Principles of Managerial Finance, 12e (Gitman) Chapter 8 Capital Budgeting Cash Flows Learning Goal 1: Understand the key motives for capital expenditure and the steps in the capital budgeting process. 1) Capital budgeting techniques are used to evaluate the firm's fixed asset investments which provide the basis for the firm's earning power and value. Answer: TRUE Topic: Concept of Capital Budgeting Question Status: Previous Edition 2) The purchase of additional physical facilities, such as additional property or a new factory, is an example of a capital expenditure. Answer: TRUE Topic: Capital Budgeting Terminology Question Status: Previous Edition 3) Capital budgeting is the process of evaluating and selecting short-term investments consistent with the 1 firm's goal of owner wealth maximization. Answer: FALSE Topic: Concept of Capital Budgeting Question Status: Previous Edition 4) A $60,000 outlay for a new machine with a usable life of 15 years is an operating expenditure that would appear as a current asset on the firm's balance sheet. Answer: FALSE Topic: Capital Budgeting Terminology Question Status: Previous Edition 5) A capital expenditure is an outlay of funds invested only in fixed assets that is expected to produce benefits over a period of time less than one year. Answer: FALSE Topic: Capital Budgeting Terminology Question Status: Previous Edition 6) An outlay for advertising and management consulting is considered to be a fixed asset expenditure. 2 FALSE Topic: Capital Budgeting Terminology Question Status: Previous Edition 7) Capital expenditure proposals are reviewed to assess their appropriateness in light of the firm's overall objectives and plans, and to evaluate their economic validity. Answer: TRUE Topic: Concept of Capital Budgeting Question Status: Previous Edition 3 Answer: TRUE Topic: Motives for Capital Budgeting Question Status: Previous Edition 11) The capital budgeting process consists of five distinct but interrelated steps: proposal generation. or renew fixed assets or to obtain some other. review 4 . Answer: TRUE Topic: Motives for Capital Budgeting Question Status: Previous Edition 9) The primary motive for capital expenditures is to refurbish fixed assets. replace.8) The basic motives for capital expenditures are to expand. less tangible benefit over a long period. Answer: FALSE Topic: Motives for Capital Budgeting Question Status: Previous Edition 10) Research and development is considered to be a motive for making capital expenditures. implementation. Answer: FALSE Topic: Steps in Capital Budgeting Process Question Status: Previous Edition 13) ________ is the process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization. Answer: TRUE Topic: Steps in Capital Budgeting Process Question Status: Previous Edition 12) The capital budgeting process consists of four distinct but interrelated steps: proposal generation.and analysis. decision making. A) Recapitalizing assets B) Capital budgeting C) Ratio analysis D) Restructuring debt 5 . review and analysis. decision making. and termination. and follow-up. B Topic: Concept of Capital Budgeting Question Status: Previous Edition 14) Fixed assets that provide the basis for the firm's profit and value are often called A) tangible assets. B) non-current assets. D) book assets. C) earning assets. Answer: C Topic: Capital Budgeting Terminology Question Status: Previous Edition 6 . B) follow-up. B) replacement. 7 . D) education. Answer: A Topic: Motives for Capital Budgeting Expenditures Question Status: Previous Edition 16) The final step in the capital budgeting process is A) implementation.15) The most common motive for adding fixed assets to the firm is A) expansion. C) renewal. C) re-evaluation. D) transformation. D) proposal generation. C) decision-making. B) implementation.000 outlay for a new machine with a usable life of 15 years is called A) capital expenditure.B Topic: Steps in Capital Budgeting Process Question Status: Previous Edition 17) The first step in the capital budgeting process is A) review and analysis. B) 8 . Answer: D Topic: Steps in Capital Budgeting Process Question Status: Previous Edition 18) A $60. D) commonly used to expand the level of operations. B) expected to produce benefits over a period of time greater than one year. D) none of the above. Answer: C Topic: Concept of Capital Budgeting Question Status: 9 . C) an outlay for current asset expansion. Answer: A Topic: Capital Budgeting Terminology Question Status: Previous Edition 19) A capital expenditure is all of the following EXCEPT A) an outlay made for the earning assets of the firm.operating expenditure. C) replacement expenditure. Previous Edition 10 . invention. B) replacement. B) follow-up. C) renewal. 11 . D) Answer: D Topic: Motives for Capital Budgeting Expenditures Question Status: Previous Edition 21) All of the following are steps in the capital budgeting process EXCEPT A) implementation. D) decision-making.20) All of the following are motives for capital budgeting expenditures EXCEPT A) expansion. C) transformation. C Topic: Steps in Capital Budgeting Process Question Status: Previous Edition Learning Goal 2: Define basic capital budgeting terminology. 1) A firm with limited funds for investment in capital assets must ration those funds by allocating them to projects that will maximize share value. Answer: FALSE Topic: Independent Projects Question Status: Previous Edition 3) A non-conventional cash flow pattern associated with capital investment projects consists of an initial 12 . so that the acceptance of one eliminates the others from further consideration. Answer: TRUE Topic: Capital Rationing Question Status: Previous Edition 2) Independent projects are projects that compete with one another for the firm's resources. (1) installing air conditioning in the plant (2) acquiring a small supplier (3) purchasing a new computer system Answer: FALSE Topic: Mutually Exclusive Projects Question Status: Previous Edition 13 . all independent projects that meet its minimum investment criteria should be implemented. Answer: TRUE Topic: Concept of Capital Budgeting Question Status: Previous