Chapter 06 - Making Capital Investment DecisionsChapter 06 Making Capital Investment Decisions Answer Key Multiple Choice Questions 1. The changes in a firm's future cash flows that are a direct consequence of accepting a project are called _____ cash flows. A. incremental B. stand-alone C. after-tax D. net present value E. erosion Difficulty level: Easy Topic: INCREMENTAL CASH FLOWS Type: DEFINITIONS 2. The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost. A. incremental B. sunk C. opportunity D. erosion E. equivalent annual Difficulty level: Easy Topic: EQUIVALENT ANNUAL COST Type: DEFINITIONS 6-1 Chapter 06 - Making Capital Investment Decisions 3. A cost that has already been paid, or the liability to pay has already been incurred, is a(n): A. salvage value expense. B. net working capital expense. C. sunk cost. D. opportunity cost. E. erosion cost. Difficulty level: Easy Topic: SUNK COSTS Type: DEFINITIONS 4. The most valuable investment given up if an alternative investment is chosen is a(n): A. salvage value expense. B. net working capital expense. C. sunk cost. D. opportunity cost. E. erosion cost. Difficulty level: Easy Topic: OPPORTUNITY COSTS Type: DEFINITIONS 5. The cash flows of a new project that come at the expense of a firm's existing projects are called: A. salvage value expenses. B. net working capital expenses. C. sunk costs. D. opportunity costs. E. erosion costs. Difficulty level: Easy Topic: EROSION COSTS Type: DEFINITIONS 6-2 Chapter 06 - Making Capital Investment Decisions 6. A pro forma financial statement is one that: A. projects future years' operations. B. is expressed as a percentage of the total assets of the firm. C. is expressed as a percentage of the total sales of the firm. D. is expressed relative to a chosen base year's financial statement. E. reflects the past and current operations of the firm. Difficulty level: Easy Topic: PRO FORMA FINANCIAL STATEMENTS Type: DEFINITIONS 7. The depreciation method currently allowed under U.S. tax law governing the accelerated write-off of property under various lifetime classifications is called _____ depreciation. A. FIFO B. MACRS C. straight-line D. sum-of-years digits E. curvilinear Difficulty level: Easy Topic: MACRS DEPRECIATION Type: DEFINITIONS 8. The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called the: A. after-tax depreciation savings. B. depreciable basis. C. depreciation tax shield. D. operating cash flow. E. after-tax salvage value. Difficulty level: Easy Topic: DEPRECIATION TAX SHIELD Type: DEFINITIONS 6-3 Chapter 06 - Making Capital Investment Decisions 9. The cash flow from projects for a company is computed as the: A. net operating cash flow generated by the project, less any sunk costs and erosion costs. B. sum of the incremental operating cash flow and after-tax salvage value of the project. C. net income generated by the project, plus the annual depreciation expense. D. sum of the incremental operating cash flow, capital spending, and net working capital expenses incurred by the project. E. sum of the sunk costs, opportunity costs, and erosion costs of the project. Difficulty level: Medium Topic: CASH FLOW Type: DEFINITIONS 10. Interest rates or rates of return on investments that have been adjusted for the effects of inflation are called _____ rates. A. real B. nominal C. effective D. stripped E. coupon Difficulty level: Medium Topic: REAL RATES Type: DEFINITIONS 11. The increase you realize in buying power as a result of owning a bond is referred to as the _____ rate of return. A. inflated B. realized C. nominal D. real E. risk-free Difficulty level: Easy Topic: REAL RATE OF RETURN Type: DEFINITIONS 6-4 D. eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. an increase in taxes IV. I and IV only D. E. III. and IV Difficulty level: Medium Topic: INCREMENTAL CASH FLOW Type: CONCEPTS 6-5 . One purpose of identifying all of the incremental cash flows related to a proposed project is to: A. I. I and III only B. isolate the total sunk costs so they can be evaluated to determine if the project will add value to the firm. C.Making Capital Investment Decisions 12. a decrease in the cost of goods sold A. will generally reflect no incremental sales. an increase in accounts receivable II. has to be prepared reflecting the total sales and expenses of a firm. will reflect a reduction in the sales of the firm. include both the proposed and the current operations of a firm in the analysis of the project. a decrease in net working capital III. E. The pro forma income statement for a cost reduction project: A. B. make each project appear as profitable as possible for the firm. III. and IV only E.Chapter 06 . Difficulty level: Medium Topic: INCREMENTAL CASH FLOW Type: CONCEPTS 14. D. C. Which of the following are examples of an incremental cash flow? I. II. III and IV only C. Difficulty level: Easy Topic: PRO FORMA INCOME STATEMENT Type: CONCEPTS 13. I. B. cannot be prepared due to the lack of any project related sales. identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis. will always reflect a negative project operating cash flow. loss of current sales due to a new project being implemented. sunk E. Difficulty level: Easy Topic: EROSION Type: CONCEPTS 6-6 . E. D. additional income generated from the sales of a newly added product. A. loss of cash due to the expenses required to fix a parking lot after a heavy rain storm. Now. will occur if a project is accepted and once incurred. opportunity B. Erosion can be explained as the: A. incremental D. the $500 you spent fixing the transmission is a(n) _____ cost. You spent $500 last week fixing the transmission in your car. the brakes are acting up and you are trying to decide whether to fix them or trade the car in for a newer model. is paid to a third party and cannot be refunded for any reason whatsoever.Making