Financial Statements & Cash Flows Quiz
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Questions and Answers

What is the total expected revenue from selling shark attractant cans in a year?

  • £50,000
  • £200,000
  • £150,000
  • £100,000 (correct)

    • What is the total annual fixed cost for the project?

  • £90,000
  • £12,000 (correct)
  • £20,000
  • £10,000

    • What is the estimated selling price of the vacant lot after taxes?

  • €2,000,000
  • €2,500,000
  • €1,500,000 (correct)
  • €1,000,000

    • How much net working capital is required at the start of the project?

    <p>£20,000</p> Signup and view all the answers

    What is the total investment in manufacturing equipment for the project?

    <p>£90,000</p> Signup and view all the answers

    What is the expected growth rate of production cash outflows due to increased rare metal costs?

    <p>10 percent per year</p> Signup and view all the answers

    What is the tax rate applicable to the project?

    <p>34%</p> Signup and view all the answers

    What is the estimated market value of the manufacturing facilities at the end of five years?

    <p>€1,000,000</p> Signup and view all the answers

    What will be the net working capital level at the end of year 3?

    <p>€250,000</p> Signup and view all the answers

    What is the formula used to calculate the operating cash flow (OCF) for the project?

    <p>Net Income + Depreciation - Increase in Net Working Capital</p> Signup and view all the answers

    What is the calculated Net Present Value (NPV) of the project?

    <p>£10,648</p> Signup and view all the answers

    What is the corporate tax rate applicable to the wind turbine project?

    <p>20 percent</p> Signup and view all the answers

    How is depreciation considered in the context of cash flow for the project?

    <p>It is a non-cash deduction that affects tax obligations.</p> Signup and view all the answers

    What should incremental cash flows consist of?

    <p>Changes in cash flows due to a project</p> Signup and view all the answers

    Which of the following cash flows should be ignored when assessing a project's viability?

    <p>Sunk costs that have already occurred</p> Signup and view all the answers

    Which type of cash flow involves potential lost revenues due to a new investment?

    <p>Opportunity costs</p> Signup and view all the answers

    When evaluating side effects from a new project, which of the following should be included?

    <p>Erasions that decrease existing cash flows</p> Signup and view all the answers

    Which cash flow represents expenses that benefit multiple projects and are divided among them?

    <p>Allocated costs</p> Signup and view all the answers

    Which step is necessary before conducting an investment appraisal?

    <p>Generate cash flow forecasts</p> Signup and view all the answers

    What does the term 'synergy' refer to in capital investment decisions?

    <p>Increased cash flows from existing projects due to a new investment</p> Signup and view all the answers

    Which of the following statements about cash flows versus accounting figures is accurate?

    <p>Cash flows are critical inputs into NPV analysis.</p> Signup and view all the answers

    What is the initial net working capital required for the power mulcher project?

    <p>£20,000</p> Signup and view all the answers

    What will the total net working capital be at the end of Year 1 if sales are projected at £360,000?

    <p>£54,000</p> Signup and view all the answers

    What method is used to depreciate the equipment cost of £800,000?

    <p>Reducing balance method</p> Signup and view all the answers

    What is the depreciation amount if the equipment is expected to be worth £160,000 after eight years?

    <p>£39,428</p> Signup and view all the answers

    If the relevant tax rate is 23%, what factor should be considered in tax payment calculations?

    <p>Effective tax rate</p> Signup and view all the answers

    How is the net present value (NPV) calculated for the project?

    <p>Future cash flows minus initial investment</p> Signup and view all the answers

    What is the internal rate of return (IRR) for the power mulcher project?

    <p>19.1%</p> Signup and view all the answers

    After how many years will the investment reach its payback period of 3.95 years?

    <p>Approximately 4 years</p> Signup and view all the answers

    What is the initial depreciation amount for Year 1 using a 20% reducing balance method?

    <p>600,000</p> Signup and view all the answers

    In Year 5, what is the calculated net income before taxes?

    <p>1,020,506</p> Signup and view all the answers

    What is the total operating cash flow for Year 3?

