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Q:
Operating leverage is a measure of the sensitivity of net income to changes in revenue.
A) True
B) False
Q:
Depreciation and amortization can be considered a fixed cost of the firm, for accounting break-even purposes.
A) True
B) False
Q:
EBITDA is more sensitive to changes in revenue than EBIT.
A) True
B) False
Q:
Distinguishing between fixed and variable costs will enable one to calculate the sensitivity of EBITDA to changes in revenue.
A) True
B) False
Q:
A synonym for pretax operating cash flow is EBIT.
A) True
B) False
Q:
A project with a higher proportion of fixed costs will have cash flows and accounting profits that are more sensitive to changes in revenues than an otherwise identical project with a lower proportion of fixed costs.
A) True
B) False
Q:
Total variable costs for a firm do not vary directly with the number of units sold.
A) True
B) False
Q:
When is the appropriate time to harvest an asset?A) That point in time where harvesting the asset yields the largest internal rate of return.B) That point in time where harvesting the asset yields the smallest payback.C) That point in time where harvesting the asset yields the largest accounting rate of return.D) That point in time where harvesting the asset yields the largest net present value.
Q:
Equivalent Annual Cost: Your firm is considering an investment that will cost $750,000 today. The investment will produce cash flows of $250,000 in year 1, $400,000 in year 2, and $600,000 in year 3. The discount rate that your firm uses for projects of this type is 11.75%.What is the investment's equivalent annual cost? (Round off to the nearest whole dollar)A) $163,613B) $225,008C) $68,888D) $92,845
Q:
Your firm is evaluating the merits of several different machines. Machine A has a useful life of 5-years, generates an NPV of $53,250, an IRR of 13.6% and an equivalent annual cost of $10,316. Machine B has a useful life of 3-years, an NPV of $61,051, an IRR of 12.5%, and an equivalent annual cost of $9,724. Machine C has a useful life of 4-years, generates an NPV of $55,225, an IRR of 15.2% and an equivalent annual cost of $7,535 Machine D has a useful life of 7-years, generates an NPV of $64,020, an IRR of 11.4% and an equivalent annual cost of $8,885.
Which machine should be purchased and why?
A) Machine C, because it has the highest IRR.
B) Machine D, because it has the highest NPV.
C) Machine A, because it has the most positive EAC
D) Machine B, because it has the shortest useful life.
Q:
Which of the following is an example of a fixed cost?
A) Cost of equipment purchased for an assembly line to be used in the production of a new product.
B) Assembly costs associated with the production of a new product.
C) Labor costs associated with the production of a new product.
D) Shipping costs associated with the sale of a new product.
Q:
Which of the following should not be included in a schedule of cash flows from operations when evaluating a capital project?
A) Fixed costs.
B) Sunk costs.
C) Depreciation and amortization.
D) Variable costs.
Q:
Average versus Marginal Tax Rate: Suppose Franklin Corporation had pre-tax income of $300,000 in 2010 and that the firm would have paid $100,250.00 in federal income taxes. What is Franklin's average income tax rate? (Round off to the nearest 0.1%)A) 39.0%B) 34.7%C) 33.4%D) 38.6%
Q:
Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new machine for $100,000 that has a useful life of 3 years. The firm's cost of capital is 11.0% and the tax rate is 40%. This machine will be sold for its salvage value of $20,000 at the end of 3-years. The machine will require an investment of $2,500 in spare parts inventory upon installation. The machine will cost $8,000 to ship and $4,000 to install and modify it.Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in working capital will be liquidated at termination of the project at the end of year 3.MACRS Rates 33% 45% 15% 7%Using MACRS, what is the operating cash flow in year 1?A) $53,784B) $35,238C) $86,999D) $42,512
Q:
General Mills just is undertaking an analysis on a new cereal. The firm realizes that if they come out with a new product it would affect sales of existing products? What is the best course of action for General Mills in this analysis?
A) Treat the reduction of sales from existing cereals as a sunk cost.
B) Account for the reduction of sales from existing cereals in the projection of cash flows on the new product.
C) Include the allocated costs of the new cereal in the sales of the pre-existing products.