Capital Investment Decisions 15. In analyzing the brake situation. will be incurred if a project is accepted. E. will change if a project is undertaken. C. loss of revenue due to customer theft. fixed C. has previously been incurred and cannot be changed. B. C. B. Sunk costs include any cost that: A. cannot be recouped. Difficulty level: Easy Topic: SUNK COST Type: CONCEPTS 16.Chapter 06 . relevant Difficulty level: Easy Topic: SUNK COST Type: CONCEPTS 17. loss of revenue due to employee theft. D. sunk costs II. II. and IV only Difficulty level: Medium Topic: TYPES OF COSTS Type: CONCEPTS 6-7 . Which of the following should be included in the analysis of a project? I. II. II and IV only D. I. III. the loss of sales due to a new product which you recently introduced IV. and IV only E. I. I and II only B.Making Capital Investment Decisions 18. and IV Difficulty level: Medium Topic: EROSION Type: CONCEPTS 19. III. opportunity costs III. I. II and IV only E. erosion costs IV. III and IV only C. III and IV only D.Chapter 06 . the loss of sales due to increased competition in the product market II. III only B. II. the loss of sales because your chief competitor just opened a store across the street from your store III. Which of the following are examples of erosion? I. the loss of sales due to a new product recently introduced by your competitor A. incremental costs A. III and IV only C. a decrease in accounts payable of $2. C. D. I and II only B. All of the following are anticipated effects of a proposed project. I and III only C. Difficulty level: Medium Topic: NET WORKING CAPITAL Type: CONCEPTS 22. are generally excluded from project analysis due to their irrelevance to the total project. an increase in fixed assets of $7.500 III. a decrease in accounts receivable D. E. affect the initial and the final cash flows of a project but not the cash flows of the middle years. an increase in inventory C. B. a decrease in accounts payable B. II. an increase in the firm's checking account balance E.000 II.600 IV. II. III. II and IV only D.Making Capital Investment Decisions 20. Which of these should be included in the initial project cash flow related to net working capital? I. a decrease in fixed assets Difficulty level: Easy Topic: NET WORKING CAPITAL Type: CONCEPTS 6-8 . can affect the cash flows of a project every year of the project's life.Chapter 06 .100 A. I. only affect the initial cash flows of a project. and IV Difficulty level: Medium Topic: NET WORKING CAPITAL Type: CONCEPTS 21. I. Changes in the net working capital: A. are included in project analysis only if they represent cash outflows. an inventory decrease of $5. an increase in accounts receivable of $1. and IV only E. Which one of the following will decrease net working capital of a firm? A. will write off the entire cost of an asset over the asset's class life. B. A company which uses the MACRS system of depreciation: A. will expense the cost of nonresidential real estate over a period of 7 years.Making Capital Investment Decisions 23. B. D. but not always. D. E. requirements generally. is the only expenditure where at least a partial recovery can be made at the end of a project. will have equal depreciation costs each year of an asset's life. cannot expense any of the cost of a new asset during the first year of the asset's life. create a cash inflow at the beginning of a project. Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped by the end of the project. can depreciate the cost of land. expenditures commonly occur at the end of a project. Difficulty level: Easy Topic: MACRS Type: CONCEPTS 6-9 . E. if it so desires. C. is frequently affected by the additional sales generated by a new project. Difficulty level: Easy Topic: NET WORKING CAPITAL Type: CONCEPTS 24.Chapter 06 . C. 000. III and IV only C. II and IV only E. minus 20% of the asset cost. II. minus 32% of 80% of the asset cost A. II only B. I.Making Capital Investment Decisions 25. and IV Difficulty level: Easy Topic: MACRS Type: CONCEPTS 6-10 . 68% of 80% of the asset cost IV. Bet‘r Bilt Toys just purchased some MACRS 5-year property at a cost of $230. 52% of the asset cost II. I and III only D. 48% of the asset cost III.Chapter 06 . III. the asset cost. Which of the following will correctly give you the book value of this equipment at the end of year 2? I. 000 (1 . The book value of an asset is primarily used to compute the: A. Difficulty level: Easy Topic: BOOK VALUE Type: CONCEPTS 6-11 . B. Will Do.32) (1 + . E. Inc.192) B.. $650.20) (1 . $650..000 (1 . amount of cash received from the sale of an asset. $650.Chapter 06 . change in depreciation needed to reflect the market value of the asset.000 (1 + . annual depreciation tax shield. D..192) D.192) E.192 Difficulty level: Medium Topic: MACRS Type: CONCEPTS 27.000 (1 ... amount of tax due on the sale of an asset. $650.32) (1 . C. What is the proper methodology for computing the depreciation expense for year 3 if the equipment is classified as 5-year property for MACRS? A. $650.000.20) (1 + . just purchased some equipment at a cost of $650.000 ..Making Capital Investment Decisions 26.32) C.20) (1 . amount of tax saved annually due to the depreciation expense. B. book value minus the market value. the net working capital requirement increases. sales price minus the book value. market value. C. B.Making Capital Investment Decisions 28. sales price plus the tax due based on the book value minus the sales price. book value if straight-line depreciation is used. market value minus the book value. the earnings before interest and taxes decreases. C. the interest expense is lowered. C. book value if MACRS depreciation is used. E. sales price minus the tax due based on the sales price minus the book value. The salvage value of an asset creates an after-tax cash inflow to the firm in an amount equal