Chapter 9: Fundamentals of Capital Budgeting
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
1) A capital budget lists the potential projects a company may undertake in future years.
2) Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present
value (NPV).
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
3) How does the capital budgeting process begin?
A) by forecasting the future consequences for the firm of each potential project
B) by evaluating the net present value (NPV) of each project’s cash flows
C) by compiling a list of potential projects
D) by analyzing alternate projects
4) What is the ultimate goal of the capital budgeting process?
A) to forecast the consequences of a list of future projects to the firm
B) to determine the effect of the decision to accept or reject a project on the firm’s cash flows
C) to determine how the consequences of making a particular decision affects the firm’s revenues and
costs
D) to list the projects and investments that a company plans to undertake in the future
5) Which of the following best defines incremental earnings?
A) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment
decision
B) the earnings arising from all projects that a company plans to undertake in a fixed timespan
C) the amount by which a firm’s earnings are expected to change as the result of an investment decision
D) cash flows arising from a particular investment decision
6) Which of the following best describes why the predicted incremental earnings arising from a given decision
are not sufficient in and of themselves to determine whether that decision is worthwhile?
A) They do not show how the firm’s earnings are expected to change as the result of a particular decision.
B) They are not easily predicted from historical financial statements of a firm and its competitors.
C) These earnings are not actual cash flows.
D) They do not tell how the decision affects the firm’s reported profits from an accounting perspective.
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
7) What is the correct tax rate that should be used for capital budgeting decisions?
8) How do we handle interest expense when making a capital budgeting decision?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
9) When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales
and costs generated by this process.
10) Interest and other financing–related expenses are excluded when determining a project’s unlevered net
income.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
11) Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost
$6 million 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 have a working life of six
years. Which of these activities will be reported as an operating expense?
A) the delivery and install cost only
B) the delivery and install cost and the cost of the depositor
C) the cost of the depositor only
D) the redesign of the plant only
12) Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost
$6 million 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 have a working life of six
years. If straight–line depreciation is used, what are the yearly depreciation expenses in this case?
A) $1,500,000
B) $1,501,667
C) $1,000,000
D) $1,001,667
13) An oil company is buying a semi–submersible oil rig for $20 million. Additionally, it will cost $1.5 million to
move the oil rig to the oil–field and to prepare it for operations. If it is depreciated over five years using
straight–line depreciation, what are the yearly depreciation expenses in this case?
A) $4.0 million
B) $3.8 million
C) $5.0 million
D) $4.3 million
14) Which of the following is usually NOT a factor that must be considered when estimating the revenues and
costs arising from a new product?
A) the sales of a new product will typically accelerate, plateau, and ultimately decline over time
B) the fluctuations in the cost of capital over the period in question
C) competition tends to reduce profit margins over time in most industries
D) the prices of technology products generally fall over time
15) Vernon–Nelson Chemicals is planning to release a new brand of insecticide, Bee–Safe, that will kill many
insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $20
million, and there will be an additional $2 million cost to reconfigure existing plant. The equipment is
expected to have a lifetime of eight years and will be depreciated by the straight–line method over its lifetime.
The firm expects that they should be able to sell 1,500,000 gallons per year at a price of $52 per gallon. It will
take $38 per gallon to manufacture and support the product. If Vernon–Nelson’s marginal tax rate is 40%,
what are the incremental earnings in year 3 of this project?
A) $18.5 million
B) $10.5 million
C) $12.6 million
D) $11.1 million
16) CathFoods will release a new range of candies which contain anti–oxidants. New equipment to manufacture
the candy will cost $2 million, which will be depreciated by straight–line depreciation over five 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 five years with production and support costs of $1.5
million per year. If CathFood’s marginal tax rate is 35%, what are the incremental earnings in the second year
of this project?
A) $2.100 million
B) $1.500 million
C) $1.753 million
D) $1.365 million
17) A small manufacturer that makes clothespins and other household products buys new injection molding
equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same
amount of time with an estimated increase in sales of 15%. If the manufacturer currently makes 75 tons of
clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the
new equipment?
A) $202,500
B) $20,700
C) $80,500
D) $857,000
18) Which of the following factors that a manager should bear in mind when estimating a project’s revenues and
costs is NOT correct?
