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    Chapter 06 Making Investment Decisions With The Net Present Value Rule

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    Saranyieh Ramasamy
    This document discusses key concepts for making investment decisions using net present value analysis. It covers estimating cash flows, identifying relevant costs, and discounting cash flows for inflation and interest rates. Specifically: - Cash flows should be estimated on an incremental basis and consistently treat inflation. - When using excess capacity, only incremental costs are relevant to the decision. - Sunk costs are irrelevant but opportunity costs, even if not involving cash flows, can be relevant. - Net working capital is not depreciated but should be included in cash flows since firms must invest in short-term assets to produce goods.

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    Chapter 06 Making Investment Decisions With The Net Present Value Rule

    Uploaded by

    Saranyieh Ramasamy
    86 views4 pages
    This document discusses key concepts for making investment decisions using net present value analysis. It covers estimating cash flows, identifying relevant costs, and discounting cash flows for inflation and interest rates. Specifically: - Cash flows should be estimated on an incremental basis and consistently treat inflation. - When using excess capacity, only incremental costs are relevant to the decision. - Sunk costs are irrelevant but opportunity costs, even if not involving cash flows, can be relevant. - Net working capital is not depreciated but should be included in cash flows since firms must invest in short-term assets to produce goods.

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    Chap006 (Q)

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    This document discusses key concepts for making investment decisions using net present value analysis. It covers estimating cash flows, identifying relevant costs, and discounting cash flows for inflation and interest rates. Specifically: - Cash flows should be estimated on an incremental basis and consistently treat inflation. - When using excess capacity, only incremental costs are relevant to the decision. - Sunk costs are irrelevant but opportunity costs, even if not involving cash flows, can be relevant. - Net working capital is not depreciated but should be included in cash flows since firms must invest in short-term assets to produce goods.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    86 views4 pages

    Chapter 06 Making Investment Decisions With The Net Present Value Rule

    Uploaded by

    Saranyieh Ramasamy
    This document discusses key concepts for making investment decisions using net present value analysis. It covers estimating cash flows, identifying relevant costs, and discounting cash flows for inflation and interest rates. Specifically: - Cash flows should be estimated on an incremental basis and consistently treat inflation. - When using excess capacity, only incremental costs are relevant to the decision. - Sunk costs are irrelevant but opportunity costs, even if not involving cash flows, can be relevant. - Net working capital is not depreciated but should be included in cash flows since firms must invest in short-term assets to produce goods.

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    © All Rights Reserved
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    Chapter 06 Making Investment Decisions with the Net Present Value Rule

    1. Important points to remember while estimating cash flows of projects are:


    I) only cash flow is relevant
    II) always estimate cash flows on an incremental basis
    III) be consistent in the treatment of inflation
    A. I only
    B. I and II only
    C. II, and III only
    D. I,II, and III

    2. Preferably, cash flows for a project are estimated as:


    A. Cash flows before taxes
    B. Cash flows after taxes
    C. Accounting profits before taxes
    D. Accounting profits after taxes

    3. When a firm has the opportunity to add a project that will utilize excess factory capacity
    (that is currently not being used), which costs should be used to determine if the added project
    should be undertaken?
    A. Opportunity cost
    B. Sunk cost
    C. Incremental costs
    D. None of the above

    4. A reduction in the sales of existing products caused by the introduction of a new product is
    an example of:
    A. incidental effects
    B. opportunity cost
    C. sunk cost
    D. none of the above

    5. For example, when Honda develops a new engine, the incidental effects might include the
    following:
    I) demand for replacement parts
    II) profitable service facilities
    III) offer modified or improved versions of the engine for other uses
    A. I only
    B. I and II only
    C. I,II, and III
    D. None of the given ones
    6. The cost of a resource that may be relevant to an investment decision even when no cash
    changes hand is called a (an):
    A. Sunk cost
    B. Opportunity cost
    C. Working capital
    D. None of the above

    7. Net Working Capital is the:


    I) short-term assets
    II) short term liabilities
    III) long-term assets
    IV) long term liabilities
    A. I only
    B. (I - II)
    C. (III - I)
    D. (III - IV)

    8. Investment in net working capital is not depreciated because:


    A. It is not a cash flow
    B. It is recovered during or at the end of the project and is not a depreciating asset
    C. It is a sunk cost
    D. All of the above

    9. Net Working Capital should be considered in project cash flows because:


    A. Firms must invest cash in short-term assets to produce finished goods
    B. They are sunk costs
    C. Firms need positive NPV projects for investment
    D. None of the above

    12. The principal short-term assets are:


    I) Cash, II) Accounts receivable, III) Inventories, and IV) Accounts Payable
    A. I only
    B. I and IV only
    C. I, II, and III
    D. IV only

    13. The value of a previously purchased machine to be used by a proposed project is an


    example of:
    A. Sunk cost
    B. Opportunity cost
    C. Fixed cost
    D. None of the above
    14. Money that a firm has already spent or committed to spend regardless of whether a project
    is taken is called:
    A. Fixed cost
    B. Opportunity cost
    C. Sunk cost
    D. None of the above

    15. The cost that is incurred as a result of past, irrevocable decisions and is irrelevant to future
    decisions is called:
    A. Opportunity cost
    B. Sunk cost
    C. Incremental cost
    D. None of the above

    18. If the discount rate is stated in nominal terms, then in order to calculate the NPV in a
    consistent manner requires that project:
    I) cash flows be estimated in nominal terms
    II) cash flows be estimated in real terms
    III) accounting income be used
    A. I only
    B. II only
    C. III only
    D. None of the above

    19. If the discount rate is stated in real terms, then in order to calculate the NPV in a
    consistent manner requires that project:
    I) cash flows be estimated in nominal terms
    II) cash flows be estimated in real terms
    III) accounting income be used
    A. I only
    B. II only
    C. III only
    D. None of the above

    20. A firm owns a building with a book value of $150,000 and a market value of $250,000. If
    the building is utilized for a project, then the opportunity cost ignoring taxes is:
    A. $100,000
    B. $150,000
    C. $250,000
    D. None of the above
    21. The real interest rate is 3% and the inflation rate is 5%. What is the nominal interest rate?
    A. 3%
    B. 5%
    C. 8.15%
    D. 2%

    22. If the nominal interest rate is 7. 5% and the inflation rate is 4%, what is the real interest
    rate?
    A. 4%
    B. 9.5%
    C. 3.4%
    D. None of the above

    23. A cash flow received in two years is expected to be $10,816 in nominal terms. If the real
    rate of interest is 2% and the inflation rate is 4%, what is the real cash flow for year-2?
    A. $11,236
    B. $10,816
    C. $10,000
    D. $9,246

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