to the: A. Difficulty level: Easy Topic: SALVAGE VALUE Type: CONCEPTS 30. E. The pre-tax salvage value of an asset is equal to the: A. the depreciation expense increases. A project's operating cash flow will increase when: A. D. D. E. sales price plus the tax due based on the sales price minus the book value.Chapter 06 . Difficulty level: Easy Topic: PROJECT OCF Type: CONCEPTS 6-12 . D. the sales projections are lowered. sales price of the asset. B. Difficulty level: Easy Topic: SALVAGE VALUE Type: CONCEPTS 29. both the depreciation expense and the interest expense are equal to zero. EBIT + Depreciation + Taxes III. Which of the following are correct methods for computing the operating cash flow of a project assuming that the interest expense is equal to zero? I.Making Capital Investment Decisions 31. II. II and III only D. I and III only B. Difficulty level: Easy Topic: PROJECT CASH FLOWS Type: CONCEPTS 32. include all incremental costs. II and IV only C. and IV only Difficulty level: Medium Topic: PROJECT OCF Type: CONCEPTS 33. D. including opportunity costs. include all sunk costs and opportunity costs. Net Income + Depreciation IV. and IV only E. III. III. E. The bottom-up approach to computing the operating cash flow applies only when: A. taxes are ignored and the interest expense is equal to zero. C. the interest expense is equal to zero. (Sales . B. B.Taxes II. EBIT + Depreciation . D. include all financing costs related to new debt acquired to finance the project. E.Costs) (Taxes + Depreciation) (1 . no fixed assets are required for the project. be computed on a pre-tax basis. The cash flows of a project should: A. be applied to the year when the related expense or income is recognized by GAAP.Taxes) A. C. I.Chapter 06 . Difficulty level: Medium Topic: BOTTOM-UP OCF Type: CONCEPTS 6-13 . the project is a cost-cutting project. equipment rental Difficulty level: Easy Topic: TAX SHIELD Type: CONCEPTS 36. employee salaries B. Tax shield refers to a reduction in taxes created by: A. applies only if a project produces sales.Chapter 06 .taxes + depreciation. E. building maintenance D. The top-down approach to computing the operating cash flow: A. a reduction in sales. office rent C. noncash expenses. C. E. B. Difficulty level: Easy Topic: TAX SHIELD Type: CONCEPTS 6-14 . a project's incremental expenses. C. D. B. can only be used if the entire cash flows of a firm are included.Making Capital Investment Decisions 34. D.costs . opportunity costs. An increase in which one of the following will increase the operating cash flow? A. an increase in interest expense. ignores all noncash items. equipment depreciation E. includes the interest expense related to a project. Difficulty level: Medium Topic: TOP-DOWN OCF Type: CONCEPTS 35. is equal to sales . and will be replaced once they are worn out. have differing operating costs. D. D. and will be replaced when worn out. have different machine lives. differing machine lives. the replacement parts approach. operating cash flows for cost-cutting projects of equal duration. the tax shield benefits of depreciation given the purchase of new assets for a project. the annual operating cost of a machine if the annual maintenance is performed versus when the maintenance is not performed as recommended. The machines sell for differing prices. These machines should be compared using: A. Toni's Tools is comparing machines to determine which one to purchase. cost-cutting D. A. revenue-cutting E. B. the depreciation tax shield approach. their equivalent annual costs. revenue-generating Difficulty level: Easy Topic: COST-CUTTING Type: CONCEPTS 38. The equivalent annual cost method is useful in determining: A. which one of two machines to acquire given equal machine lives but unequal machine costs. Difficulty level: Medium Topic: EQUIVALENT ANNUAL COST Type: CONCEPTS 6-15 . E.Making Capital Investment Decisions 37. which one of two machines to purchase when the machines are mutually exclusive. both net present value and the internal rate of return. net present value only. Difficulty level: Medium Topic: EQUIVALENT ANNUAL COST Type: CONCEPTS 39. opportunity C.Chapter 06 . C. C. B. sunk cost B. A project which is designed to improve the manufacturing efficiency of a firm but will generate no additional sales is referred to as a(n) _____ project. E. Other equipment costing $780.000.000 = $1.000 E.010.000 will also be required.000 D.000 B. At the time of the purchase.000.000 Difficulty level: Medium Topic: RELEVANT CASH FLOWS Type: PROBLEMS 41.890. $1. $1.Making Capital Investment Decisions 40. Today. What amount should be used as the initial cash flow for this building project? A.050.000 + $5.000 C.010. Marshall's & Co. The company now wants to build a new retail store on the site. This equipment could be used for producing awnings if $5.000 C.000.000 CF0 = $810.000 is spent for equipment modifications. $1. The lot was recently appraised at $810.225.000. the land is valued at $425. $2.000 B.000 + $780.000 + $15. The company currently owns some unused equipment valued at $60.060.840. Jamestown Ltd. The building cost is estimated at $1. $800. What is the amount of the initial cash flow for this expansion project? A.Chapter 06 . The company owns land beside its current manufacturing facility that could be used for the expansion. $1. $2.200.000 CF0 = $425.000 E. currently produces boat sails and is considering expanding its operations to include awnings for homes and travel trailers.2 million.000.000 + $60. $1. The company bought this land ten years ago at a cost of $250. $1.000 = $2.110. $1. The grading and excavation work necessary to build on the land will cost $15.000 to grade the lot and another $4.000 D. the company spent $50.200.000 Difficulty level: Medium Topic: RELEVANT CASH FLOWS Type: PROBLEMS 6-16 .285.000 to build a small building