    <p>1,748,736</p> Signup and view all the answers

    What is the residual value at the end of the depreciation period?

    <p>1,000,000</p> Signup and view all the answers

    How much revenue is generated in Year 2 according to the forecast?

    <p>2,448,000</p> Signup and view all the answers

    What is the tax payment for Year 3 calculated at a 20% tax rate?

    <p>341,184</p> Signup and view all the answers

    What is the difference in net working capital (Δ NWC) from Year 4 to Year 5?

    <p>-90,000</p> Signup and view all the answers

    How much is the operating cost at Year 1?

    <p>800,000</p> Signup and view all the answers

    What is the forecasted sales amount in Year 4?

    <p>4,244,832</p> Signup and view all the answers

    What total amount is forecasted for cash flow in Year 2?

    <p>998,400</p> Signup and view all the answers

    What is the NPV for Energy Renewables Ltd?

    <p>€821,934.75</p> Signup and view all the answers

    What is the Profitability Index (PI) calculated for this investment?

    <p>1.18</p> Signup and view all the answers

    What is the calculated IRR for Energy Renewables Ltd?

    <p>15.48%</p> Signup and view all the answers

    Which cash flow year contains the highest net cash flow for Energy Renewables Ltd?

    <p>Year 5</p> Signup and view all the answers

    What is the ordinary payback period for Energy Renewables Ltd?

    <p>3.9 years</p> Signup and view all the answers

    In capital budgeting, what do 'nominal cash flows' refer to?

    <p>The actual cash received or paid out</p> Signup and view all the answers

    What formula is used to approximate real interest rates?

    <p>$R_{real} = rac{1 + R_{nominal}}{1 + R_{inflation}} - 1$</p> Signup and view all the answers

    What effect does inflation have on capital budgeting cash flows?

    <p>It decreases the purchasing power of cash</p> Signup and view all the answers

    In the context of the cash flows given, what discount rate would likely be used for real cash flows?

    <p>Real discount rate only</p> Signup and view all the answers

    With cash flow projections, which year has a cash flow of €1,020,506?

    <p>Year 3</p> Signup and view all the answers

    What is the balance after Year 1 based on the investment cash flows?

    <p>(3,921,428.57)</p> Signup and view all the answers

    How is the Discounted Payback Period different from the Ordinary Payback Period?

    <p>It discounts future cash flows</p> Signup and view all the answers

    What is the primary characteristic of real cash flows?

    <p>They reflect the purchasing power over time</p> Signup and view all the answers

    What would be the net income for Year 0 in the projected cash flows?

    <p>0</p> Signup and view all the answers

    What is the expected production of wind turbines in Year 3 of the project?

    <p>24 units</p> Signup and view all the answers

    What is the projected manufacturing cost per unit in Year 1?

    <p>€100,000</p> Signup and view all the answers

    What will the net working capital be at the end of Year 4?

    <p>€210,000</p> Signup and view all the answers

    How much is the expected market value of the vacant lot after taxes?

    <p>€1,500,000</p> Signup and view all the answers

    What is the expected total increase in production costs due to the inflation of rare metals by the end of Year 5?

    <p>40%</p> Signup and view all the answers

    What should be included when calculating incremental cash flows?

    <p>Opportunity costs</p> Signup and view all the answers

    What is a sunk cost?

    <p>A cost that has already been incurred</p> Signup and view all the answers

    Which of the following describes a side effect in capital budgeting?

    <p>Increased cash flows due to a new project</p> Signup and view all the answers

    When determining cash flows for a new project, which expenses should be allocated?

    <p>Allocated costs that benefit multiple projects</p> Signup and view all the answers

    What is the main consequence of ignoring incremental cash flows in project evaluation?

    <p>Making decisions based on historical costs</p> Signup and view all the answers

    Which of the following is true about cash flows versus accounting figures?

    <p>Cash flows are more critical for project analysis than accounting figures</p> Signup and view all the answers

    What does erosion refer to in the context of capital budgeting?

    <p>Loss of existing product revenues due to new competition</p> Signup and view all the answers

    What is the required net working capital at the end of Year 1 if sales are projected at £360,000?

