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41)
Which of the following statements is false?
41)
A)
The firm deducts a fraction of the investments in plant, property, and equipment each year as
depreciation.
B)
Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in
capital budgeting analysis.
C)
A good rule to remember is that if our decision does not affect a cash flow then the cash flow
should not affect our decision.
D)
If securities are fairly priced, the net present value of a fixed set of cash flows is independent
of how those cash flows are financed.
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 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. 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 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
42)
The required net working capital in the first year for the Sisyphean Corporation's project is closest
to:
42)
A)
$5,400
B)
$3,600
C)
$2,880
D)
$3,960
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 pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on its pre-tax income.
43)
The amount that Ford Motor Company owe in taxes next year without the launch of the new SUV
is closest to:
43)
A)
$31.5 million
B)
$13.5 million
C)
$56.0 million
D)
$24.0 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.
44)
The level of incremental sales associated with introducing the new one hour photo service is closest
to:
44)
A)
$150,000
B)
$90,000
C)
$60,000
D)
$120,000
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 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. 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 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
45)
The incremental unlevered net income in the first year for the Sisyphean Corporation's project is
closest to:
45)
A)
$18,000
B)
$5,200
C)
$11,700
D)
$8,000
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 setup 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%.
46)
Assume that THSI's cost of capital for this project is 15%. The NPV of this temporary housing
project is closest to:
46)
A)
-$435,000
B)
-$650,000
C)
$1,960,000
D)
$435,000
47)
Which of the following statements is false?
47)
A)
Net working capital is the difference between current liabilities and current assets.
B)
A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into
based on its overall level of pre-tax income.
C)
Free Cash Flow = (Revenues - Costs) × (1 -c) - Capital Expenditures -NWC +c×
Depreciation.
D)
Because only the tax consequences of depreciation are relevant for free cash flow, we should
use the depreciation expense that the firm will use for tax purposed in our free cash flow
forecasts.
48)
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 pre-tax income from now on, Luther first pay
taxes in?
48)
A)
4 years.
B)
5 years.
C)
7 years.
D)
2 years.
49)
Which of the following statements is false?
49)
A)
The decision to continue or abandon should be based only on the incremental costs and
benefits of the project going forward.
B)
A sunk cost is any unrecoverable cost for which the firm is already liable.
C)
Unlevered Net Income = EBIT ×c.
D)
The simplest method used to calculate depreciation is the straight-line method.
50)
Money that has been or will be paid regardless of the decision whether or not to proceed with the
project is
50)
A)
a sunk cost.
B)
an opportunity cost.
C)
considered as part of the initial investment in the project.
D)
cannibalization.
51)
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
again has informed you that an outside buyer is interested in purchasing this land and would be
willing to pay $650,000 for it. When calculating the NPV of your new office complex, ignoring
taxes, the appropriate incremental cash flow for the use of this land is:
51)
A)
$0
B)
$100,000
C)
$650,000
D)
$750,000
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
they 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?
52)
A)
$5 million
B)
$150 million
C)
$255 million
D)
$170 million
53)
Which of the following statements is false?
53)
A)
Sunk costs are incremental with respect to the current decision regarding the project and
should be included in its analysis.
B)
Overhead expenses are associated with activities that are not directly attributable to a single
business activity but instead affect many different areas of the corporation.
C)
When computing the incremental earnings of an investment decision, we should include all
changes between the firm’s earnings with the project versus without the project.
D)
Because value is lost when a resource is used by another project, we should include the
opportunity cost as an incremental cost of the project.
54)
Which of the following costs would you consider when making a capital budgeting decision?
54)
A)
Fixed overhead cost
B)
Opportunity cost
C)
Sunk cost
D)
Interest expense
55)
Which of the following statements is false?
55)
A)
The ultimate goal in capital budgeting is to determine the effect of the decision to take a
particular project on the firm's cash flows.
B)
Earnings are not cash flows.
C)
To the extent that overhead costs are fixed and will be incurred in any case, they are
incremental to the project and should be included in the capital budgeting analysis.
D)
Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 -c).
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 pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on its pre-tax income.
56)
The amount that Ford Motor Company owe in taxes next year with the launch of the new SUV is
closest to:
56)
A)
$13.5 million
B)
$31.5 million
C)
$24.0 million
D)
$56.0 million
57)
Which of the following statements is false?
57)
A)
To compute the NPV for a project, you need to estimate the incremental cash flows and
choose a discount rate.
B)
Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our
NPV analysis for the project.
C)
Estimates of the cash flows and cost of capital are often subject to significant uncertainty.
D)
When we are certain regarding the input to a capital budgeting decision, it is often useful to
determine the break-even level of that input.
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 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. 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 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
58)
The change in Net working capital from year one to year two is closest to:
58)
A)
An increase of $396
B)
A decrease of $396
C)
An increase of $360
D)
A decrease of $360
59)
Which of the following statements is false?
59)
A)
Net Working Capital = Cash + Inventory + Payables - Receivables.
B)
Depreciation is not a cash expense paid by the firm.
C)
Since 1997, companies can "carry back" losses for two years and "carry forward" losses for 20
years.
D)
Earnings do not represent real profits.
60)
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 their average
corporate tax rate is 30%, then what is the value of the depreciation tax shield on their new project?
60)
A)
$1,500,000
B)
$750,000
C)
$1,750,000
D)
$1,000,000
61)
Which of the following statements is false?
61)
A)
The opportunity cost of using a resource is the value it could have provided in its best
alternative use.
B)
We begin the capital budgeting process by determining the incremental earnings of a project.
C)
The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of
pre-tax income.
D)
Investments in plant, property, and equipment are directly listed as expense when calculating
earnings.
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
Use the information for the question(s) below.
Kinston Industries is considering investing in a machine that will cost $125,000 and will last for three years. The machine
will generate revenues of $120,000 each year and the cost of goods sold will be 50% of sales. At the end of year three the
machine will be sold for $15,000. The appropriate cost of capital is 10% and Kinston is in the 35% tax bracket.
62)
Assume that Kinston's new machine will be depreciated using MACRS according to the following schedule:
Year 3 Years
133.33%
244.45%
314.81%
47.41%
What is the NPV of this project?
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 -5,000 -5,000 10,000
- capital expenditures -90,000
63)
Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate. How much can
the discount rate vary before the NPV reaches zero?
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 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. 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 6% of its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
64)
Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income
for all three years of the Sisyphean Companies project.
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 -5,000 -5,000 10,000
- capital expenditures -90,000
31