on the lot to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. purchased a corner lot in Eglon City five years ago at a cost of $640.000 + $1.000.285. Walks Softly estimates it can sell 5.000 Sales = (5. The company no longer uses this equipment in its current operations and has received an offer of $50.000 to update the equipment with the latest technology.000 from a firm who would like to purchase it. $245. in cash. Last year. Wilbert's is debating whether to sell the equipment or to expand its operations such that the equipment can be used.000 D.000. $313.000 D. Wilbert's.000 B.000 Difficulty level: Medium Topic: RELEVANT CASH FLOWS Type: PROBLEMS 6-17 . if any. Currently. It is considering adding a lower-priced line of shoes which sell for $49 a pair. Inc.000 pairs of the lower-priced shoes but will sell 1. $60. for a piece of equipment three years ago. $80. Inc. sells customized shoes. paid $90. When evaluating the expansion option. what value. the company spent $10.Making Capital Investment Decisions 42. it sells 10.000 C.000 Difficulty level: Easy Topic: RELEVANT CASH FLOWS Type: PROBLEMS 43. $857. $40. $90. What is the amount of the sales that should be used when evaluating the addition of the lower-priced shoes? A. $50.000 E. should Wilbert's assign to this equipment as an initial cost of the project? A.000 E.000 C.000 CF0 = $50.Chapter 06 . Walks Softly.000 B. $789.000 pairs of shoes annually at an average price of $68 a pair.000 less pairs of the higher-priced shoes by doing so.000 $49) .000 $68) = $177. $177.(1. 000 Difficulty level: Easy Topic: OPPORTUNITY COST Type: PROBLEMS 45. $89. A recent appraisal on the house valued it at $210. what value. The maintenance expenses on the house average $200 a month. The annual property taxes are $5.000 . If you sell the house you will incur $20. You own a house that you rent for $1.000 Opportunity cost = $210. $210. $515.$20.Chapter 06 .000 and a market value of $295.000. $395.000 when you purchased it several years ago. should be included in the initial cash flow of the project for this building? A. $185.000. $268. The house cost $89. $295. What value should you place on this house when analyzing the option of using it as a professional office? A. If the company decides to assign this warehouse to a new project.000 in expenses. Your firm purchased a warehouse for $335.000 C.Making Capital Investment Decisions 44.000 D.000. Four years ago.000 E.000 E. repairs were made to the building which cost $60.000 Difficulty level: Medium Topic: OPPORTUNITY COST Type: PROBLEMS 6-18 .000.000 D. $190.000. You are deciding whether to sell the house or convert it for your own use as a professional office. The warehouse has a current book value of $268.200 a month. if any.000 = $190. The warehouse is totally paid for and solely owned by your firm. The annual taxes on the property are $20.000 B. $0 B.000 Opportunity cost = $295. $120.000 C.000 six years ago. and 4. $650. should it include in the project analysis? A. Jamie expects that her Class A sales will decline to 950 units while the Class C campers decline to 2. $6. The facility itself cost $650.Chapter 06 . $590.950) $125.000 each. Class C homes are priced at $39.789.000 E.000 Class A motor homes.500 and the pop-ups sell for $5. Jamie is considering adding a mid-range camper and expects that if she does so she can sell 1.000 Difficulty level: Medium Topic: EROSION COST Type: PROBLEMS 6-19 .000] + [(2.000 for the land and facility last week. $93. The facility is located on a piece of land that originally cost $129. $118.900. $53. What is the erosion cost? A.500 C.000 D.200. Class A motor homes sell for an average of $125.000 E.Making Capital Investment Decisions 46. Big Joe's owns a manufacturing facility that is currently sitting idle. the book value of the land and the facility are $129. $0 B. if any.000 D. The sales of pop-ups will not be affected. Big Joe's received an offer of $590.000 Difficulty level: Easy Topic: OPPORTUNITY COST Type: PROBLEMS 47. $779. what cost. However.200) $39.000 and $186.150.000 .250.000 each. $18.500 of them.100. 2.000 to build.500 Erosion cost = [(1.100.000 pop-up trailers each year. respectively.000 B.000 C. Jamie's Motor Home Sales currently sells 1.000 CF0 = $590. The new mid-range camper will sell for $47.500 .2. if the new camper is added.500] = $18. $315. If Big Joe's were to consider using this land and facility in a new project. As of now.750.500.000. The firm rejected this offer even though it was told that it is a reasonable offer in today's market.500 Class C motor homes. The tax rate is 35%. What is the operating cash flow for this project? A. $33.000 = $33. The applicable tax rate is 34%.000 . OCF = $50.$30.000 and will be depreciated straight-line to a zero book value over the 10 year life of the project.300 B.000 in fixed assets and another $20. The project has a 4-year life. $18. OCF = $110.300 Difficulty level: Medium Topic: OCF Type: PROBLEMS 49.000.000.000 with associated costs of $70.000 4)] = $7.700. Kurt's Kabinets is looking at a project that will require $80. $5.000 C.70.300 E.000 in net working capital. The project is expected to produce sales of $110.000 . $13.Making Capital Investment Decisions 48.000 E. $13.000 and costs by $30.000 .000 $1.34 [$50. Ernie's Electrical is evaluating a project which will increase sales by $50.30.($150.700 = $18. $7.000 10)] = $1.000 B.000 Difficulty level: Medium Topic: OCF Type: PROBLEMS 6-20 .000 .35 [$110.$70.000. $40.Chapter 06 .300 D.000 $7.300 Tax = . $27. The project will cost $150.000 Tax = . The company uses straight-line depreciation to a zero book value over the life of the project. $3.