    <p>£54,000</p> Signup and view all the answers

    Which amount represents the depreciation for Year 1 using the 18% reducing balance method?

    <p>£39,428</p> Signup and view all the answers

    What is the net present value (NPV) calculated for the power mulcher project?

    <p>£124,925</p> Signup and view all the answers

    How will the investment in equipment be treated in terms of its residual value after eight years?

    <p>The equipment will have a value of £160,000.</p> Signup and view all the answers

    What does the calculated payback period of 3.95 years indicate about the project?

    <p>The project recoups its initial investment in about 4 years.</p> Signup and view all the answers

    What is the total fixed cost incurred for the project annually?

    <p>£25,000</p> Signup and view all the answers

    Which step is NOT part of the capital budgeting analysis process described?

    <p>Evaluate marketing strategies</p> Signup and view all the answers

    What is the total investment required at the start of the project?

    <p>£110,000</p> Signup and view all the answers

    How is the equipment depreciated over the project's life?

    <p>Straight-line method</p> Signup and view all the answers

    What will be the annual operating cash flow if the project generates £51,780 in net income?

    <p>£51,780</p> Signup and view all the answers

    How much annual fixed cost is associated with the project?

    <p>£12,000</p> Signup and view all the answers

    What is the cash flow consequence of depreciation in the project?

    <p>It reduces tax liability.</p> Signup and view all the answers

    What will be the net income before taxes if the operating cash flow is £51,780?

    <p>£51,780</p> Signup and view all the answers

    What would be the project’s overall NPV if the calculated amount is £10,648?

    <p>Accept the project</p> Signup and view all the answers

    What would the investment be worth after three years if it has only depreciated to zero value?

    <p>£0</p> Signup and view all the answers

    What is the total depreciation amount for Year 5 using the 20% reducing balance method?

    <p>228,800</p> Signup and view all the answers

    What represents the net income before taxes for Year 3?

    <p>1,705,920</p> Signup and view all the answers

    Which year shows the highest operating cash flow?

    <p>Year 3</p> Signup and view all the answers

    What is the value of taxes paid in Year 4 at a 20% tax rate?

    <p>341,184</p> Signup and view all the answers

    What amount represents the net working capital (NWC) at the start of Year 3?

    <p>160,000</p> Signup and view all the answers

    What is the calculated increase (Δ NWC) in net working capital from Year 3 to Year 4?

    <p>90,000</p> Signup and view all the answers

    What is the total cash flow for Year 2?

    <p>998,400</p> Signup and view all the answers

    What is the operating cost at Year 1?

    <p>800,000</p> Signup and view all the answers

    How much is the net income for Year 1?

    <p>160,000</p> Signup and view all the answers

    What is the Profitability Index (PI) for the investment?

    <p>1.18</p> Signup and view all the answers

    What is the Payback Period for Energy Renewables Ltd?

    <p>3.9 years</p> Signup and view all the answers

    What is the internal rate of return (IRR) calculated for the project?

    <p>15.48%</p> Signup and view all the answers

    What cash flow year contains the lowest net cash flow?

    <p>Year 0</p> Signup and view all the answers

    Which value represents the initial cash outlay for Energy Renewables Ltd?

    <p>€4,600,000</p> Signup and view all the answers

    How is 'Real Cash Flow' defined in capital budgeting?

    <p>Cash flows adjusted for inflation</p> Signup and view all the answers

    What is the ordinary payback period for the investment?

    <p>3.9 years</p> Signup and view all the answers

    Which of the following statements is true about nominal versus real cash flows?

    <p>Nominal cash flows are always higher than real cash flows.</p> Signup and view all the answers

    Which statement is accurate regarding discounted payback period?

    <p>It is the time required to recover discounted initial investments.</p> Signup and view all the answers

    What does the acronym NPV stand for?

    <p>Net Present Value</p> Signup and view all the answers

    Study Notes

    Financial Statements & Operations

    • Financial statements project future years' operations.
    • To prepare these statements, need total required investment and estimations of variable and fixed costs, sales, etc.

