Fabozzi Frank, Peterson Pamela. Financial Management and Analysis Workbook

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110 QUESTIONS AND PROBLEMS

______________ in making investment decisions, not only

to ______________ how much the firm’s ______________

cash flows will ______________ if it invests in a project,

but also the ______________ associated with these

______________ cash flows.

3. Cash flow ______________ comes from two sources:

______________ risk and ______________ risk.

______________ risk is the degree of ______________

related to the number of units that will be ______________

and the ______________ of the good or service and

______________ risk is the degree of ______________ con-

cerning ______________ cash flows that arises from the

particular ______________ of fixed and variable

______________ costs. The combination of the two risks is

______________ risk and is reflected in the ______________

rate, which is the rate of ______________ required to com-

pensate the suppliers of ______________ for the amount of

risk they bear, the ______________ rate of return or, from

the firm’s perspective, the ______________ of capital.

4. Capital ______________ is the process of ______________

and ______________ investments in ______________ lived

assets, or assets expected to produce ______________ over

more than ______________ year. Because a firm must

continually evaluate possible investments, capital

______________ is a(n) ______________ process. However,

before a firm begins thinking about capital ______________,

it must first determine its corporate ______________ —its

broad set of ______________ for future investment.

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Capital Budgeting: Cash Flows 111

5. Projects are classified by the ______________ of the project

life, the ______________, and the ______________ on

other projects. The ______________ or ______________

life of an asset is an estimate of the ______________ of time

that the asset will provide ______________ to the firm. The

investment’s ______________ of return can be classified

according to the ______________ of the project represented

by the investment. The degree of ______________ on other

projects is classified as follows: ______________ projects,

______________ projects, ______________ projects, and

______________ projects.

6. The ______________ between the cash flows of the firm

______________ the investment project and the cash flows of

the firm ______________ the investment project, both over

the same period of time, is the project’s ______________ cash

flows. A more useful way of evaluating the ______________

in the value is the breakdown of the project’s cash flows into

two ______________: ______________ cash flows and

______________ cash flows, which are the ______________

needed to ______________ the project’s assets and any cash

flows from ______________ of the project’s assets.

7. The ______________ form of investment is a cash

______________ when the asset is ______________ and

there may be either a cash ______________ or a(n)

______________ at the end of its ______________ life. In

most cases these are not the only cash flows—the invest-

ment may result in changes in ______________,

______________, ______________, and ______________

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112 QUESTIONS AND PROBLEMS

capital. These are ______________ cash flows as they

result directly from the day-to-day activities of the firm.

8. The effect ______________ has on taxes is called the

______________. Because it reduces taxable income,

depreciation reduces the tax ______________, which

amounts to a cash ______________. For tax purposes,

firms are permitted to use ______________ depreciation or

______________ depreciation. A(n) ______________

method is preferred in most situations because it results in

______________ deductions ______________ in the asset’s

life than using ______________ depreciation.

9. ______________ value is ______________ considered in

calculating ______________. Instead, it is our best

______________ today of what the ______________ will

be ______________ at the end of its ______________ life

some time in the future. ______________ value is our esti-

mate of how much we can get when we ______________

of the asset.

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Capital Budgeting: Cash Flows 113

SHORT ANSWER QUESTIONS

Refer to Chapter 12, pages 355–392 in Financial Manage-

ment and Analysis.

1. List and describe the ﬁve stages of the capital budgeting

process.

2. Compare the investment decisions in short-term assets ver-

sus long-term assets.

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114 QUESTIONS AND PROBLEMS

3. Explain the difference between independent, mutually

exclusive, contingent, and complementary projects.

4. What are the cash flows that comprise an investment?

PROBLEMS

Refer to Chapter 12, pages 355–392 in Financial Manage-

ment and Analysis.

1. An asset is purchased for $10,000. It is classiﬁed as ﬁve-

year property and will be depreciated using the straight-

line method. The asset has no salvage value and is

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Capital Budgeting: Cash Flows 115

expected to increase revenues by $15,000 a year and

expenses by $8,000 a year. If the tax rate is 30%, deter-

mine the cash ﬂows from asset acquisition, asset disposi-

tion, and operating cash ﬂows.