Edition 5) The following three projects would seem to compete with one another form the firm's resources and therefore would be examples of mutually exclusive projects. Answer: FALSE Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 4) If a firm has unlimited funds to invest in capital assets.outflow followed by a series of inflows. Answer: FALSE Topic: Independent Projects Question Status: Previous Edition 14 . or 3) to contract with another company for production. Answer: FALSE Topic: Mutually Exclusive Projects Question Status: Previous Edition 8) To increase its production capacity. a firm is considering: 1) to expand its plant. Answer: FALSE Topic: Mutually Exclusive Projects Question Status: Previous Edition 7) Mutually exclusive projects are projects whose cash flows are unrelated to one another.6) If a firm has unlimited funds to invest. all the mutually exclusive projects that meet its minimum investment criteria can be implemented. These three projects would appear to be good examples of independent projects. 2) to acquire another company. the acceptance of one does not eliminate the others from further consideration. Answer: TRUE Topic: Independent versus Mutually Exclusive Projects Question Status: Previous Edition 10) Mutually exclusive projects are those whose cash flows are unrelated to one another. Answer: FALSE Topic: Independent versus Mutually Exclusive Projects Question Status: Previous Edition 15 . the acceptance of one does not eliminate any others from further consideration. the acceptance of one does not eliminate any others from further consideration. the acceptance of one does not eliminate any others from further consideration.9) Independent projects are those whose cash flows are unrelated to one another. Answer: FALSE Topic: Independent versus Mutually Exclusive Projects Question Status: Previous Edition 11) Mutually exclusive projects are those whose cash flows compete with one another. the acceptance of one eliminates others from further consideration. it is able to accept all independent projects that provide an acceptable return. Answer: FALSE Topic: Capital Rationing Question Status: Previous Edition 16 .12) Mutually exclusive projects are those whose cash flows compete with one another. Answer: TRUE Topic: Independent versus Mutually Exclusive Projects Question Status: Previous Edition 13) If a firm is subject to capital rationing. 14) If a firm has unlimited funds. and numerous projects compete for these dollars. Answer: TRUE Topic: Capital Rationing Question Status: Previous Edition 16) The ranking approach involves the ranking of capital expenditure projects on the basis of some predetermined measure such as the rate of return. it is able to accept all independent projects that provide an acceptable return. Answer: TRUE Topic: Accept-Reject versus Ranking Approaches Question Status: Previous Edition 17 . Answer: TRUE Topic: Capital Rationing Question Status: Previous Edition 15) If a firm is subject to capital rationing. it has only a fixed number of dollars available for capital expenditures. Answer: FALSE Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 20) 18 . Answer: FALSE Topic: Accept-Reject versus Ranking Approaches Question Status: Previous Edition 18) A conventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows. Answer: TRUE Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 19) A nonconventional cash flow pattern is one in which an initial outflow is followed only by a series of inflows.17) The accept-reject approach involves the ranking of capital expenditure projects on the basis of some predetermined measure such as the rate of return. A nonconventional cash flow pattern is one in which an initial outflow is followed by a series of both inflows and outflows. Answer: TRUE Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 21) Relevant cash flows are the incremental cash outflows and inflows associated with a proposed capital expenditure. Answer: TRUE Topic: Relevant Cash Flows Question Status: Previous Edition 19 . 22) The three major cash flow components include the initial investment. Answer: TRUE Topic: Major Cash Flow Components Question Status: Previous Edition 23) The three major cash flow components include the initial investment. D) 20 . operating cash inflows. and terminal cash flows. C) Nonconventional flow. non-operating cash inflows. Answer: FALSE Topic: Major Cash Flow Components Question Status: Previous Edition 24) Which pattern of cash flow stream is the most difficult to use when evaluating projects? A) Mixed stream. and terminal cash flows. B) Conventional flow. B) a mixed stream and non-conventional cash flow. C) an annuity and non-conventional cash flow.) A) an annuity and conventional cash flow. D) a mixed stream and conventional cash flow.1 25) The cash flow pattern depicted is associated with a capital investment and may be characterized as (See Table 8.1. Answer: C Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition Table 8. Answer: A Topic: Conventional versus Nonconventional Cash Flows 21 .Annuity. Question Status: Previous Edition 22 . B) a mixed stream and non-conventional cash flow. C) an annuity and non-conventional cash flow. D) a mixed stream and conventional cash flow.) A) an annuity and conventional cash flow.Table 8. A) Capital. Answer: D Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 27) ________ projects do not compete with each other.2 26) The cash flow pattern depicted is associated with a capital investment and may be characterized as (See Table 8.2. the acceptance of one ________ the others from consideration. eliminates B) 23 . Independent. does not eliminate Answer: C Topic: Mutually Exclusive Projects Question Status: 24 . A) Capital. the acceptance of one ________ the others from consideration. eliminates D) Replacement. does not eliminate C) Mutually exclusive. does not eliminate C) Mutually exclusive. eliminates B) Independent. does not eliminate Answer: B Topic: Independent Projects Question Status: Previous Edition 28) ________ projects have the same function. eliminates D) Replacement. Previous Edition 29) A firm with limited dollars available for capital expenditures is subject to A) capital dependency. Answer: D Topic: Capital Rationing Question Status: Previous Edition 25 . B) mutually exclusive projects. C) working capital constraints. D) capital rationing. D) inflow followed by a series of outflows. B) inflow followed by a series of both cash inflows and outflows. C) outflow followed by a series of inflows. 