A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated
or faces increased competition.
B) Prices and costs tend to rise with the general level of inflation in the economy.
C) A new product typically has its highest sales immediately after release as customers are attracted by the
novelty of the product.
D) The prices of technology products tend to fall over time as newer, superior technologies emerge and
production costs decline.
19) A brewer is launching a new product; brewed ginger ale with a low alcohol content. The brewer plans to
spend $4 million promoting this product this year, which is expected to expand its sales of this product to
$10 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year
and next year in their other products as customers switch to drinking the new ginger ale. The gross profit
margin for the new ginger ale is 40%, the gross profit margin of all of the brewer’s other products is 30%, and
the brewer’s marginal corporate tax rate is 35%. What are incremental earnings arising from the promotional
campaign this year?
A) $4.290 million
B) $4.68 million
C) $1.95 million
D) $5.28 million
20) A stationery company plans to launch a new type of indelible ink pen. Advertising for the new product will
be heavy and will cost the company $10 million, although the company expects general revenues of $280
million next year from sources other than sales of the new pen. If the company has a corporate tax–rate of
40% on its pretax income, what effect will the advertising for the new pen have on its taxes?
A) Increase taxes by $10 million
B) Reduce taxes by $4 million
C) It will have no effect on taxes.
D) Increase taxes by $4 million
21) Which of the following statements is FALSE?
A) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pretax
income.
C) The opportunity cost of using a resource is the value it could have provided in its best alternative use.
D) We begin the capital budgeting process by determining the incremental earnings of a project.
22) Which of the following statements is FALSE?
A) When evaluating a capital budgeting decision, we generally include interest expense.
B) Many projects use a resource that the company already owns.
C) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by
forecasting earnings.
D) Only include as incremental expenses in your capital budgeting analysis the additional overhead
expenses that arise because of the decision to take on the project.
23) Which of the following costs would you consider when making a capital budgeting decision?
A) interest expense
B) fixed overhead cost
C) sunk cost
D) opportunity cost
24) A decrease in the sales of a current project because of the launching of a new project is
A) an overhead expense.
B) irrelevant to the investment decision.
C) cannibalization.
D) a sunk cost.
Use the information for the question(s) below.
Ford Motor Company is considering launching a new line of hybrid diesel–electric SUVs. The heavy advertising
expenses associated with the new SUV launch would generate operating losses of $35 million next year. Without the
new SUV, Ford expects to earn pretax income of $80 million from operations next year. Ford pays a 30% tax rate on its
pretax income.
25) The amount that Ford Motor Company owes in taxes next year without the launch of the new SUV is closest
to:
A) $24.0 million
B) $31.5 million
C) $56.0 million
D) $13.5 million
26) The amount that Ford Motor Company owes in taxes next year with the launch of the new SUV is closest to:
A) $13.5 million
B) $24.0 million
C) $31.5 million
D) $56.0 million
Use the information for the question(s) below.
Food For Less (FFL), a grocery store, is considering offering one–hour photo developing in their store. The firm expects
that sales from the new one–hour machine will be $150,000 per year. FFL currently offers overnight film processing with
annual sales of $100,000. While many of the one–hour photo sales will be to new customers, FFL estimates that 60% of
their current overnight photo customers will switch and use the one–hour service.
27) The level of incremental sales associated with introducing the new one hour photo service is closest to:
A) $90,000
B) $60,000
C) $120,000
D) $150,000
Use the information for the question(s) below.
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 2000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 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 2% of its annual sales in cash, 4%
of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts
payable. The firm is in the 35% tax bracket and has a cost of capital of 10%.
28) The depreciation tax shield for the Sisyphean Corporation’s project in the first year is closest to:
A) $5200
B) $2800
C) $8000
D) $3500
29) Which of the following would you NOT consider when making a capital budgeting decision?
A) The cost of a marketing study completed last year.
B) The additional taxes a firm would have to pay in the next year.
C) The change in direct labor expense due to the purchase of a new machine.
D) The opportunity to lease out a warehouse instead of using it to house a new production line.
30) Which of the following is an example of cannibalization?
A) A convenience store begins selling pre–paid cell phones.
B) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A grocery store begins selling T–shirts featuring the local university’s mascot.
