Finance 320F Exam Study Guide with complete solutions

Finance 320F Exam Study Guide with complete solutions Incremental Cash Flows After Taxes (ICFAT) - Answer️️ -are the periodic cash outflows and inflows that occur if, and only if, an investment project is accepted. Incremental cash flow focus on the project, not the company as a whole. Economic interdependencies - Answer️️ -Adopting a project would change the cash flows in other parts of the company. Synergy - Answer️️ -The positive effect where adopting the project would increase the cash flows from existing operation. Erosion - Answer️️ -The negative effect where adopting the project would decrease the cash flows from existing operations Sunk costs - Answer️️ -Costs that have already been incurred. As such they would not be affected by the capital budgeting decision and are thus not incremental cash flows. Revenue enhancing project - Answer️️ -These projects introduce a new product, improve an existing product, or involve other aspects to increase sales, such as a major marketing campaign. Cost reduction project - Answer️️ -These projects focus on reducing costs. Outsourcing of business functions or production, improving supply chains, employing machine learning lead to lower costs and thus higher income. ©SOPHIABENNETT 2024/2025 9:45 AM Page | 2 Corporate Social Responsibility project - Answer️️ -The ExxonMobil project is an example of corporations contributing to society. While the corporation's function in society is to efficiently produce goods and services, corporations are expected to be good citizens. These projects do help society, and also enhance the reputation of the company. Regulatory requirements project - Answer️️ -Governments regulate economic activity to protect society from harmful effects. The most cost-effective way to handle toxic waste from a production process is to dump it into Lake Lady Bird. These projects are undertaken because they are required. Free Cash Flow (FCF) from assets - Answer️️ -The amount of cash generated by a company that is available to distribute to the firm's creditors and owners Operating cash flow: is earnings before interest plus depreciation minus taxes. and, its important to remember that these cash flows have not yet occurred--we estimate what they would be if the project were to be adopted. Capital spending: is the cash that must be invested in the project's capital assets to produce the projected operating cash flow! any operating cash flow that must be invested in productive assets is not available for the company's security holders, so the projected capital expenditures must be subtracted from the operating cash flow. Additions to Net working capital: Are investments in the project's short term assets. A project may require investments in such items as accounts payable and inventory. ©SOPHIABENNETT 2024/2025 9:45 AM Page | 3 Some operating cash flow may have to be invested in these short-term assets and is thus not available (free) to be paid to the security holders. Capital spending - Answer️️ -is the cash that must be invested in the project's capital assets. Operating cash flow is earnings before interest plus depreciation - taxes. In capital budgeting OCF measure the cash flows from operating the project, but does not include the cash flows related to capital spending or changes in NWC. Initial cash flows - Answer️️ -Initial cash flows: Expenditures that are undertaken to obtain assets and begin a capital budgeting project. Direct expenditures are those directly connected with obtaining the capital asset. Indirect expenditures, which result from our decision to purchase the asset, should also be included at the project's inception. Operating Cash Flow - Answer️️ -Cash flows received from the operating of the capital budgeting project. Terminal cash flows - Answer️️ -Cash flows incurred in closing down a capital budgeting project. Flat money - Answer️️ -money issued by a government that is not backed by a physical commodity such as gold or silver Specie Money - Answer️️ -A metallic money that possesses intrinsic value and is naturally limited in supply. Inflation - Answer️️ -A decrease in the purchasing power of a unit of a currency ©SOPHIABENNETT 2024/2025 9:45 AM Page | 4 Deflation - Answer️️ -An increase in the purchasing power of a unit of a currency nominal interest rate - Answer️️ -An interest rate that is not adjusted for inflation. real interest rate - Answer️️ -An interest rate reflecting the real change in purchasing power of a currency. inflation premium - Answer️️ -The extra rate of return required by investors to compensate them for the loss of purchasing power of the currency. Opportunity Cost In the context of capital budgeting, what is an opportunity cost? - Answer️️ -In general we've seen the opportunity cost as the discount rate used in valuing future cash flows. In capital budgeting, the opportunity cost is a much broader concept that helps us sort out what is relevant in our capital budgeting decision. In capital budgeting we are not evaluating the entire company. Rather, we are looking as a specific project managers are considering. We must therefore sort out what would change if the project were undertaken—how adopting the project would change the company's cash flows and wealth. This concept thus underlies the five rules for capital budgeting projects. Rule 1: Include only incremental cash flows. What cash flow would you have to give up to obtain productive assets? What cash inflows would result if you were to take on the project? ©SOPHIABENNETT 2024/2025 9:45 AM Page | 5 Rule 2: Include economic interdependencies. A project may increase the cash flows or decrease the cash flows from your existing business operations. These synergies and erosions must be considered. Rule 3: If you're using it, it is an opportunity cost. The cost of any asset used in the project is a cost and should be included. Rule 4: Forget sunk costs. Get over it! Only future cash flows count. Rule 5: Taxes count. Taxes are a cost and if the project doesn't work on an after-tax basis don't do it. Cash flow and depreciation "When evaluating projects, we're only concerned with the relevant incremental after-tax cash flows. Therefore, because depreciation is a non cash expense, we should ignore its effects when evaluating projects." Critically evaluate this statement. - Answer️️ - Depreciation is a noncash expense charged against accounting earnings to write off the cost of an asset during its estimated useful life. While you c