($80.000 .000 C. What is the operating cash flow for this project? A.000 D. $8.000 . $120.340 E. $86. What is the amount of the operating cash flow? A.000 Difficulty level: Medium Topic: BOTTOM-UP OCF Type: PROBLEMS 51.000 D.400 E.000.000 . $58. $114.000 .400 C.Making Capital Investment Decisions 50.Chapter 06 .06) + $32. $34.000. The firm has no interest expense. and net working capital of $56. The firm has a tax rate of 34% and a profit margin of 6%. $52.05) + $80. depreciation of $32.000 B.900 OCF = ($760.980 D. The annual depreciation expense is $80.000.000 = $58.616 C.340 OCF = ($439.340 Difficulty level: Medium Topic: BOTTOM-UP OCF Type: PROBLEMS 6-21 . $123. Le Place has sales of $439. Peter's Boats has sales of $760. $49.000 = $118. $54.000 and a profit margin of 5%. What is the amount of the operating cash flow if the company has no long-term debt? A.000. $118.384 B. ($24.200 OCF = $6.$1. $8.$2. $4.000 B.Chapter 06 .$10. $200 B. $4.500 C.500. $4.000 to $24. taxes will increase by $1.000. $6. taxes will increase from $23. An initial cash outlay of $2. What is the amount of the operating cash flow using the top-down approach? A. Ben's Border Café is considering a project which will produce sales of $16. If the project is implemented.000 . $2.500 . If the project is implemented.200 D. $7.500 .000 and increase cash expenses by $10.500.500 OCF = $16. Ronnie's Coffee House is considering a project which will produce sales of $6.500 and depreciation will increase from $4.300.000 .200 Difficulty level: Medium Topic: TOP-DOWN OCF Type: PROBLEMS 6-22 . $1.500 Difficulty level: Medium Topic: TOP-DOWN OCF Type: PROBLEMS 53.000 D.500 C.$23.000.000 to $5.000 and increase cash expenses by $2. $3.000) = $4.500 E.000 .000 is required for net working capital.300 = $2. The additional depreciation expense will be $1.500 E.Making Capital Investment Decisions 52. What is the amount of the operating cash flow using the topdown approach? A. $9. The project will cost $40. A project will increase sales by $140.000 4) .650 C. $37.000 and be depreciated using the straight-line method to a zero book value over the 4-year life of the project.850 B. The project will cost $100.000) (1 -. The company has a marginal tax rate of 34%.000 E.000 and cash expenses by $51. $5.000 and will be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. A project will increase sales by $60.000 4) .35] = $9.000 .000 and cash expenses by $95.500 D.$51. $8.750 Depreciation tax shield = ($100.000. What is the operating cash flow of the project using the tax shield approach? A. $10. $17. What is the value of the depreciation tax shield? A.000 C.350 Difficulty level: Medium Topic: TAX SHIELD OCF Type: PROBLEMS 55. $9.Chapter 06 .500 B.350 OCF = [($60. $22.500 Difficulty level: Medium Topic: DEPRECIATION TAX SHIELD Type: PROBLEMS 6-23 . The company has a marginal tax rate of 35%.34 = $8. $25.Making Capital Investment Decisions 54. $8.700 E.000.350 D.35)] + [($40. Sun Lee's Furniture just purchased some fixed assets classified as 5-year property for MACRS.608 E. $4.1920 = $4. $2.800 Depreciation for year 3 = $24.Making Capital Investment Decisions 56.765 D. The assets cost $24.000. $2. $4.000 .507 C.Chapter 06 . What is the amount of the depreciation expense for the third year? A.608 Difficulty level: Easy Topic: MACRS DEPRECIATION Type: PROBLEMS 6-24 .304 B. $2. 040. $19. $20.Making Capital Investment Decisions 57.468.20 C. $48.280.80 B.468.192)] = $19.00 D. $48.80 Difficulty level: Medium Topic: MACRS DEPRECIATION Type: PROBLEMS 6-25 .Chapter 06 . $27.00 Book value at the end of year 3 = $67.[$67. The equipment cost $67.20 E.20 + .672.32 + . What will the book value of this equipment be at the end of three years should you decide to resell the equipment at that point in time? A.600 . You just purchased some equipment that is classified as 5-year property for MACRS.600.600 (.131. $633.36 Difficulty level: Medium Topic: MACRS DEPRECIATION Type: PROBLEMS 6-26 .63 Depreciation for year 2 = $1.67 D.477.93 B.900.900 .Making Capital Investment Decisions 58.Chapter 06 .36 E. The assets cost $1. What is the amount of the depreciation expense for year 2? A. LiCheng's Enterprises just purchased some fixed assets that are classified as 3-year property for MACRS. $562. $1.4444 = $844. $719. $844.27 C. $4. The assets are classified as 5-year property for MACRS. $1.Making Capital Investment Decisions 59.20 + .48 B.800 .800.32 + .500.800 (. RP&A. What is the current book value of these assets? A.1152)] = $3.702.44 C.500.Chapter 06 .421.44 Difficulty level: Medium Topic: MACRS DEPRECIATION Type: PROBLEMS 6-27 .00 D.140. It no longer needs these assets so is going to sell them today at a price of $3. purchased some fixed assets four years ago at a cost of $19. $3.40 Book value at the end of year 3 = $19. $5.67 E.[$19. Inc.421.192 + .016. $3. Which one of the following statements is correct if your tax rate is 34%? A. You own some equipment which you purchased three years ago at a cost of $135.Chapter 06 . The book value today is $8.320. The taxable amount on the sale is $38. The equipment is 5-year property for MACRS...000 (1 .830.880. The tax due on the sale is $14.20 as a result of this sale..Making Capital Investment Decisions 60.500 . Tax = $82.000.500. The book value today is $64.2 .32 . E. You are considering selling the equipment today for $82.80. B.34 = $14.219. D. You will receive a tax refund of $13.[$135.192)] . C.830.80 Difficulty level: Medium Topic: SALVAGE VALUE Type: PROBLEMS 6-28 .478. $18. What is the net cash flow from the salvage value if the tax rate is 34%? A..358..000 .000 .000.80 E.000.20 = $18.000 (1 .904. Ronnie has been offered $19.88 B.00 D.720.32) = $18. Ronnie's Custom Cars purchased some fixed assets two years ago for $39.909.80 Difficulty level: Medium Topic: SALVAGE VALUE Type: PROBLEMS 6-29 . $17. The assets are classified as 5-year property for MACRS.720) .720 Tax on sale = ($19.00 Book value at the end of year 2 = $39.09 C. Ronnie is considering selling these assets now so he can buy some newer fixed assets which utilize the latest in technology.904.2 .Chapter 06 .Making Capital Investment Decisions 61. $16. $18. $19.34 = $95.000 for his old assets.20 After-tax cash flow = $19.