Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
Chapter 13 Appendix C Income Taxes in Capital Budgeting Decisions Answer
Key
True / False Questions
1. The reduction in taxes made possible by the annual depreciation deductions equals the
depreciation deduction multiplied by the tax rate.
2. The release of working capital at the end of an investment project is a taxable cash inflow.
3. Not all cash inflows are taxable.
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
4. When a company invests in equipment, it gets to immediately expense the cost of the
equipment on the company’s tax reports.
Multiple Choice Questions
5. In an equipment selection capital budgeting decision, which of the following will increase
the present value of the tax savings from the annual depreciation deductions?
6. Depreciation expense reduces income taxes by an amount equal to:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
7. The after-tax cost of a deductible cash expense is:
8. Last year the sales at Jersey Company were $200,000 and were all cash sales. The expenses
at Jersey were $125,000 and were all cash expenses. The tax rate was 30%. The after-tax net
cash inflow at Jersey last year from these operations was:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
9. A company anticipates a taxable cash receipt of $30,000 in year 2 of a project. The
company’s tax rate is 30% and its discount rate is 10%. The present value of this future cash
flow is closest to:
10. Consider a machine which costs $115,000 now and which has a useful life of seven years.
This machine will require a major overhaul at the end of the fourth year which will cost “X”
dollars. If the tax rate is 40%, and if the after-tax cash outflow for this overhaul is $3,600,
then the amount of “X” in dollars is:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
11. Ring Corporation uses a discount rate of 12% and has a tax rate of 30%. The following
cash flows occur in the third year of an equipment selection investment project:
The total after-tax present value of the cash flows is closest to:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
12. Superstrut is considering replacing an old press that cost $80,000 six years ago with a new
one that would cost $245,000. The old press has a net book value of $15,000 and could be
sold for $5,000. The increased production of the new press would require an investment in
additional working capital of $6,000. The company’s tax rate is 40%. Superstrut’s net
investment now in the project would be:
13. A company needs an increase in working capital of $10,000 in a project that will last 4
years. The company’s tax rate is 30% and its discount rate is 8%. The present value of the
release of the working capital at the end of the project is closest to:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
14. The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office
across town. The firm would sign a 5-year lease for a fully furnished office for $24,000 per
year. The lease also requires a $30,000 security deposit upon signing. This deposit will be
given back at the end of the 5-year lease term. No other amounts will need to be invested.
However, additional operating costs are expected to be $65,000 per year for the 5 years. The
firm expects to generate an additional $100,000 of revenue per year for the 5 years from the
branch office. The firm’s after-tax cost of capital is 16% and its tax rate is 30%. The net
present value of this investment project is closest to:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
15. A company anticipates a taxable cash expense of $80,000 in year 2 of a project. The
company’s tax rate is 30% and its discount rate is 10%. The present value of this future cash
flow is closest to:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
16. Last year the sales at Seidelman Company were $700,000 and were all cash sales. The
company’s expenses were $450,000 and were all cash expenses. The tax rate was 35%. The
after-tax net cash inflow at Seidelman last year was:
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
17. Last year the sales at Summit Company were $400,000 and were all cash sales. The
expenses at Summit were $250,000 and were all cash expenses. The tax rate was 40%. The
after-tax net cash inflow at Summit last year was:
18. Suppose a machine costs $20,000 now, has an expected life of eight years, and will
require a $7,000 overhaul at the end of the third year. If the tax rate is 40%, then the after-tax
cost of this overhaul would be:
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19. A company anticipates a depreciation deduction of $20,000 in year 3 of a project. The
company’s tax rate is 30% and its discount rate is 14%. The present value of the annual
depreciation deductions resulting from this deduction is closest to:
Burry Inc. has provided the following data to be used in evaluating a proposed investment
project:
For tax purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 5 years. The company uses a discount rate of 11%.
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
20. When computing the net present value of the project, what are the annual after-tax cash
receipts?
21. When computing the net present value of the project, what are the annual after-tax cash
expenses?
Chapter 13 – Appendix C Income Taxes in Capital Budgeting Decisions
22. By how much does the depreciation deduction reduce taxes each year in which the
depreciation deduction is taken?
23. When computing the net present value of the project, what is the after-tax cash flow from
the salvage value in the final year?