Financial Management: Core Concepts, 4e (Brooks)
Chapter 10 Cash Flow Estimation
1) A major metric of a company’s health and its prospects for a long life is how much ________
it can generate.
A) cash flow
B) depreciation
C) tax deferral
D) net income
2) Most businesses fail because their ________ dries up.
A) net working capital
B) cash flow
C) liabilities
D) tax shield
3) The ________ is/are critical to business decisions, business growth, and ultimately business
success.
A) risk and timing but not the amount of cash flow
B) currency denomination of profits
C) risk and profits but not the amount of cash flow
D) timing and amount of cash flow
4) ________ are an accounting measure of performance during a specific period of time, while
________ is the actual inflow or outflow of money.
A) Profits; cash flow
B) Cash flows; profit
C) Dividends; cash flow
D) Profits; a dividend
5) Consider the case of a business that has had a very profitable year and earned a million dollars
in profits. Can it distribute a million dollars to its owners (via dividends)?
A) Yes, definitely
B) Maybe, maybe not
C) Definitely not
D) It can certainly distribute over a million dollars.
6) Which of the statements below is FALSE?
A) A company could show a loss for the operating period but have generated positive cash flow
for the business.
B) Profits are an accounting measure of performance during a specific period of time.
C) To obtain the operating cash flow, given the net income, we add back depreciation and
subtract taxes.
D) Cash flow is an accounting measure of performance during a specific period of time.
7) To get the operating cash flow, given the net income, we add back ________.
A) cost of goods sold
B) depreciation
C) taxes
D) EBIT
8) The revenue is $42,000, the cost of goods sold is $21,000, other expenses (from selling and
administration) are $6,000, and depreciation is $2,000. What is the EBIT?
A) $13,000
B) $29,000
C) $4,000
D) $2,000
9) A firm has revenue of $50,000, the cost of goods sold is $32,000, other expenses (from selling
and administration) are $14,000, interest expenses are $4,000 and depreciation is $5,000. What is
the EBIT?
A) $8,000
B) $-1,000
C) $-5,000
D) $00
10) The revenue is $94,000, the cost of goods sold is $51,000, other expenses (from selling and
administration) are $21,000, and depreciation is $12,000. What is the EBIT?
A) $6,000
B) $7,000
C) $10,000
D) Cannot tell because we do not know the interest paid.
11) Operating Cash Flow (OCF) is equal to what?
A) EBIT – Depreciation + Taxes
B) EBIT + Depreciation – Taxes
C) EBIT – Depreciation – Taxes
D) EBIT + Depreciation + Taxes
12) The EBIT is $16,000, depreciation is $4,000, interest payments are $6,000, and taxes are
$2,000. What is the operating cash flow (OCF)?
A) $16,000
B) $12,000
C) $18,000
D) $8,000
13) Profits can be defined as an accounting measure of performance during a specific period of
time.
14) A firm can spend its reported profits.
15) If the company had a large depreciation expense during the period, the income statement
could show a loss for the period, even though the cash account may have grown during the same
period.
17) On a corporate income statement, interest is paid after taxes are paid.
18) Explain how to compute an operating cash flow (OCF) from a modified income statement.
19) Explain the distinction between profits and cash flow.
1) The projected revenues and costs that form the basis of the potential for a project’s acceptance
or rejection are estimates of ________.
A) future activity
B) past activity
C) known activity
D) current activity
2) In terms of revenues and costs for a project, which of the statements below is FALSE?
A) Projected revenues and costs are estimates of future activity.
B) Estimates of revenues and costs begin with operating cash flow of the project.
C) Projected revenues and costs form the basis of the potential for a project’s acceptance or
rejection.
D) Estimates of revenues and costs begin with sales forecasts and the production costs associated
with the sales forecast.
3) Managers typically look at the initial outlay for the project as its capital expenditure and
determine ________ from this capital expenditure.