26 . B) inflow followed by a broken series.30) A conventional cash flow pattern associated with capital investment projects consists of an initial A) outflow followed by a broken cash series. D) inflow followed by a series of outflows. C) outflow followed by a series of inflows. Answer: C Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 31) A non-conventional cash flow pattern associated with capital investment projects consists of an initial A) outflow followed by a series of both cash inflows and outflows. A) A mixed stream B) A conventional C) A non-conventional D) An annuity Answer: D Topic: Annuity Cash Flows Question Status: Previous Edition 33) The cash flows of any project having a conventional pattern include all of the basic components EXCEPT A) initial investment. B) 27 .A Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 32) ________ is a series of equal annual cash flows. B) mutually exclusive projects. C) replacement projects. Answer: B Topic: Mutually Exclusive Projects Question Status: 28 . so that the acceptance of one eliminates the others from further consideration are called A) independent projects. D) none of the above. D) terminal cash flow. C) operating cash inflows.operating cash outflows. Answer: B Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 34) Projects that compete with one another. Previous Edition 29 . B) 4.35) A firm with unlimited funds must evaluate five projects. 2 or 5. Answer: B Topic: Independent versus Mutually Exclusive Projects Question Status: Previous Edition 36) The evaluation of capital expenditure proposals to determine whether they meet the firm's minimum acceptance criteria is called A) the ranking approach. and 3. 30 . 5. 4. and 3. 2 or 5. 1. D) 4. The projects are listed with their returns. and 2. A ranking of the projects on the basis of their returns from the best to the worst according to their acceptability to the firm would be A) 4. and 5 are mutually exclusive. 1. Projects 1 and 2 are independent and Projects 3. C) 3. and 4. 1. 1. B) an independent investment. C) the accept-reject approach. D) a mutually exclusive investment. C) the accept-reject approach. Answer: C Topic: Accept-Reject versus Ranking Approaches Question Status: Previous Edition 37) The ordering of capital expenditure projects on the basis of some predetermined measure such as the rate of return is called A) the ranking approach. B) an independent investment. Answer: A Topic: 31 . D) a mutually exclusive investment. Accept-Reject versus Ranking Approaches Question Status: Previous Edition Learning Goal 3: Discuss relevant cash flows. Answer: TRUE Topic: Relevant Cash Flows Question Status: Previous Edition 32 . expansion versus replacement decisions. 1) Accounting figures and cash flows are not necessarily the same due to the presence of certain non-cash expenditures on the firm's income statement. sunk costs and opportunity costs. and international capital budgeting. 2) The relevant cash flows for a proposed capital expenditure are the incremental after-tax cash outflows and resulting subsequent inflows. Answer: TRUE Topic: International Capital Budgeting Question Status: Previous Edition 4) If a new asset is being considered as a replacement for an old asset. the relevant cash flows would be found by adding together the expected cash flows still remaining on the old asset to the expected cash flows for new asset. managerial. Answer: FALSE Topic: Replacement Project Analysis Question Status: Previous Edition 33 . and technical assets to a foreign country. Answer: TRUE Topic: Relevant Cash Flows Question Status: Previous Edition 3) Foreign direct investment is the transfer of capital. a U.5) International capital budgeting differs from domestic capital budgeting because (1) cash inflows and outflows occur in a foreign currency. Answer: TRUE Topic: Sunk Costs Question Status: Previous Edition 34 . and (2) foreign investments potentially face significant political risk. Answer: TRUE Topic: International Capital Budgeting Question Status: Previous Edition 7) Sunk costs are cash outlays that have already been made and therefore have no effect on the cash flows relevant to the current decision. As a result. Answer: TRUE Topic: International Capital Budgeting Question Status: Previous Edition 6) In case of international capital budgeting. sunk costs should not be included as relevant in computing a project's incremental cash flows.S. company can minimize its political risk by creating a joint venture with a competent and well-connected local partner. Answer: FALSE Topic: International Capital Budgeting Question Status: Previous Edition 10) A sunk cost is a cash flow that could be realized from the best alternative use of an owned asset. long-term currency risk can be minimized by at least partly financing the foreign investment with a dollar-denominated capital contribution from the parent company rather than in the local capital markets. Answer: TRUE Topic: Opportunity Cost Question Status: Previous Edition 9) In case of international capital budgeting.8) Opportunity costs should be included as cash cash flows when determining a project's incremental cash flows. Answer: FALSE Topic: Sunk Costs Question Status: Previous Edition 35 . C) consistent cash flows. B) relevant cash flows. D) 36 .11) An opportunity cost is a cash flow that could be realized from the best alternative use of an owned asset. Answer: TRUE Topic: Sunk Costs Question Status: Previous Edition 13) Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as A) necessary cash flows. Answer: TRUE Topic: Opportunity Cost Question Status: Previous Edition 12) A sunk cost is a cash outlay that has already been made and therefore has no effect on the cash flows relevant to a current decision. A) conventional B) non-conventional C) incremental initial D) Answer: C Topic: Replacement Project Analysis Question Status: Previous Edition 15) Relevant cash flows for a project are best described as A) 37 . Answer: B Topic: Relevant Cash Flows Question Status: Previous Edition 14) When making replacement decisions. due to the need to calculate ________ cash inflows.ordinary cash flows. the development of relevant cash flows is complicated when compared to expansion decisions. incidental cash flows. C) sunk cash flows. Answer: B Topic: Relevant Cash Flows Question Status: Previous Edition 38 . B) incremental cash flows. D) accounting cash flows. 