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
31) How are the taxes paid under MACRS different from that paid under straight–line depreciation?
32) If available, should MACRS be preferred to straight–line depreciation?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
33) To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm’s earnings.
34) The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the
changes in Net Working Capital.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
35) Which of the following adjustments should NOT be made when computing free cash flow from incremental
earnings?
A) adding depreciation
B) subtracting increases in Net Working Capital
C) subtracting depreciation expenses from taxable earnings
D) subtracting all non–cash expenses
36) Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost
$6 million 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 profits by $4
million per year, starting at the end of the first 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 flows associated with the new machine in year
2?
A) $1,001,667
B) $1,298,917
C) $3,247,834
D) $2,200,667
37) 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
38) Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost
$6 million 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 profits by $4
million per year, starting at the end of the first 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 flows associated with the new machine in year
1?
A) –$6,000,000
B) –$6,010,000
C) –$3,709,417
D) $1,001,667
39) 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 five 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 five 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 flows in the
second year of this project?
A) $2.015 million
B) $1.765 million
C) $2.500 million
D) $2.415 million
Use the table for the question(s) below.
Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
Cash 50 Accounts payable 42
Accounts receivable 22 Total current liabilities 42
Inventories 17
Total current assets 89
Long–Term Assets Long–Term Liabilities
Net property, plant,
and equipment 121 Long–term debt 128
Total long–term assets 121 Total long–term liabilities 128
Total Assets 210 Total Liabilities 170
Stockholders’ Equity 40
Total Liabilities and 210
Stockholders’ Equity
40) The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is this
firm’s Net Working Capital?
A) $30,000
B) $89,000
C) $40,000
D) $47,000
41) A firm reports that in a certain year it had a net income of $4.5 million, depreciation expenses of $2.8 million,
capital expenditures of $2.3 million, and Net Working Capital decreased by $1.5 million. What is the firm’s
free cash flow for that year?
A) $6.5 million
B) $2.4 million
C) $8.1 million
D) $11.1 million
42) A company buys tracking software for its warehouse which, along with the computer system and ancillaries
to run it, will cost $1.8 million. This purchase will be deducted over five years. It is expected that the
software will reduce inventory by $10.5 million at the end of the first 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 flows in the first year?
A) $10,422,000
B) $10,566,000
C) $10,278,000
D) $10,020,000
43) Year 0 Year 1 Year 2 Year 3
Revenues 800,000 800,000 800,000
Costs of Goods Sold –320,000 –320,000 –320,000
Gross Profit 480,000 480,000 480,000
Selling, General and Admin –105,000 –105,000 –105,000
Depreciation –200,000 –200,000 –200,000
EBIT 175,000 175,000 175,000
Income tax (35%) –61,250 –61,250 –61,250
Incremental Earnings 113,750 113,750 113,750
Capital Purchases –600,000
Changes to NWC –12,000 –12,000 –12,000
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 8.5%, what is the net present value (NPV) of this project?
A) –$153,046
B) $231,973
C) $300,691
D) –$278,832
44) Year 0 Year 1 Year 2 Year 3 Year 4
Revenues 120,000 400,000 400,000 300,00
Costs of Goods Sold –60,000 –200,000 –200,000 –150,000
Gross Profit 60,000 200,000 200,000 150,000
Selling, General and Admin –6,000 –6,000 –6,000 –6,000
Depreciation –70,000 –70,000 –70,000 –70,000
EBIT –16,000 124,000 124,000 74,000
Income tax (35%) 5,600 –43,400 –43,400 –25,900
Incremental Earnings –10,400 80,600 80,600 48,100
Capital Purchases –280,000
Changes to NWC –5,000 –5,000 –5,000 –5,000
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) –$214,525
B) $108,306
C) $76,607
D) –$145,283
45) Your firm is considering building a new office complex. Your firm already owns land suitable for the new
complex. The current book value of the land is $100,000; however, a commercial real estate agent has
informed you that an outside buyer is interested in purchasing this land would be willing to pay $650,000 for
it. When calculating the net present value (NPV) of your new office complex, ignoring taxes, the
appropriate incremental cash flow for the use of this land is:
A) $100,000
B) $650,000
C) $0
D) $750,000
46) You are considering adding a microbrewery onto one of your firm’s existing restaurants. This will entail an
increase in inventory of $8000, an increase in accounts payables of $2500, and an increase in property, plant,
and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital
resulting from the addition of the microbrewery is:
A) $45,500
B) $6,500
C) $10,500
D) $5,500
47) You are considering adding a microbrewery onto one of your firm’s existing restaurants. This will entail an
investment of $40,000 in new equipment. This equipment will be depreciated straight line over five years.
