Question 1

Toyota's capital budgeting analysis for the Prius,a gas-electric hybrid,was faulty because the car line has not made a profit to date.

Accepted Answer

The statement is false. Toyota's capital budgeting analysis for the Prius was not faulty because the car line has actually made a profit since its launch in 1997. In fact, the Prius has become one of Toyota's best-selling models and has contributed significantly to the company's overall profitability.

Question 2

TRL,Inc.has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000.The present value of all benefits the center will produce in its lifetime are $19,000,000,so TRL should not build the convention center.

Accepted Answer

The decision should be based on comparing the additional costs to complete the project ($18,000,000) with the present value of future benefits ($19,000,000), not on the sunk cost of $2,000,000 already spent on engineering fees. Since the benefits exceed the additional costs, TRL should proceed with the project.

Question 3

Hershey's expects to sell $2 million of its new candy bar,although $200,000 of this amount would have been spent on its existing candy bar.The $2 million is the appropriate cash inflow for the new candy bar project,while the $200,000 will be counted against the return on the old candy bar.

Accepted Answer

The appropriate cash inflow for the new candy bar project would be the net increase in sales, which is $1.8 million ($2 million - $200,000), as the $200,000 represents cannibalization of sales from its existing candy bar and should not be counted as new revenue generated by the project.

Question 4

Additional investment in working capital,even if it may be recovered at the end of a project,must be included in capital budgeting analysis because of the time value of money.

Accepted Answer

Additional investment in working capital will tie up funds for a certain period of time, and the opportunity cost of these funds must be considered in capital budgeting analysis. The time value of money concept takes into account the potential return that could be earned from investing those funds elsewhere during the project timeline. Therefore, even if the working capital investment is expected to be recovered at the end of the project, it must still be included in capital budgeting analysis.

Question 5

Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

Accepted Answer

Interest payments are considered financing costs and are not included in the project's incremental cash flows. Incremental cash flows focus on the project's direct operational cash inflows and outflows.

Question 6

Adding gourmet coffee stations to my convenience store is expected to increase sales of my breakfast sandwiches; however,the sales of breakfast sandwiches should not be included in the evaluation of the gourmet coffee project because only relevant,incremental cash flows should be considered.

Accepted Answer

The sales of breakfast sandwiches should be included in the evaluation of the gourmet coffee project if the addition of gourmet coffee stations is expected to increase their sales. This is because the incremental cash flows from the increased sales of breakfast sandwiches are relevant to assessing the project's overall impact.

Question 7

A grocery store decides to offer beer for sale and this decision results in more potato chip sales.This is an example of a synergistic effect.

Accepted Answer

A synergistic effect is when the combination of two things produces a greater effect than the sum of their individual effects. In this case, the addition of beer sales and the resulting increase in potato chip sales is an example of a synergistic effect.

Question 8

In measuring cash flows,we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.

Accepted Answer

Only the incremental or incremental after-tax cash flows that can be directly attributed to the investment proposal being evaluated are relevant for decision-making purposes. Other factors or cash flows that are not directly related to the project may cloud the analysis and lead to incorrect conclusions.

Question 9

The guiding rule in deciding if a free cash flow is incremental is to look at the company with,versus without,the new project.

Accepted Answer

When determining if a free cash flow is incremental, the guiding rule is to compare the company with the new project to the company without the new project. This allows for the identification of any additional cash flow generated as a result of the new project. Therefore, the statement is true.

Question 10

As a rule,any cash flows that are not affected by the accept/reject criterion should not be included in capital-budgeting analysis.

Accepted Answer

Only cash flows that are directly affected by the accept/reject decision should be included in capital-budgeting analysis. Other cash flows, such as sunk costs or incidental expenses, are considered irrelevant and should not impact the decision.

Question 11

Synergistic benefits from an investment project include cannibalism.

Accepted Answer

Synergistic benefits refer to the additional value that is created when two or more entities (such as companies or projects) combine their efforts or resources. Cannibalism, on the other hand, means that one entity is eating away or taking market share from another entity. These two concepts are not related, and synergistic benefits do not involve cannibalism.

Question 12

Accounting profits,adjusted for taxes and differences in accounting methods,provide the best measure of relevant cash flows for capital budgeting purposes.

Accepted Answer

Accounting profits are not always representative of relevant cash flows for capital budgeting purposes, as they may not account for changes in working capital, timing of cash flows, and other non-cash expenses. Therefore, adjustments and considerations beyond accounting profits are necessary to determine relevant cash flows.

Question 13

Sunk costs are cash outflows that will occur regardless of the current accept/reject decision,and therefore should be excluded from the analysis.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered. Since they are not affected by the current decision, they should not be included in the analysis.

Question 14

Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity.

Accepted Answer

While accounting profits are important in measuring a company's financial performance, they do not always accurately reflect the economic reality of a project or investment. Capital budgeting decisions rely on cash flows and other financial metrics, such as net present value and internal rate of return, in order to accurately evaluate the potential return on investment.

Question 15

If a project uses an asset the corporation already owns,the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets.

Accepted Answer

The cost of an asset for capital budgeting purposes is not zero just because the corporation already owns it. The opportunity cost of using the asset in the new project, which could include potential rental income if the asset were leased out or its sale value if it were sold, must be considered in the project's analysis.

Question 16

The initial outlay for a new project is an example of an opportunity cost.

Accepted Answer

The initial outlay for a new project is a direct cost associated with the project, not an opportunity cost. Opportunity cost refers to the value of the next best alternative that is foregone by choosing one option over another.

Question 17

For companies in competitive markets,the evolution and introduction of new products may serve more to preserve market share than to expand it.

Accepted Answer

In highly competitive markets, new products may not necessarily attract new customers but rather help companies to maintain their current market share by keeping up with the competition and meeting customer demands.

Question 18

To be included in a capital budgeting analysis,all incremental free cash flows must be expensed on the company's books,otherwise generally accepted accounting principles will be violated.

Accepted Answer

Incremental free cash flows are not expensed on the company's books, but rather they are included in the capital budgeting analysis as cash inflows or outflows. This does not violate generally accepted accounting principles.

Question 19

Capital budgeting decisions are based on free cash flow because free cash flow better reflects when money is received and available for reinvestment than account profits.

Accepted Answer

Free cash flow is considered more accurate than accounting profits for capital budgeting decisions because it takes into account the timing of cash inflows and outflows, and reflects the cash available for reinvestment in the business. In contrast, accounting profits can be manipulated by non-cash items and do not necessarily represent the actual cash flows of the business.

Question 20

Overhead costs are sometimes incremental cash flows and other times are considered sunk costs.

Accepted Answer

Overhead costs can be incremental if they change as a result of a specific decision or action, such as implementing a new project or expanding a business. However, if the overhead costs are already incurred and cannot be recovered, they are considered sunk costs and should not be factored into future decision-making.

Quiz 11: Cash Flows and Other Topics in Capital Budgeting