16) In developing the cash flows for an expansion project, the analysis is the same as the analysis for replacement projects where A) all cash flows from the old assets are equal. B) prior cash flows are irrelevant. C) all cash flows from the old asset are zero. D) cash inflows equal cash outflows. Answer: C Topic: Expansion versus Replacement Project Analysis Question Status: Previous Edition 17) Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called A) incremental historical costs. B) incremental past expenses. C) opportunity costs foregone. D) 39 sunk costs. Answer: D Topic: Sunk Costs Question Status: Previous Edition 18) Cash flows that could be realized from the best alternative use of an owned asset are called A) incremental costs. B) lost resale opportunities. C) opportunity costs. D) sunk costs. Answer: C Topic: Sunk Costs Question Status: Previous Edition 19) In international capital budgeting decisions, political risks can be minimized using all of the following strategies EXCEPT A) 40 structuring the investment as a joint venture and selecting well-connected local partner. B) structuring the financing of such investments as equity rather than as debt. C) structuring the financing of such investments as debt rather than as equity. D) none of the above. Answer: B Topic: International Capital Budgeting Question Status: Previous Edition 20) Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after tax operating cash flows? Why or why not? Answer: Financing costs are not an incremental cash flow for capital budgeting purposes. Financing costs are a direct consequence of how the project is financed, not whether the project is economically viable. Financing costs are embedded in the required rate of return used to discount project cash flows. Topic: Relevant Cash Flows Question Status: Previous Edition 41 21) Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost Answer: There is no one correct answer to this question. 1) To calculate the initial investment. we subtract all cash inflows occurring at time zero from all cash outflows occurring at time zero. Topic: Sunk Costs versus Opportunity Costs Question Status: Previous Edition Learning Goal 4: Calculate the initial investment associated with a proposed capital expenditure. Answer: TRUE Topic: Initial Investment Question Status: Previous Edition 2) Under MACRS depreciation. the depreciable value of an asset is equal to the asset's purchase price minus any installation costs. Answer: FALSE Topic: 42 . A correct answer depends upon the student's response. the difference between the sales price and its book value is considered as recaptured depreciation and will be taxed as ordinary income.1) Question Status: Previous Edition 5) Recaptured depreciation is the portion of the sale price that is below book value and has not been depreciated. Answer: FALSE Topic: 43 . Answer: TRUE Topic: Depreciation and Taxes (Equation 8.Depreciable Value of an Asset Question Status: Previous Edition 3) The book value of an asset is equal to its depreciable value minus the accumulated depreciation. Answer: TRUE Topic: Book Value of an Asset (Equation 8.1) Question Status: Previous Edition 4) In case of an existing asset which is depreciable and is used in business and is sold for a price equal to its initial purchase price. Depreciation and Taxes (Equation 8.1) Question Status: Previous Edition 6) The basic cash flows that must be considered when determining the initial investment associated with a capital expenditure are the installed cost of the new asset. the after-tax proceeds (if any) from the sale of an old asset. Answer: TRUE Topic: Depreciation and Taxes Question Status: Previous Edition 8) Recaptured depreciation is the portion of the sale price that is in excess of the initial purchase price. Answer: TRUE Topic: Initial Investment Question Status: Previous Edition 7) Capital gain is the portion of the sale price that is in excess of the initial purchase price. and the change (if any) in net working capital. Answer: FALSE Topic: Depreciation and Taxes 44 . not against ordinary income. any loss on the sale of the asset is deductible only against other capital gains income. Answer: TRUE Topic: Depreciation and Taxes 45 . Answer: FALSE Topic: Depreciation and Taxes Question Status: Previous Edition 10) The change in net working capitalregardless of whether an increase or decreaseis not taxable because it merely involves a net build-up or reduction of current balance sheet accounts. Answer: TRUE Topic: Net Working Capital Investment Question Status: Previous Edition 11) If an asset is sold for more than its initial purchase price.Question Status: Previous Edition 9) If an asset is depreciable and used in business. the gain on the sale is composed of two parts: a capital gain and recaptured depreciation. Answer: TRUE Topic: Net Working Capital Investment 46 . Answer: TRUE Topic: Depreciation and Taxes (Equation 8.Question Status: Previous Edition 12) If an asset is sold for book value. the gain on the sale is composed of two parts: a capital gain and recaptured depreciation. the loss on the sale may be used to offset ordinary operating income. Answer: FALSE Topic: Depreciation and Taxes (Equation 8. this change in net working capital represents an initial cash outflow.1) Question Status: Previous Edition 14) If an investment in a new asset results in a change in current assets that exceeds the change in current liabilities.1) Question Status: Previous Edition 13) If