D) Ignore the fact that sales of other products will be affected.
Q:
Which of the following statements is true?
A) The calculation of free cash flow does not include the impact of income taxes.
B) Accounting earnings are an unreliable measure of the costs and benefits of a project.
C) The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as the incremental principle.
D) Depreciation expense should not be included in the calculation of incremental net operating profits after-tax.
Q:
Which of the following statements is correct?
A) Incremental net operating profits after-tax should include sunk costs associated with a project.
B) Incremental net operating profits after-tax should include the effects of financing costs associated with a project.
C) Incremental net operating profits after-tax should exclude the effects of depreciation costs associated with a project.
D) Incremental net operating profits after-tax should exclude the effects of financing costs associated with a project.
Q:
Why is depreciation and amortization added back when calculating free cash flows generated by a project?
Q:
Explain why in practice the cash flows associated with a project are not certain cash flows.
Q:
Briefly explain the two methods of comparing projects with different useful lives.
Q:
The cost of using an existing asset: Small Appliances, Inc., is considering starting a new line of business with the excess capacity it currently has on its rivet machine. The current machine is expected to last four years at the current rate of production. However, if a new line of business is taken on, then the machine will have to be replaced in three years instead of four. A new machine that will last four years would cost $50,000. What is the cost of taking on the new line of business? Round to the nearest dollar and assume a 9 percent cost of capital.A) $11,917B) $12,500C) $15,433D) $50,000
Q:
When to replace an asset: Burt's Pizzas is considering whether to purchase an oven. Burt's calculates that its current oven generates $4,000 of cash flow per year. A new oven would cost $15,000 and would provide cash flow of $6,000 per year for six years. What is the equivalent annual cash flow for the new oven (round to the nearest dollar), and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12 percent.A) $2,352, do not purchase the ovenB) $6,000, purchase the ovenC) $9,668, purchase the ovenD) $24,668, purchase the new oven
Q:
When to replace an asset: Nemo Haulers is considering whether to purchase a new mini tractor for moving furniture within its warehouse. Nemo calculates that its current mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost $3,000 and would provide cash flow of $4,000 per year for five years. What is the equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10 percent.A) $3,000, do not purchase the new tractorB) $3,209, purchase the new tractorC) $4,000, purchase the new tractorD) $12,163, purchase the new tractor
Q:
When to harvest an asset: Farmer Ag owns a special species of cotton-producing plant that, if left unharvested, grows a bigger bowl of cotton through time. The NPV, at the beginning of the year that harvesting takes place, is as follows. When should Farmer Ag harvest its cotton? Assume a discount rate of 14 percent.
NPV1 = $50,000
NPV2 = $60,000
NPV3 = $69,000
NPV4 = $77,280
NPV5 = $85,008
A) Harvest now
B) Harvest in year 1
C) Harvest in year 2
D) Harvest in year 3
Q:
When to harvest an asset: Cleveland Millicrum is considering when to harvest its moldy bread supply for antibiotics. It has calculated that the current NPV dollars for harvesting the bread are increasing according to the following schedule. When should the firm harvest the bread? The cost of capital for the firm is 14 percent.