A) interest expenses
B) dividends
C) depreciation
D) CEO expenses
4) ________ cash flow is the increase in cash generated by a new project above the current cash
flow without the new project.
A) Future
B) Current
C) Discounted
D) Incremental
5) ________ of a project are those that have already been incurred and cannot be reversed.
A) Erosion costs
B) Opportunity costs
C) Sunk costs
D) Working capital costs
6) ________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow
of a new project.
A) Cost recovery of divested assets
B) Capital expenditures
C) Sunk costs
D) Opportunity costs
7) Whenever a new product competes against a company’s already existing products and reduces
the sales of those products, ________ occur.
A) erosion costs
B) opportunity costs
C) sunk costs
D) working capital costs
8) Which of the below statements is FALSE?
A) Whenever a new product competes against a company’s already existing products and reduces
the sales of other products, opportunity costs occur.
B) Erosion can provide cost savings.
C) A synergy gain occurs when a new product can be introduced that complements another
current product so that sales for this current product increases.
D) Increases in working capital accounts necessary to support a project add upfront costs, but
also provide for cost reductions at the end of the project.
9) Which of the statements below is TRUE?
A) The increase in working capital accounts necessary to support a project also provides for cost
increases at the end of the project.
B) An increase in working capital can be brought about by an increase in inventory.
C) Decreases in accounts receivables constitute a use of cash flow because you are helping your
customers finance their purchases.
D) Decreases in accounts payable constitute a source of cash flow because you are using your
suppliers to help finance your business operations.
10) Whenever a new product competes against a company’s already existing products and
reduces the sales of the other products, net working capital increases occur.
11) Erosion is the additional cash generated by a new project beyond the current cash flow with
the addition of a specific new project.
12) If four plus five equals ten, that’s synergy.
13) Name and describe three issues that can affect the incremental cash flow of a new project.
14) Explain why one must be careful when accounting for erosion costs.
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10.3 Capital Spending and Depreciation
1) ________ is the process of “expiring” the cost of a long-term tangible asset over its useful life.
A) Expiration
B) Depreciation
C) Economic recovery
D) Salvaging
2) There are two main reasons why we need to deal with depreciation. Which of the below is one
of these reasons?
A) The gain but not the loss when a capital asset is disposed
B) The loss but not the gain when a capital asset is disposed
C) The tax flow implications from the OCF
D) The tax rate implications from the OCF
3) Which of the methods below is a way to allocate depreciation?
A) The allocation each year is the amount of cost as determined by the actual estimated usage for
that year.
B) Use the government-mandated accelerated depreciation system, which depreciates the capital
asset at the minimum accelerated amount allowed each year.
C) The allocation each year is the same amount of cost as determined by the average expected
operating cash inflow divided by the number of years of useful life of the machines.
D) Use the government-mandated accelerated depreciation system, which depreciates the capital
asset at the maximum accelerated amount allowed each year.
4) A firm is considering purchasing two assets. Asset A will have a useful life of 12 years and
cost $4 million; it will have installation costs of $600,000 but no salvage or residual value. Asset
B will have a useful life of 8 years and cost $2.3 million; it will have installation costs of
$220,000 and a salvage or residual value of $100,000. Which asset will have a greater annual
straight-line depreciation?
A) Asset A has $30,000 more in depreciation per year.
B) Asset A has $80,833 more in depreciation per year.
C) Asset B has $72,458 more in depreciation per year.
D) Asset B has $108,622 more in depreciation per year.
5) A firm is considering purchasing two assets. Asset L will have a useful life of 15 years and
cost $4 million; it will have installation costs of $750,000 but no salvage or residual value. Asset
S will have a useful life of 5 years and cost $2 million; it will have installation costs of $500,000
and a salvage or residual value of $400,000. Which asset will have a greater annual straight-line
depreciation?
A) Asset L has $37,500 more in depreciation per year.
B) Asset L has $54,167 more in depreciation per year.
C) Asset S has $103,333 more in depreciation per year.
