Question 1

Kelvin Crackers is evaluating the introduction of a new line of organic cracker products.Market research suggests that approximately one-third 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 Kelvin Crackers is evaluating the introduction of...

Question 2

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York 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 3

Kelvin Crackers will finance a new organic cracker 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 Kelvin Crackers will finance a new organic...

Question 4

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York 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 5

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 should be based on cause-and-effect relationships, not just on percentage of space used. The accounting department may use other methods, such as direct labor hours, machine hours, or number of employees involved in the project, to allocate overhead costs.

Question 6

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 assumption that projects can add sales to existing lines of business, as the goal is to assess all potential benefits and impacts of a project, including synergies with current operations.

Question 7

Cash flows are the source of value.

Accepted Answer

Cash flows are the ultimate source of value for any business or investment. These cash flows can be in the form of revenues generated, dividends paid out, or any other cash inflows. The valuation of any asset or investment depends on its expected future cash flows.

Question 8

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 9

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 $2500 a month.

Accepted Answer

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

Question 10

Enviro Co.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?

Accepted Answer

The relevant cost of the new building includes the cost of constructing 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 total relevant cost is $2,500,000 + $48,000 + $50,000 = $3,098,000. However, the question asks for the cost of the building only, so we need to subtract the opportunity cost of selling the land, which is not a necessary cost of the project. Therefore, the relevant cost of the new building is $2,500,000 + $48,000 = $2,548,000. The closest answer choice to this amount is C) $3,050,000.

Question 11

Freedom Inc 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 [blank].

Accepted Answer

Operating cash flow can be calculated as:
Operating cash flow = Net Operating Income + Non-cash expenses (e.g. depreciation) - Taxes
Therefore, Operating cash flow = $1,000,000 + $150,000 - $350,000 = $800,000. Thus, the correct answer is C.

Question 12

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

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. This is because the sale of the old asset affects the cash flow and tax liability of the replacement asset, and ignoring it can result in inaccurate analysis and decision making.

Question 13

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

Accepted Answer

The initial outlay of an asset typically includes installation costs as well as any other costs necessary to get the asset up and running.

Question 14

Jennifer Jones included the cost of test marketing before production in the calculation of the initial outlay.Apparently, Jennifer does not understand the concept of

Accepted Answer

Test marketing costs are sunk costs, which means they are already incurred and cannot be recovered. Including them in the calculation of initial outlay is not appropriate as they do not affect the future cash flows associated with the project.

Question 15

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 statement describes a variable cost, as the space is being converted for a new purpose and will incur costs to make that conversion. A sunk cost is a cost that has already been incurred and cannot be recovered, regardless of future decisions (such as the cost of the previous company renting the space as a warehouse).

Question 16

Calculating project cash flows is a [blank] step procedure.

Accepted Answer

Calculating project cash flows is a four-step procedure. These steps include identifying the cash flow elements, estimating the cash flows, analyzing the cash flows, and assessing risk and uncertainty.

Question 17

Terminal cash flows can include expenses as well as revenues.

Accepted Answer

Terminal cash flows take into account all the expenses and revenues expected at the end of a project or investment, not just revenues.

Question 18

The owner of a convenience shop is considering adding a take-out sandwich section to her offerings.The new activity will occupy 25% of the space and account for 30% of total revenues.Property insurance on the building is $9000 per year and will not change because of the new activity.How much of the insurance premium should be allocated to the new product line?

Accepted Answer

The insurance premium should not be allocated based on the new activity since it remains unchanged regardless of the addition of the take-out sandwich section.

Question 19

Urban 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 [blank].

Accepted Answer

Operating cash flow = incremental sales - total cash operating expenses - depreciation - taxes 
= $5,000,000 - $3,500,000 - $500,000 - (0.35*$5,000,000) 
= $1,150,000

Question 20

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...

Quiz 12: Analyzing Project Cash Flows