$95.$18. 000 piece of equipment. is considering the purchase of a $225. $38. $37. Inc.880) ..108 D. What is the after-tax cash flow from this sale if the tax rate is 35%? A. $46.000 .892 After-tax cash flow = $50.892 = $46. Winslow. $53. The equipment is classified as 5-year MACRS property.000.35 = $3.036 B.000 . $47.$3.1152) = $38.880 Tax on sale = ($50.2 ..32 .880 C. The company expects to sell the equipment after four years at a price of $50.000 (1 .Making Capital Investment Decisions 62..108 Difficulty level: Medium Topic: SALVAGE VALUE Type: PROBLEMS 6-30 .Chapter 06 .892 Book value at the end of year 4 = $225.$38.770 E.192 .. 000. These assets will be worthless at the end of the project.000 of net working capital will be required throughout the life of the project. An additional $3.Chapter 06 .306. The initial cost of the fixed assets is $50. What is the project's net present value if the required rate of return is 10%? A. $5.17 C. $2.11 B.954.11 E.208.09 D.208. $2.500 a year for three years. $5.Making Capital Investment Decisions 63.17 Difficulty level: Medium Topic: PROJECT NPV Type: PROBLEMS 6-31 . $4. A project is expected to create operating cash flows of $22.954. 876. Accounts payable will decrease by $10.05 C.86 E. The equipment will be depreciated straight-line to a zero book value over the life of the project. At the end of the project.000 + $15. $32. $49.$15.000 a year for four years.000. net working capital will return to its normal level.$10.483.66 D.037.000 .000 + $25. $27.$120. During the life of the project.958. A project will produce operating cash flows of $45.000 + $10.000 .000 and accounts receivable will increase by $15.000 = $65.000. The equipment will be salvaged at the end of the project creating a $25.000 = -$115.48 B. $16.000 -$30.000 Difficulty level: Challenge Topic: PROJECT NPV Type: PROBLEMS 6-32 .Making Capital Investment Decisions 64.000 after-tax cash flow. The project requires the purchase of equipment at an initial cost of $120.000 . inventory will be lowered by $30.Chapter 06 .000 C04 = $45.000.02 CF0 = $30. What is the net present value of this project given a required return of 14%? A. $3.117. $13. $1.41 E. What is the net present value of the project if the required rate of return is 11%? A.896.400 Difficulty level: Medium Topic: COST-CUTTING Type: PROBLEMS 6-33 . $8. $9.353.72 D. The system will cost $48. A project will produce an operating cash flow of $7. This system is expected to have a 5-year life and will be depreciated to zero using straight-line depreciation. The initial cash investment in the project will be $11.($48. Matty's Place is considering the installation of a new computer system that will cut annual operating costs by $11. $20.398. $1. $11.300 a year for three years.000 5) = $1. $20.000 E.600 Earnings before interest and taxes = $11. The net after-tax salvage value is estimated at $3.500 and will be received during the last year of the project's life.000 .798.600 B.000.072.29 B.000 C. -$9.600.Making Capital Investment Decisions 65. What is the amount of the earnings before interest and taxes for this project? A.400 D.87 C.29 Difficulty level: Medium Topic: PROJECT NPV Type: PROBLEMS 66. $10.Chapter 06 .000 to purchase and install. The equipment will be depreciated using straight-line depreciation to a book value of zero. $26. The life of the equipment is 8 years.000 8 = $175. The Wolf's Den Outdoor Gear is considering replacing the equipment it uses to produce tents.400 Difficulty level: Medium Topic: COST-CUTTING Type: PROBLEMS 6-34 .400. $53.. The equipment would cost $1.Chapter 06 .600 B. What is the net income from this proposed project? A.000) (1 .400 C.000 a year.000 E.$175.400 D.000 Net income = ($215.4 million and lower manufacturing costs by an estimated $215. $40. $13.600 Annual depreciation = $1.000 . $32. The required rate of return is 13% and the tax rate is 34%.34) = $26.Making Capital Investment Decisions 67. 000.000 + (-$23. Yes. Thornley Machines is considering a 3-year project with an initial cost of $618.Making Capital Investment Decisions 68.00.593.34 = $20. Yes.34)] + $23. D. The NPV is -$2. At the end of the project the equipment will be sold for an estimated $60.000 (1 .000 3 = $206.78. The equipment is depreciated straight-line to a zero book value over the life of the project.940 + [$60. The tax rate is 34%.00.000) = -$641. The project will require $23. The NPV is $32.106.Chapter 06 .000 = $307.$20. The NPV is $27. E.000 .000 a year.40.884. Should this project be implemented if Thornley's requires a 9% rate of return? Why or why not? A..354.060 OCF = $265.000 Annual depreciation = $618.940 C03 = $244. No.54. B.540 Difficulty level: Challenge Topic: COST-CUTTING Type: PROBLEMS 6-35 .000 Taxes = ($265. CF0 = -$618.000. Yes. The NPV is $43.000) .000 in extra inventory for spare parts and accessories.000 . The NPV is $196. The project will not directly produce any sales but will reduce operating costs by $265.646.$206. Yes. C.060 = $244. 