Questions and Answers
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
The difference between a firm's cash flows with a project versus without the project is called ________________.
The stand-alone principle assumes that evaluation of a project may be based on the project's ________________ cash flows.
incremental
Sunk costs are costs that ____.
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Opportunity costs are ____.
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One of the most important steps in estimating cash flow is to determine the _________ cash flows.
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The most valuable alternative that is given up if an investment is undertaken is called what?
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Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.
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Erosion will ______ the sales of existing products.
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According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a 'minifirm.'
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Which of the following are considered relevant cash flows?
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Which of the following is an example of a sunk cost?
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True or false: Investment in net working capital may arise from the need to cover credit sales.
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Opportunity costs are classified as ____ costs in project analysis.
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Which of the following is an example of an opportunity cost?
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True or false: In calculating cash flows, you should consider all financing costs.
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Cash flows used in project estimation should always reflect:
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Side effects from investing in a project refer to cash flows from:
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Investment in net working capital arises when ___.
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To prepare pro forma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required.
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Which of the following are fixed costs?
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Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
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Which of the following are components of project cash flow?
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Estimates of which of the following are needed to prepare pro forma income statements?
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True or false: Fixed costs cannot be changed over the life of the investment.
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Given a level of investment in net working capital, that same investment must be at some time in the future ________.
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Once cash flows have been estimated, which of the following investment criteria can be applied to them?
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Operating cash flow is a function of:
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What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC
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Side effects from investing in a project refer to cash flows from:
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True or false: Net working capital will be recovered at the end of a project.
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True or false: The depreciation tax shield is the depreciation deduction divided by the tax rate.
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Estimates of which of the following are needed to prepare pro forma income statements?
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The depreciation tax ___ is the tax savings that results from the depreciation deduction.
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Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?
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Which of the following are reasons why NPV is considered a superior capital budgeting technique?
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The possibility that errors in projected cash flows will lead to incorrect decisions is known as:
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Study Notes
Cash Flow Fundamentals
- Relevant cash flows are crucial for estimating cash flow; they directly affect project evaluation.
- Incremental cash flows represent the difference in cash flows with and without a project and are integral for decision-making.
Project Evaluation Principles
- The stand-alone principle allows projects to be analyzed independently using their incremental cash flows, ensuring accurate evaluation based on specific projects alone.
- Sunk costs refer to expenses that have already been incurred and will not influence future project decisions, hence should be ignored in financial analysis.
Opportunity Costs
- Opportunity costs reflect the potential benefits that are lost when choosing one investment over another.
- Relevant opportunity costs must be considered in project analysis as they impact the overall profitability and viability of the investment.
Cash Flow Estimation Techniques
- Estimating cash flows involves identifying sources such as operating cash flows, net working capital investments, and possible erosion of sales from existing products.
- Accurate estimations require after-tax cash flows to capture the true financial impact of a project.
Financial Projections
- Preparing pro forma financial statements necessitates forecasts of sales, pricing, variable costs, and total fixed costs, which are essential for assessing project viability.
- Fixed and variable costs must be clearly identified, as they influence cash flow calculations.
Cash Flow Components
- Key components of project cash flow include capital spending, operating cash flow, and changes in net working capital.
- Operating cash flow is primarily derived from earnings before interest and taxes (EBIT), with adjustments for depreciation and taxes.
Financial Metrics and Techniques
- Various investment criteria can be used to evaluate estimated cash flows, including Net Present Value (NPV), Internal Rate of Return (IRR), and payback period assessments.
- The Depreciation Tax Shield Approach helps quantify tax savings resulting from depreciation, which is crucial for assessing cash flow impact.
Risks in Cash Flow Projections
- Estimation risk and forecasting risk highlight the uncertainties in projected cash flows, potentially leading to poor decision-making.
- Accurate cash flow forecasting is vital: operating cash flows from net sales are particularly challenging yet critical to predict long-term project success.
Key Insights
- Side effects from investments, such as erosion effects and beneficial spillover effects, need to be evaluated as they impact overall project cash flows.
- Net working capital invested in a project is expected to be recovered post-project, which is a key consideration in cash flow analysis.
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Test your knowledge on key finance concepts with these smartbook flashcards. This quiz covers important terms related to cash flow estimation and incremental cash flows. Each card presents a definition to reinforce your understanding.