21
48) Which of the following are included in the terminal cash flow?
A) the expected salvage value of the asset
B) any tax payments or receipts associated with the salvage value of the asset
C) recapture of any working capital increase included in the initial outlay
D) all of the above
Keywords: Terminal Cash Flow
Learning Obj.: L.O. 11.2
AACSB: Reflective Thinking
49) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping
and another $7,000 to get the machine integrated with the company‘s existing assets. Trinitron must
maintain a supply of special lubricating oil just in case the machine breaks down. The company
purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its
expected useful life of 8 years. What will depreciation expense be during the first year?
A) $13,000
B) $12,500
C) $11,625
D) $11,500
Keywords: Depreciation Expense
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
50) Trinitron, Inc. purchased a new molding machine for $85,000. The company paid $8,000 for shipping
and another $7,000 to get the machine integrated with the company‘s existing assets. Trinitron, Inc. must
maintain a supply of special lubricating oil just in case the machine breaks down. The company
purchased a supply of oil for $4,000. The machine is to be depreciated on a straight-line basis over its
expected useful life of 8 years. Trinitron is replacing an old machine that was purchased 6 years ago for
$50,000. The old machine was being depreciated on a straight-line basis over a ten year expected useful
life. The machine was sold for $15,000. Trinitron’s marginal tax rate is 40%. What is the amount of the
initial outlay?
A) $89,000
B) $87,000
C) $91,000
D) $85,000
Keywords: Initial Outlay
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
22
51) When terminating a project for capital budgeting purposes, the working capital outlay required at the
initiation of the project will
A) not affect the terminal cash flow.
B) decrease the terminal cash flow because it is a historical cost.
C) increase the terminal cash flow because it is recaptured.
D) decrease the terminal cash flow because it is an outlay.
Keywords: Recapture, Net Working Capital
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
52) J.B. Enterprises purchased a new molding machine for $85,000. The company paid $8,000 for shipping
and another $7,000 to get the machine integrated with the company‘s existing assets. J.B. must maintain a
supply of special lubricating oil just in case the machine breaks down. The company purchased a supply
of oil for $4,000. The machine is to be depreciated on a straight-line basis over its expected useful life of 8
years. Which of the following statements concerning the change in working capital is MOST accurate?
A) The $4,000 paid for oil is added to the initial outlay, offset by the tax savings $1600.
B) The $4,000 may be expensed each year over the life of the project as part of the incremental free cash
flows.
C) The $4,000 is added to the initial outlay and recaptured during the terminal year, hence having no
impact on the projects NPV or IRR.
D) Even if the $4,000 is fully recovered at the end of the project, the project’s NPV and IRR will be lower if
the change in working capital is included in the analysis.
Keywords: Working Capital, Initial Outlay, Terminal Cash Flow
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
53) AFB, Inc. is considering replacing an old machine with a new one. Two months ago their chief
engineer completed a training seminar on the new machine‘s operation and efficiency. The $3,000 cost for
this training session has already been paid. If the new machine is purchased, it would require $7,000 in
installation and modification costs to make it suitable for operation in the factory. The old machine
originally cost $80,000 five years ago and is being depreciated by $10,000 per year. The new machine will
cost $100,000 before installation and modification. It will be depreciated by $12,000 per year. The old
machine can be sold today for $12,000. The marginal tax rate for the firm is 40%. Compute the relevant
initial outlay in this capital budgeting decision.
A) $79,500
B) $97,800
C) $90,800
D) $87,800
Keywords: Initial Outlay, Sunk Costs, Tax Effect on Sale of Old Asset
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
23
54) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being
depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost
the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold
as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten
years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease
by $12,000 per year. QRW’s marginal tax rate is 40%. Additional working capital of $3,000 is required to
maintain the new machine and higher sales level. The initial outlay for the new machine is
A) $113,000.
B) $112,200.
C) $111,000.
D) $109,800.
Keywords: Initial Outlay
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
55) QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being
depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost
the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold
as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten
years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease
by $12,000 per year. QRW‘s marginal tax rate is 40%. Additional working capital of $3,000 is required to
maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the
end of the project’s ten-year life. What is the incremental free cash flow during year 1 of the project?
A) $12,800
B) $14,400
C) $11,400
D) $15,200
Keywords: Incremental Free Cash Flows
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
56) Which of the following should be excluded in an analysis of a new project’s cash flows?