002 C.006 E. $325. $101.000. $79. One machine costs $136. This machine costs $10.000 and lasts about 4 years before it needs replaced. uses tool and die machines to produce equipment for other firms.776 C.) A.556 B.Chapter 06 .000 a year to operate. $340. $351. Inc. Jackson & Sons uses packing machines to prepare its products for shipping. Tool Makers. $38. Each machine has a life of 3 years before it is replaced. $345.Making Capital Investment Decisions 69. $154. The initial cost of one customized tool and die machine is $850.797 D.012 D. The operating cost per machine is $6.000 a year. $347. What is the equivalent annual cost of this machine if the required return is 9%? (Round your answer to whole dollars.619 Difficulty level: Challenge Topic: EQUIVALENT ANNUAL COST Type: PROBLEMS 70. $50.797 B. What is the equivalent annual cost of one packing machine if the required rate of return is 12%? (Round your answer to whole dollars.) A.224 Difficulty level: Challenge Topic: EQUIVALENT ANNUAL COST Type: PROBLEMS 6-36 .648 E. 912 a year C. and a 3-year life. because its equivalent annual cost is $199. Machine A has a cost of $290. because it will save the company about $8. Inc. because it will save the company about $200. annual operating costs of $8. and has a 2-year life. because it will save the company about $132. Machine B. Machine B costs $180.000. Whichever machine is purchased will be replaced at the end of its useful life. Bruno's.759 Machine B lowers the annual cost of the equipment by about $11.912 $121. Machine A. has annual operating costs of $12.600 a year B. Machine A.600 a year E. is analyzing two machines to determine which one it should purchase.000. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.000 a year D.) A. Machine B.000.Chapter 06 . The company requires a 14% rate of return and uses straight-line depreciation to a zero book value.600. because it will save the company about $11.312). Machine B. Difficulty level: Challenge Topic: EQUIVALENT ANNUAL COST Type: PROBLEMS 6-37 . = ($132.Making Capital Investment Decisions 71.000. $7.000 and will also increase accounts payable by $45.000 the first year and $145. Kay's Nautique is considering a project which will require additional inventory of $128.10) = $91. What is the initial project cash flow needed for net working capital? A. $181.Making Capital Investment Decisions 72.000 . Lottie's Boutique needs to maintain 20% of its sales in net working capital.000 C.Chapter 06 . $136. $91. $35.$110.000 B.000 E. -$7.000) .20 = $7.000 C.000 E. -$35.000 a year for the following two years. $0 D.000 Difficulty level: Medium Topic: NET WORKING CAPITAL Type: PROBLEMS 6-38 . $99. What amount should be included in the project analysis for the last year of the project in regards to the net working capital? A. Accounts receivable are currently $80.000 to $130.000 as suppliers are willing to finance part of these purchases.000 .000 NWC requirement = $128.000 D.000 NWC recovery = ($145.000 and are expected to increase by 10% if this project is accepted.000 Difficulty level: Medium Topic: NET WORKING CAPITAL Type: PROBLEMS 73.000 .000 + ($80. $75. Lottie's is considering a 3-year project which will increase sales from their current level of $110.000 B.$45. 000. As part of the expansion plan.000 B.000 . For the project analysis. The company will also spend $200. The project will require $325.000 and long-term debt is expected to increase by $300. $100. the company will be offering credit to its customers and thus expects accounts receivable to rise by $25.000 for new fixed assets. the fixed assets can be sold for 25% of their original cost.(. Jeff's Stereo Sound is expanding its product offerings to reach a wider range of customers.000 Difficulty level: Medium Topic: NET WORKING CAPITAL Type: PROBLEMS Margarite's Enterprises is considering a new project.000.000 D.000.000) + $25.000 for a building contractor to expand the size of the showroom. The fixed assets will be depreciated straight-line to a zero book value over the life of the project.000 and costs of $430.000 Initial NWC requirement = $150. $150. The project is expected to generate annual sales of $554. At the end of the project. $160.000 E.000 = $100.000 C.50 $150. Short-term debt is expected to increase by $100.Chapter 06 . The net working capital returns to its original level at the end of the project.000 and increasing its debt to suppliers by 50% of that amount.000 for additional inventory and $35. $175.Making Capital Investment Decisions 74. what amount should be used as the initial cash flow for net working capital? A. The tax rate is 35% and the required rate of return is 15%. $125. 6-39 . The expansion project includes increasing the floor inventory by $150. The project has a 5-year life.000 for additional accounts receivable. $75. $59. $37.000 Difficulty level: Medium Topic: EBIT Type: PROBLEMS 77.000 D.009 E.Making Capital Investment Decisions 75. What is the initial cost of this project? A.000 + $160.438 B. What is the amount of the earnings before interest and taxes for the first year of this project? A.000 D. $420. $520.) A.000 C. $38.000 = $420. $67.812.Chapter 06 .000 + $35.000 . $60.000 (1 . $620. $76.$100.500 B.25 $325. What is the amount of the after-tax cash flow from the sale of the fixed assets at the end of this project? (Round your answer to whole dollars. $425. $159.000 5) = $59.000 Initial cash outflow = $325.500 E.35) = $52.000 B.000 Difficulty level: Medium Topic: RELEVANT COSTS Type: PROBLEMS 76.813 (rounded) Difficulty level: Medium Topic: AFTER-TAX SALVAGE VALUE Type: PROBLEMS 6-40 .000 E.918 C.813 D.000 C. $52. $28. $81.($325.250 After-tax salvage value = ..000 .000 EBIT = $554.000 . $325.50 = $52.$430. What is the value of the depreciation tax shield in year 2 of the project? A. Annual sales from this project are estimated at $1.2 million. 79. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. The tax rate is 34%. Net working capital equal to 20% of sales will be required to support the project. None of the above Depreciation tax shield = $1. The firm desires a minimal 14% rate of return on this project.000 Difficulty level: Medium Topic: DEPRECIATION TAX SHIELD Type: PROBLEMS 6-41 . $247.000 Difficulty level: Medium Topic: RECOVERY OF NET WORKING CAPITAL Type: PROBLEMS Louie's Leisure Products is considering a project which will require the purchase of $1.