Chapter 12: Cash Flow Estimation and Risk Analysis
66. Liberty Services is now at the end of the final year of a project. The equipment originally cost $19,000, 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.
$5,500
b.
$4,345
c.
$5,995
d.
$5,885
e.
$6,710
a
b.
c.
d.
e.
MODERATE
12-2 Analysis of an Expansion Project
Multiple Choice
FOFM.BRIG.17.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
United States – OH – DISC.FOFM.BRIG.17.03 – Capital budgeting and cost of capital
Salvage value
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:42 PM
67. 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 $6,500. 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?
United States – OH – DISC.FOFM.BRIG.17.06 – Finance function
Project NPV
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:41 PM
Chapter 12: Cash Flow Estimation and Risk Analysis
Year
Depreciation Rate
1
0.20
2
0.32
3
0.19
4
0.12
5
0.11
6
0.06
a.
$8,468
b.
$5,986
c.
$6,424
d.
$7,300
e.
$7,884
d
b.
c.
d.
e.
MODERATE
12-2 Analysis of an Expansion Project
Multiple Choice
FOFM.BRIG.17.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
United States – OH – DISC.FOFM.BRIG.17.03 – Capital budgeting and cost of capital
Salvage value
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:43 PM
68. TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be
Chapter 12: Cash Flow Estimation and Risk Analysis
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.) Do not round the intermediate
calculations and round the final answer to the nearest whole number.
WACC
10.0%
Pre-tax cash flow reduction for other products (cannibalization)
-$5,000
Investment cost (depreciable basis)
$80,000
Straight-line depr. rate
33.333%
Annual sales revenues
$66,500
Annual operating costs (excl. depr.)
-$25,000
Tax rate
35.0%
a.
2,477
b.
1,680
c.
2,211
d.
2,101
e.
2,742
c
c.
Chapter 12: Cash Flow Estimation and Risk Analysis
e.
CHALLENGING
12-2 Analysis of an Expansion Project
Multiple Choice
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
Project NPV
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:44 PM
69. 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? Do not round the intermediate calculations and round the final answer to the nearest whole number.
WACC
10.0%
Net investment cost (depreciable basis)
$200,000
Units sold
58,000
Average price per unit, Year 1
$25.00
Fixed op. cost excl. depr. (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.
0$66,796
b.
0$75,339
c.
0$92,426
d.
0$77,669
e.
0$61,359
Chapter 12: Cash Flow Estimation and Risk Analysis
70. 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.) Do not round the intermediate calculations and round the final answer
to the nearest whole number.
WACC
10.0%
Opportunity cost
$100,000
Net equipment cost (depreciable basis)
$65,000
Straight-line depr. rate for equipment
33.333%
Annual sales revenues
$150,000
Annual operating costs (excl. depr.)
$25,000
Tax rate
35%
a.
55,915
b.
061,507
c.
054,238
d.
048,087
b.
c.
d.
e.
CHALLENGING
12-2 Analysis of an Expansion Project
Multiple Choice
FOFM.BRIG.17.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
NPV including inflation
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:45 PM
Chapter 12: Cash Flow Estimation and Risk Analysis
e.
043,614
a
c.
e.
MODERATE/CHALLENGING
71. 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? Do not round the intermediate calculations and round the final answer to the nearest whole
number.
WACC
10.0%
Chapter 12: Cash Flow Estimation and Risk Analysis
Net investment cost (depreciable basis)
$200,000
Units sold
59,000
Average price per unit, Year 1
$25.00
Fixed op. cost excl. depr. (constant)
$150,000
Variable op. cost/unit, Year 1
$20.20
Annual depreciation rate
33.333%
Expected inflation
4.00%
Tax rate
40.0%
a.
$16,034
b.
$18,118
c.
$19,080
d.
$19,882
e.
