58. Which of the following statements is CORRECT?
a.
Only incremental cash flows are relevant in project analysis, the proper incremental cash
flows are the reported accounting profits, and thus reported accounting income should be
used as the basis for investor and managerial decisions.
b.
It is unrealistic to believe that any increases in net working capital required at the start of
an expansion project can be recovered at the project’s completion. Working capital like
inventory is almost always used up in operations. Thus, cash flows associated with
working capital should be included only at the start of a project’s life.
c.
If equipment is expected to be sold for more than its book value at the end of a project’s
life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project
cash flow will be greater than if the asset had been sold at book value, other things held
constant.
d.
Changes in net working capital refer to changes in current assets and current liabilities, not
to changes in long-term assets and liabilities. Therefore, changes in net working capital
should not be considered in a capital budgeting analysis.
e.
If an asset is sold for less than its book value at the end of a project’s life, it will generate a
loss for the firm, hence its terminal cash flow will be negative.
59. You have just landed an internship in the CFO’s office of Hawkesworth Inc. Your first task is to
estimate the Year 1 cash flow for a project with the following data. What is the Year 1 cash flow?
Sales revenues
$13,000
Depreciation
$4,000
Other operating costs
$6,000
Tax rate
35.0%
a.
$5,950
b.
$6,099
c.
$6,251
d.
$6,407
e.
$6,568
Sales revenues
$13,000
Operating income (EBIT)
After-tax EBIT
60. In your first job with TBL Inc. your task is to consider a new project whose data are shown below.
What is the project’s Year 1 cash flow?
Sales revenues
$22,250
Depreciation
$8,000
Other operating costs
$12,000
Tax rate
35.0%
a.
$8,903
b.
$9,179
c.
$9,463
d.
$9,746
e.
$10,039
Sales revenues
Operating income (EBIT)
After-tax EBIT
+ Depreciation
Cash flow, Year 1
61. Fitzgerald Computers is considering a new project whose data are shown below. The required
equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the
straight-line method over 3 years. Revenues and other operating costs are expected to be constant over
the project’s 3-year life. What is the project’s Year 1 cash flow?
Equipment cost (depreciable basis)
$65,000
Straight-line depreciation rate
33.333%
Sales revenues, each year
$60,000
Operating costs (excl. deprec.)
$25,000
+ Depreciation
Cash flow, Year 1
Tax rate
35.0%
a.
$28,115
b.
$28,836
c.
$29,575
d.
$30,333
e.
$31,092
62. VR Corporation has the opportunity to invest in a new project, the details of which are shown below.
What is the Year 1 cash flow for the project?
Sales revenues, each year
$42,500
Depreciation
$10,000
Other operating costs
$17,000
Interest expense
$4,000
Tax rate
35.0%
a.
$16,351
b.
$17,212
c.
$18,118
d.
$19,071
e.
$20,075
Sales revenues
$42,500
Equipment life, years
Equipment cost
$65,000
Depreciation:
Rate = 33.333%
$21,667
Sales revenues
$60,000
Operating income (EBIT)
$13,333
After-tax EBIT
+ Depreciation
Cash flow, Year 1
$30,333
63. Taylor Inc., the company you work for, is considering a new project whose data are shown below.
What is the project’s Year 1 cash flow?
Sales revenues, each year
$62,500
Depreciation
$8,000
Other operating costs
$25,000
Interest expense
$8,000
Tax rate
35.0%
a.
$25,816
b.
$27,175
c.
$28,534
d.
$29,960
e.
$31,458
Sales revenues
$62,500
Operating income (EBIT)
$29,500
After-tax EBIT
$19,175
+ Depreciation
Cash flow, Year 1
$27,175
Operating income (EBIT)
$15,500
After-tax EBIT
$10,075
+ Depreciation
Cash flow, Year 1
$20,075
64. Erickson Inc. is considering a capital budgeting project that has an expected return of 25% and a
standard deviation of 30%. What is the project’s coefficient of variation?
a.
1.20
b.
1.26
c.
1.32
d.
1.39
e.
1.46
65. McLeod Inc. is considering an investment that has an expected return of 15% and a standard deviation
of 10%. What is the investment’s coefficient of variation?
a.
0.67
b.
0.73
c.
0.81
d.
0.89
e.
0.98
Standard deviation
10.0%
Coefficient of variation = Std dev/Expected return =
66. Your new employer, Freeman Software, is considering a new project whose data are shown below.
The equipment that would be used has a 3-year tax life, and the allowed depreciation rates for such
property are 33.33%, 44.45%, 14.81%, and 7.41% for Years 1 through 4. Revenues and other
operating costs are expected to be constant over the project’s 10-year expected life. What is the Year 1
cash flow?
Equipment cost (depreciable basis)
$65,000
Sales revenues, each year
$60,000
Operating costs (excl. deprec.)
