24) An asset was purchased three years ago for $100,000 and can be sold for $40,000 today. The asset has
been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both
ordinary income and capital gain.
(a) Compute recaptured depreciation and capital gain (loss), if any.
(b) Find the firm’s tax liability.
25) A machine was purchased two years ago for $120,000 and can be sold for $50,000 today. The machine
has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on
both ordinary income and capital gains.
(a) Compute recaptured depreciation and capital gain (loss), if any.
(b) Find the firm’s tax liability.
26) Compute the depreciation values for an asset which costs $55,000 and requires $5,000 in installation
costs using MACRS 5-year recovery period.
27) A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate
the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years
at an estimated sale price of $15,000. The machine has an original purchase price of $80,000, installation
cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to
decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The
terminal cash flow is ________.
A) $24,000
B) $16,000
C) $14,000
D) $26,000
28) A corporation is evaluating the relevant cash flows for a capital budgeting decision and must estimate
the terminal cash flow. The proposed machine will be disposed of at the end of its usable life of five years
at an estimated sale price of $2,000. The machine has an original purchase price of $80,000, installation
cost of $20,000, and will be depreciated under the five-year MACRS. Net working capital is expected to
decline by $5,000. The firm has a 40 percent tax rate on ordinary income and long-term capital gain. The
terminal cash flow is ________.
A) $5,800
B) $7,800
C) $8,200
D) $6,200
29) Which of the following must be considered in computing the terminal value of a replacement project?
A) operating cash flow for the final year
B) after-tax proceeds from the sale of a new asset
C) before-tax proceeds from the sale of an old asset
D) before-tax proceeds from the sale of a new asset
11.5 Summarizing the net cash flows
1) All benefits expected from a proposed project must be measured on a cash flow basis which may be
found by adding any non-cash charges deducted as an expense on a firm’s income statement back to net
profits after taxes.
2) In computing after-tax operating cash flows, both operating costs and financing costs must be
deducted from any cash inflows received.
3) In computing after-tax operating cash flows, only operating costs but not financing costs must be
deducted from any cash inflows received.
4) In evaluating a proposed project, incremental operating cash inflows are relevant cash flows.
5) Benefits expected from proposed capital expenditures ________.
A) must be on a pre-tax basis because it provides the true position of profits by the firm
B) must be on an after-tax basis because no benefits may be used until tax claims are satisfied
C) may be valued either on pre-tax or after-tax basis based on the size of the firm
D) are independent of interest and taxes
6) One basic technique used to evaluate after-tax operating cash flows is to ________.
A) add noncash charges to net income
B) subtract depreciation from operating revenues
C) add cash expenses to net income
D) subtract cash expenses from noncash charges
Table 11.2
Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year
beginning in 2019. For each investment proposal, the relevant cash flows and other relevant financial data
are summarized in the table below. New assets will be depreciated under the MACRS system rather than
being fully expensed right away. In the case of a replacement decision, the total installed cost of the
equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax
rate on ordinary income and on long-term capital gains. The firm’s cost of capital is 15 percent.
______________________________________________________________________
*Not applicable
7) For Proposal 1, the cash flow pattern for the expansion project is ________. (See Table 11.2)
A) a mixed stream and conventional
B) a mixed stream and nonconventional
C) a perpetuity and conventional
D) an annuity and nonconventional
8) For Proposal 1, the initial outlay equals ________. (See Table 11.2)
A) $1,380,000
B) $1,440,000
C) $1,500,000
D) $1,620,000
9) For Proposal 1, the depreciation expense for year 1 is ________. (See Table 11.2)
A) $110,400
B) $115,200
C) $150,000
D) $300,000
10) For Proposal 1, the annual incremental after-tax cash flow from operations for year 1 is ________. (See
Table 11.2)
A) $60,000
B) $255,000
C) $300,000
D) $210,000
11) For Proposal 2, the cash flow pattern for the replacement project is ________. (See Table 11.2)
A) a mixed stream and conventional
B) a mixed stream and nonconventional
C) a perpetuity and conventional
D) an annuity and nonconventional
12) For Proposal 2, the book value of the existing asset at the end of the fifth year is ________. (See Table
11.2)
A) $13,600
B) $34,400
C) $66,400
D) $80,000
13) For Proposal 2, the tax effect on the sale of the existing asset at the end of the fifth year results in
________. (See Table 11.2)
A) $12,000 tax liability
B) $14,560 tax liability
C) $25,280 tax liability
D) $16,600 tax liability
14) For Proposal 2, the initial outlay equals ________. (See Table 11.2)
A) $120,720 cash outflow
B) $164,560 cash outflow
C) $150,000 cash outflow
D) $167,520 cash outflow
15) For Proposal 2, the incremental depreciation expense for year 2 is ________. (See Table 11.2)
A) $16,800
B) $26,400
C) $38,400
D) $60,000
16) For Proposal 2, the annual incremental after-tax cash flow from operations for year 2 is ________. (See
Table 11.2)
A) $18,000
B) $24,000
C) $56,000
D) $84,000
17) For Proposal 3, the cash flow pattern for the replacement project is ________. (See Table 11.2)
A) a mixed stream and conventional
B) a mixed stream and nonconventional
C) a perpetuity and conventional
D) an annuity and nonconventional
18) For Proposal 3, the book value of the existing asset is ________. (See Table 11.2)
A) $21,000
B) $43,000
C) $52,000
D) $80,000
19) For Proposal 3, the tax effect on the sale of the existing asset results in ________. (See Table 11.2)
A) $8,000 tax liability
B) $16,000 tax liability
C) $20,000 tax liability
D) $23,200 tax liability
20) For Proposal 3, the initial outlay equals ________. (See Table 11.2)
A) $170,400
B) $211,000
C) $196,000
D) $300,000
21) For Proposal 3, the incremental depreciation expense for year 3 is ________. (See Table 11.2)
A) $21,000
B) $42,000
C) $47,850
D) $50,850
22) For Proposal 3, the incremental depreciation expense for year 6 is ________. (See Table 11.2)
A) $15,750
B) $10,750
C) $23,000
D) $36,150
23) For Proposal 3, the annual incremental after-tax cash flow from operations for year 3 is ________. (See
Table 11.2)
A) $45,000
B) $75,150
C) $90,150
D) $93,800
Table 11.3
Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment
proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be
depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000
and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three
years of depreciation has already been taken. The new equipment is expected to result in incremental
before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate.
