Question 1

When determining how much overhead cost to include in incremental cash flows for a capital budgeting decision,the allocation of overhead by the accounting department based on percentage of space used by a project should always be used.

Accepted Answer

the allocation of overhead cost should be done through a thorough analysis of the actual cost drivers of the overhead, such as labor or machine usage, rather than just based on percentage of space used.

Question 2

In making a capital budgeting decision we only include the incremental cash flows resulting from the investment decision.

Accepted Answer

In making a capital budgeting decision, only the incremental cash flows resulting from the investment decision are considered because these are the cash flows that are directly affected by the investment and represent the additional cash flows the company would receive or lose if they proceed with the project. Other cash flows, such as sunk costs and overhead expenses, are not included because they are not affected by the investment decision.

Question 3

A company converts space to use as a manufacturing facility.Previously it was rented to another company as a warehouse.This is an example of a sunk cost.

Accepted Answer

This is not an example of a sunk cost because the cost of converting the space to a manufacturing facility is not irretrievable and can potentially be recovered in the future through the manufacturing operations. The sunk cost would be the cost incurred by the previous company to rent the space as a warehouse.

Question 4

Cape Cod Cranberries will finance a new organic juice production facility with a $10,000,000 bond issue.Interest on the bonds will be $637,500 per year for the life of the project.Should the interest payments be subtracted from the project's incremental cash flows?

Accepted Answer

The answer of Cape Cod Cranberries will finance a new...

Question 5

The initial outlay involves the immediate cash outflow necessary to purchase the asset and put it in operating order.

Accepted Answer

The initial outlay is the immediate cash outflow required to acquire and prepare an asset for its intended use.

Question 6

Incremental cash flows include all of the following EXCEPT
A)research and development costs.
B)increased labor costs from the project.
C)advertising costs.
D)both B and C.

Accepted Answer

Research and development costs are typically considered part of the initial investment and not part of incremental cash flows, which only consider the additional cash flows directly resulting from the project. Increased labor costs and advertising costs are examples of incremental cash flows.

Question 7

The pertinent issue for determining whether overhead costs should be part of a project's relevant after-tax cash flow is whether the project benefits from the overhead items.

Accepted Answer

The answer of The pertinent issue for determining whether overhead...

Question 8

To be conservative,capital budgeting analysis assumes that projects cannot add sales to existing lines of business.

Accepted Answer

Capital budgeting analysis often includes the consideration of how new projects might add sales or synergies to existing lines of business, enhancing overall profitability.

Question 9

The initial outlay of an asset does not include installation costs.

Accepted Answer

The initial outlay of an asset includes all costs associated with acquiring and preparing the asset for its intended use, including installation costs.

Question 10

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York state to New York City.The controller argues that depreciation has to be included among the expenses.The Treasurer argues that depreciation is irrelevant because it does not affect cash flow.Who is correct?

Accepted Answer

The answer of Anderson-EOG Inc.is evaluating the construction of a...

Question 11

Diamond Inc.has estimated that a new building will cost $2,500,000 to construct.Land was purchased a year ago for $500,000 and could be sold today for $550,000.An environmental impact study required by the state was performed at a cost of $48,000.For capital budgeting purposes,what is the relevant cost of the new building?
A)$2,500,000
B)$3,048,000
C)$3,050,000
D)$3,098,000

Accepted Answer

The relevant cost of the new building includes the cost to construct the building ($2,500,000), the cost of the environmental impact study ($48,000), and the opportunity cost of selling the land ($550,000 - $500,000 = $50,000). Therefore, the relevant cost is $2,500,000 + $48,000 + $50,000 = $3,050,000. Option C is the correct choice.

Question 12

Mr.Smith included the cost of test marketing before production in the calculation of the initial outlay.Apparently,Mr.Smith does not understand the concept of
A)side-effect costs.
B)opportunity costs.
C)sunk costs.
D)variable costs.

Accepted Answer

Test marketing costs are sunk costs - costs that have already been incurred and cannot be recovered. They should not be included in the initial outlay calculation as they do not affect future cash flows.

Question 13

Schiller Construction Inc.has estimated the following revenues and expenses related to phase I of a proposed new housing development.Incremental sales= $5,000,000,total cash operating expenses $3,500,000,depreciation $500,000,taxes 35%,interest expense,$200,000.Operating cash flow equals
A)$650,000
B)$1,000,000
C)$1,150,000
D)$975,000

Accepted Answer

Operating cash flow can be calculated using the following formula:

Operating cash flow = incremental sales - total cash operating expenses - depreciation - taxes

Using the numbers given:

Operating cash flow = $5,000,000 - $3,500,000 - $500,000 - 0.35($5,000,000 - $500,000) = $1,150,000

Therefore, the best choice is C – $1,150,000.

Question 14

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York state to New York City.The controller argues that every project of the company has to absorb a portion of administrative overhead including corporate headquarters and executive salaries.The Treasurer argues that these costs are irrelevant because they are merely being shifted from part of the company to another.Who is correct?

Accepted Answer

The answer of Anderson-EOG Inc.is evaluating the construction of a...

Question 15

Briefly explain why each of the following should or should not be considered in forecasting incremental cash flows from a project:
a.The cost of building a prototype of a new product to see if it was feasible.
b.Market research suggests that after buying a company's "smart phone" customers will begin to buy more of the same company's notebook computers.
c.A company decides to use existing space for storage.The company could have rented the space to another business for $2,500 a month.

Accepted Answer

The answer of Briefly explain why each of the following...

Question 16

When replacing an existing asset,the cash inflow associated with the sale of the old asset and any related tax effects must be considered and accounted for in the analysis.

Accepted Answer

The cash inflow associated with the sale of the old asset and any related tax effects must be considered when replacing an existing asset to accurately account for the total cost and benefit of the replacement decision.

Question 17

Thaler & Co.anticipates an increase of $1,000,000 in Net Operating Income from first year sales of a new product.Taxes will be $350,000 and the company took $150,000 in depreciation expense.Operating cash flow equals
A)$1,000,000
B)$500,000
C)$800,000
D)$650,000

Accepted Answer

Operating Cash Flow = Net Operating Income + Depreciation Expense - Taxes 
= $1,000,000 + $150,000 - $350,000 
= $800,000

Question 18

Sunk costs are a type of incremental cash flow that should be included in all capital-budgeting decisions.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, and therefore should not be considered in future capital-budgeting decisions which focus on incremental cash flows.

Question 19

In measuring cash flows we are interested only in the incremental or differential after-tax cash flows that are attributed to the investment proposal being evaluated.

Accepted Answer

Measuring incremental or differential after-tax cash flows is the basis for determining the feasibility and profitability of an investment proposal. Other cash flows that are not attributed to the investment proposal can be ignored in this analysis.

Question 20

Cape Cod Cranberries is evaluating the introduction of a new line of organic cranberry products.Market research suggests that approximates 1/3 of sales of the new products will come at the expense of existing product lines.How should this "cannibalization effect" be incorporated into the analysis.

Accepted Answer

The answer of Cape Cod Cranberries is evaluating the introduction...

Quiz 12: Analyzing Project Cash Flows