If your firm’s marginal corporate tax rate is 35%, then what is the value of the microbrewery’s depreciation
tax shield in the first year of operation?
A) $2800
B) $5200
C) $26,000
D) $14,000
48) The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5
million. If Sisyphean’s marginal corporate tax rate is 40% 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) $1,000,000
B) $750,000
C) $1,750,000
D) $1,500,000
Use the information for the question(s) below.
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 2000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit to manufacture of $9 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 2% of its annual sales in cash, 4%
of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts
payable. The firm is in the 35% tax bracket and has a cost of capital of 10%.
49) The required net working capital in the first year for the Sisyphean Corporation’s project is closest to:
A) $3600
B) $5400
C) $2880
D) $3960
50) The required net working capital in the second year for the Sisyphean Corporation’s project is closest to:
A) $5940
B) $4360
C) $3190
D) $3960
51) The change in net working capital from year 1 to year 2 is closest to:
A) a decrease of $396
B) a decrease of $360
C) an increase of $396
D) an increase of $360
52) Bubba Ho–Tep Company reported net income of $300 million for the most recent fiscal year. The firm had
depreciation expenses of $125 million and capital expenditures of $150 million. Although it had no interest
expense, the firm did have an increase in net working capital of $20 million. What is Bubba Ho–Tep’s free
cash flow?
A) $5 million
B) $255 million
C) $150 million
D) $170 million
Use the information for the question(s) below.
Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing
facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups
providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will
generate $20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are
expected to total $12 million during this year and depreciation expense will be another $3 million. THSI will require no
working capital for this investment. THSI’s marginal tax rate is 35%.
53) Ignoring the original investment of $5 million, what is THSI’s free cash flow for the first and only year of
operation?
A) $8.0 million
B) $6.25 million
C) $5.0 million
D) $3.75 million
54) Assume that THSI’s cost of capital for this project is 15%. The net present value (NPV) of this temporary
housing project is closest to:
A) –$435,000
B) $1,960,000
C) $435,000
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the
project will produce the following cash flows for the first two years (in millions).
Year
1
2
Revenues
1200
1400
Operating expense
450
525
Depreciation
240
280
Increase in working capital
60
70
Capital expenditures
300
350
Marginal corporate tax rate
30%
30%
55) The depreciation tax shield for Shepard Industries project in year 1 is closest to:
A) $168
B) $96
C) $84
D) $72
56) The depreciation tax shield for Shepard Industries project in year 2 is closest to:
A) $196
B) $84
C) $96
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on
using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following
incremental cash flow projects:
Year
0
1
2
3
Sales (Revenues)
100,000
100,000
100,000
– Cost of Goods Sold (50% of Sales)
50,000
50,000
50,000
– Depreciation
30,000
30,000
30,000
= EBIT
20,000
20,000
20,000
– Taxes (35%)
7000
7000
7000
= unlevered net income
13,000
13,000
13,000
+ Depreciation
30,000
30,000
30,000
+ changes to working capital
–5000
–5000
10,000
– capital expenditures
–90,000
57) The free cash flow for the first year of Epiphany‘s project is closest to:
A) $25,000
B) $45,000
C) $43,000
D) $38,000
58) The free cash flow for the last year of Epiphany‘s project is closest to:
A) $43,000
B) $38,000
C) $53,000
D) $35,000
59) The net present value (NPV) for Epiphany’s Project is closest to:
A) $4825
B) $20,400
C) $11,946
D) $39,000
60) Luther Industries has outstanding tax loss carryforwards of $70 million from losses over the past four years.
If Luther earns $15 million per year in pretax income from now on, in how many years will Luther first pay
taxes?
