978-0133423822 Chapter 12 Part 2

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35) Anderson-EOG Inc. is evaluating the construction of a gas pipeline to bring natural gas

from Western New York state to New York City. The controller argues that depreciation has

to be included among the expenses. The Treasurer argues that depreciation is irrelevant

because it does not afect cash low. Who is correct?

Question Status: Previous edition

Objective: 12.1 Identify incremental cash lows that are relevant to project evaluation.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

36) Anderson-EOG Inc. is evaluating the construction of a gas pipeline to bring natural gas

from Western New York state to New York City. The controller argues that every project of

the company has to absorb a portion of administrative overhead including corporate

headquarters and executive salaries. The Treasurer argues that these costs are irrelevant

because they are merely being shifted from part of the company to another. Who is correct?

Question Status: Previous edition

Objective: 12.1 Identify incremental cash lows that are relevant to project evaluation.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

12.2 Forecasting Project Cash Flows

1) Thaler & Co. anticipates an increase of $1,000,000 in Net Operating Income from irst

year sales of a new product. Taxes will be $350,000 and the company took $150,000 in

depreciation expense. Operating cash low equals

A) $1,000,000

B) $500,000

C) $800,000

D) $650,000

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

2) Schiller Construction Inc. has estimated the following revenues and expenses related to

phase I of a proposed new housing development. Incremental sales= $5,000,000, total cash

operating expenses $3,500,000, depreciation $500,000, taxes 35%, interest expense,

$200,000. Operating cash low equals

A) $650,000

B) $1,000,000

C) $1,150,000

D) $975,000

Question Status: Revised

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

3) Incremental cash lows 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.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

5) If SuperMart decides to ofer 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 outlow for working capital requirements?

A) $2,000,000

B) $1,700,000

C) $1,500,000

D) $1,000,000

Question Status: Revised

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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 efect on net present value.

C) net present value will go up.

D) the answer depends on the company’s marginal tax rate.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

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.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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

A) accounts receivable.

B) ixed assets.

C) accounts payable.

D) common stock.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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 speciically with the asset being evaluated

D) All of the above

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

10) Depreciation expenses afect capital budgeting analysis by increasing

A) taxes paid.

B) incremental cash lows.

C) the initial outlay.

D) working capital.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

11) Which of the following is included in the terminal cash low?

A) The expected salvage value of the asset

B) Tax impacts from selling assets

C) Recapture of any working capital

D) All of the above

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

12) A irm 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.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

13) XYZ, Inc. is considering adding a product line that would utilize loor space in their

manufacturing plant which is currently used for storage. XYZ will need to rent new storage

space elsewhere. The loor space would be considered a(n)

A) variable cost.

B) opportunity cost.

C) sunk cost.

D) irrelevant cash low.

Question Status: Revised

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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) A feasibility study conducted the previous year.

C) Installation

D) A and C but not B

Question Status: Revised

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

15) Which of the following would decrease after-tax operating cash lows? A decrease in

A) depreciation expense.

B) interest expense.

C) incremental sales.

D) both A and C.

Question Status: Revised

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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 will need to increase working capital by $1,000 at the beginning

of the project. Delta will depreciate the machine using the straight-line method over the

project’s ive year life to a salvage value of zero. The machine’s purchase price is $20,000.

The irm has a marginal tax rate of 34 percent, and its required rate of return is 12

percent.

16) The machine’s initial cash outlow is

A) $20,000.

B) $21,000.

C) $27,000.

D) $23,000.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

17) The machine’s incremental after-tax cash inlow for year 1 is

A) $6,420.

B) $7,980.

C) $8,620.

D) $5,980.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

18) The machine’s after-tax incremental cash low in year ive is

A) $6,980.

B) $5,980.

C) $7,120.

D) $8,620.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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.

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

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 modiications 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

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

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 modiications 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 project?

A) $3,025,000

B) $2,950,000

C) $2,575,000

D) $2,350,000

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

23) ABC will purchase a machine that will cost $2,575,000. Required modiications 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 irm’s tax rate is 40%.

What is the annual operating cash low?

A) $922,464

B) $1,126,287

C) $813,563

D) $1,029,811

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

24) ABC purchased a machine for $2,575,000. Required modiications 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 irm’s tax rate is 40%. What is the

termination (non-operating) cash low from the machine in year three?

A) $900,623

B) $1,109,286

C) $1,298,114

D) $879,247

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value

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

Question Status: Previous edition

Objective: 12.2 Calculate and forecast project cash lows for expansion type projects.

Keywords: incremental cash lows

Principles: Principle 3: Cash Flows Are the Source of Value