D) Asset S has $37,500 more in depreciation per year.
6) A firm is considering purchasing two assets. Asset A will have a useful life of 12 years and
cost $3 million; it will have installation costs of $400,000 and a salvage or residual value of
$400,000. Asset B will have a useful life of 8 years and cost $2.5 million; it will have installation
costs of $300,000 and a salvage or residual value of $800,000. Which asset will have a greater
annual straight-line depreciation?
A) Asset A has $30,000 more in depreciation per year.
B) Asset A has $37,500 more in depreciation per year.
C) Asset B has $30,000 more in depreciation per year.
D) The depreciation per year is the same for each asset.
7) A firm is considering purchasing an asset that will have a useful life of 15 years and cost $5
million; it will have installation costs of $500,000 and a salvage or residual value of $500,000.
What is the annual straight-line depreciation for this asset?
A) $333,333 per year
B) $500,000 per year
C) $600,000 per year
D) $700,000 per year
8) A firm is considering purchasing an asset that will have a useful life of 15 years and cost $7.5
million; it will have installation costs of $300,000 and a salvage or residual value of $1,800,000.
What is the annual straight-line depreciation for this asset?
A) $400,000 per year
B) $422,000 per year
C) $498,750 per year
D) $530,450 per year
9) ________ costs each year do not reflect cash flow because the actual purchase and installation
(outflow of dollars) of the asset have already taken place.
A) Depreciation
B) Sunk
C) Opportunity
D) Working Capital
10) Which of the statements below is FALSE?
A) Under the modified accelerated cost recovery system (MACRS) system of depreciation, the
government classifies all assets into groups that are assigned specific “lives” for the purpose of
depreciation.
B) Under the modified accelerated cost recovery system (MACRS) system of depreciation, once
the assigned class life is established, an adjustable percentage of the cost is expensed each year
as depreciation.
C) Under the modified accelerated cost recovery system (MACRS) system of depreciation, it can
be assumed that an asset’s assigned life class is the shortest allowable recovery period for
allocating the capital expenditure costs and reducing taxes.
D) Depreciation or “expired” costs each year do not reflect cash flows because the actual
purchase and installation (outflow of dollars) of the machines have already taken place.
11) The advantage of ________ over ________ depreciation is that you can write off more of
your capital costs in the earlier years.
A) straight-line depreciation; the modified accelerated cost recovery system
B) straight-line depreciation; straight-line deductions
C) MACRS; straight-line depreciation
D) MACRS; straight-line deductions
12) A firm is considering purchasing an asset that will cost $5 million. Other depreciable costs
include $800,000 in installation costs. If the asset is classified in the 5-year class, what is the
annual depreciation for years 1, 3, and 6 for this asset, using the fixed depreciation percentages
given by MACRS? (The percentages are 20.00%, 19.20%, and 5.76%, respectively.)
A) $1,856,000, $1,113,600, and $334,080 for years 1, 3, and 6, respectively
B) $1,160,000, $1,113,600, and $334,080 for years 1, 3, and 6, respectively
C) $1,160,000, $1,113,600, and $668,160 for years 1, 3, and 6, respectively
D) $5,800,000, $1,160,000, and $1,113,600 for years 1, 3, and 6, respectively
13) A firm is considering purchasing an asset that will cost $1 million. Other depreciable costs
include $100,000 in installation costs. If the asset is classified in the 3-year class, what is the
annual depreciation for each year for this asset using the fixed depreciation percentages given by
MACRS? (The percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively.)
A) $366,667, $366,667, $366,667 and $0 for years 1, 2, 3, and 4, respectively
B) $275,000, $275,000, $275,000, and $275,000 for years 1, 2, 3, and 4, respectively
C) $366,630, $488,950, $162,910, and $81,510 for years 1, 2, 3, and 4, respectively
D) $366,630, $488,950, $81,510, and $81,510 for years 1, 2, 3, and 4, respectively