Question 1

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?

Accepted Answer

The answer of Anderson-EOG Inc.is evaluating the the construction of...

Question 2

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.

Accepted Answer

The answer of The pertinent issue for determining whether overhead...

Question 3

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.

Accepted Answer

The cash inflow from the sale of the old asset and any related tax effects are relevant and must be included in the analysis when replacing an existing asset.

Question 4

Diamond Inc.has estimated that a new building will cost $2,500,000 to construct.Land was purchased a year ago for $500,000 and could be sold today for $550,000.An environmental impact study required by the state was performed at a cost of $48,000.For capital budgeting purposes,what is the relevant cost of the new building?
A)$2,500,000
B)$3,048,000
C)$3,050,000
D)$3,098,000

Accepted Answer

The relevant cost for capital budgeting purposes includes the cost of constructing the new building ($2,500,000), the cost of land purchased a year ago ($500,000), and the environmental impact study required by the state ($48,000). However, the current market value of the land ($550,000) is not relevant as it does not impact the cost of constructing the new building. Therefore, the relevant cost is $2,500,000 + $500,000 + $48,000 = $3,050,000.

Question 5

The initial outlay involves the immediate cash outflow necessary to purchase the asset and put it in operating order.

Accepted Answer

The initial outlay is indeed the immediate cash outflow required for purchasing and putting the asset in operating order.

Question 6

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

Accepted Answer

The initial outlay of an asset includes all costs incurred in acquiring and installing the asset. Therefore, installation costs must be included in the initial outlay.

Question 7

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.

Accepted Answer

Test marketing costs are considered sunk costs because they are already incurred and cannot be recovered, regardless of the decision to proceed with production or not. Including sunk costs in the calculation of initial outlay is not appropriate as it does not affect the future cash flows of the project.

Question 8

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

Accepted Answer

The formula for calculating operating cash flow is as follows:

Operating Cash Flow = Net Operating Income + Depreciation - Taxes

Given the information in the problem, we can plug in the numbers:

Operating Cash Flow = $1,000,000 + $150,000 - $350,000
Operating Cash Flow = $800,000

Therefore, the correct choice is C, as it represents the calculated operating cash flow.

Question 9

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?

Accepted Answer

The answer of Anderson-EOG Inc.is evaluating the the construction of...

Question 10

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.

Accepted Answer

When evaluating an investment proposal, we are only concerned with the incremental or differential after-tax cash flows that can be directly attributed to the proposed investment. Other cash flows that are unrelated to the investment proposal should not be included in the analysis.

Question 11

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.

Accepted Answer

The answer of Cape Cod Cranberries is evaluating the introduction...

Question 12

Incremental cash flows include all of the following EXCEPT:
A)research and development costs .
B)increased labor costs from the project.
C)advertising costs .
D)both B and C.

Accepted Answer

Incremental cash flows are the additional cash flows a business earns or incurs as a result of taking on a new project or investment. Research and development costs are typically considered sunk costs and are not included in incremental cash flow calculations. Therefore, option A is the correct answer. Option B (increased labor costs) and option C (advertising costs) would both typically be considered incremental cash flows.

Question 13

In making a capital budgeting decision we only include the incremental cash flows resulting from the investment decision.

Accepted Answer

In capital budgeting, we consider only the incremental cash flows, which are the cash flows that result from the investment decision and would not have occurred otherwise. This includes both inflows (such as increased revenue or reduced costs) and outflows (such as the initial investment and ongoing expenses related to the project). Non-incremental cash flows, such as sunk costs or expenses that would have occurred regardless of the investment decision, are not considered.

Question 14

The opportunity cost of using a resource in some way is the amount the resource could earn if used in an alternative way.

Accepted Answer

This statement defines the basic concept of opportunity cost, which is the value of the next best alternative foregone.

Question 15

To be conservative,capital budgeting analysis assumes that projects cannot add sales to existing lines of business.

Accepted Answer

Capital budgeting analysis considers the potential increase in sales as a result of new projects or expansion of existing lines of business. However, to err on the side of caution, conservative assumptions may be made in the analysis.

Question 16

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.

Accepted Answer

The answer of Briefly explain why each of the following...

Question 17

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?

Accepted Answer

The answer of Cape Cod Cranberries will finance a new...

Question 18

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

Accepted Answer

Operating Income = Incremental sales - Cash expenses - Depreciation
Operating Income = $5,000,000 - $3,500,000 - $500,000
Operating Income = $1,000,000

Taxes = 35% × Operating Income
Taxes = 0.35 × $1,000,000
Taxes = $350,000

Operating Cash Flow = Operating Income - Taxes - Interest Expense
Operating Cash Flow = $1,000,000 - $350,000 - $200,000
Operating Cash Flow = $450,000

Therefore, the operating cash flow for phase I of the proposed new housing development is $1,150,000.

Question 19

Sunk costs are a type of incremental cash flow that should be included in all capital-budgeting decisions.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, and therefore should not be considered in future capital-budgeting decisions which focus on incremental cash flows.

Question 20

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.

Accepted Answer

The allocation of overhead costs should not be based solely on percentage of space used by a project. Other methods such as activity-based costing or direct tracing of costs may be more appropriate for certain projects.

Quiz 12: Analyzing Project Cash Flows