an asset is sold for less than its book value. Question Status: Previous Edition 15) If an investment in a new asset results in a change in current liabilities that exceeds the change in current assets. this change in net working capital represents an initial cash outflow. Answer: FALSE Topic: Net Working Capital Investment Question Status: Previous Edition 47 . D) 48 . B) the increase in current assets. the change in net working capital must be considered as part of A) the operating cash inflows. C) the incremental operating cash inflows. B) the initial investment. C) the increase in current liabilities. D) the operating cash outflows. Answer: B Topic: Net Working Capital Investment Question Status: Previous Edition 17) The change in net working capital when evaluating a capital budgeting decision is A) the change in current liabilities minus the change in current assets.16) When evaluating a capital budgeting project. D) depreciated value plus recaptured depreciation.the change in current assets minus the change in current liabilities.1) Question Status: Previous Edition 19) An important cash inflow in the analysis of initial cash flows for a replacement project is A) 49 . C) original purchase price minus accumulated depreciation. B) original purchase price minus annual depreciation expense. Answer: C Topic: Book Value of an Asset (Equation 8. Answer: D Topic: Net Working Capital Investment Question Status: Previous Edition 18) The book value of an asset is equal to the A) fair market value minus the accounting value. B) the cost of the new asset. D) the sale value of the old asset. C) installation cost. Answer: D Topic: Replacement Project Analysis Question Status: Previous Edition 20) The tax treatment regarding the sale of existing assets that are sold for more than the book value and more than the original purchase price results in A) an ordinary tax benefit. D) a capital gain tax liability and recaptured depreciation taxed as ordinary income. Answer: D Topic: 50 . B) no tax benefit or liability.taxes. C) recaptured depreciation taxed as ordinary income. 1) Question Status: Previous Edition 51 .Depreciation and Taxes (Equation 8. A) an increase in net working capital is considered a cash inflow. B) cost of the new asset. C) proceeds from the sale of the existing asset. B) a decrease in net working capital is considered a cash outflow. C) an increase in net working capital is considered a cash outflow.21) In evaluating the initial investment for a capital budgeting project. D) 52 . D) net working capital does not have to be considered. Answer: C Topic: Net Working Capital Investment Question Status: Previous Edition 22) The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT A) incremental annual savings produced by the new asset. B) a capital gain tax liability.1) Question Status: Previous Edition 24) The tax treatment regarding the sale of existing assets that are sold for their book value results in A) 53 .taxes on the sale of an existing asset. Answer: A Topic: Initial Investment Question Status: Previous Edition 23) The tax treatment regarding the sale of existing assets that are sold for more than the book value but less than the original purchase price results in A) an ordinary tax benefit. Answer: C Topic: Depreciation and Taxes (Equation 8. C) recaptured depreciation taxed as ordinary income. D) a capital gain tax liability and recaptured depreciation taxed as ordinary income. B) a capital loss tax benefit. Answer: B Topic: Depreciation and Taxes (Equation 8. C) recaptured depreciation taxed as ordinary income. C) recaptured depreciation taxed as ordinary income. B) no tax benefit or liability. D) a capital gain tax liability and recaptured depreciation taxed as ordinary income.an ordinary tax benefit. D) a capital gain tax liability and recaptured depreciation taxed as ordinary income. Answer: B Topic: 54 .1) Question Status: Previous Edition 25) The tax treatment regarding the sale of existing assets that are sold for less than the book value results in A) an ordinary tax benefit. Depreciation and Taxes (Equation 8.1) Question Status: Previous Edition 55 . and long-term debt by $100.000.000. Management expects cash to increase by $10. The change in net working capital is A) an increase of $120.26) A corporation is considering expanding operations to meet growing demand. With the capital expansion the current accounts are expected to change. At the same time accounts payable will increase by $50. and long-term debt by $80.000. At the same time accounts payable will increase by $40. accounts receivable by $40. the current accounts are expected to change. Management expects cash to increase by $20. B) a decrease of $10.000.000. C) a decrease of $120.000.000.000. The change in net working capital is A) an increase of $10.000. and inventories by $30.000. C) 56 . D) an increase of $60. accounts receivable by $20. accruals by $10.000.000. B) a decrease of $40. With the capital expansion.000.000.000.000.000.000. Answer: D Topic: Net Working Capital Investment Question Status: Previous Edition 27) A corporation is considering expanding operations to meet growing demand. accruals by $30. and inventories by $60. C) $4.1) Question Status: 57 .000.000. If the assumed tax rate is 40 percent on ordinary income and capital gains. D) an increase of $80.a decrease of $90.720 tax liability.560 tax liability.000. Answer: B Topic: Net Working Capital Investment Question Status: Previous Edition 28) A corporation is selling an existing asset for $21. and has been depreciated for four full years. Answer: D Topic: Depreciation and Taxes (Equation 8. the tax effect of this transaction is A) $0 tax liability. cost $10. B) $7. The asset.400 tax liability.000. was being depreciated under MACRS using a five-year recovery period. when purchased. D) $7. C) $3. Answer: A Topic: Depreciation and Taxes (Equation 8. D) $3.700. and has been depreciated for four full years.160 tax benefit. cost $10.160 tax liability. was being depreciated under MACRS using a five-year recovery period.1) Question Status: Previous Edition 58 .000. when purchased.Previous Edition 29) A corporation is selling an existing asset for $1. The asset. the tax effect of this transaction is A) $0 tax liability. If the assumed tax rate is 40 percent on ordinary income and capital gains. B) $840 tax liability. 