$100. $95. $340.000 D.000 .000 Net working capital recovery = $160. $295. $134.4 million in new equipment.000 E. $147.34 = $68. All of the net working capital will be recouped at the end of the project. $220.000 + $35.000 D.000 = $95. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project.Chapter 06 .000 B.812 C.000 C.Making Capital Investment Decisions 78.812 E.000 7 . What is the cash flow recovery from net working capital at the end of this project? A.400. $400.000 B. $195. $95. $144.000 = $240.34) = $184. $424.. Schroeder's expects to sell the equipment at the end of the project for 10% of its original cost. The tax rate is 40%.200.20 $1. All of the net working capital will be recouped at the end of the project.200 B.Making Capital Investment Decisions 80.000 E. $184.600 C. Net working capital equal to 10% of sales will be required to support the project.Chapter 06 .600 B. $240.000 C. The equipment will be depreciated straight-line to a zero book value over the 5-year life of the project.000 . $47. $81.800 NWC recapture = .800 After-tax salvage value = $1. Schroeder desires a 12% rate of return on this project. What is the recovery amount attributable to net working capital at the end of the project? A. $55.20 (1 . $159.000 Difficulty level: Medium Topic: CHANGE IN NET WORKING CAPITAL Type: PROBLEMS Schroeder Electronics is considering a project which will require the purchase of $5 million in new equipment.000 E. 6-42 . Annual sales from this project are estimated at $2.800 Difficulty level: Medium Topic: AFTER-TAX SALVAGE VALUE Type: PROBLEMS 81. $72.600 D.400.200 D. What is the amount of the after-tax salvage value of the equipment? A.3 million. 000 B. $130.000 Difficulty level: Medium Topic: CHANGE IN NET WORKING CAPITAL Type: PROBLEMS 6-43 .000 C. $230. $300.000 Difficulty level: Medium Topic: AFTER-TAX SALVAGE VALUE Type: PROBLEMS 84.40 = $400.000 E. $250. $154..000 E.000.000 D.40) = $300.000 = $230.000.300.000 C.000 B.000 Difficulty level: Medium Topic: DEPRECIATION TAX SHIELD Type: PROBLEMS 83. $240.000 5 .Making Capital Investment Decisions 82. $334. $1.Chapter 06 . $200.000 Depreciation tax shield = $5.000 After-tax salvage value = $5.000 D.600 C. What is the value of the depreciation tax shield in year 2 of the project? A. $134.000 B.000 . What is the recovery amount attributable to net working capital at the end of the project? A.000.10 $2. $400.400 D.000 NWC recapture = . $150. What is the amount of the after-tax salvage value of the equipment? A.000 E.10 (1 . $195. $134. $240. and tax-shield approaches. Topic: EQUIVALENT ANNUAL COST Type: ESSAYS 87. The top-down approach defines OCF as sales minus costs minus taxes. Topic: OPERATING CASH FLOW Type: ESSAYS 86. This chapter introduced three new methods for calculating project operating cash flow (OCF). Should financing costs be included as an incremental cash flow in capital budgeting analysis? Financing costs are not an incremental cash flow for capital budgeting purposes. Under what circumstances is each method appropriate? Three additional formulations of OCF provided in this chapter are the bottom-up. not whether the project is economically viable. Financing costs are a direct consequence of how the project is financed. When is it appropriate to use the equivalent annual cost (EAC) methodology. the tax-shield approach separately illustrates the project benefits associated with after-tax gross profit (revenue gains and/or cost reductions) and with the depreciation tax shield. the least negative EAC value. The manager should choose the project whose EAC is lowest. top-down. The first is useful when the analyst has prepared pro forma income statements for a project (since OCF is equal to net income plus depreciation). and is useful if one has reliable estimates of the relevant dollar costs (perhaps in a situation where fixed and variable costs are the focus of the analysis). that is. Financing costs are embedded in the required rate of return used to discount project cash flows.Making Capital Investment Decisions Essay Questions 85. and how do you make a decision using it? The EAC should be used to evaluate two or more mutually exclusive projects with different lives that will be replicated essentially forever. Finally. Topic: FINANCING COSTS Type: ESSAYS 6-44 .Chapter 06 . Explain the use of real and nominal discount rates in discounting cash flows. Which is used more often and why? The most important thing to remember is that real cash flows should be discounted at the real interest rate and nominal cash flows should be discounted at the nominal discount rate. thus providing an impetus for capital expenditure and continued growth. since nominal cash flows do include inflation. Topic: MACRS DEPRECIATION Type: ESSAYS 89. if an assets were placed in service in the first or the last month or the fiscal year. Since most cash flows are nominal. discounting real cash flows at the nominal rate will artificially reduce the NPV and lead the analyst to reject projects that otherwise should be accepted. This method provides a tax incentive for capital investment in years when the firm is in higher tax brackets. the asset is written off at the mid-year point. Explain the half year convention used in MACRS depreciation. nominal rates are used more often in practice.Chapter 06 . Since real cash flows do not include inflation. MACRS depreciation assumes all assets were placed in service at mid-year which allows for one full year of straight line depreciation without regard to salvage value in the first year of use. or any place in between. Topic: REAL AND NOMINAL DISCOUNT RATES Type: ESSAYS 6-45 . Thus. Likewise.Making Capital Investment Decisions 88. they must be discounted at the nominal discount rate which includes inflation. Discounting nominal cash flows at the real discount rate will result in an artificially high NPV and thus lead to accepting projects that should otherwise not be accepted.