TEST BANK CHAPTER 12 CASH FLOW ESTIMATION AND RISK ANALYSIS QUẢN TRỊ TÀI CHÍNH

CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Cash flow estimation KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Cash flow estimation Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS KEYWORDS: Bloom’s: Knowledge Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy This is especially true for large product development projects a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS TOPICS: Cash flow estimation KEYWORDS: Bloom’s: Knowledge Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS capital TOPICS: Relevant cash flows KEYWORDS: Bloom’s: Knowledge If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Relevant cash flows KEYWORDS: Bloom’s: Knowledge If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Relevant cash flows KEYWORDS: Bloom's: Comprehension Any cash flows that can be classified as incremental to a particular project—i.e., results directly from the decision to undertake the project—should be reflected in the capital budgeting analysis a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES 12-1 Conceptual Issues in Cash Flow Estimation : Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS LEARNING O FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Relevant cash flows KEYWORDS: Bloom’s: Knowledge We can identify the cash costs and cash inflows to a company that will result from a project These could be called "direct inflows and outflows," and the net difference is the direct net cash flow If there are other costs and benefits that not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of the capital budgeting analysis a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Externalities KEYWORDS: Bloom’s: Knowledge In cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects on the firm's long-run cash flows a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY Cengage Learning Testing, Powered by Cognero Page CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS REFERENCES: 12-1 Conceptual Issues in Cash Flow Estimation LEARNING OBJECTIV FOFM.BRIG.16.12.01 - Conceptual Issues in Cash Flow Estimation ES: NATIONAL STANDAR United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking DS: STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Externalities KEYWORDS: Bloom’s: Knowledge 10 Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision—estimates of its effect would really just be guesses In this case, the externality should be ignored—i.e., not considered at all—because if it were considered it would make the analysis appear more precise than it really is a True b Fals e ANSWER: False RATIONALE: If the externality is potentially important, it should not be ignored, because then a large error might be made At the very least, it should be discussed, and possibly Cengage Learning Testing, Powered by Cognero Page 10 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS RATIONALE: NPV with no adjustment t=0 t=1 t=2 t=3 0.0% 0.0% 0.0% Price per unit $25.00 $25.00 $25.00 VC per unit $20.20 $20.20 $20.20 Units sold 49,000 49,000 49,000 $1,225,000 $1,225,000 $1,225,000 − Fixed op cost (excl deprec.) 150,000 150,000 150,000 − Variable op costs per unit = $20.20 989,800 989,800 989,800 − Depreciation Rate = 33.3% 66,667 66,667 66,667 Investment cost WACC = 10% −$200,000 Inflation (set to 0%) Sales revenues Operating income (EBIT) − Taxes $ Rate = 40% EBIT(1 − T) Cengage Learning Testing, Powered by Cognero 18,533 $ 7,413 $ 11,120 18,533 $ 7,413 $ 11,120 18,533 7,413 $ 11,120 Page 121 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS 66,667 66,667 66,667 − $200,00 $ 77,787 $ 77,787 $ 77,787 t=0 t=1 t=2 t=3 4.0% 4.0% 4.0% Price per unit $25.00 $26.00 $27.04 VC per unit $20.20 $21.01 $21.85 Units sold 49,000 49,000 49,000 $1,225,000 $1,274,000 $1,324,960 150,000 150,000 150,000 + Depreciation Project CFs NPV w/o infl adjustment $6,556 − NPV with adjustment Investment cost WACC = 10% Inflation (set to 0%) Sales revenues − Fixed op cost (excl deprec.) Cengage Learning Testing, Powered by Cognero −$200,000 Page 122 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS − Variable op costs per unit = $20.20 − Depreciation Rate = 33.3% $ Operating income (EBIT) − Taxes Rate = 40% $ + Depreciation NPV w/infl adjustment Increase w/infl adjustment POINTS: 1,029,392 1,070,568 66,666 66,666 66,666 18,534 $ 7,414 EBIT(1 − T) − $200,00 Project CFs 989,800 11,120 27,942 $ 11,177 $ 16,765 37,726 15,091 $ 22,636 66,666 66,666 66,666 $ 77,786 $ 83,431 $ 89,302 $6,760 $13,316 DIFFICULTY: CHALLENGING REFERENCES 12-2 Analysis of an Expansion Project Cengage Learning Testing, Powered by Cognero Page 123 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS : LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: NPV including inflation KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem 79 Foley Systems is considering a new investment whose data are shown below The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require additional net operating working capital that would be recovered at the end of the project's life Revenues and other operating costs are expected to be constant over the project's life What is the project's NPV? (Hint: Cash flows from operations are constant in Years to 3.) WACC 10.0% Net investment in fixed assets (basis) $75,000 Required net operating working capital $15,000 Cengage Learning Testing, Powered by Cognero Page 124 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS Straight-line depreciation rate 33.333% Annual sales revenues $75,000 Annual operating costs (excl depreciation) $25,000 Tax rate 35.0% a $23,852 b $25,045 c $26,297 d $27,612 e $28,993 ANSWER: a t=0 RATIONALE: Investment in fixed assets WACC = 10% Investment in NOWC Sales revenues Cengage Learning Testing, Powered by Cognero t=1 t=2 t=3 $75,000 $75,000 $75,000 −$75,000 −$15,000 Page 125 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS − Operating costs (excl deprec.) 