000. cost $10. the tax effect of this transaction is A) $0 tax liability.600 tax liability. C) 59 .000. the tax effect of this transaction is A) $0 tax liability. C) $3. B) $1. D) $280 tax benefit. Answer: D Topic: Depreciation and Taxes (Equation 8. The asset. was being depreciated under MACRS using a five-year recovery period and has been depreciated for four full years.000. and has been depreciated for four full years.000. when purchased. The asset.100 tax liability. B) $1.30) A corporation is selling an existing asset for $1. when purchased. was being depreciated under MACRS using a five-year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains.1) Question Status: Previous Edition 31) A firm is selling an existing asset for $5. cost $10. If the assumed tax rate is 40 percent on ordinary income and capital gains.320 tax liability. Answer: B Topic: Depreciation and Taxes (Equation 8. a loss on the sale of a non-depreciable asset is ________. D) $2.1) Question Status: Previous Edition 32) A loss on the sale of an asset that is depreciable and used in business is ________.160 tax liability. A) deductible from capital gains income.000 tax benefit. deductible from ordinary income B) deductible from ordinary income. deductible only against capital gains C) a credit against the tax liability. not deductible D) not deductible. deductible only against capital gains Answer: B Topic: Depreciation and Taxes Question Status: Previous Edition 60 .$1. 440 $54.000 and will also be depreciated under MACRS using a five-year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains. the existing asset originally cost $30. The existing asset can be sold for $25.1) Question Status: Previous Edition 61 . A) $42. The new asset will cost $75.000.240 $50. Two years ago. the initial investment is ________.000 and was being depreciated under MACRS using a five-year recovery period.33) A corporation has decided to replace an existing asset with a newer model.000 B) C) D) Answer: C Topic: Initial Investment (Equation 8.000 $52. 000 and will also be depreciated under MACRS using a five-year recovery period. The existing asset can be sold for $30.240 $27.000 and was being depreciated under MACRS using a five-year recovery period. the initial investment is ________. Two years ago.600 B) C) D) Answer: A Topic: Initial Investment (Equation 8. the existing asset originally cost $70. A) $48.560 $44.34) A corporation has decided to replace an existing asset with a newer model. The new asset will cost $80. C) 62 .1) Question Status: Previous Edition 35) The portion of an asset's sale price that is above its book value and below its initial purchase price is called A) a capital gain.360 $49.000. If the assumed tax rate is 40 percent on ordinary income and capital gains. B) recaptured depreciation. B) recaptured depreciation. C) a capital loss. D) book value. Answer: C Topic: Depreciation and Taxes (Equation 8. Answer: B Topic: Depreciation and Taxes (Equation 8. D) book value.a capital loss.1) Question Status: Previous Edition 36) The portion of an asset's sale price that is below its book value and below its initial purchase price is called A) a capital gain.1) Question Status: Previous Edition 63 . and accounts payable increase by $500. B) increase by $1. D) experience no change. inventory decreases by $500.500. Answer: D Topic: Net Working Capital Investment Question Status: Previous Edition 64 .000.000.000. C) increase by $2.000.37) If accounts receivable increase by $1.000.000.000. net working capital would A) decrease by $500.000. 000 Topic: Depreciation (Equation 8. Answer: Initial purchase price = book value + accumulated depreciation = 34.800 + 85.000 and can be sold for $125.200. C) the resale value of an old asset being replaced.38) All of the following would be used in the computation of an investment's initial investment EXCEPT A) the annual after tax inflow expected from the investment.1) Question Status: Previous Edition 40) A mixer was purchased two years ago for $120.800 and total accumulated depreciation of $85. B) the initial purchase price of the investment. The mixer has been 65 . Answer: A Topic: Initial Investment Question Status: Previous Edition 39) Compute the initial purchase price for an asset with book value of $34.200 = $120.000 today. D) the tax on the sale of an old asset being replaced. 960 Topic: MACRS Depreciation and Taxes (Equation 8.000 .000 Recaptured depreciation = 40.000 (b) Tax liability = 11. (a) Compute recaptured depreciation and capital gain (loss).1) Question Status: Previous Edition 41) An asset was purchased three years ago for $100. The asset has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gain.000 Capital gain = 0 $11.29. Answer: (a) Book Value = 100.000 = 5. Answer: (a) Book Value = 120.400 Capital gain = 125.40 = $4.0.400 Topic: MACRS Depreciation and Taxes (Equation 8.0.600 = $62.1) Question Status: Previous Edition 66 . if any.000 .000 (1 .0.000 (1 .20 .000 × 0. if any.600 Recaptured depreciation = 120.000 $67.32 .40 = $26.400 (b) Tax liability = 67.120.000 .0.000 = $11. (b) Find the firm's tax liability.depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gain.57.20 . (a) Compute recaptured depreciation and capital gain (loss).19) = $29.32) = $57. (b) Find the firm's tax liability.000 and can be sold for $40.400 × 0.000 today.0. 600 Recaptured depreciation = $0 Capital loss = 57.000 = $60.50.1) Question Status: Previous Edition Table 8. The machine has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gains.600 . Answer: Depreciable Value = 55.20 .000 in installation costs using MACRS 5-year recovery period.600 (b) Tax benefit = 7.000 + 5. (b) Find the firm's tax liability.000 and requires $5.1) Question Status: Previous Edition 43) Compute the depreciation values for an asset which costs $55.000 today.0.40 = $3. Answer: (a) Book Value = 120.42) A machine was purchased two years ago for $120.000 and can be sold for $50.3 67 .600 × 0.000 = 7.000 Topic: MACRS Depreciation (Equation 8. if any.040 Topic: MACRS Depreciation and Taxes (Equation 8.000 (1 .32) = $57.0. (a) Compute recaptured depreciation and capital gain (loss). 