NPV increase if harvested next year over that of harvesting now 25%
NPV increase if harvested year 2 over that of harvesting year 1 20%
NPV increase if harvested year 3 over that of harvesting year 2 17%
NPV increase if harvested year 4 over that of harvesting year 3 13%
NPV increase if harvested year 5 over that of harvesting year 4 10%
A) Harvest now
B) Harvest year 2
C) Harvest year 3
D) Harvest year 4
Q:
Projects with different lives: Your firm is deciding whether to purchase a high-quality printer for your office or one of lesser quality. The high-quality printer costs $40,000 and should last four years. The lesser quality printer costs $30,000 and should last three years. If the cost of capital for the firm is 13 percent, then what is the equivalent annual cost for the best choice for the firm? Round to the nearest dollar.A) $10,000, either printerB) $10,000, lesser quality printerC) $12,706, lesser quality printerD) $13,448, high-quality printer
Q:
Projects with different lives: Your firm is deciding whether to purchase a durable delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should last five years. The short-term vehicle costs $10,000 and should last two years. If the cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the best choice for the firm? (Round final answer to nearest whole dollar.)A) $5,000, either vehicleB) $5,000, short-term vehicleC) $6,151, short-term vehicleD) $7,458, long-term vehicle
Q:
Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a 40 percent probability of revenues totaling $3 million and a 60 percent probability of revenues totaling $1 million per year. Its cash expenses will be $1.0 million while depreciation expense will be $200,000; then what is the expected free cash flow from taking the project if the marginal tax rate for the firm is 30 percent?A) $200,000B) $420,000C) $600,000D) $620,000
Q:
Computing the terminal-year FCF: Babaloo Nightclubs, purchased a disco mirror that currently has a book value of $10,000. If Babaloo sells the disco mirror for $500 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 39 percent marginal tax rate?A) $500B) $3,705C) $4,205D) $9,500
Q:
Computing the terminal-year FCF: Miles Cyprus Corp. purchased a truck that currently has a book value of $1,000. If the firm sells the truck for $5,000 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 30 percent marginal tax rate?
A) $1,200
B) $3,800
C) $4,000
D) $5,000
Q:
Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate the average tax rate for Lansing, Inc., this year. Lansing's pretax income was $275,000.(Round final answer to nearest whole percent.)Exhibit 11.6 U.S. Corporate Tax Rate Schedule in 2007Taxable IncomeMoreThan But Not More Than Tax Owed$0 $50,000 15% of amount beyond $0$50,000 $75,000 $7,500 + 25% of amount beyond $50,000$75,000 $100,000 $13,750 + 34% of amount beyond $75,000$100,000 $335,000 $22,250 + 39% of amount beyond $100,000$335,000 $10,000,000 $113,900 + 34% of amount beyond $335,000$10,000,000 $15,000,000 $3,400,000 + 35% of amount beyond $10,000,000$15,000,000 $18,333,333 $5,150,000 + 38% of amount beyond $15,000,000$18,333,333 ------- 35% on all incomeA) 8.0%B) 25.0%C) 32.9%D) 39.0%
Q:
Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate the total taxes paid for Lansing, Inc., this year. Lansing's pretax income was $275,000.Exhibit 11.6 U.S. Corporate Tax Rate Schedule in 2007Taxable IncomeMoreThan But Not More Than Tax Owed$0 $50,000 15% of amount beyond $0$50,000 $75,000 $7,500 + 25% of amount beyond $50,000$75,000 $100,000 $13,750 + 34% of amount beyond $75,000$100,000 $335,000 $22,250 + 39% of amount beyond $100,000$335,000 $10,000,000 $113,900 + 34% of amount beyond $335,000$10,000,000 $15,000,000 $3,400,000 + 35% of amount beyond $10,000,000$15,000,000 $18,333,333 $5,150,000 + 38% of amount beyond $15,000,000$18,333,333 ------- 35% on all incomeA) $22,500B) $68,250C) $90,500D) $107,250
Q:
Free cash flow: What are Champagne's cash flows associated with investments for 2008?
A) $500,000
B) $700,000
C) $1,200,000
D) None of the above.
Q:
Free cash flow: What is Champagne's NOPAT for 2008?A) $1,750,000B) $2,500,000C) $3,250,000D) $4,000,000
Q:
Free cash flow: What is Champagne's free cash flow for 2008?A) $2,050,000B) $2,500,000C) $3,250,000D) $4,000,000
Q:
Free cash flow: What is Champagne's cash flow from operations for 2008?A) $2,050,000B) $2,500,000C) $3,250,000D) $4,000,000
Q:
Free cash flow: What is Provo's cash flows associated with investments for 2008?A) $300,000B) $500,000C) $800,000D) None of the above.