A) additional investment in fixed assets
B) additional investment in accounts receivable
C) additional investment in inventory
D) additional interest expenses on debt financing
Keywords: Financing Cash Flow
Learning Obj.: L.O. 11.2
AACSB: Reflective Thinking
24
57) A new machine can be purchased for $1,200,000. It will cost $35,000 to ship and $15,000 to modify the
machine. A $12,000 recently completed feasibility study indicated that the firm can employ an existing
factory owned by the firm, which would have otherwise been sold for $180,000. The firm will borrow
$750,000 to finance the acquisition. Total interest expense for 5-years is expected to approximate $350,000.
What is the investment cost of the machine for capital budgeting purposes?
A) $2,180,000
B) $1,780,000
C) $1,442,000
D) $1,430,000
Keywords: Initial Outlay, Sunk Costs
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
58) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased
for $4,550,000. It will cost $65,000 to ship and $190,500 to install the processor. A recently completed
feasibility study that was performed at a cost of $45,000 indicated that the processor would produce a
positive NPV. Studies have shown that employee-training expenses will be $150,000. What is the total
investment in the processing line for capital budgeting purposes?
A) $4,550,000
B) $4,700,000
C) $4,955,500
D) $5,000,500
Keywords: Initial Outlay, Sunk Costs
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
59) Which of the following should NOT be included as investment costs in evaluating a capital asset?
A) interest payments and other financing cash flows that result from raising funds to finance a project
B) employee training expenses
C) shipping expenses
D) installation expenses
Keywords: Incremental Cash Flows, Financing Cash Flows
Learning Obj.: L.O. 11.2
AACSB: Reflective Thinking
25
60) A new machine can be purchased for $1,800,000. It will cost $35,000 to ship and $15,000 to fine-tune
the machine. The new machine will replace an older version that is fully depreciated and will be sold for
$200,000. The firm’s income tax rate is 35%. What is the initial outlay for capital budgeting purposes?
A) $1,580,000
B) $1,630,000
C) $1,650,000
D) $1,720,000
Keywords: Initial Outlay, Tax Effect of Sale of Old Asset
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
61) Waterford Industries is considering the purchase of a new machine. It will replace an existing but
obsolete machine that will be sold for $50,000. The existing machine is 8 years old, cost $200,000, had a 10-
year useful life, and is being depreciated to zero using the straight-line method. Waterford’s income tax
rate is 35%. What is the after-tax salvage value of the old machine?
A) $42,000
B) $46,500
C) $50,000
D) $53,500
Keywords: After-tax Salvage Value, Depreciation
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
62) Alloy Corp. is considering the acquisition of a new processing line. The processor can be purchased
for $3,750,000; it will have a 10-year useful life. It will cost $165,000 to ship and $85,250 to install the
processor. A recently completed feasibility study that was performed at a cost of $65,000 indicated that
the processor would produce a positive NPV. The processor will be depreciated using the straight-line
method to zero expected salvage value. Studies have shown that employee-training expenses will be
$125,000. What will be the annual depreciation expense of the processing line for capital budgeting
purposes?
A) $375,000
B) $419,025
C) $390,000
D) $400,025
Keywords: Initial Depreciation Value, Sunk Costs
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
26
63) Propell Inc. is considering the purchase of a new machine that will cost $178,000, plus an additional
$12,000 to ship and install. The new machine will have a 5-year useful life and will be depreciated using
the straight-line method. The machine is expected to generate new sales of $85,000 per year and is
expected to increase operating costs by $10,000 annually. Propell’s income tax rate is 40%. What is the
projected incremental cash flow of the machine for year 1?
A) $54,800
B) $60,200
C) $66,350
D) $68,200
Keywords: Incremental Cash Flows, Depreciation Expense
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
64) Lasalle Industries is considering the purchase of a new machine that will cost $250,000, plus an
additional $10,000 to ship and install. The new machine will have a 5-year useful life and will be
depreciated to zero using the straight-line method. The machine is expected to have a salvage value of
$30,000 at the end of year five. LaSalle’s income tax rate is 40%. The additional net working capital from
this project of $50,000 is expected to return to its pre-project level upon termination. What is the non-
operating terminal cash flow of the machine?
A) -$32,000
B) $48,000
C) $68,000
D) $80,000
Keywords: Terminal Cash Flow, Recapture of Net Working Capital, Salvage Value
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
65) LaSalle Industries is considering the purchase of a new strapping machine, which will cost $150,000,
plus an additional $10,500 to ship and install. The new machine will have a 5-year useful life and will be
depreciated to zero using the straight-line method. The machine is expected to generate new sales of
$45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years. The
machine is expected to have a salvage value of $20,000. LaSalle’s income tax rate is 35%. What is the
machine‘s IRR?