3) Answer: Book value of existing press = $35. (See Table 8. (See Table 8. The new press costs $55. MACRS Depreciation and Taxes (Equation 8.200 × 0.000 and requires $5.000 .200 recaptured depreciation $3. 44) Calculate the book value of the existing press being replaced. The old press was purchased 2 years ago for an installed cost of $35.40 = $1. MACRS Depreciation and Taxes (Equation 8.000 and can be sold for $20. The firm is in 40 percent marginal tax rate.000 × [1 .20 + 0.32)] = 16.800 Topic: Initial Investment.Fine Press is considering replacing the existing press with a more efficient press.(0.000 in installation costs.280 tax Topic: Initial Investment.1) Question Status: Previous Edition 68 .16.3) Answer: Tax: $20.800 = $3.1) Question Status: Previous Edition 45) Calculate the tax effect from the sale of the existing asset. Both presses are depreciated under the MACRS 5-year recovery schedule.000 net of any removal costs today. MACRS Depreciation and Taxes (Equation 8. incremental operating cash inflows are relevant cash flows.46) Calculate the initial investment of the new asset. 1) All benefits expected from a proposed project must be measured on a cash flow basis which may be found by adding any non-cash charges deducted as an expense on the firm's income statement back to net profits after taxes.3) Answer: Topic: Initial Investment. (See Table 8. Answer: 69 .1) Question Status: Previous Edition Learning Goal 5: Find the relevant operating cash inflows associated with a proposed capital expenditure. Answer: TRUE Topic: Operating Cash Flow Question Status: Previous Edition 2) In evaluating a proposed project. Answer: TRUE Topic: Operating Cash Flow Question Status: Previous Edition 5) Benefits expected from proposed capital expenditures must be on an after-tax basis because A) taxes are cash outflows. both operating costs and financing costs must be deducted from any cash inflows received.TRUE Topic: Operating Cash Flow Question Status: Previous Edition 3) In computing after-tax operating cash flows. 70 . only operating costs but not financing costs must be deducted from any cash inflows received. Answer: FALSE Topic: Operating Cash Flow Question Status: Previous Edition 4) In computing after-tax operating cash flows. accepted practice to do so. C) there may also be tax benefits to be evaluated.B) no benefits may be used by the firm until tax claims are satisfied. D) it is common. Answer: B Topic: Relevant Cash Flows Question Status: Previous Edition 71 . ______________________________________________________________________ 72 . B) subtract depreciation from operating revenues. For each investment proposal. Answer: A Topic: Operating Cash Flow Question Status: Previous Edition Table 8. the total installed cost of the equipment will be partially offset by the sale of existing equipment.6) One basic technique used to evaluate after-tax operating cash flows is to A) add noncash charges to net income. C) add cash expenses to net income. the relevant cash flows and other relevant financial data are summarized in the table below. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. Inc. D) subtract cash expenses from noncash charges.4 Computer Disk Duplicators. In the case of a replacement decision. has been considering several capital investment proposals for the year beginning in 2004. 4. C) an annuity and conventional.*Not applicable 7) For Proposal 1.) A) a mixed stream and conventional. the cash flow pattern for the expansion project is ________. D) an annuity and non-conventional. B) a mixed stream and non-conventional. (See Table 8. Answer: A Topic: Expansion Project Analysis Question Status: Previous Edition 73 . 620.440.000 C) D) $1. (See Table 8.000 $1.000 B) $1.8) For Proposal 1. the depreciation expense for year 1 is ________.) A) $1.4.000 B) C) D) $300.400 $115.500. (See Table 8.200 $150.000 74 .4.000 Answer: C Topic: Initial Outlay Question Status: Previous Edition 9) For Proposal 1. the initial outlay equals ________.380.) A) $110. ) A) $60. the annual incremental after-tax cash flow from operations for year 1 is ________.000 $300.C Topic: Incremental Depreciation Question Status: Previous Edition 10) For Proposal 1. B) 75 .4. (See Table 8.) A) a mixed stream and conventional.000 B) C) D) Answer: D Topic: Incremental Operating Cash Flows Question Status: Previous Edition 11) For Proposal 2. the cash flow pattern for the replacement project is ________.000 $210. (See Table 8.4.000 $255. 400 $80.000 B) C) D) Answer: A Topic: Depreciation and Taxes (Equation 8.1) Question Status: 76 . the book value of the existing asset is ________. D) an annuity and non-conventional.400 $66.600 $34. C) an annuity and conventional.4.a mixed stream and non-conventional.) A) $13. Answer: A Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 12) For Proposal 2. (See Table 8. Previous Edition 77 . C) $150.560 tax liability.4.520 cash outflow. C) $25. (See Table 8. D) $16. 78 . B) $164.000 cash outflow.) A) $120. the tax effect on the sale of the existing asset results in ________.1) Question Status: Previous Edition 14) For Proposal 2.000 tax liability. the initial outlay equals ________.) A) $12.13) For Proposal 2.720 cash outflow.4. Answer: B Topic: Depreciation and Taxes (Equation 8.560 cash outflow.600 tax liability. (See Table 8. D) $167.280 tax liability. B) $14. ) A) $18.) A) $16. the annual incremental after-tax cash flow from operations for year 2 is ________. the incremental depreciation expense for year 2 is ________.800 $26.4.400 $60. (See Table 8.400 $38.000 B) C) D) Answer: D Topic: Incremental Depreciation Question Status: Previous Edition 16) For Proposal 2.4. (See Table 8.B Topic: Initial Outlay Question Status: Previous Edition 15) For Proposal 2.000 B) 79 . 4. D) an annuity and non-conventional.000 $84. C) an annuity and conventional.000 C) D) Answer: C Topic: Incremental Operating Cash Flows Question Status: Previous Edition 17) For Proposal 3. Answer: A Topic: Replacement Project Analysis Question Status: 80 .