Q:
Free cash flow: What is Provo's NOPAT for 2008?A) $2,400,000B) $2,600,000C) $3,400,000D) $4,000,000
Q:
Free cash flow: What is Provo's free cash flow for 2008?A) $2,400,000B) $2,600,000C) $3,400,000D) $4,000,000
Q:
Free cash flow: What is Provo's cash flow from operations for 2008?A) $2,400,000B) $2,600,000C) $3,400,000D) $4,000,000
Q:
Norman, Inc., is considering two mutually exclusive projects. Project A is a six-year project with a NPV of $3,000 and Project B is a four-year project with an NPV of $2,278. Project A has an equivalent annual cash flow of $730 and Project B has an equivalent annual cash flow of $750. Which project should the firm select?A) Choose Project A because it has the higher NPV.B) Choose Project B because it has the lower NPV.C) Choose Project B because it has the higher equivalent annual cash flow.D) Choose Project A because it has the lower equivalent annual cash flow.
Q:
The proper time to harvest an asset is when:
A) the percentage NPV increase of harvesting a project at a future point in time is at the last date where the increase is greater than the cost of capital.
B) the percentage NPV increase of harvesting a project at a future point in time is at the first date where the increase is less than the cost of capital.
C) the percentage NPV increase of harvesting a project at a future point in time is at the first date where the increase is greater than the cost of capital.
D) None of the above.
Q:
Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it currently owns. If it harvests the water in year 1, the NPV of the project would increase over an immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.
A) Harvest immediately.
B) Harvest in year 1.
C) Harvest in year 2.
D) Harvest in year 3.
Q:
Windy Burgers is trying to determine when to harvest a herd of cows that it currently owns. If it harvests the herd in year 1, the NPV of the project would increase over an immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15 percent over that of year 1 and year 3 would create an NPV increase of 7 percent over that of year 2. If the cost of capital is 12 percent for Windy, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.
A) Harvest immediately.
B) Harvest in year 1.
C) Harvest in year 2.
D) Harvest in year 3.
Q:
If you are deciding whether to take one project or another, where the projects have different useful lives, then you could utilize:
A) a repeated investment analysis to decide which project is better for the firm.
B) an equivalent annual annuity analysis to decide which project is better for the firm.
C) Either of the above.
D) None of the above.
Q:
In order for a project to generate a positive net working capital cash flow at the conclusion of a project,
A) the project must have generated a cumulative negative cash flow during the life of the project.
B) the project must have generated a cumulative positive cash flow during the life of the project.
C) the project must have generated a cumulative negative cash flow at the conclusion of the project.
D) the project could not have generated a positive cash flow at the opening of the project.
Q:
When compared to the straight-line depreciation method, MACRS has:
A) a greater proportion of its depreciation early in the life of the asset.
B) a lesser proportion of its depreciation early in the life of the asset.
C) an equal proportion of its depreciation early in the life of the asset.
D) None of the above.
Q:
For a U.S. corporation with income above $20 million,
A) the average tax rate is less than the marginal tax rate.
B) the average tax rate is equal to the marginal tax rate.
C) the average tax rate is greater than the marginal tax rate.
D) None of the above.
Q:
A tax system in which taxpayers pay a progressively larger share of their income in taxes as their income rises is called:
A) a flat tax system.
B) a progressive tax system.
C) a digressive tax system.
D) a political tax system.
Q:
If you are discounting a project's cash flows using the nominal cost of capital, then that means that you have taken the following into account:
A) the real rate of return.
B) the expected rate of inflation.
C) Both of the above.
D) None of the above.
Q:
If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation is anticipated to be 8 percent, then what should nominal rate of return be? (Round final percentage answer to decimal places.)
A) 14.05%
B) 33.05%
C) 23.12%
D) None of the above.
Q:
If inflation is anticipated to be 10 percent during the next year while a nominal rate of 20 percent will be earned on U.S. Treasury bills, then what is the accurate real rate of return on these securities?(Round final percentage answer to decimal places.)A) 20.05%B) 10.01%C) 9.09%D) None of the above.
Q:
_____________ represent dollars stated in terms of constant purchasing power.
A) Nominal dollars
B) Real dollars
C) Inflated dollars
D) None of the above
Q:
Which of the following is the best example of a sunk cost?
A) Future payments on a leased building.
B) Future research and development costs.
C) Historical research and development costs.
D) Historical noncash expenses.
Q:
If a firm has the option of leasing some factory space to another firm or utilizing it for another product line, then if the firm chose the product line how should it handle the lost lease payments on the factory space?