$13,308
a
Investment cost
WACC =
10%
-$200,000
Price per unit
$25.00
$25.00
$25.00
VC per unit
$20.20
$20.20
$20.20
Units sold
59,000
59,000
59,000
Sales revenues
$1,475,000
$1,475,000
$1,475,000
rate =
33.3%
66,667
66,667
66,667
rate =
40%
26,613
26,613
26,613
EBIT(1 – T)
019,760
019,760
019,760
+ Depreciation
66,667
66,667
66,667
Project CFs
-$200,000
$106,587
$106,587
$106,587
Inflation
4.0%
4.0%
4.0%
Price per unit
$25.00
$26.00
$27.04
VC per unit
$20.20
$21.01
$21.85
Units sold
59,000
59,000
59,000
Sales revenues
$1,475,000
$1,534,000
$1,595,360
costs
Chapter 12: Cash Flow Estimation and Risk Analysis
rate =
33.3%
66,666
66,666
66,666
rate =
40%
26,614
31,145
35,857
EBIT(1 – T)
019,760
025,751
031,981
+ Depreciation
66,666
66,666
66,666
Project CFs
-$200,000
$106,586
$113,383
$120,452
b.
c.
d.
e.
CHALLENGING
12-2 Analysis of an Expansion Project
Multiple Choice
FOFM.BRIG.17.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
United States – OH – DISC.FOFM.BRIG.17.06 – Finance function
NPV including inflation
Bloom’s: Evaluation
6/23/2015 3:26 PM
8/25/2015 1:30 PM
72. 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.) Do not round the intermediate calculations and round the final answer to the nearest whole number.
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
$50,000
Annual operating costs (excl. depr.)
$25,000
Tax rate
35.0%
a.
$-–16,559
b.
$-20,368
c.
$-18,380
d.
$-19,043
e.
$-17,221
a
Chapter 12: Cash Flow Estimation and Risk Analysis
73. 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? Do not round the intermediate calculations and round
the final answer to the nearest whole number.
WACC
10.0%
Net investment in fixed assets (depreciable basis)
$70,000
CHALLENGING
Chapter 12: Cash Flow Estimation and Risk Analysis
Required net operating working capital
$10,000
Straight-line depreciation rate
33.333%
Annual sales revenues
$77,000
Annual operating costs (excl. depreciation)
$30,000
Expected pre-tax salvage value
$5,000
Tax rate
35.0%
a.
$26,238
b.
$026,500
c.
$020,728
d.
$021,777
e.
$028,861
a
b.
c.
d.
e.
CHALLENGING
12-2 Analysis of an Expansion Project
FOFM.BRIG.17.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
Chapter 12: Cash Flow Estimation and Risk Analysis
74. 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.) Do not round
the intermediate calculations and round the final answer to the nearest whole number.
WACC
10.0%
Net investment cost (depreciable basis)
$60,000
Number of cars washed
2,770
Average price per car
$25.00
Fixed op. cost (excl. depr.)
$10,000
Variable op. cost/unit (i.e., VC per car washed)
$5.375
Annual depreciation
$20,000
Tax rate
35.0%
a.
-$35,149
b.
-$34,446
c.
-$28,119
d.
-$33,040
e.
-$41,827
a
Project NPV
Bloom’s: Analysis
6/23/2015 3:26 PM
8/25/2015 1:32 PM
Chapter 12: Cash Flow Estimation and Risk Analysis
Chapter 12: Cash Flow Estimation and Risk Analysis
e
75. 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%
$750.0
$750.0
$750.0
$817.0
$163.4
Prob =
60%
-$1,000
$520.0
$520.0
$520.0
$259.8
$155.9
Prob =
20%
-$250.0
-$250.0
-$250.0
-$1,605.7
-$321.1
Exp. NPV=
$–1.8
a.
$77.8
b.
$90.0
c.
$64.8
d.
$63.3
e.
$76.3
b.
c.
d.
e.
CHALLENGING
12-5 Measuring Stand-Alone Risk
Multiple Choice
FOFM.BRIG.17.12.05 – Measuring Stand-Alone Risk
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
Sensitivity analysis
Bloom’s: Evaluation
6/23/2015 3:26 PM
8/25/2015 1:33 PM
Chapter 12: Cash Flow Estimation and Risk Analysis
Prob =
Prob =
Prob =
Prob =
QUESTION TYPE:
Multiple Choice
LEARNING OBJECTIVES:
FFMC.BRIG.15.12.07 – Real options
NATIONAL STANDARDS:
United States – BUSPROG.FOFM.BRIG.17.03 – BUSPROG: Analytic
STATE STANDARDS:
Abandonment option
Bloom’s: Evaluation
DATE CREATED:
6/23/2015 3:26 PM
DATE MODIFIED:
8/25/2015 1:35 PM