25,000 25,000 25,000 Depreciation 25,000 25,000 25,000 $25,000 $25,000 $25,000 8,750 8,750 8,750 $16,250 $16,250 $16,250 25,000 25,000 25,000 $41,250 $41,250 $41,250 Rate = 33.333% Operating income (EBIT) − Taxes Rate = 35% EBIT(1 − T) + Depreciation EBIT(1 − T) + DEP −$90,000 Recovery of NOWC 15,000 − $90,000 Project CFs NPV POINTS: $41,250 $41,250 $56,250 $23,852 DIFFICULTY: CHALLENGING REFERENCES 12-2 Analysis of an Expansion Project : Cengage Learning Testing, Powered by Cognero Page 126 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem 80 Thomson Media is considering some new equipment whose data are shown below The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down Also, additional net operating working capital would be required, but it would be recovered at the end of the project's life Revenues and other operating costs are expected to be constant over the project's 3-year life What is the project's NPV? WACC 10.0% Net investment in fixed assets (depreciable basis) $70,000 Required net operating working capital $10,000 Straight-line depreciation rate Cengage Learning Testing, Powered by Cognero 33.333% Page 127 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS Annual sales revenues $75,000 Annual operating costs (excl depreciation) $30,000 Expected pre-tax salvage value $5,000 Tax rate 35.0% a $20,762 b $21,854 c $23,005 d $24,155 e $25,363 ANSWER: c RATIONALE: Investment in fixed assets Investment in NOWC Sales revenues Cengage Learning Testing, Powered by Cognero Page 128 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS − Operating costs (excl deprec.) Depreciation Operating income (EBIT) − Taxes EBIT(1 − T) + Depreciation EBIT(1 − T) + DEP Recovery of NOWC Salvage value, pre-tax − Tax on salvage value Project CFs NPV Cengage Learning Testing, Powered by Cognero Page 129 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS POINTS: DIFFICULTY: CHALLENGING REFERENCES 12-2 Analysis of an Expansion Project : LEARNING O FOFM.BRIG.16.12.02 - Analysis of an Expansion Project BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Project NPV KEYWORDS: Bloom's: Analysis OTHER: Multiple Choice: Problem 81 Florida Car Wash is considering a new project whose data are shown below The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year No change in net operating working capital would be required Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV change? (Hint: Note that cash flows are constant at the Year level, whatever that level is.) Cengage Learning Testing, Powered by Cognero Page 130 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS WACC Net investment cost (depreciable basis) Number of cars washed Average price per car Fixed oper costs (excl depreciation) Variable oper cost/unit (i.e., VC per car washed) Annual depreciation Tax rate 10.0% $60,000 2,800 $25.00 $10,000 $5.375 $20,000 35.0% a − $28,939 b − $30,462 c − $32,066 d − $33,753 e − $35,530 Cengage Learning Testing, Powered by Cognero Page 131 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS ANSWER: e RATIONALE: Base Case Calculations Investment cost Cars washed Price per car Variable cost/unit Sales revenues − Fixed op cost (excl deprec.) $10,000 − Variable op costs − Depreciation Operating income (EBIT) − Taxes EBIT(1 − T) Cengage Learning Testing, Powered by Cognero Page 132 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS + Depreciation Project CFs Base-Case NPV Bad Case Calculations Investment cost Cars washed Declines by: 40% Price per car Variable cost/unit Sales revenues − Fixed op cost (excl deprec.) − Variable op costs Cengage Learning Testing, Powered by Cognero Page 133 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS − Depreciation Operating income (EBIT) − Taxes EBIT(1 − T) + Depreciation Project CFs Bad-Case NPV Change in NPV Cengage Learning Testing, Powered by Cognero Page 134 CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS POINTS: DIFFICULTY: CHALLENGING REFERENCES 12-5 Measuring Stand-Alone Risk : LEARNING O FOFM.BRIG.16.12.05 - Measuring Stand-Alone Risk BJECTIVES: NATIONAL ST United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ANDARDS: STATE STAND United States - OH - DISC.FOFM.BRIG.16.01 - Stocks and bonds ARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of capital TOPICS: Sensitivity analysis KEYWORDS: Bloom's: Evaluation OTHER: Multiple Choice: Problem Cengage Learning Testing, Powered by Cognero Page 135