978-0132757089 Chapter 12 Part 1

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Financial Management: Principles and Applications, 11e (Titman)

Chapter 12 Analyzing Project Cash Flows

1) Incremental cash flows from a project =

A) Firm cash flows without the project plus or minus changes in net income.

B) Firm cash flows with the project plus firm cash flows without the project.

C) Firm cash flows with the project minus firm cash flows without the project.

D) Firm cash flows without the project plus or minus changes in revenue with the project.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: real cash flows

Principles: Principle 3: Cash Flows Are the Source of Value

2) Which of the following is NOT one of the categories for a project’s relevant after-tax cash

flows?

A) Financing flows

B) Initial cash outflow

C) Differential flows over the project’s life

D) Terminal cash flow

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

3) Which of the following is NOT part of a project’s initial cash outflow?

A) The asset’s purchase price

B) Funds committed to support increased inventory levels due to expected increased sales if the

firm adopts the project

C) A marketing survey completed last year to determine the project’s feasibility

D) Expenses incurred to install the asset

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

4) Relevant incremental cash flows include:

A) sales captured from the firm’s competitors.

B) retained sales that would have been lost to new competing products.

C) incremental sales brought to the firm as a whole.

D) all of the above.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

5) Which of the following is NOT considered in the calculation of incremental cash flows?

A) Depreciation tax shield

B) Sunk costs

C) Opportunity costs

D) Both A and B

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

6) Which of the following cash flows should be included as incremental costs when evaluating

capital projects?

A) Investment in working capital that is directly related to a project

B) Expenses that are incurred in order to modify a firm’s production facility in order to invest in

a project

C) Overhead expenses that are directly related to a project

D) Opportunity costs that are directly related to a project

E) All of the above

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

7) Depreciation expenses affect tax-related cash flows by:

A) increasing taxable income, thus increasing taxes.

B) decreasing taxable income, thus reducing taxes.

C) decreasing taxable income, but not altering cash flows since depreciation is not a cash

expense.

D) all of the above.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: straight line depreciation

Principles: Principle 3: Cash Flows Are the Source of Value

8) Which of the following would be considered a termination cash flow?

A) The expected salvage value of the asset

B) Any tax payments or refunds associated with the salvage value of the asset

C) Recapture of any investment in working capital that was included as an incremental cash

outlay

D) All of the above

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

9) How is interest expense that is associated with a project treated in the capital budgeting

process?

A) It is treated as a cash outflow when estimating the incremental cash flows associated with a

project.

B) It is built into the discount rate.

C) It is considered a synergistic incremental cash flow.

D) Interest expense is not relevant to any capital budgeting decisions.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

10) Which of the following best describes why cash flows are utilized rather than accounting

profits when evaluating capital projects?

A) Cash flows have a greater present value than accounting profits.

B) Cash flows reflect the timing of benefits and costs more accurately than accounting profits.

C) Cash flows are more stable than accounting profits.

D) Cash flows improve the tax position of a firm more than accounting profits.

E) None of the above.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

11) Which of the following is the best example of an incremental cash inflow/outflow?

A) Cash flows that are achieved by diverting sales from other projects of the firm

B) Cash flows that are associated with the financing of a project

C) Cash flows that occur a little at a time

D) What the total cash flows will be to the company if the project is undertaken as opposed to

what they would have been if the project had not been undertaken

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

12) Which of the following is an example of a sunk cost?

A) Overhead costs that are associated with a project

B) Interest expense associated with a project

C) Market study expenses incurred in order to decide if a firm should accept a project

D) Income taxes associated with a project

E) Depreciation expenses associated with a project

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

13) Which of the following cash flows should be included as incremental costs when evaluating

capital projects?

A) Overhead expenses that are directly related to a project

B) Interest expense that is directly related to the financing of a project

C) Sunk costs that are related to a project

D) Principal payments that are directly related to the financing of a project

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

14) The calculation of differential cash flows over a project’s life should include which of the

following?

A) Labor and material savings

B) Additional revenues attributable to the project

C) Investment in net working capital

D) All of the above

E) None of the above

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

15) Which of the following cash flows are NOT considered in the calculation of the initial outlay

for a capital investment proposal?

A) Increase in accounts receivable

B) The cost of shipping new equipment

C) The cost of issuing new bonds if the project is financed by a new bond issue

D) The cost of installing new equipment

E) All of the above should be considered.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

16) Which of the following expenses should be included when estimating cash flows for

investment projects?

A) Interest expense related to financing a project

B) Sunk costs

C) Required principal payments related to financing a project

D) Opportunity costs

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

17) When evaluating Capital Budgeting decisions, which of the following items should NOT be

included in the construction of cash flow projections for purposes of analysis?

A) Net salvage value

B) Land and building expenses

C) Changes in net working capital requirements

D) Shipping and installation costs

E) All of the above should be included.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

18) Holding all other variables constant, which of the following would INCREASE net working

capital for given year on a project?

A) Allowing customers less time to pay for purchases

B) Taking longer to pay suppliers

C) Increasing inventory levels

D) Both A and C

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

19) If an investment project would make use of land which the firm currently owns, the project

should be charged with:

A) a sunk cost.

B) an opportunity cost.

C) amortization.

D) interest.

E) abuse of power.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

20) The owner of a convenience store 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 $9,000 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?

A) $2,700

B) $2,475

C) $2,250

D) $0.00

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

21) Mr. Smith included the cost of test marketing before production in the calculation of the

initial outlay. Apparently, Mr. Smith does not understand the concept of:

A) side-effect costs.

B) opportunity costs.

C) sunk costs.

D) variable costs.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

22) Sunk costs are a type of incremental cash flow that should be included in all capital-

budgeting decisions.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

23) 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.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

24) 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.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

25) The initial outlay involves the immediate cash outflow necessary to purchase the asset and

put it in operating order.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

26) 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.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

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

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

28) In making a capital budgeting decision we only include the incremental cash flows resulting

from the investment decision.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

29) To be conservative, capital budgeting analysis assumes that projects cannot add sales to

existing lines of business.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

30) The opportunity cost of using a resource in some way is the amount the resource could earn

if used in an alternative way.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

31) In measuring cash flows we are interested only in the incremental or differential after-tax

cash flows that are attributed to the investment proposal being evaluated.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

32) 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 $2,500 a month.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

33) Cape Cod Cranberries will finance a new organic juice 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?

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

34) Cape Cod Cranberries is evaluating the introduction of a new line of organic cranberry

products. Market research suggests that approximates 1/3 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.

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

35) Anderson-EOG Inc. is evaluating the the construction of a gas pipeline to bring natural gas

from Western New York state 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?

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

36) Anderson-EOG Inc. is evaluating the the construction of a gas pipeline to bring natural gas

from Western New York state 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?

Topic: 12.1 Identifying Incremental Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

1) Thaler & Co. anticipates an increase of $1,000,0000 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

A) $1,000,000

B) $500,000

C) $800,000

D) $650,000

Topic: 12.2 Forecasting Project Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

2) Schiller Construction Inc. has estimated the following revenues and expenses related phase I

of a proposed new housing development? Incremental sales= $5,000,000, total cash expenses

$3,500,000, depreciation $500,000, taxes 35%, interest expense, $200,000. Operating cash flow

equals

A) $650,000

B) $1,000,000

C) $1,150,000

D) $975,000

Topic: 12.2 Forecasting Project Cash Flows

Keywords: incremental cash flow

Principles: Principle 3: Cash Flows Are the Source of Value