    Incremental Cash Flows & Examples

    • Definition: Cash flows in a project vs. without a project.
    • Criteria: Include all cash changes directly resulting from the project.
    • Example: Energy Renewables Ltd. and Majestic Mulch and Compost Ltd case studies used; Shark Attractant Project used
    • Steps:
      • Calculate depreciation
      • Calculate tax payment
      • Generate cash flow forecast
      • Investment appraisal

    Pro Forma Financial Statements Example (Shark Attractant Project)

    • Assumptions: 50,000 cans sold annually at £4/can; manufacture cost £2.50/can; 3 year life expectancy; 20% return on investment; £12,000/year fixed costs; £90,000 investment in manufacturing equipment depreciated straight-line over 3 years, 34% tax rate.

    • Additional Information: Cost to remove equipment equals value; £20,000 investment in net working capital; tax rate is 34%.

    • Pro Forma Income Statement:

      • Sales: £200,000
      • Variable costs: £125,000
      • Gross profit: £75,000
      • Fixed costs: £12,000
      • Depreciation: £30,000
      • Profit before taxes: £33,000
      • Taxes: £11,220
      • Net income: £21,780

    • Pro Forma Capital Requirements:

      • Year 0: £20,000 net working capital, £90,000 investment
      • Year 1: £60,000 investment, £20,000 net working capital
      • Year 2: £30,000 investment, £20,000 net working capital
      • Year 3: £20,000 investment

    Project Cash Flows & Operating Cash Flow (OCF)

    • Components: Project OCF (operating cash flow) and project CAPEX (capital expenditures).
    • Definition: Project operating cash flow or OCF = net income + depreciation – increase (or + decrease) in net working capital

    Project Value Calculation Example

    • Calculation:
    • NPV = -£110,000 + 51,780/1.2 + 51,780 / 1.2^2 + 71,780 / 1.2^3 =
    • £10,648
    • Decision: Accept the project (positive NPV)

    Depreciation

    • Definition: Non-cash deduction affecting tax bill.
    • Methods: Reducing balance and straight-line.
    • Example:
      • Purchase of an asset for €500,000 with a five-year life and the asset being worthless. Annual depreciation: €500,000/5 = €100,000. Various other depreciation examples provided in the text.

    Depreciation - 18% Reducing Balance Example

    • Calculation example with initial value and written-down values over multiple years.

    Example - Reducing Balance Depreciation (Staple Supply Ltd)

    • A company buys a system costing €160,000.
    • 20% reducing balance is used for depreciation calculations.
    • The system is worth €10,000 after 4 years
    • Tax consequences of €55,536 tax loss if sold for €10,000
    • Total after-tax cash flow from the sale is a €28,882 inflow.

    Example: Majestic Mulch and Compost Ltd

    • Feasibility of new power mulching tools.
    • Features: £120 / unit price to start, falling to £110 after three years (competition factors); investment in £800,000 equipment; 18% reducing balance depreciation, industrial equipment with 20% residual value in 8 years; 15% required return, and 23% tax rate.
    • Projected Cash flow: need to project future cash flow based on the features of the project.

    What Do I Need to Do?

    • Steps to follow for an investment analysis:
      • Find projected sales for each year
      • Calculate depreciation
      • Prepare pro forma statements, starting from operating cash flow
      • Calculate changes to NWC
      • Calculate projected cash flows
      • Find NPV
      • Make investment decision

    Inflation and Capital Budgeting

    • Nominal vs Real Cash Flows: Nominal cash flows represent the actual amount of money, while real cash flows consider the purchasing power after adjusting for inflation.
    • Real interest rates take into account the effect of inflation. An approximate formula used for real interest rate is: Real interest rate = Nominal interest rate – Inflation rate.
    • Example of nominal vs real cash flow calculation included.

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    Description

    Test your knowledge on financial statements, cash flow analysis, and project investment evaluation. This quiz covers essential concepts such as incremental cash flow, pro forma financial statements, and the considerations for investments. Dive into real-world examples and theoretical insights to enhance your understanding.

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