3) Incremental cash flows include all of the following EXCEPT:
A) research and development costs .
B) increased labor costs from the project.
C) advertising costs .
D) both B and C.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
4) Diamond Inc. has estimated that a new building will cost $2,500,000 to construct. Land was
purchased a year ago for $500,000 and could be sold today for $550,000. An environmental
impact study required by the state was performed at a cost of $48,000. For capital budgeting
purposes, what is the relevant cost of the new building?
A) $2,500,000
B) $3,048,000
C) $3,050,000
D) $3,098,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
5) If SuperMart decides to offer a line of groceries at its discount retail outlet, inventories are
expected to increase by $1,200,000, accounts receivable by $300,000 and accounts payable by
$500,000. What is the cash outflow for working capital requirements?
A) $2,000,000
B) $1,700,000
C) $1,500,000
D) $1,000,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: working capital
Principles: Principle 3: Cash Flows Are the Source of Value
6) If depreciation expense is taken over 5 years rather than 3 years, all things equal,
A) net present value will go down.
B) depreciation has no effect on net present value.
C) net present value will go up.
D) the answer depends on the company’s marginal tax rate.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: straight line depreciation
Principles: Principle 3: Cash Flows Are the Source of Value
11
7) If the federal income tax rate were increased, the impact of the tax increase on acceptable
investment proposals would be to (ignore the impact of the tax change on the cost of capital):
A) decrease the tax shelter from depreciation.
B) decrease net present value but the internal rate of return would stay the same.
C) increase net present value because the tax shelter from interest and depreciation becomes
more valuable.
D) decrease both net present value. and internal rate of return.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
8) Which of the following would increase the net working capital for a project? An increase in:
A) accounts receivable.
B) fixed assets.
C) accounts payable.
D) common stock.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: working capital
Principles: Principle 3: Cash Flows Are the Source of Value
9) Which of the following should be included in the initial outlay?
A) Shipping and installation costs
B) Increased working capital requirements
C) Cost of employee training associated specifically with the asset being evaluated
D) All of the above
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
10) Depreciation expenses affect capital budgeting analysis by increasing:
A) taxes paid.
B) incremental cash flows.
C) the initial outlay.
D) working capital.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
12
11) Which of the following is included in the terminal cash flow?
A) The expected salvage value of the asset
B) Tax impacts from selling asset
C) Recapture of any working capital
D) All of the above
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
12) A firm purchased an asset with a 5-year life for $90,000, and it cost $10,000 for shipping and
installation. According to the current tax laws the cost basis of the asset at time of purchase is:
A) $100,000.
B) $95,000.
C) $80,000.
D) $70,000.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: straight line depreciation
Principles: Principle 3: Cash Flows Are the Source of Value
13) XYZ, Inc. is considering adding a product line that would utilize unused floor place of their
manufacturing plant. The floor space would be considered a(n):
A) variable cost.
B) opportunity cost.
C) sunk cost.
D) irrelevant cash flow.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
14) Which of the following is included in the calculation of the initial outlay for a capital
investment?
A) Investment in working capital
B) Shipping expenses
C) Installation
D) All of the above
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
13
15) Which of the following would decrease free cash flows? A decrease in:
A) depreciation expense.
B) interest expense.
C) incremental sales.
D) both A and C.
E) all of the above.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
Use the following information to answer the following question(s).
Delta Inc. is considering the purchase of a new machine which is expected to increase sales by
$10,000 in addition to increasing non-depreciation expenses by $3,000 annually. Due to the sales
increase, Delta expects its working capital to increase $1,000 during the life of the project. Delta
will depreciate the machine using the straight-line method over the project’s five year life to a
salvage value of zero. The machine’s purchase price is $20,000. The firm has a marginal tax rate
of 34 percent, and its required rate of return is 12 percent.
16) The machine’s initial cash outflow is:
A) $20,000.
B) $21,000.
C) $27,000.
D) $23,000.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
17) The machine’s incremental after-tax cash inflow for year 1 is:
A) $6,420.
B) $7,980.
C) $8,620.
D) $5,980.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
14
18) The machine’s after-tax incremental cash flow in year five is:
A) $6,980.
B) $5,980.
C) $7,120.
D) $8,620.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
19) The machine’s NPV is:
A) $1,556.56.
B) $2,556.56.
C) $1,123.99.
D) $2,123.99.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
20) The machine’s IRR is:
A) less than 0.
B) greater than 12 percent.
C) less than 12 percent.
D) equal to 12 percent.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
21) ABC already spent $85,000 on a feasibility study for a machine that will produce a new
product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC
will need to invest $75,000 for additional inventory. The machine has an IRS approved useful
life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after
which it will be sold for $600,000. What is the depreciable cost basis of the machine?
A) $3,025,000
B) $2,950,000
C) $2,575,000
D) $2,350,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: straight line depreciation
Principles: Principle 3: Cash Flows Are the Source of Value
15
22) ABC already spent $85,000 on a feasibility study for a machine that will produce a new
product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC
will need to invest $75,000 for additional inventory. The machine has an IRS approved useful
life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after
which it will be sold for $600,000. What is the total investment amount required for the
machine?
A) $3,025,000
B) $2,950,000
C) $2,575,000
D) $2,350,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
23) ABC will purchase a machine that will cost $2,575,000. Required modifications will cost
$375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS
approved useful life of 7 years; it is presumed to have no salvage value. ABC plans to depreciate
the machine by using the straight-line method. The machine is expected to increase ABC’s sales
revenues by $1,890,000 per year; operating costs excluding depreciation are estimated at
$454,600 per year. Assume that the firm’s tax rate is 40%. What is the annual operating cash
flow?
