22) The incremental unlevered net income Shepard Industries in year two is closest to:
A) $355
B) $415
C) $600
D) $510
23) The depreciation tax shield for Shepard Industries project in year one is closest to:
A) $84
B) $168
C) $96
D) $72
24) The depreciation tax shield for Shepard Industries project in year two is closest to:
A) $84
B) $196
C) $72
D) $96
25) The free cash flow from Shepard Industries project in year one is closest to:
A) $240
B) $300
C) -$5
D) $390
26) The free cash flow from Shepard Industries project in year two is closest to:
A) $345
B) $455
C) $275
D) -$5
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
27) The free cash flow for the first year of Epiphany’s project is closest to:
A) $43,000
B) $25,000
C) $38,000
D) $45,000
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%)
= 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
= Free Cash Flow
-90,000
38,000
38,000
53,000
-90,000
33,929
30,293
37,724
discount rate
NPV = 11,946
IRR = 19.14%
28) The free cash flow for the last year of Epiphany’s project is closest to:
A) $53,000
B) $38,000
C) $35,000
D) $43,000
29) The NPV for Epiphany’s Project is closest to:
A) $4,825
B) $39,000
C) $11,946
D) $20,400
30) 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
pays taxes in:
A) 7 years
B) 2 years
C) 4 years
D) 5 years
26
31) You are considering investing $600,000 in a new automated inventory system that will
provide after-tax cost savings of $50,000 next year. These cost savings are expected to grow at
the same rate as sales. If sales are expected to grow at 5% per year and your cost of capital is
10%, then what is the NPV of the automated inventory system?
A) $400,000
B) $500,000
C) -$100,000
D) $1,000,000
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%.
32) Calculate the total Free Cash Flows for each of the three years for the Sisyphean
Corporation’s new project.
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.
33) Assume that Kinston’s new machine will be depreciated straight line to a salvage value of
$5,000 at the end of year three. What is the after-tax salvage value of this project?
34) Assume that Kinston’s new machine will be depreciated straight line to a salvage value of
$5,000 at the end of year three. What is the NPV for this project?
35) Assume that Kinston’s new machine will be depreciated using MACRS according to the
following schedule:
Year
3 Years
1
33.33%
2
44.45%
3
14.81%
4
7.41%
What is the NPV of this project?
Sales (revenues)
120,000
120,000
120,000
Cost of Goods Sold
60,000
60,000
60,000
– Depreciation
41,663
55,563
18,513
EBIT
18,338
41,488
-Taxes (35%)
14,521
= unlevered net income
11,919
26,967
+ Depreciation
41,663
55,563
18,513
+ capital expenditures
+ Liquidation cash flows
12,992
Free Cash Flow
53,582
58,447
58,471
PV of FCF (I = 10%)
48,711
48,303
43,930
NPV =
15,944
8.3 Choosing Among Alternatives
Use the following information to answer the question(s) below.
Galt Motors currently produces 500,000 electric motors a year and expects output levels to
remain steady in the future. It buys armatures from an outside supplier at a price of $2.50 each.
The plant manager believes that it would be cheaper to make these armatures rather than buy
them. Direct in-house production costs are estimated to be only $1.80 per armature. The
necessary machinery would cost $700,000 and would be obsolete in 10 years. This investment
would be depreciated to zero for tax purposes using a 10-year straight line depreciation. The
plant manager estimates that the operation would require additional working capital of $40,000
but argues that this sum can be ignored since it is recoverable at the end of the ten years. The
expected proceeds from scrapping the machinery after 10 years are estimated to be $10,000. Galt
Motors pays tax at a rate of 35% and has an opportunity cost of capital of 14%.
1) The incremental cash flow that Galt Motors will incur today (Year 0) if they elect to
manufacture armatures in house is closest to:
A) -740,000
B) -700,000
C) -660,000
D) 740,000
2) The incremental cash flow that Galt Motors will incur in year 4 if they elect to manufacture
armatures in house is closest to:
A) 25,000
B) 350,000
C) 375,000
D) 1,250,000
3) The incremental cash flow that Galt Motors will incur in year 10 if they elect to manufacture
armatures in house is closest to:
A) 40,000
B) 335,000
C) 375,000
D) 415,000
4) The NPV for Galt Motors of manufacturing the armatures in house is closest to:
A) 1,095,000
B) 1,215,000
C) 1,225,000
D) 1,250,000
5) The IRR for Galt Motors of manufacturing the armatures in house is closest to:
A) 48%
B) 49%
C) 50%
D) 53%
6) What decision should Galt Motors take regarding manufacturing the armatures in house?
A) Proceed with in house manufacture since NPV is negative
B) Proceed with in house manufacture since NPV is positive
C) Reject in-house manufacture since NPV is negative
D) Reject in-house manufacture since IRR is greater than 14%
Use the following information to answer the question(s) below.
Two years ago the Krusty Krab Restaurant purchased a grill for $50,000. The owner, Eugene
Krabs, has learned that a new grill is available that will cook Krabby Patties twice as fast as the
existing grill. This new grill can be purchased for $80,000 and would be depreciated straight line
over 8 years, after which it would have no salvage value. Eugene Krab expects that the new grill
will produce EBITDA of $50,000 per year for the next eight years while the existing grill
produces EBITDA of only $35,000 per year. The current grill is being depreciated straight line
over its useful life of 10 years after which it will have no salvage value. All other operating
expenses are identical for both grills. The existing grill can be sold to another restaurant now for
$30,000. The Krusty Krab’s tax rate is 35%.
7) The incremental cash flow that the Krusty Krab will incur today (Year 0) if they elect to
upgrade to the new grill is closest to:
A) -80,000
B) -50,000
C) -46,500
D) +30,000