Question 1

One purpose of identifying all of the incremental cash ﬂows related to a proposed project is to:

Accepted Answer

The purpose of identifying all of the incremental cash flows related to a proposed project is to eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. This is because sunk costs, or costs that have already been incurred, should not influence the decision-making process for future investments as they cannot be recovered or changed.

Question 2

The pro-forma income statement for a cost reduction project:

Accepted Answer

A pro-forma income statement for a cost reduction project will typically not include incremental sales, but rather show the impact of cost reductions on existing sales. It will reflect the same level of total sales as before the project, but with lower expenses and potentially higher profits.

Question 3

The changes in a ﬁrm's future cash ﬂows that are a direct consequence of accepting a project are called ______ cash ﬂows.

Accepted Answer

Incremental cash flows refer to the changes in a firm's future cash flows that result from accepting a project. These changes are compared to the firm's current or baseline cash flows to determine the project's profitability. Stand-alone cash flows refer to the cash flows of a project if it were undertaken as a separate entity, without considering the firm's other operations or projects. After-tax cash flows take into account the tax implications of a project. Net present value refers to the present value of a project's cash inflows minus the present value of its cash outflows, discounted at the appropriate cost of capital. Erosion refers to the reduction in cash flows of existing products or services caused by the introduction of a new product or service.

Question 4

The most valuable investment given up if an alternative investment is chosen is a(n):

Accepted Answer

The opportunity cost is the value of the best alternative forgone when a choice is made. Therefore, the most valuable investment given up if an alternative investment is chosen is the opportunity cost. A, B, C, and E do not accurately describe the cost associated with giving up an investment opportunity.

Question 5

The cash ﬂow tax savings generated as a result of a ﬁrm's tax-deductible depreciation expense is called the:

Accepted Answer

The cash flow tax savings generated by deductible depreciation expense is referred to as depreciation tax shield. This tax savings is calculated by multiplying the amount of depreciation expense by the marginal tax rate of the firm.

Question 6

The depreciation method currently allowed under EU tax law governing the accelerated write-off of property under various lifetime classiﬁcations is called _____ depreciation.

Accepted Answer

The term "accelerated write-off" suggests that the depreciation method is designed to allow for a faster write-off of property than the normal straight-line method. The reducing balance method is a common accelerated depreciation method that allows for a larger deduction in the earlier years of an asset's life and a smaller deduction in later years. This method is often used to encourage investment and economic growth by reducing the tax burden on businesses that invest in new property. None of the other options listed are specifically designed for accelerated depreciation.

Question 7

Which of the following are examples of an incremental cash ﬂow? I.An increase in trade receivables.
II)A decrease in net working capital.
III)An increase in taxes.
IV)A decrease in the cost of goods sold.

Accepted Answer

Incremental cash flows refer to the additional cash flows a company expects to generate from a particular investment or project. All the options listed (I, II, III, IV) represent changes in cash flows due to a new project or investment: I) An increase in trade receivables affects cash flow; II) A decrease in net working capital usually frees up cash; III) An increase in taxes affects cash outflows; IV) A decrease in the cost of goods sold improves cash flow by reducing expenses.

Question 8

Sunk costs include any cost that:

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered or changed. They are irrelevant in decision-making because they cannot be changed regardless of whether a project is accepted or not.

Question 9

A pro-forma ﬁnancial statement is one that:

Accepted Answer

A pro-forma financial statement is a projection of future years' operations, including income statements, balance sheets, and cash flow statements. It is used to estimate the company's financial performance and make informed business decisions based on those estimates. Therefore, choice A is the correct answer. Choices B, C, D, and E are not accurate definitions of pro-forma financial statements.

Question 10

The increase you realize in buying power as a result of owning a bond is referred to as the _____ rate of return.

Accepted Answer

The increase in buying power as a result of owning a bond is referred to as the real rate of return, which takes into account inflation. The nominal rate of return is the stated rate of return on the bond, while the realized rate of return is the actual rate of return earned after accounting for any fees or taxes. The risk-free rate of return is the rate of return on an investment that has no risk, such as a U.S. Treasury bond.

Question 11

Erosion can be explained as the:

Accepted Answer

Erosion, in a business context, refers to the loss of current sales (revenue) when a new project or product is introduced, which can cannibalize the sales of existing products or services.