A) $922,464
B) $1,126,287
C) $813,563
D) $1,029,811
Topic: 12.2 Forecasting Project Cash Flows
Keywords: operating cash flows
Principles: Principle 3: Cash Flows Are the Source of Value
24) ABC purchased a machine for $2,575,000. Required modifications will cost $375,000. ABC
will need to invest $75,000 for additional inventory. The machine has an IRS approved useful
life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after–
which it will be sold for $600,000. ABC plans to depreciate the machine by using the straight-
line method. Assume that the firm’s tax rate is 40%. What is the termination (non-operating) cash
flow from the machine in year three?
A) $900,623
B) $1,109,286
C) $1,298,114
D) $879,247
Topic: 12.2 Forecasting Project Cash Flows
Keywords: operating cash flows
Principles: Principle 3: Cash Flows Are the Source of Value
16
25) Famous Danish Corp. is replacing an old cookie cutter with a new one. The cookie cutter is
being sold for $25,000 and it has a net book value of $75,000. Assume that Famous Danish is in
the 34% income tax bracket. How much will Famous Danish net from the sale?
A) $61,000
B) $55,000
C) $75,000
D) $42,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
26) Burr Habit Corporation is considering a new product line. The company currently
manufactures several lines of snow skiing apparel. The new products, insulated ski shorts, are
expected to generate sales less cost of goods sold of $1 million per year for the next five years.
They expect that during this five year period, they will lose about $250,000 per year in sales less
cost of goods sold on their existing lines of longer ski pants as a result of the introduction of the
new product line. The new line will require no additional equipment or space in the plant and can
be produced in the same manner as the existing apparel products. The new project will, however,
require that the company spend an additional $80,000 per year on insurance in case customers
sue for frostbite. Also, a new marketing director would be hired to oversee the line at $45,000 per
year in salary and benefits. Because of the different construction of the shorts, an increase in
inventory of 3,800 would be required initially. If the marginal tax rate is 30%, compute the
incremental after tax cash flows per year for years 1-5.
A) $434,500 per year
B) $625,000 per year
C) $187,500 per year
D) $437,500 per year
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
17
27) Regal Enterprises is considering the purchase of a new embroidering machine. It is expected
to generate additional sales of $400,000 per year. The machine will cost $295,000, plus $3,000 to
install it. The embroiderer will save $12,000 in labor expense each year. Regal is in the 34%
income tax bracket. The machine will be depreciated on a straight-line basis over five years (it
has no salvage value). The embroiderer will require annual operating expenses of $136,000.
What is the annual operating cash flow that the machine will generate?
A) $316,954
B) $124,000
C) $202,424
D) $165,816
Topic: 12.2 Forecasting Project Cash Flows
Keywords: operating cash flows
Principles: Principle 3: Cash Flows Are the Source of Value
28) Woodstock Inc. expects to own a building for five years, then sell it for $1,500,000 net of
taxes, sales commissions and other selling costs. Woodstock’s cost of capital is 11%. How much
will the sale of the building contribute to the NPV of the project?
A) $890,177
B) $1,351,351
C) $1,500,000
D) $2,527,587
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
29) Which of the following would cause free cash flow to differ from operating cash flow when
an investment project is terminated?
A) Sale of assets
B) Recovery of net working capital
C) Income taxes
D) All of the above
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
18
30) Which of the following should be considered in the estimation of free cash flows?
A) Cash generated from the sale of a project
B) Recovery of net working capital
C) Operating cash flow
D) All of the above
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
31) The Director of Capital Budgeting of Capital Assets Corp. is considering the acquisition of a
new high speed photocopy machine. The photocopy machine is priced at $85,000 and would
require $2,000 in transportation costs and $4,000 for installation. The equipment will have a
useful life of 5 years. The proposal will require that Capital Assets Corp. send technician for
training at a cost of $5,000. The firm’s marginal tax rate is 40 percent. How much is the initial
cash outlay of the photocopy machine?
A) $58,600
B) $64,000
C) $77,000
D) $81,000
E) $96,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
32) Jefferson Corporation is considering an expansion project. The necessary equipment could be
purchased for $15 million and shipping and installation costs are another $500,000. The project
40%. What is the project’s initial investment outlay (in millions)?
A) $15.0
B) $15.5
C) $16.5
D) $17.0
E) $17.5
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
19
33) In the fourth and final year of a project, SVC expects operating cash flow of $440,000. The
project required an $80,000 investment in working capital at the beginning. Of that amount,
$60,000 will be recovered in year 4. Machinery associated with the project will be sold for
exactly its under appreciated value of $15,000. Total free cash flow for the fourth year is:
A) $75,000.
B) $1$500,000.
C) $515,000.
D) $535,000.
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
34) Wright’s Warehouse has the following projections for Year 1 of a capital budgeting project.
Year 1 Incremental Projections:
Sales $200,000
Variable Costs $120,000
Fixed Costs $40,000
Depreciation Expense $20,000
Tax Rate 40%
Calculate the operating cash flow for Year 1.
A) $12,000
B) $32,000
C) $52,000
D) $72,000
Topic: 12.2 Forecasting Project Cash Flows
Keywords: incremental cash flow
Principles: Principle 3: Cash Flows Are the Source of Value
20