A) 15.75%
B) 18.86%
C) 19.15%
D) 20.03%
Keywords: Incremental After-Tax Cash Flows, Internal Rate of Return, Initial Outlay, Depreciation Expense
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
27
66) An asset with an original cost of $100,000 and a current book value of $20,000 is sold for $50,000 as
part of a capital budgeting project. The company has a tax rate of 30%. This transaction will have what
impact on the project’s initial outlay?
A) reduce it by $20,000
B) reduce it by $50,000
C) reduce it by $6,000
D) reduce it by $15,000
Keywords: Tax Effect, Initial Outlay
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
67) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being
depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost
the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold
as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten
years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease
by $12,000 per year. AFB’s marginal tax rate is 40%. Additional working capital of $3,000 is required to
maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the
end of the project’s ten-year life. What is the incremental free cash flow during years 2 through 10 of the
project?
A) $13,600
B) $14,400
C) $15,800
D) $16,400
Keywords: Incremental Free Cash Flows
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
28
68) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being
depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost
the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold
as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten
years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease
by $12,000 per year. AFB’s marginal tax rate is 40%. Additional working capital of $3,000 is required to
maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the
end of the project’s ten-year life. What is the project‘s terminal cash flow?
A) $3,000
B) $5,000
C) $6,000
D) $8,000
Keywords: Terminal Cash Flow
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
69) Mountain Recreation, Inc. is considering a new product line. The company currently manufactures
several lines of snow skiing apparel. The new products, insulated ski bikinis, are expected to generate
sales of $1.2 million per year for the next five years. They expect that during this five-year period, they
will lose about $150,000 each year in sales on their existing lines of longer ski pants. The new line will
require no additional equipment or space in the plant and can be produced in the same manner as the
apparel products. The new project will, however, require that the company spend an additional $50,000
per year on insurance in case customers sue for frostbite. Also, a new marketing director would be hired
to oversee the line at $75,000 per year in salary and benefits. Because of the different construction of the
bikinis, an increase in inventory of $9,000 would be required initially. If the marginal tax rate is 35%,
compute the incremental after-tax cash flows for years 1-5.
A) $634,500 per year
B) $625,000 per year
C) $601,250 per year
D) $537,500 per year
Keywords: Incremental After-Tax Cash Flows, Cannibalism, Additional Net Working Capital
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
29
70) Bellington, Inc. is considering the purchase of new, sophisticated machinery for a special three-year
project. The machinery requires a special lubricating oil that probably will never be used, but must be
available at all times should the machine break down. Bellington purchases $2,000 of lubricating oil to
keep on hand just in case it is needed. At the end of the three-year project, it is expected the lubricating oil
can be sold back to the distributor for $2,000. Which of the following statements is MOST correct?
A) The lubricating oil is a sunk cost that should be excluded from the analysis.
B) The $2,000 for the lubricating oil should be excluded from the analysis because it is recovered at the
end of three years, so the final cost is zero.
C) The $2,000 represents an additional investment in working capital that should be included in the
capital budgeting analysis.
D) The $2,000 for lubricating oil is simply an accounting entry and does not represent a real cash flow.
Keywords: Additional Investment in Working Capital
Learning Obj.: L.O. 11.2
AACSB: Reflective Thinking
71) Your company is considering the replacement of an old delivery van with a new one that is more
efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated
using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for
$7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the
company‘s products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years,
at which time the van will be sold for its estimated salvage value of $18,000. The new van will be
depreciated using the simplified straight-line method over its 5-year useful life. The company‘s tax rate is
35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will
be recaptured at the end of year five. What is the tax effect of selling the old machine?
A) a savings of $2,800
B) a savings of $2,450
C) additional taxes paid of $2,450
D) a tax savings of $1,400
Keywords: Tax Effect, Sale of Old Machine, Depreciation
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking
30
72) Your company is considering the replacement of an old delivery van with a new one that is more
efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated
using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for
$7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the
company‘s products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years,
at which time the van will be sold for its estimated salvage value of $18,000. The new van will be
depreciated using the simplified straight-line method over its 5-year useful life. The company‘s tax rate is
35%. Working capital is expected to increase by $5,000 at the inception of the project, but this amount will
be recaptured at the end of year five. What is the initial outlay required to fund this replacement project?
A) $81,200
B) $78,600
C) $74,500
D) $73,580
Keywords: Initial Outlay, Tax Effect of Sale of Old Machine, Depreciation, Net Working Capital
Learning Obj.: L.O. 11.2
AACSB: Analytical Thinking