Question 1

Additions to tangible assets, intangible assets ,and current assets can be described as:

Accepted Answer

Additions to tangible assets, intangible assets, and current assets represent investments made by a company. As such, the associated cash flows for these investments would be categorized as cash flows associated with investments.

Question 2

The impact of a project on a firm's overall value depends on

Accepted Answer

The impact of a project on a firm's overall value depends on the project's cash flow, because ultimately it is the cash flow generated by the project that contributes to the firm's overall value. Accounting earnings, while important in their own right, may not accurately reflect the cash flow generated by the project, which is the key consideration when assessing its impact on the firm's overall value. Similarly, while cash flow is important for assessing the impact of the project, it is the project's cash flow, rather than the firm's cash flow, that is most relevant for determining the project's contribution to firm value.

Question 3

The term ___________ refers to the fact that these cash flows reflect the amount by which the firm's total after-tax free cash flows will change if the project is adopted.

Accepted Answer

Incremental cash flows refer to the change in the firm's total after-tax free cash flows that result from adopting a new project. This includes any additional cash inflows and outflows directly attributable to the project, as well as any changes in existing cash flows resulting from the project. The other options listed (periodic and ending cash flows) do not accurately describe this concept.

Question 4

_________ refers to the cash flow that a project is expected to generate after all operating expenses and taxes have been paid.

Accepted Answer

Incremental cash flow from operations factors in all of the operating and tax expenses associated with a project and determines how much cash the project is expected to generate. Operating income and EBITDA do not take into account all expenses and taxes, so they are not the correct choices.

Question 5

If the salvage value, at the time of an asset disposition, is less than the book value of the asset, then the firm will effectively receive a positive cash flow from taxes on the sale.

Accepted Answer

When the salvage value is less than the book value, the firm incurs a loss on the sale, which can be used to offset taxable income, resulting in a tax benefit and thus a positive cash flow from taxes.

Question 6

Terminal-year free cash flows may differ from the cash flows provided in the typical year of a project for reasons such as the return/repayment of increases/reductions in additional working capital in the prior years.

Accepted Answer

Terminal-year free cash flows can be influenced by changes in working capital that occurred in prior years and were either returned or repaid during the terminal year of the project. This can cause the cash flows in the terminal year to differ from a typical year's cash flows.

Question 7

The cash flows used in capital budgeting calculations are based on:

Accepted Answer

The cash flows used in capital budgeting calculations should be based on forecasts of future cash revenues, expenses and investment outlays, and not on historical estimates or forecasts of net income or retained earnings. Forecasts of future cash flows are important because they represent the actual cash that the project is expected to generate or consume over the life of the project.

Question 8

The unadjusted NPV of two projects with different useful lives can be compared to evaluate which project is the better of the two.

Accepted Answer

The unadjusted NPV does not account for the different time horizons of projects with different useful lives, making it an inappropriate measure for direct comparison.

Question 9

You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately if the current NPV of the project is positive.

Accepted Answer

If the current NPV of the project is positive, then the present value of the expected future cash flows from the uranium mine must be greater than the initial investment required to begin harvesting. Given that the price of uranium is expected to increase at a rate of 3 percent per year, there is potential for future cash flows to increase over time. However, the cost of capital for the firm is high at 15 percent, which means that the initial investment will need to generate a significant return to be profitable. Therefore, if the NPV is positive, it suggests that the expected cash flows are sufficient to generate a return that exceeds the cost of capital, and it would be advisable to begin harvesting immediately.

Question 10

The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate for a total of four years.

Accepted Answer

The MACRS (Modified Accelerated Cost Recovery System) for three-year property includes a half-year convention, which spreads the depreciation over four tax years.

Question 11

You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately under all circumstances.

Accepted Answer

The decision to begin harvesting should consider the cost of capital and the expected increase in uranium prices. If the cost of capital (15%) is significantly higher than the price increase rate (3%), it may not be financially beneficial to start harvesting immediately.

Question 12

The expected cash flows for a project are fixed amounts that have zero variability in the projected values.

Accepted Answer

The expected cash flows for a project may have some degree of variability or uncertainty in their projected values. For example, changes in market conditions, inflation rates, or technological advancements can impact the future expected cash flows of a project. Therefore, it is important to consider the risks and uncertainties related to the cash flow projections when evaluating the feasibility and profitability of a project.

Question 13

The firm's ____________ is used to calculate NOPAT because the profits from a project are assumed to be incremental to the firm.

Accepted Answer

The firm's marginal tax rate is used to calculate NOPAT because it represents the tax rate that will be applied to the additional profits earned from a project. It assumes that the profits from the project are incremental to the firm, meaning they are in addition to the profits already earned and taxed at the company's current tax rate.

Question 14

The ___________ is intended to reconcile changes in the balance sheet cash accounts.

Accepted Answer

The accounting statement of cash flows is specifically designed to reconcile changes in the balance sheet cash accounts, whereas the capital budgeting cash flow calculation typically focuses on future cash flows for investment decision-making, and the accounting statement of income shows a company's revenue and expenses over a period of time but does not necessarily reconcile cash account changes.

Question 15

If the current market price of corn is $100 per bushel and the nominal rate of interest is 10 percent, then the real price of corn next period should also be $100.

Accepted Answer

The real price of corn is the nominal price of corn divided by the price level. The price level is the general level of prices in the economy. If the nominal rate of interest is 10 percent, then the price level will increase by 10 percent next period. Therefore, the real price of corn will remain the same.

Question 16

A progressive tax system means that a taxpayer will pay a higher tax rate for a given dollar of earnings for every successive year.

Accepted Answer

A progressive tax system means that the tax rate increases as the income increases. It does not necessarily mean that the tax rate increases for every successive year.

Question 17

The NPV of a project is estimated by:

Accepted Answer

NPV stands for Net Present Value. It is calculated by discounting the expected cash flows of a project in the future to present value using a discount rate that reflects the time value of money and the risk associated with the project. This helps in determining the current value of the expected future cash flows of the project, which is then compared with the initial investment to calculate the net present value of the project. Therefore, option A is the correct answer.

Question 18

In order to calculate free cash flow by starting with incremental cash flow from operations, we should

Accepted Answer

To calculate free cash flow starting with incremental cash flow from operations, you subtract both the incremental capital expenditures (which are cash outflows for investing in long-term assets) and the incremental additions to working capital (which represent cash tied up in the business operations and not available as free cash). This approach reflects the cash that is truly free for distribution to all stakeholders after maintaining or expanding the asset base.

Question 19

It is possible for a firm to have one depreciation schedule for tax purposes and another for financial reporting purposes.

Accepted Answer

The tax regulations may require a specific depreciation method, while a firm may choose a different method for financial reporting purposes, resulting in different depreciation schedules.

Question 20

The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as:

Accepted Answer

The stand-alone principle states that we can evaluate the cash flows from a project independently of the cash flows for the firm. This means that we can analyze the potential of a specific project without considering the impact it may have on the overall cash flows of the firm.

Quiz 11: Cash Flows and Capital Budgeting