2. The Cookies-R-Us bakery is considering the purchase of

an additional cookie press for $49,000. It is classified as a

seven-year property and will be depreciated using straight-

line depreciation. The addition of the press is expected to

increase revenues by $18,000 a year and cash operating

expenses by $5,000 a year. The salvage value is $10,000 at

the end of seven years. If the tax rate is 25%, determine

the cash flows from asset acquisition, asset disposition,

and operating cash flows.

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116 QUESTIONS AND PROBLEMS

3. A new piece of equipment will cost a firm $20,000 to pur-

chase and $8,000 to install and make it adaptable to the

firm’s specific needs. In addition, $2,000 investment in

spare parts inventory will be maintained to prevent down-

time. The equipment has a seven-year life and will be

depreciated using the straight-line method. It is expected

to have a salvage value of $5,000 at the end of seven years.

It will have no effect on revenues but is expected to

decrease expenses by $3,000 a year through cost efficien-

cies. Determine the cash flows from asset acquisition, asset

disposition, and operating cash flows.

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CHAPTER

117

Capital Budgeting Techniques

FILL IN THE BLANKS

Refer to Chapter 13, pages 399–444 in Financial Manage-

ment and Analysis.

1. The ______________ of capital is what the ﬁrm must

______________ for the funds needed to ______________

an investment. The ______________ of capital may be

a(n) ______________ cost, such as the ______________

paid on debt, or a(n) ______________ cost, such as the

expected ______________ appreciation of shares of the

ﬁrm’s ______________ stock, or the ______________

required by the ______________ of ______________ to

compensate them for the time ______________ of money

and the ______________ associated with the investment.

The more ______________ the future cash ﬂows, the

______________ the cost of capital.

2. The ______________ period for a project is the ______________

of time it takes to get your ______________ back. It is the

period from the ______________ cash ______________ to the

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118 QUESTIONS AND PROBLEMS

time when the project’s cash ______________ add up to the

______________ cash ______________. The ______________

period is also referred to as the ______________ period or the

capital ______________ period.

3. The ______________ period is the time needed to

______________ back the ______________ investment in

terms of ______________ future cash flows, therefore the

______________ period is ______________ for

______________ cash flows than for ______________

flows that are not ______________.

4. The ______________ value (______________) is the

present value of all ______________ cash flows. The

term ______________ is used because we want to deter-

mine the ______________ between the ______________

in the operating cash flows and the investment cash

flows. Often ______________ in operating cash flows are

______________ and the ______________ cash flows are

______________, hence the reference to the

______________ as the ______________ between the

present value of the cash ______________ and the

present value of the cash ______________.

5. The ______________ technique considers all expected

______________ cash flows, the ______________ of

money and the ______________ of the ______________

cash flows. Evaluating projects using ______________ will

lead us to select the ones that ______________ owners’

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Capital Budgeting Techniques 119

wealth. The ______________ technique also allows you to

______________ the effect of ______________ in cost of

capital on a project’s ______________.

6. A project’s ______________ profile, also referred to as the

______________ profile, shows how ______________ changes

as the ______________ rate changes. The ______________

profile is a(n) ______________ depiction of the relation

between the ______________ of a project and the

______________ rate. It shows the ______________ of a

project for a(n) ______________ of ______________ rates.

7. The ______________ (______________) is the ratio of the

present value of change in ______________ cash

______________ to the present value of ______________

cash ______________. The ______________ is often

referred to as the ______________ ratio, as it is the ratio of

the ______________ from an investment to its

______________. The ______________ tells us how much

value we get for each dollar invested.

8. An investment’s ______________ of return

(______________) is the ______________ rate that makes

the present value of all expected ______________ cash

flows equal to ______________; or, in other words, the

______________ is the ______________ rate that causes

______________ to equal ______________. The

______________ is a(n) ______________—what is earned,

on average, per year. When evaluating ______________

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