20) Which of the following would you NOT consider when making a capital budgeting
decision?
A) the additional taxes a irm would have to pay in the next year
B) the cost of a marketing study completed last year
C) the opportunity to lease out a warehouse instead of using it to house a new production
line
D) the change in direct labor expense due to the purchase of a new machine
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
21) Which of the following is an example of cannibalization?
A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to
its product line.
B) A grocery store begins selling T-shirts featuring the local university’s mascot.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A convenience store begins selling pre-paid cell phones.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
22) How are the taxes paid under MACRS diferent from that paid under straight-line
depreciation?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
23) If available, should MACRS be preferred to straight-line depreciation?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
11
9.3 Determining Incremental Free Cash Flow
1) To evaluate a capital budgeting decision, it is suicient to determine its consequences
for the irm’s earnings.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
2) The cash low efect from a change in Net Working Capital is always equal in size and
opposite in sign to the changes in Net Working Capital.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) Which of the following adjustments should NOT be made when computing free cash low
from incremental earnings?
A) adding depreciation
B) adding all non-cash expenses
C) subtracting increases in Net Working Capital
D) subtracting depreciation expenses from taxable earnings
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
12
4) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $5,000,000 to buy the machine and $10,000 to have it delivered
and installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to raise gross proits by $4,500,000 per year, starting at
the end of the irst year, with associated costs of $1 million for each of those years. The
machine is expected to have a working life of six years and will be depreciated over those
six years. The marginal tax rate is 40%. What are the incremental free cash lows
associated with the new machine in year 2?
A) $835,000
B) $2,665,000
C) $2,434,000
D) $831,667
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) Which of the following formulas will correctly calculate Net Working Capital?
A) Cash + Inventory + Receivables + Payables
B) Cash + Inventory + Receivables – Payables
C) Cash + Inventory – Receivables + Payables
D) Cash – Inventory + Receivables + Payables
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
13
6) Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $6,000,000 to buy the machine and $20,000 to have it delivered
and installed. Building a clean room in the plant for the machine will cost an additional $3
million. The machine is expected to raise gross proits by $4,000,000 per year, starting at
the end of the irst year, with associated costs of $1 million for each of those years. The
machine is expected to have a working life of ive years and will be depreciated over those
ive years. The marginal tax rate is 40%. What are the incremental free cash lows
associated with the new machine in year 0?
A) -$6,020,000
B) -$6,000,000
C) -$5,418,000
D) $1,204,000
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7) CathFoods will release a new range of candies which contain antioxidants. New
equipment to manufacture the candy will cost $2 million, which will be depreciated by
straight-line depreciation over four years. In addition, there will be $5 million spent on
promoting the new candy line. It is expected that the range of candies will bring in
revenues of $4 million per year for four years with production and support costs of $1.5
million per year. If CathFood’s marginal tax rate is 35%, what are the incremental free cash
lows in the second year of this project?
A) $1.800 million
B) $1.400 million
C) $2.000 million
D) $0.700 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
14
8) Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash $47 Accounts payable $40
Accounts receivable 23 Total current liabilities 40
Inventories 16
Total current assets 86
Long-Term Assets Long-Term Liabilities
Net property, plant,
and equipment 164 Long-term debt 170
Total long-term
assets 164
Total long-term
liabilities 170
Total Assets 250 Total Liabilities 210
Stockholders’ Equity 40
Total Liabilities and
Stockholders’ Equity
250
The balance sheet for a small irm is shown above. All amounts are in thousands of dollars.
What is this irm’s Net Working Capital?
A) $126 thousand
B) $7 thousand
C) $46 thousand
D) $86 thousand
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
9) A irm reports that in a certain year it had a net income of $5.0 million, depreciation
expenses of $3.0 million, capital expenditures of $2.0 million, and Net Working Capital
decreased by $1.1 million. What is the irm’s free cash low for that year?
A) $11.1 million
B) $7.1 million
C) $5.1 million
D) $4.9 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
15
10) A company buys tracking software for its warehouse which, along with the computer
system and ancillaries to run it, will cost $1.6 million. This purchase will be deducted over
ive years. It is expected that the software will reduce inventory by $10.7 million at the end
of the irst year after it is installed, though there will be an annual cost of $120,000 per
year to run the system. If the company‘s marginal tax rate is 40%, how will the purchase of
this item change the company’s free cash lows in the irst year?
A) $10.756 million
B) $10.380 million
C) $9.680 million
D) $11.832 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
11)
Cromwell Industries is considering a new project which will have costs, revenues, etc. as
shown by the data above. If the cost of capital is 8.0%, what is the net present value (NPV)
of this project?
A) -$56,662
B) -$59,810
C) $62,958
D) $69,254
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
16
12)
A garage is installing a new “bubble-wash” car wash. It will promote the car wash as a fun
activity for the family, and it is expected that the novelty of this approach will boost sales in
the medium term. If the cost of capital is 10%, what is the net present value (NPV) of this
project?
A) -$135,493
B) -$143,021
C) $165,603
D) $150,548
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
17
13) Your irm is considering building a new oice complex. Your irm already owns land
suitable for the new complex. The current book value of the land is $130,000; however, a
commercial real estate agent has informed you that an outside buyer is interested in
purchasing this land would be willing to pay $700,000 for it. When calculating the net
present value (NPV) of your new oice complex, ignoring taxes, the appropriate
incremental cash low for the use of this land is ________.
A) $700,000
B) $0
C) $130,000
D) $830,000
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
14) You are considering adding a microbrewery onto one of your irm’s existing
restaurants. This will entail an increase in inventory of $8700, an increase in accounts
payables of $2300, and an increase in property, plant, and equipment of $48,000. All other
accounts will remain unchanged. The change in net working capital resulting from the
addition of the microbrewery is ________.
A) $54,400
B) $11,000
C) $7680
D) $6400
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
18
15) You are considering adding a microbrewery onto one of your irm’s existing
restaurants. This will entail an investment of $47,000 in new equipment. This equipment
will be depreciated straight-line over ive years. If your irm’s marginal corporate tax rate is
35%, then what is the value of the microbrewery’s depreciation tax shield in the irst year
of operation?
A) $3290
B) $16,450
C) $6110
D) $30,550
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
16) The Sisyphean Company is considering a new project that will have an annual
depreciation expense of $3.6 million. If Sisyphean’s marginal corporate tax rate is 35% and
its average corporate tax rate is 30%, then what is the value of the depreciation tax shield
on the company’s new project?
A) $1,080,000
B) $1,260,000
C) $1,890,000
D) $1,134,000
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
19
17) The Sisyphean Corporation is considering investing in a new cane manufacturing
machine that has an estimated life of three years. The cost of the machine is $30,000 and
the machine will be depreciated straight line over its three-year life to a residual value of
$0.
The cane manufacturing machine will result in sales of 2500 canes in year 1. Sales are
estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will
charge its customers is $16 each and is to remain constant. The canes have a cost per unit
to manufacture of $10 each.
Installation of the machine and the resulting increase in manufacturing capacity will
require an increase in various net working capital accounts. It is estimated that the
Sisyphean Corporation needs to hold 3% of its annual sales in cash, 5% of its annual sales
in accounts receivable, 10% of its annual sales in inventory, and 5% of its annual sales in
accounts payable. The irm is in the 35% tax bracket and has a cost of capital of 9%.
The required net working capital in the irst year for the Sisyphean Corporation’s project is
closest to ________.
A) $5200
B) $5668
C) -$2800
D) $9200
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
20