Foundations of Finance, 7e (Keown)Chapter 11 Cash Flows and
Other Topics in Capital Budgeting11.1 Learning Objective 1True or
False1) Accounting profits are used to make capital budgeting
decisions because generally accepted accounting principles ensure
that profits are the best measure of a company's economic
activity.Answer!AL"#$iff 1%eywords&apital 'udgeting $ecisions(
Accounting )rofits vs &ash !low*) &apital budgeting
decisions are based on free cash flow because free cash flow better
reflects when money is received and available for reinvestment than
account profits. Answer+,-#$iff 1%eywords&apital 'udgeting
$ecisions( !ree &ash !low( Accounting )rofits.) +he guiding
rule in deciding if a free cash flow is incremental is to look at
the company with( versus without( the new project.Answer+,-#$iff
1%eywords/ncremental !ree &ash !lows0) A grocery store decides
to offer beer for sale and this decision results in more potato
chip sales. +his is an e1ample of a synergistic effect.
Answer+,-#$iff 1%eywords"ynergistic #ffects2) Additional investment
in working capital( even if it may be recovered at the end of a
project( must be included in capital budgeting analysis because of
the time value of money. Answer+,-#$iff 1%eywordsAdditional 3orking
&apital( ,ecovery of Additional 3orking &apital( +ime 4alue
of 5oney6) "unk costs are cash outflows that will occur regardless
of the current accept7reject decision( and therefore should be
e1cluded from the analysis.Answer+,-#$iff 1%eywords"unk
&osts1&opyright 8 *911 )earson #ducation(
/nc.https://www.coursehero.com/file/7243689/chapter-11/This study
resource wasshared via CourseHero.com:) Overhead costs are
sometimes incremental cash flows and other times are considered
sunk costs.Answer+,-#$iff 1%eywordsOverhead &osts( /ncremental
&ash !lows;) /nterest payments on a loan obtained specifically
to fund a new project should be considered an incremental cash flow
for the new project when determining the accept7reject
decision.Answer!AL"#$iff 1%eywords!inancing &ash !low(
/ncremental &ash !lows capital budgeting analysis for the
)rius( a gas=electric hybrid( was faulty because the car line has
not made a profit to date.Answer!AL"#$iff 1%eywords&apital
'udgeting*&opyright 8 *911 )earson #ducation(
/nc.https://www.coursehero.com/file/7243689/chapter-11/This study
resource wasshared via CourseHero.com12) Accounting profits(
adjusted for ta1es and differences in accounting methods( provide
the best measure of relevant cash flows for capital budgeting
purposes.Answer!AL"#$iff 1%eywordsAccounting )rofits( &ash
!low16) ?ershey>s e1pects to sell @* million of its new candy
bar( although @*99(999 of this amount would have been spent on its
e1isting candy bar.+he @* million is the appropriate cash inflow
for the new candy bar project( while the @*99(999 will be counted
against the return on the old candy bar.Answer!AL"#$iff
1%eywords/ncremental &ash !lows( &annibalism 1:) Adding
gourmet coffee stations to my convenience store is e1pected to
increase sales of my breakfast sandwichesA however( the sales of
breakfast sandwiches should not be included in the evaluation of
the gourmet coffee project because only relevant( incremental cash
flows should be considered.Answer!AL"#$iff 1%eywords"ynergistic
#ffects1;) As a rule( any cash flows that are not affected by the
accept7reject criterion should not be included in capital=budgeting
analysis.Answer+,-#$iff 1%eywords"unk &osts1s free cash flows
will fall into one of three categoriesG1) incremental costs( G*)
sunk costs( and G.) opportunity costs.Answer!AL"#$iff 1%eywords!ree
&ash !low*0) +he initial outlay includes the cost of purchasing
the asset and getting it operational( including the purchase price(
shipping and installation( and any training costs for employees who
will be operating the eCuipment( and any increases in working
capital reCuirements.Answer+,-#$iff 1%eywords/nitial Outlay*2) +he
initial outlay includes the cost of purchasing the asset and
getting is operational( but this e1cludes any training costs for
employees which should be included as part of differential cash
flows over the life of the project.Answer!AL"#$iff 1%eywords/nitial
Outlay;&opyright 8 *911 )earson #ducation(
/nc.https://www.coursehero.com/file/7243689/chapter-11/This study
resource wasshared via CourseHero.com*6) /n a replacement decision(
the initial outlay is eCual to the cost of the new asset less the
reduction in depreciation from elimination of the old
asset.Answer!AL"#$iff 1%eywords,eplacement )roject( /nitial Outlay
*:) Operating cash flow is eCual to the change in #'/+ less the
change in interest e1pense( less the change in ta1es( plus the
change in depreciation.Answer!AL"#$iff 1%eywordsOperating &ash
!low( /nterest #1pense*;) &hanges in capital spending are not
incorporated directly into capital budgeting problems because the
amounts are included in the operating cash flows through the
inclusion of depreciation e1pense.Answer!AL"#$iff
1%eywords&apital "pending( !ree &ash !lows( Operating
&ash !low *s annual free cash flow is the change in operating
cash flow less any change in net working capital and less any
change in capital spending.Answer+,-#$iff 1%eywords!ree &ash
!lowMultiple Choice1) +aste Hood &hocolates develops a new
candy bar and plans to sell each bar for @1. +aste Hood predicts
that 1 million candy bars will be sold in the first year if the new
candy bar is produced and sold( and includes @1 million of
incremental revenues in its capital budgeting analysis. A senior
e1ecutive in the company believes that 1 million candy bars will be
sold( but lowers the estimate of incremental revenue to @:99(999.
3hat would e1plain this changeIA) cannibaliBation of .99(999 of
+aste Hood &hocolates' other candy bars') e1cessive marketing
costs to sell the 1 million candy bars&) a lower discount
rate$) a higher selling price for the new candy barsAnswerA$iff
1%eywords/ncremental ,evenues( &annibaliBation
