Question 1

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0?

Accepted Answer

Initial investment in inventory to support the project is considered a part of the initial outlay or cash flow at Time 0 because it represents a cash outflow necessary to start the project.

Question 2

Which one of the following best describes the concept of erosion?

Accepted Answer

Erosion refers to the reduction in cash flows that a company experiences from its existing products or services due to the introduction of a new product or service.

Question 3

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

Accepted Answer

The stand-alone principle advocates that project analysis should be based solely on incremental costs, which are the additional costs that will be incurred as a result of undertaking a project. Sunk costs (A) are costs that have already been incurred and cannot be recovered, and therefore should not be included in project analysis. Total costs (B) are not useful for evaluating a single project since it does not distinguish between costs that are directly attributable to the project and those that are not. Variable costs (C) and fixed costs (E) are useful in determining cost behavior, but they are not relevant in a stand-alone analysis where only the incremental costs matter.

Question 4

Net working capital:

Accepted Answer

Net working capital can create either an initial cash inflow or outflow depending on the changes in current assets and liabilities. For example, an increase in accounts receivable would require an investment of cash, while an increase in accounts payable would result in a cash saving. Therefore, net working capital is an important consideration in project analysis. The other statements are not accurate regarding net working capital.

Question 5

Kelley's Baskets makes handmade baskets and is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

Accepted Answer

The incremental operating cash flow related to the wreath project would be any cash flows that are directly related to the project and differ from the cash flows without the project. In this case, hiring additional employees to handle the increased workload for the wreath project is a cash outflow that is specific to the project and thus represents an incremental operating cash flow. Storing supplies in the same space currently used for materials storage is a sunk cost that does not change with the acceptance of the wreath project and thus is not incremental. Utilizing the basket manager to oversee wreath production is also not incremental since the manager would still be employed regardless of whether the firm makes baskets or wreaths. Researching the market and assuming lower interest expense are not cash flows and thus are not examples of incremental operating cash flows.

Question 6

Frank's is a furniture store that is considering adding appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances?

Accepted Answer

Selling furniture to appliance customers represents an incremental cash flow because it represents additional revenue that would not have been generated without the addition of appliances to the store's offerings. The other options listed do not represent incremental cash flows related to appliances specifically.

Question 7

Pro forma statements for a proposed project should generally do all of the following except:

Accepted Answer

Pro forma statements for a proposed project should focus on the project's incremental cash flows, which include revenues and costs directly related to the project, taxes, and any changes in net working capital and capital spending. Interest expense is not included because it is a financing cost, and the analysis should be focused on the project's operational performance before financing considerations.

Question 8

Dependable Motors just purchased some MACRS five-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for Years 1 to 3, respectively. Assume the firm opted to forego any bonus depreciation. Which one of the following will correctly give you the book value of this equipment at the end of Year 2?

Accepted Answer

The book value at the end of Year 2 is calculated by subtracting the depreciation of the first two years from the initial cost. The depreciation rates for the first two years are .2 and .32, so the book value is $216,000 * (1 - .2 - .32).

Question 9

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?

Accepted Answer

The option that is forgone so that an asset can be utilized by a specific project is called the opportunity cost. This is because when an asset is devoted to a particular project, the benefit that could have been gained from using that asset elsewhere is the opportunity cost. The other answer choices do not relate specifically to the concept of foregone opportunities in asset utilization.

Question 10

Which one of the following is an example of a sunk cost?

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered or changed. Option B is an example of a sunk cost because the $1,200 paid for repairing a machine last year is a cost that has already been incurred and cannot be recovered. The other options (A, C, D, and E) involve potential future costs or benefits that can be altered by current decisions.

Question 11

Which one of the following is a project cash inflow? Ignore any tax effects.

Accepted Answer

Decrease in inventory is considered a project cash inflow because it signifies that less cash is tied up in inventory, effectively increasing the cash available for use in other areas of the project or business.

Question 12

Pro forma financial statements can best be described as financial statements:

Accepted Answer

Pro forma financial statements are projections of future financial performance and therefore show projected values for future time periods.

Question 13

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

Accepted Answer

Erosion in a business context refers to the reduction in sales or market share due to internal factors, such as introducing a new product that cannibalizes the sales of an existing product. In this case, selling fewer hot dogs because hamburgers were added to the menu illustrates erosion.

Question 14

A project's cash flow is equal to the project's operating cash flow:

Accepted Answer

The correct calculation of a project's cash flow involves subtracting both the project's change in net working capital and capital spending from its operating cash flow. This accounts for the cash needed to fund working capital and capital expenditures, which are not captured in operating cash flow alone.

Question 15

Which one of the following costs was incurred in the past and cannot be recouped?

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered or changed.

Question 16

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

Accepted Answer

The stand-alone principle assumes that a project's incremental cash flows should be analyzed independent of the cash flows of other projects or the overall company. This is why each project should be evaluated based on its own incremental cash flows, rather than looking at company-wide or industry-wide cash flows.

Question 17

The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's:

Accepted Answer

Incremental cash flows represent the difference between the cash flows a company will receive if they go ahead with the project versus if they don't. Therefore, the answer is A. Internal and external cash flows refer to the sources of cash for the company from operations and outside sources, respectively. Erosion effects refers to revenue lost by an existing product or service when a new one is introduced. Financing cash flows refer to cash inflows and outflows related to financing activities such as raising capital or repaying debt.

Question 18

Which one of the following should not be included in the analysis of a new product?

Accepted Answer

Money already spent for research and development is a sunk cost and should not be included in the analysis of a new product.

Question 19

Changes in the net working capital requirements:

Accepted Answer

Changes in net working capital requirements can affect the cash flows of a project every year of the project's life as they are related to the cash inflows and outflows associated with current assets and current liabilities. Therefore, they cannot be ignored and should be considered in project analysis.

Question 20

GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?

Accepted Answer

The $1,200 cost for repairing the machine is a sunk cost since it is a past cost that cannot be recovered regardless of the company's decision to assign the machine to the proposed project or not. Therefore, it should not be considered when analyzing the feasibility of the proposed project.

Quiz 10: Making Capital Investment Decisions