Question 1

Give an example of each of the following: (a) Opportunity cost, (b) Substitutionary effect, (c) Complementary effect and (d) Sunk cost.

Accepted Answer

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Question 2

When calculating operating cash flow for a project, why would one treat EBIT as a negative for tax purposes when there is an operating loss?

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Question 3

Everything held constant, would you rather depreciate a project with straight-line depreciation or with DDB?

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Question 4

Which of the following expenditures qualify for the Section 179 deduction?

Accepted Answer

Section 179 deduction can be claimed on qualifying property such as machinery, equipment, furniture, and off-the-shelf software. Buildings, property purchased from related parties, furniture held in a trust, and property acquired by inheritance are not eligible for the Section 179 deduction.

Question 5

Will operating cash flow typically be larger or smaller than net income? Why?

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Question 6

The research chemists at MegaClean created a new cleaner that keeps car and truck tires shiny and clean for one year. They believe that this product will be highly successful and will attract customers to purchase their existing line of household cleaning products. This is an example of ___________.

Accepted Answer

This is an example of the complementary effect, where the newly created product complements the existing line of household cleaning products and is expected to increase their sales.

Question 7

A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct?

Accepted Answer

The $20,000 in revenue generated by the new branch bank is not entirely incremental cash flow because it is possible that some customers from the main office may switch to the new branch. As a result, it is likely that the actual incremental cash flow will be less than $20,000 due to substitutionary effects. Therefore, choice C is the best answer.

Question 8

Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula. This new product is expected to reduce the sales of their existing product, Cherry Coke, by $10 million dollars per year. This is an example of a _______________.

Accepted Answer

This is an example of a substitutionary effect because the introduction of Very Berry Coke is expected to lead to a decrease in sales of Cherry Coke, as they both appeal to consumers who are looking for a fruity flavor in their soda.

Question 9

AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n) _______________.

Accepted Answer

The $125,000 spent on the study is a sunk cost because it is a cost that has already been incurred and cannot be recovered.

Question 10

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n) ________________.

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered, regardless of whether a project is undertaken or not. This cost is irrelevant to decision-making because it cannot be avoided or altered. Incremental cash outflows and opportunity costs are relevant costs that should be considered in making decisions. Expensible item is not a relevant accounting term.

Question 11

A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications which has a monthly cost of $50 per month. This is an example of _____________.

Accepted Answer

Incremental cash flow refers to the additional cash flow a company receives from taking on a new project. The monthly cost of the phone line is an additional expense directly associated with the new ATM, making it an incremental cash flow.

Question 12

The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as the _________________.

Accepted Answer

The process described is known as pro forma analysis. Pro forma analysis involves creating financial projections for future periods based on past performance and expected changes. The projections are based on relevant parts of the financial statements, such as income statements and balance sheets, and are used to estimate expected future cash flows.

Question 13

Your company has spent $200,000 on research to develop a new computer game. The firm is planning to spend $300,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $25,000. The machine has an expected life of 3 years, a $50,000 estimated resale value, and falls under the MACRS 7-Year class life. Revenue from the new game is expected to be $400,000 per year, with costs of $150,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 10 percent, and it expects net working capital to increase by $75,000 at the beginning of the project. What will the cash flows for this three-year project be?

Accepted Answer

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Question 14

An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the ___________________.

Accepted Answer

The cost of an asset plus the additional expenses incurred to acquire and prepare it for use, such as installation or testing fees, is known as the depreciable basis. This amount is used to calculate the asset's depreciation over its useful life, which represents the cost of the asset as it wears out over time. Therefore, the correct answer is D.

Question 15

In a cost-cutting proposal, what might cause you to sometimes have a negative EBIT?

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Question 16

How would you compute the equity flotation cost if a firm were going to use a mixture of retained earnings and new equity to finance a project? Give an example.

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Quiz 12: Estimating Cash Flows on Capital Budgeting Projects