A) Ignore it.
B) Include it as an opportunity cost.
C) Include half of it as additional revenue for the project.
D) None of the above.
Q:
Whenever a project has a negative impact on an existing project's cash flows, then that effect should:
A) be ignored.
B) be ignored if the project is evaluated using the correct cost of capital.
C) be included as a negative revenue amount on the new project's cash flow analysis.
D) be included if the impact is limited to noncash expenditures.
Q:
A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. If the firm takes that project, then it will reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?A) $2.4 millionB) $3.4 millionC) $4.6 millionD) $5.0 million
Q:
Brown Mack, Inc., currently has two large manufacturing divisions that share a single plant. Brown Mack owns the plant but has calculated that $6 million of overhead expenses should be allocated to the two equal-sized divisions. If Brown Mack starts a third manufacturing division, of equal size to the other two divisions, then what overhead cost should the new division take into account on its capital budgeting cash flow analysis?
A) $0
B) $2 million
C) $3 million
D) $6 million
Q:
Corporate overhead allocations should only be taken into account on project analysis if:
A) the firm is currently covering all of its overhead allocations.
B) the firm is currently unable to cover all of its overhead allocations.
C) the overhead allocations involve cash expenditures.
D) None of the above.
Q:
Which of the following should not be included in a project's cash flow calculations?
A) cash expenses
B) cash revenues
C) allocated expenses
D) None of the above.
Q:
The impact of a project on a firm's overall value depends on
A) a firm's accounting earnings.
B) a firm's cash flow.
C) a project's cash flow.
D) None of the above.
Q:
Additions to tangible assets, intangible assets ,and current assets can be described as:
A) cash flows associated with investments.
B) operating cash flows.
C) free cash flows.
D) None of the above.
Q:
The firm's ____________ is used to calculate NOPAT because the profits from a project are assumed to be incremental to the firm.
A) average tax rate
B) marginal tax rate
C) lowest marginal tax rate
D) None of the above.
Q:
The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as:
A) the stand-alone principle.
B) the dependent principle.
C) the independent principle.
D) None of the above.
Q:
In order to calculate free cash flow by starting with incremental cash flow from operations, we should
A) subtract the incremental capital expenditures and add the incremental additions to working capital.
B) add the incremental capital expenditures and the incremental additions to working capital.
C) subtract the incremental capital expenditures and the incremental additions to working capital.
D) None of the above.
Q:
_________ refers to the cash flow that a project is expected to generate after all operating expenses and taxes have been paid.
A) Incremental cash flow from operations
B) Operating income
C) EBITDA
D) None of the above.
Q:
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.
A) Periodic
B) ending cash flows
C) Incremental
D) None of the above.
Q:
The ___________ is intended to reconcile changes in the balance sheet cash accounts.
A) capital budgeting cash flow calculation
B) accounting statement of cash flows
C) accounting statement of income
D) None of the above.
Q:
The NPV of a project is estimated by:
A) discounting the expected cash flows of a project in the future.
B) discounting only the certain cash flows of a project in the future.
C) discounting the variance of the expected cash flows of a project in the future.
D) None of the above.
Q:
The cash flows used in capital budgeting calculations are based on:
A) historical estimates.
B) forecasts of future cash revenues, expenses, and investment outlays.
C) forecasts of net income.
D) forecasts of retained earnings available for financing projects.
Q:
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.
A) True
B) False
Q:
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.
A) True
B) False
Q:
The unadjusted NPV of two projects with different useful lives can be compared to evaluate which project is the better of the two.
A) True
B) False
Q:
The expected cash flows for a project are fixed amounts that have zero variability in the projected values.
A) True
B) False
Q:
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.
A) True
B) False
Q:
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.
A) True
B) False
Q:
The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate for a total of four years.
A) True
B) False
Q:
It is possible for a firm to have one depreciation schedule for tax purposes and another for financial reporting purposes.
A) True
B) False
Q:
A progressive tax system means that a taxpayer will pay a higher tax rate for a given dollar of earnings for every successive year.
A) True
B) False
Q:
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.
A) True
B) False