$24.000 $66. (See Table 8.) A) a mixed stream and conventional. the cash flow pattern for the replacement project is ________. B) a mixed stream and non-conventional. Previous Edition 81 . C) $20.) A) $8.200 tax liability.000 $52. (See Table 8. 82 .4. B) $16.000 tax liability.) A) $21.18) For Proposal 3.1) Question Status: Previous Edition 19) For Proposal 3. D) $23.000 $43.000 tax liability. the book value of the existing asset is ________. the tax effect on the sale of the existing asset results in ________. (See Table 8.4.000 $80.000 tax liability.000 B) C) D) Answer: D Topic: Depreciation and Taxes (Equation 8. (See Table 8.1) Question Status: Previous Edition 20) For Proposal 3.000 $196.000 $300.4.) A) $21.4. (See Table 8. the initial outlay equals ________.000 B) C) D) Answer: B Topic: Initial Outlay Question Status: Previous Edition 21) For Proposal 3.) A) $170.400 $211.000 B) 83 . the incremental depreciation expense for year 3 is ________.B Topic: Depreciation and Taxes (Equation 8. 750 $10.$42.150 B) C) D) Answer: A Topic: Incremental Depreciation Question Status: 84 . the incremental depreciation expense for year 6 is ________.000 $47. (See Table 8.) A) $15.4.850 C) D) Answer: C Topic: Incremental Depreciation Question Status: Previous Edition 22) For Proposal 3.750 $23.000 $36.850 $50. Previous Edition 85 . (See Table 8. 24) The cash flow pattern for the capital investment proposal is ________. Inc.23) For Proposal 3. The existing equipment.000. (See Table 8.000 and will be sold for $10.000 per year. The new equipment is expected to result in incremental before-tax net profits of $15.4.000. The firm has a 40 percent tax rate.140 B) C) D) Answer: D Topic: Incremental Operating Cash Flows Question Status: Previous Edition Table 8.5) A) a mixed stream and conventional. The asset will be depreciated using a five-year recovery schedule.5 Cuda Marine Engines.150 $90.000 $75. the annual incremental after-tax cash flow from operations for year 3 is ________. The proposed asset costs $50. has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. which originally cost $25.000 and has installation costs of $3. must develop the relevant cash flows for a replacement capital investment proposal. B) 86 .150 $109.) A) $45. (See Table 8.250 $25.250 $15. D) an annuity and non-conventional. C) an annuity and conventional.000 B) C) D) Answer: A Topic: Depreciation and Taxes (Equation 8.1) Question Status: 87 .a mixed stream and non-conventional.000 $21.5) A) $7. Answer: A Topic: Conventional versus Nonconventional Cash Flows Question Status: Previous Edition 25) The book value of the existing asset is ________. 100 tax liability. Answer: C Topic: Depreciation and Taxes (Equation 8. D) $6.5) A) $800 tax benefit.000 tax liability. B) $1. (See Table 8.000 tax liability.1) Question Status: Previous Edition 88 . C) $1.Previous Edition 26) The tax effect on the sale of the existing asset results in ________. 5) A) $41.950 89 .27) The initial outlay equals ________.5) A) $2.250 $7.100 $44.960 B) C) D) Answer: B Topic: Initial Investment Question Status: Previous Edition 28) The incremental depreciation expense for year 1 is ________.600 $7.100 $38.000 B) C) D) $7.800 $38. (See Table 8. (See Table 8. (See Table 8.360 B) C) D) Answer: D Topic: Incremental Depreciation Question Status: Previous Edition 30) The annual incremental after-tax cash flow from operations for year 1 is ________.250 $5.B Topic: Incremental Depreciation Question Status: Previous Edition 29) The incremental depreciation expense for year 5 is ________. (See Table 8.5) A) $2.950 B) 90 .110 $7.5) A) $13.950 $6. 600 $25.600 $30.000 C) D) Answer: B Topic: Incremental Operating Cash Flows Question Status: Previous Edition 91 .$16. ) Answer: Tax: $105.800 Total tax liability $22. a manufacturer of dance and exercise apparel.000 . (See Table 8. Inc. is considering replacing an existing piece of equipment with a more sophisticated machine.4 = $2.32)] = 48.000 × [1 .Table 8.20 + 0. (See Table 8. The following information is given. 31) Calculate the book value of the existing asset being replaced.6.6 Degnan Dance Company.(0.) Answer: Book value of existing equipment = $100.000 Topic: MACRS Depreciation (Equation 8.6.1) Question Status: Previous Edition 32) Calculate the tax effect from the sale of the existing asset.000 = $5.$100.000 $ 52. The firm pays 40 percent taxes on ordinary income and capital gains.800 92 .4 = 20..000 capital gain×0.000 recaptured depreciation ×0. Topic: MACRS Depreciation and Taxes (Equation 8.) Answer: Topic: Initial Investment Question Status: Previous Edition 93 .6. (See Table 8.1) Question Status: Previous Edition 33) Calculate the initial investment required for the new asset. 34) Calculate the incremental earnings before depreciation and taxes. (See Table 8.6.) Answer: Topic: Incremental EBDT Question Status: Previous Edition 35) Calculate the incremental depreciation. (See Table 8.6.) Answer: Topic: Incremental Depreciation Question Status: Previous Edition 94 36) Summarize the incremental after-tax cash flow (relevant cash flows) for years t = 0 through t = 5. (See Table 8.6.) Answer: Topic: Incremental Cash Flows Question Status: Previous Edition Learning Goal 6: Determine the terminal cash flow associated with a proposed capital expenditure. 1) 95 A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $15,000. The machine has an original purchase price of $80,000, installation cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is A) $24,000. $16,000. $14,000. $26,000. B) C) D) Answer: B Topic: Terminal Cash Flows (Equation 8.1) Question Status: Previous Edition 2) A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years at an estimated sale price of $2,000. The machine has an original purchase price of $80,000, installation cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The terminal cash flow is A) $5,800. B) $7,800. 96 C) $8. $6.1) Question Status: Previous Edition 97 .200. D) Answer: C Topic: Terminal Cash Flows (Equation 8.200.
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