24) The cash flow pattern for the capital investment proposal is ________. (See Table 11.3)
A) a mixed stream and conventional
B) a mixed stream and nonconventional
C) a perpetuity and conventional
D) an annuity and nonconventional
25) The book value of the existing asset is ________. (See Table 11.3)
A) $7,250
B) $15,000
C) $21,250
D) $25,000
26) The tax effect on the sale of the existing asset results in ________. (See Table 11.3)
A) $800 tax benefit
B) $1,000 tax liability
C) $1,100 tax liability
D) $6,000 tax liability
27) The initial outlay equals ________. (See Table 11.3)
A) $41,100
B) $44,100
C) $38,800
D) $38,960
28) The incremental depreciation expense for year 1 is ________. (See Table 11.3)
A) $2,250
B) $7,600
C) $7,000
D) $7,950
29) The incremental depreciation expense for year 5 is ________. (See Table 11.3)
A) $2,250
B) $5,110
C) $7,950
D) $6,360
30) The annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 11.3)
A) $13,950
B) $16,600
C) $25,600
D) $30,000
Table 11.4
Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an
existing piece of equipment with a more sophisticated machine. The following information is given.
The firm pays 40 percent taxes on ordinary income and capital gains.
31) Calculate the book value of the existing asset being replaced. (See Table 11.4)
32) Calculate the tax effect from the sale of the existing asset. (See Table 11.4)
33) Calculate the initial investment required for the new asset. (See Table 11.4)
34) Calculate the incremental earnings before depreciation and taxes. (See Table 11.4)
35) Calculate the incremental depreciation. (See Table 11.4)
36) Summarize the incremental after-tax cash flow (relevant cash flows) for years t = 0 through t = 5. (See
Table 11.4)
Table 11.5
Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The gluing machine
costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of
an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated
under MACRS using a five-year recovery schedule and can currently be sold for $15,000. The existing
gluer has a remaining useful life of five years. If held until year 5, the existing machine’s market value
would be zero. Over its five-year life, the new machine should reduce operating costs (excluding
depreciation) by $17,000 per year. Training costs of employees who will operate the new machine will be
a one-time cost of $5,000 which should be included in the initial outlay. The new machine will be
depreciated under MACRS using a five-year recovery period. The firm has a 12 percent cost of capital
and a 40 percent tax on ordinary income and capital gains.
37) The payback period for the project is ________. (See Table 11.5)
A) 2 years
B) 3 years
C) between 3 and 4 years
D) between 4 and 5 years
38) The tax effect of the sale of the existing asset is ________. (See Table 11.5)
A) a tax liability of $2,340
B) a tax benefit of $1,500
C) a tax liability of $3,320
D) a tax liability of $5,320
39) The initial outlay for this project is ________. (See Table 11.5)
A) $42,820
B) $40,320
C) $47,820
D) $35,140
40) The present value of the project’s annual cash flows is ________. (See Table 11.5)
A) $47,820
B) $42,820
C) $51,635
D) $100,563
41) The net present value of the project is ________. (See Table 11.5)
A) $3,815
B) $2,445
C) $5,614
D) $7,500
42) The internal rate of return for the project is ________. (See Table 11.5)
A) between 7 and 8 percent
B) between 9 and 10 percent
C) greater than 12 percent
D) between 10 and 11 percent
Table 11.4
Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an
existing piece of equipment with a more sophisticated machine. The following information is given.
The firm pays 40 percent taxes on ordinary income and capital gains.
43) Given the information in Table 11.4, compute the initial investment.
44) Given the information in Table 11.4, compute the incremental annual cash flows.
45) Given the information in Table 11.4, compute the payback period.
46) Given the information in Table 11.4 and 15 percent cost of capital,
(a) Compute the net present value.
(b) Should the project be accepted?