Question 12

Which of the following are examples of erosion? I.The loss of sales due to increased competition in the product market.
II)The loss of sales because your chief competitor just opened a store across the street from your
Store.
III)The loss of sales due to a new product which you recently introduced.
IV)The loss of sales due to a new product recently introduced by your competitor.

Accepted Answer

The answer of Which of the following are examples of...

Question 13

A project's cash ﬂows might consist of:

Accepted Answer

The answer of A project's cash ﬂows might consist of:
...

Question 14

You spent €500 last week ﬁxing the transmission in your car.Now, the brakes are acting up and you are trying to decide whether to ﬁx them or trade the car in for a newer model.In analyzing the brake
Situation, the €500 you spent ﬁxing the transmission is a(n) _____ cost.

Accepted Answer

The €500 spent on fixing the transmission is a sunk cost, meaning it cannot be recouped regardless of the decision to fix the brakes or trade in the car. Therefore, it should not be a factor in the decision-making process. The decision should be based solely on the cost of fixing the brakes versus the cost of trading in for a newer model.

Question 15

A cost that has already been paid, or the liability to pay has already been incurred, is a(n):

Accepted Answer

A sunk cost is a cost that has already been paid or committed and cannot be recovered. It is not relevant to future decision-making because it cannot be changed or reversed.

Question 16

The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost.

Accepted Answer

The concept described in the question refers to the equivalent annual cost (EAC) of a project, which is the annual payment that, if paid over the same period as the project's life, would result in the same present value as the project's costs. A, B, C, and D are not the correct terms to describe this concept.

Question 17

The cash ﬂows of a new project that come at the expense of a ﬁrm's existing projects are called:

Accepted Answer

The definition given in the question matches the concept of erosion costs, which are the cash flows that result from the introduction of a new product, service, or project that reduces the sales or cash flows of existing products, services, or projects. Therefore, the correct answer is E. Salvage value expenses refer to the cash flows generated from the sale of an asset at the end of its useful life. Net working capital expenses refer to the increase in investment in working capital required by a project. Sunk costs are costs that have already been incurred and cannot be recovered. Opportunity costs are the benefits foregone by choosing one alternative over another.

Question 18

Interest rates or rates of return on investments that have been adjusted for the effects of inﬂation are called _____ rates.

Accepted Answer

Real rates of return are adjusted for inflation, while nominal rates are not. Effective rates take compounding into account, stripped rates refer to certain types of bonds, and coupon rates refer to the interest payments made on bonds.

Question 19

Which of the following should be included in the analysis of a project's incremental cash ﬂows? I.Sunk costs.
II)Opportunity costs.
III)Erosion costs.
IV)Incremental costs.

Accepted Answer

Incremental cash flows for a project should include opportunity costs, erosion costs (also known as cannibalization effects), and the specific incremental costs associated with the project. Sunk costs, which are costs that have already been incurred and cannot be recovered, should not be included in the analysis of a project's incremental cash flows.

Question 20

All of the following are anticipated effects of a proposed project.Which of these should be included in the initial project cash ﬂow related to net working capital?
I.An inventory decrease of €5,000.
II.An increase in trade receivables of €1,500.
III.An increase in non-current assets of €7,600.
IV.A decrease in trade payables of €2,100.

Accepted Answer

Net working capital is the difference between current assets and current liabilities. Any changes in current assets or current liabilities impact the net working capital, and thus, should be included in the initial project cash flow related to net working capital.

I. An inventory decrease of €5,000 is a current asset and would result in a positive impact on net working capital. Hence, it should be included in the initial project cash flow related to net working capital.

II. An increase in trade receivables of €1,500 is a current asset and would result in a negative impact on net working capital. Hence, it should be included in the initial project cash flow related to net working capital.

III. An increase in non-current assets of €7,600 is not a current asset and does not impact net working capital. Hence, it should not be included in the initial project cash flow related to net working capital.

IV. A decrease in trade payables of €2,100 is a current liability and would result in a negative impact on net working capital. Hence, it should be included in the initial project cash flow related to net working capital.

Therefore, options A, B, and C can be eliminated. Option D includes all the changes that impact net working capital, and hence, is the correct answer. Option E includes an item (increase in non-current assets) that does not impact net working capital, and hence, is incorrect.

Quiz 7: Making Capital Investment Decisions