CHAPTER 8
Making Capital Investment Decisions
I. DEFINITIONS
INCREMENTAL CASH FLOWS
a 1. The changes in a firm’s future cash flows that are a direct consequence of accepting a
project are called _____ cash flows.
a. incremental b. stand-alone c. after-tax d. net present value e. erosion Difficulty level: Easy
EQUIVALENT ANNUAL COST
e 2. The annual annuity stream of payments with the same present value as a project’s costs
is called the project’s _____ cost.
a. incremental b. sunk c. opportunity d. erosion e. equivalent annual Difficulty level: Easy
SUNK COSTS
c 3. A cost that has already been paid, or the liability to pay has already been incurred, is
a(n):
a. salvage value expense. b. net working capital expense. c. sunk cost. d. opportunity cost. e. erosion cost. Difficulty level: Easy
OPPORTUNITY COSTS
d 4. The most valuable investment given up if an alternative investment is chosen is a(n): a. salvage value expense. b. net working capital expense. c. sunk cost. d. opportunity cost. e. erosion cost. Difficulty level: Easy
EROSION COSTS
e
5.
The cash flows of a new project that come at the expense of a firm’s existing projects are called:
salvage value expenses.
net working capital expenses. sunk costs.
opportunity costs. erosion costs.
a. b. c. d. e. Difficulty level: Easy
PRO FORMA FINANCIAL STATEMENTS
a 6. A pro forma financial statement is one that: a. projects future years’ operations. b. is expressed as a percentage of the total assets of the firm. c. is expressed as a percentage of the total sales of the firm. d. is expressed relative to a chosen base year’s financial statement. e. reflects the past and current operations of the firm. Difficulty level: Easy
MACRS DEPRECIATION
b 7. The depreciation method currently allowed under US tax law governing the accelerated
write-off of property under various lifetime classifications is called _____ depreciation.
a. FIFO b. MACRS c. straight-line d. sum-of-years digits e. curvilinear Difficulty level: Easy
DEPRECIATION TAX SHIELD
c 8. The cash flow tax savings generated as a result of a firm’s tax-deductible depreciation
expense is called the:
a. after-tax depreciation savings. b. depreciable basis. c. depreciation tax shield. d. operating cash flow. e. after-tax salvage value. Difficulty level: Easy
CASH FLOW
d 9. The cash flow from projects for a company is computed as the: a. net operating cash flow generated by the project, less any sunk costs and erosion costs. b. sum of the incremental operating cash flow and after-tax salvage value of the project. c. net income generated by the project, plus the annual depreciation expense. d. sum of the incremental operating cash flow, capital spending, and net working capital
expenses incurred by the project.
e. sum of the sunk costs, opportunity costs, and erosion costs of the project.
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Difficulty level: Medium
II. CONCEPTS
PRO FORMA INCOME STATEMENT
b 10. The pro forma income statement for a cost reduction project: a. will reflect a reduction in the sales of the firm. b. will generally reflect no incremental sales. c. has to be prepared reflecting the total sales and expenses of a firm. d. cannot be prepared due to the lack of any project related sales. e. will always reflect a negative project operating cash flow. Difficulty level: Easy
INCREMENTAL CASH FLOW
b 11. One purpose of identifying all of the incremental cash flows related to a proposed project is to: a. isolate the total sunk costs so they can be evaluated to determine if the project will add value to the firm. b. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. c. make each project appear as profitable as possible for the firm. d. include both the proposed and the current operations of a firm in the analysis of the project. e. identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis. Difficulty level: Medium
INCREMENTAL CASH FLOW
e 12. Which of the following are examples of an incremental cash flow? I. an increase in accounts receivable II. a decrease in net working capital III. an increase in taxes IV. a decrease in the cost of goods sold a. I and III only b. III and IV only c. I and IV only d. I, III, and IV only e. I, II, III, and IV Difficulty level: Medium
INCREMENTAL CASH FLOW
c 13. Which one of the following is an example of an incremental cash flow? a. the annual salary of the company president which is a contractual obligation b. the rent on a warehouse which is currently being utilized c. the rent on some new machinery that is required for an upcoming project d. the property taxes on the currently owned warehouse which has been sitting idle but is going to be utilized for a new project e. the insurance on a company-owned building which will be utilized for a new project
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