

The cash flows of a project should include the related changes in accounts payable.

Question 61

In a cost-cutting proposal the reduction in costs has the same effect as an increase in sales.

Question 62

The tax-shield approach is used for calculating OCF, if the only information from the statement of
comprehensive income items known to you are net income and depreciation.

Question 63

You are considering investing in a piece of equipment to implement a cost-cutting proposal. The pre-tax cost reduction is expected to equal $41.67 for each of the three years of the project's life.
The equipment has an initial cost of $125 and belongs in a 20% CCA class. Assume a 34% tax
Bracket, a discount rate of 15%, and a salvage value of zero.
If the equipment is sold to another company at the end of year 3 for $20, what is the NPV?

A) -$33.56
B) -$28.91
C) $0
D) $28.91
E) $33.56

Question 64

A company is evaluating the replacement of the office copier. The cost of the maintenance contract
on the new copier should be considered in that evaluation.

Question 65

Lottie's Boutique needs to maintain 20% of its sales in net working capital. Lottie's is considering a 3-year project which will increase sales from their current level of $110,000 to $130,000 the first
Year and $145,000 a year for the following two years. What amount should be included in the
Project analysis for the last year of the project in regards to the net working capital?

A) -$35,000
B) -$7,000
C) $0
D) $7,000
E) $35,000

Question 66

Land can be depreciated for tax purposes.

Question 67

A company is evaluating the replacement of the office copier. The costs of repairs made today on
the existing copier should be considered in that evaluation.

Question 68

A decrease in the corporate tax rate decreases the value of the depreciation tax shield, all else
equal.

Question 69

A company is evaluating the replacement of the office copier. The balance due on the current
lease, which will be payable even if the copier is returned should be considered in that evaluation.

Question 70

EAC is used to evaluate mutually exclusive projects with different lives if the projects are expected
to be continuously replicated.

Question 71

A company is evaluating the replacement of the office copier. The selling price of the existing
copier should be considered in that evaluation.

Question 72

Setting the bid price requires finding the point at which project NPV is zero.

Question 73

The EAC method for evaluating projects applies when the projects have different economic lives.

Question 74

The EAC method for evaluating projects applies when the projects are mutually exclusive.

Question 75

Louie's Leisure Products is considering a project which will require the purchase of $1.4 million in new equipment. The equipment belongs in a 20% CCA class. Louie's expects to sell the equipment
At the end of the project for 20% of its original cost. Annual sales from this project are estimated at
$1)2 million. Net working capital equal to 20% of sales will be required to support the project. All of
The net working capital will be recouped at the end of the project. The firm desires a minimal 14%
Rate of return on this project. The tax rate is 34%.
What is the present value of the net working capital changes associated with the project?
The project is expected to last 7 years.

A) -$144,087
B) -$95,913
C) $0
D) $144,087
E) $184,837

Question 76

Buildings can be depreciated for tax purposes.

Question 77

The EAC method for evaluating projects applies when the projects will be replaced more or less
indefinitely.

Question 78

The tax-shield approach for calculating project operating cash flow does not require you to add
back noncash deductions such as depreciation.

Question 79

Given the following information and assuming a CCA rate of 20%, what is the NPV of this project? Initial investment = $400,000; life = five years; before-tax cost savings = $150,000 per year; salvage
Value = $30,000 in year 5; tax rate = 34%; discount rate = 14%.

A) -$149,841
B) -$33,117
C) $0
D) $19,800
E) $27,428

Question 80

Machinery and equipment can be depreciated for tax purposes.