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Chapter 12: Cash Flow and Risk M/C Problems Page 457
61. Fool Proof 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%, 45%, 15%, and 7%
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. depreciation) $25,000
Tax rate 35.0%
a. $30,258
b. $31,770
c. $33,359
d. $35,027
e. $36,778
62. Your company, CSUS Inc., 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%, 45%, 15%, and 7% 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. depreciation) $25,000
Tax rate 35.0%
a. $11,814
b. $12,436
c. $13,090
d. $13,745
e. $14,432
63. Temple Corp. 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 change in net operating 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 depreciation rate 33.3333%
Sales revenues, each year $65,500
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $15,740
b. $16,569
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c. $17,441
d. $18,359
e. $19,325
64. Liberty Services is now at the end of the final year of a project. 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
65. Marshall-Miller & Company is considering the purchase of a new machine
for $50,000, installed. The machine has a tax life of 5 years, and it
can be depreciated according to the depreciation rates below. 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
66. TexMex Food Company is considering a new salsa 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 change in net operating 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
TexMex 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 depreciation rate 33.333%
Annual sales revenues $67,500
Chapter 12: Cash Flow and Risk M/C Problems Page 459
Annual operating costs (excl. depreciation) -$25,000
Tax rate 35.0%
a. $3,636
b. $3,828
c. $4,019
d. $4,220
e. $4,431
67. Sub-Prime Loan Company is thinking of opening a new office, 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 office. 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 change in net operating 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 depreciation rate for equipment 33.333%
Annual sales revenues $123,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35%
a. $10,521
b. $11,075
c. $11,658
d. $12,271
e. $12,885
68. Desai Industries 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. No change in net
operating working capital would be required. This is just one of many
projects for the firm, so any losses on this project 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 oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation rate per year 5.00%
Tax rate 40.0%
Page 460 M/C Problems Chapter 12: Cash Flow and Risk
a. $15,925
b. $16,764
c. $17,646
d. $18,528
e. $19,455
Chapter 12: Cash Flow and Risk M/C Problems Page 461
69. Poulsen Industries 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. No change in net operating working
capital would be required. This is just one of many projects for the
firm, so any losses on this project 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 inflation adjustment is
required. What is the difference in the expected NPV if the inflation
adjustment is made versus 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 oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation 4.00%
Tax rate 40.0%
a. $12,018
b. $12,650
c. $13,316
d. $13,982
e. $14,681
70. Foley Systems 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 additional net operating 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 from operations are
constant in Years 1 to 3.)
WACC 10.0%
Net investment in fixed assets (basis) $75,000
Required net operating working capital $15,000
Straight-line depreciation rate 33.333%
Annual sales revenues $75,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $23,852
b. $25,045
c. $26,297
d. $27,612
e. $28,993
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71. Thomson Media 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, additional net operating 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 net operating working capital $10,000
Straight-line depreciation rate 33.333%
Annual sales revenues $75,000
Annual operating costs (excl. depreciation) $30,000
Expected pre-tax salvage value $5,000
Tax rate 35.0%
a. $20,762
b. $21,854
c. $23,005
d. $24,155
e. $25,363
72. Florida 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 change in net
operating 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 change? (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 oper. costs (excl. depreciation) $10,000
Variable oper. 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
Chapter 12: Cash Flow and Risk M/C Problems Page 463
73. Aggarwal 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?
WACC = 11.5% Dollars in Thousands NPV This Prob. ×
t = 0 t = 1 t = 2 t = 3 State NPV
Prob. = 20% $800.0 $800.0 $800.0 $938.1 $187.6
Prob. = 60% -$1,000 $520.0 $520.0 $520.0 $259.8 $155.9
Prob. = 20% -$200.0 -$200.0 -$200.0 -$1,484.5 -$296.9
Exp. NPV = $
46.6
a. $55.1
b. $58.0
c. $61.0
d. $64.1
e. $67.3
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