$25,000
Tax rate
35.0%
a.
$30,333
b.
$31,849
c.
$33,442
d.
$35,114
Expected return
Standard deviation
30.0%
Coefficient of variation = Std dev/Expected return =
e.
$36,869
67. Whitestone Products is considering a new project whose data are shown below. The required
equipment has a 3-year tax life, and the accelerated rates for such property are 33.33%, 44.45%,
14.81%, and 7.41% for Years 1 through 4. Revenues and other operating costs are expected to be
constant over the project’s 10-year expected operating life. What is the project’s Year 4 cash flow?
Equipment cost (depreciable basis)
$70,000
Sales revenues, each year
$42,500
Operating costs (excl. deprec.)
$25,000
Tax rate
35.0%
a.
$11,904
b.
$12,531
c.
$13,190
d.
$13,850
e.
$14,542
Equipment cost
$70,000
Depreciation rate, Year 4
Sales revenues
$42,500
Operating income (EBIT)
$12,313
After-tax EBIT
+ Depreciation
Cash flow, Year 4
$13,190
Equipment cost
$65,000
Depreciation rate
Sales revenues
$60,000
Operating income (EBIT)
$13,336
After-tax EBIT
+ Depreciation
Cash flow, Year 1
$30,333
68. DeVault Services recently hired you as a consultant to help with its capital budgeting process. The
company is considering a new project whose data are shown below. The equipment that would be used
has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would
have a zero salvage value. No new working capital would be required. Revenues and other operating
costs are expected to be constant over the project’s 3-year life. What is the project’s NPV?
Risk-adjusted WACC
10.0%
Net investment cost (depreciable basis)
$65,000
Straight-line deprec. rate
33.3333%
Sales revenues, each year
$65,500
Operating costs (excl. deprec.), each year
$25,000
Tax rate
35.0%
a.
$15,740
b.
$16,569
c.
$17,441
d.
$18,359
e.
$19,325
WACC
10.0%
Years
Sales revenues
Operating income (EBIT)
After-tax EBIT
+ Depreciation
NPV
69. Kasper Film Co. is selling off some old equipment it no longer needs because its associated project has
come to an end. The equipment originally cost $22,500, of which 75% has been depreciated. The firm
can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment’s after-tax
salvage value for use in a capital budgeting analysis? Note that if the equipment’s final market value is
less than its book value, the firm will receive a tax credit as a result of the sale.
a.
$5,558
b.
$5,850
c.
$6,143
d.
$6,450
e.
$6,772
70. McPherson Company must purchase a new milling machine. The purchase price is $50,000, including
installation. The machine has a tax life of 5 years, and it can be depreciated according to the following
rates. The firm expects to operate the machine for 4 years and then to sell it for $12,500. If the
marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end
of Year 4?
Year
Depreciation Rate
1
0.20
2
0.32
3
0.19
4
0.12
5
0.11
6
0.06
a.
$8,878
b.
$9,345
c.
$9,837
d.
$10,355
e.
$10,900
71. Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown
below. The equipment to be used would be depreciated by the straight-line method over its 3-year life
and would have a zero salvage value, and no new working capital would be required. Revenues and
other operating costs are expected to be constant over the project’s 3-year life. However, this project
would compete with other Weston’s products and would reduce their pre-tax annual cash flows. What
is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)
WACC
10.0%
Pre-tax cash flow reduction for other products (cannibalization)
$5,000
Investment cost (depreciable basis)
$80,000
Straight-line deprec. rate
33.333%
Sales revenues, each year for 3 years
$67,500
Annual operating costs (excl. deprec.)
$25,000
Tax rate
35.0%
a.
$3,636
b.
$3,828
c.
$4,019
d.
$4,220
e.
$4,431
t = 0
t = 2
t = 3
Sales revenues
$50,000
$10,000
$40,000
50,000
14,500
50,000
$50,000
Gross sales proceeds (Market value)
$12,500
Book value, end of Year 4
Profit
$ 4,000
Tax on profit
Rate = 40%
AT salvage value = market value +/− taxes
72. Century Roofing is thinking of opening a new warehouse, and the key data are shown below. The
company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides
not to open the new warehouse. The equipment for the project would be depreciated by the straight-
line method over the project’s 3-year life, after which it would be worth nothing and thus it would have
a zero salvage value. No new working capital would be required, and revenues and other operating
costs would be constant over the project’s 3-year life. What is the project’s NPV? (Hint: Cash flows are
constant in Years 1-3.)
WACC
10.0%
Opportunity cost
$100,000
Net equipment cost (depreciable basis)
$65,000
Straight-line deprec. rate for equipment
33.333%
Sales revenues, each year
$123,000
Operating costs (excl. deprec.), each year
$25,000
Tax rate
35%
a.