A) 5 years
B) 2 years
C) 7 years
D) 4 years
61) A firm is considering changing their credit terms. It is estimated that this change would result in sales
increasing by $1,000,000. This in turn would cause inventory to increase by $150,000, accounts receivable to
increase by $100,000, and accounts payable to increase by $75,000. What is the firm’s expected change in net
working capital?
A) $250,000
B) $325,000
C) $175,000
D) $1,175,000
62) A firm is considering investing in a new machine that will cost $600,000 and will be depreciated straight–line
over five years. If the firm‘s marginal tax rate is 39%, what is the annual depreciation tax shield of
purchasing the machine?
A) $46,800
B) $120,000
C) $234,000
D) $$07,692
63) A firm is considering a new project that will generate cash revenue of $1,000,000 and cash expenses of
$700,000 per year for five years. The equipment necessary for the project will cost $200,000 and will be
depreciated straight line over four years. What is the expected free cash flow in the second year of the project
if the firm’s marginal tax rate is 35%?
A) $212,500
B) $195,000
C) $162,500
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
64) If a business owner is using the extra space at home for his business, does it imply a zero opportunity cost for
the space?
65) What are project externalities?
66) What are sunk costs?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
67) Firms should use the most accelerated depreciation scheme allowable.
68) An announcement by the government that they will decrease corporate marginal tax rates in the future
would increase the attractiveness of MACRS depreciation.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
69) A company spends $20 million researching whether it is possible to create a durable plastic from the process
waste from feedstock preparation. How should the $20 million best be considered?
A) as a capital cost
B) as a fixed overhead expense
C) as an opportunity cost
D) as a sunk cost
70) Joe pre–orders a non–refundable movie ticket. He then reads a number of reviews of the movie in question
that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his
money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why?
A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
B) No, because he incurred no further costs by going to see the movie.
C) No, because the cost of the movie was not recoverable and would have been lost whatever action he
took.
D) No, because going to see the movie means that the product of his initial investment was realized as
originally planned.
71) An insurance office owns a large building downtown. The sixth floor of this building currently houses its
entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be
rented and for what price, the company must decide whether to split the Human Resources Department
between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as
they currently are. Which of the following should NOT be considered when deciding whether to rent out the
sixth floor?
A) cost involved with a loss of efficiency resulting from the Human Resources Department being split
between several spaces
B) the cost of the research into the feasibility of renting the sixth floor
C) the cost of refurbishing the new space to be occupied by the Human Resources Department
D) the amount obtained by renting the sixth floor
72) Year 0 Year 1 Year 2 Year 3
MACRS
Depreciation Rate 33.33% 44.45% 14.81% 7.41%
A fast–food company invests $2.4 million to buy machines for making slurpies. These can be depreciated
using the MACRS schedule shown above. If the cost of capital is 10%, what is the increase in the net present
value (NPV) of the product gained by using MACRS depreciation over straight–line depreciation for three
years?
A) $34,452
B) $78,084
C) $207,702
D) $66,782
73) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
MACRS
Depreciation Rate 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%
A textile company invests $12 million in an open–end spinning machine. This was depreciated using the
seven–year MACRS schedule shown above. If the company sold it immediately after the end of year 3 for $7
million, what would be the after–tax cash flow from the sale of this asset, given a tax rate of 40%?
A) $2,076,880
B) $5,699,520
C) $1,300,480
D) $1,950,720
74) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
MACRS
Depreciation Rate 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%
A bakery invests $30,000 in a light delivery truck. This was depreciated using the five–year MACRS schedule
shown above. If the company sold it immediately after the end of year 2 for $22,000, what would be the
after–tax cash flow from the sale of this asset, given a tax rate of 40%?
A) $8,544
B) $16,656
C) $5,184
D) $8,640
75) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
MACRS
Depreciation Rate 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%
Massive Amusements, an owner of theme parks, invests $60 million to build a roller coaster. This can be
depreciated using the MACRS schedule shown above. How much less is the depreciation tax shield for year
4 under MACRS depreciation than under 7–year, straight–line depreciation,if the tax rate is 40%?
A) $2,143,200
B) $1,077,429
C) $6,428,229
D) $1,285,371
Use the table for the question(s) below.
Year 0 Year 1 Year 2 Year 3