$10,521
b.
$11,075
c.
$11,658
d.
$12,271
e.
$12,885
Revenues
Operating income (EBIT)
After-tax EBIT
+ Depreciation
NPV
$12,271
After-tax EBIT
+ Depreciation
NPV
$3,828
73. Garden-Grow Products is considering a new investment whose data are shown below. The equipment
would be depreciated on a straight-line basis over the project’s 3-year life, would have a zero salvage
value, and would require some additional working capital that would be recovered at the end of the
project’s life. Revenues and other operating costs are expected to be constant over the project’s life.
What is the project’s NPV? (Hint: Cash flows are constant in Years 1 to 3.)
WACC
10.0%
Net investment in fixed assets (basis)
$75,000
Required new working capital
$15,000
Straight-line deprec. rate
33.333%
Sales revenues, each year
$75,000
Operating costs (excl. deprec.), each year
$25,000
Tax rate
35.0%
a.
$23,852
b.
$25,045
c.
$26,297
d.
$27,612
e.
$28,993
74. Sheridan Films is considering some new equipment whose data are shown below. The equipment has a
3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would
have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down.
Also, some new working capital would be required, but it would be recovered at the end of the
project’s life. Revenues and other operating costs are expected to be constant over the project’s 3-year
life. What is the project’s NPV?
WACC
10.0%
Net investment in fixed assets (depreciable basis)
$70,000
Required new working capital
$10,000
Straight-line deprec. rate
33.333%
Sales revenues, each year
$75,000
Operating costs (excl. deprec.), each year
$30,000
Expected pretax salvage value
$5,000
Tax rate
35.0%
a.
$20,762
b.
$21,854
c.
$23,005
d.
$24,155
e.
$25,363
75. Shultz Business Systems is analyzing an average-risk project, and the following data have been
developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs
will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it
will be depreciated on a straight-line basis, and there will be no salvage value. This is just one of many
projects for the firm, so any losses can be used to offset gains on other firm projects. What is the
project’s expected NPV?
WACC
10.0%
Net investment cost (depreciable basis)
$200,000
Units sold
50,000
Average price per unit, Year 1
$25.00
Fixed op. cost excl. deprec. (constant)
$150,000
Variable op. cost/unit, Year 1
$20.20
Annual depreciation rate
33.333%
Expected inflation rate per year
5.00%
Tax rate
40.0%
a.
$15,925
b.
$16,764
c.
$17,646
d.
$18,528
e.
$19,455
76. Sylvester Media is analyzing an average-risk project, and the following data have been developed.
Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be
constant, but variable costs should rise with inflation. The project should last for 3 years, it will be
depreciated on a straight-line basis, and there will be no salvage value. This is just one of many
projects for the firm, so any losses can be used to offset gains on other firm projects. The marketing
manager does not think it is necessary to adjust for inflation since both the sales price and the variable
costs will rise at the same rate, but the CFO thinks an adjustment is required. What is the difference in
the expected NPV if the inflation adjustment is made vs. if it is not made?
WACC
10.0%
Net investment cost (depreciable basis)
$200,000
Units sold
50,000
Average price per unit, Year 1
$25.00
Fixed op. cost excl. deprec. (constant)
$150,000
Variable op. cost/unit, Year 1
$20.20
Annual depreciation rate
33.333%
Expected inflation
4.00%
Tax rate
35.0%
a.
$13,286
b.
$13,985
c.
$14,721
d.
$15,457
e.
$16,230
77. Spot-Free Car Wash is considering a new project whose data are shown below. The equipment to be
used has a 3-year tax life, would be depreciated on a straight-line basis over the project’s 3-year life,
and would have a zero salvage value after Year 3. No new working capital would be required.
Revenues and other operating costs will be constant over the project’s life, and this is just one of the
firm’s many projects, so any losses on it can be used to offset profits in other units. If the number of
cars washed declined by 40% from the expected level, by how much would the project’s NPV decline?
(Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)
WACC
10.0%
Net investment cost (depreciable basis)
$60,000
Number of cars washed
2,800
Average price per car
$25.00
Fixed op. cost (excl. deprec.)
$10,000
Variable op. cost/unit (i.e., VC per car washed)
$5.375
Annual depreciation
$20,000
Tax rate
35.0%
a.
$28,939
b.
$30,462
c.
$32,066
d.
$33,753
e.
$35,530
78. Brandt Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the
following simple decision tree to show its three most likely scenarios. The firm could arrange with its
work force and suppliers to cease operations at the end of Year 1 should it choose to do so, but to
obtain this abandonment option, it would have to make a payment to those parties. How much is the
option to abandon worth to the firm?
a.
$55.08
b.
$57.98
c.
$61.03
d.
$64.08
e.
$67.29
