Chapter 12: Cash Flow and Risk M/C Problems Page 457
66. Temple Corp. is considering a new project whose data are shown below.
The equipment that would be used has a 3-year tax life, would be
depreciated by the straight-line method over its 3-year life, and would
have a zero salvage value. 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. What is the project’s NPV?
Risk-adjusted WACC 10.0%
Net investment cost (depreciable basis) $65,000
Straight-line depreciation rate 33.3333%
Sales revenues, each year $65,500
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $15,740
b. $16,569
c. $17,441
d. $18,359
e. $19,325
67. Liberty Services is now at the end of the final year of a project. The
equipment originally cost $22,500, 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. $5,558
b. $5,850
c. $6,143
d. $6,450
e. $6,772
68. 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
$12,500. 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?
Year Depreciation Rate
1 0.20
2 0.32
3 0.19
4 0.12
5 0.11
6 0.06
a. $ 8,878
b. $ 9,345
c. $ 9,837
d. $10,355
Page 458 M/C Problems Chapter 12: Cash Flow and Risk
e. $10,900
Chapter 12: Cash Flow and Risk M/C Problems Page 459
69. Mulroney Corp. is considering two mutually exclusive projects. Both
require an initial investment of $10,000 at t = 0. Project X has an
expected life of 2 years with after–tax cash inflows of $6,000 and
$7,900 at the end of Years 1 and 2, respectively. In addition, Project
X can be repeated at the end of Year 2 with no changes in its cash
flows. Project Y has an expected life of 4 years with after-tax cash
inflows of $4,300 at the end of each of the next 4 years. Each project
has a WACC of 8%. Using the replacement chain approach, what is the
NPV of the most profitable project?
a. $4,242
b. $4,246
c. $4,286
d. $4,325
e. $4,433
70. Wilson Co. is considering two mutually exclusive projects. Both
require an initial investment of $10,000 at t = 0. Project X has an
expected life of 2 years with after–tax cash inflows of $6,000 and
$8,500 at the end of Years 1 and 2, respectively. In addition, Project
X can be repeated at the end of Year 2 with no changes in its cash
flows. Project Y has an expected life of 4 years with after-tax cash
inflows of $4,600 at the end of each of the next 4 years. Each project
has a WACC of 11%. What is the equivalent annual annuity of the most
profitable project?
a. $1,345.50
b. $1,346.30
c. $1,361.52
d. $1,376.74
e. $1,411.15
71. Carlyle Inc. is considering two mutually exclusive projects. Both
require an initial investment of $15,000 at t = 0. Project S has an
expected life of 2 years with after–tax cash inflows of $7,000 and
$12,000 at the end of Years 1 and 2, respectively. In addition,
Project S can be repeated at the end of Year 2 with no changes in its
cash flows. Project L has an expected life of 4 years with after-tax
cash inflows of $5,200 at the end of each of the next 4 years. Each
project has a WACC of 9.00%. What is the equivalent annual annuity of
the most profitable project?
a. $ 569.97
b. $ 782.34
c. $ 865.31
d. $1,522.18
e. $1,846.54
Page 460 M/C Problems Chapter 12: Cash Flow and Risk
72. TexMex Food Company is considering a new salsa whose data are shown
below. The equipment to be used would be 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.)
WACC 10.0%
Pre–tax cash flow reduction for other products (cannibalization) –$5,000
Investment cost (depreciable basis) $80,000
Straight-line depreciation rate 33.333%
Annual sales revenues $67,500
Annual operating costs (excl. depreciation) –$25,000
Tax rate 35.0%
a. $3,636
b. $3,828
c. $4,019
d. $4,220
e. $4,431
73. 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.)
WACC 10.0%
Opportunity cost $100,000
Net equipment cost (depreciable basis) $65,000
Straight–line depreciation rate for equipment 33.333%
Annual sales revenues $123,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35%
a. $10,521
b. $11,075
c. $11,658
d. $12,271
e. $12,885
Chapter 12: Cash Flow and Risk M/C Problems Page 461
74. Atlas Corp. is considering two mutually exclusive projects. Both
require an initial investment of $10,000 at t = 0. Project S has an
expected life of 2 years with after–tax cash inflows of $6,000 and
$8,000 at the end of Years 1 and 2, respectively. Project L has an
expected life of 4 years with after–tax cash inflows of $4,373 at the
end of each of the next 4 years. Each project has a WACC of 9.25%, and
Project S can be repeated with no changes in its cash flows. The
controller prefers Project S, but the CFO prefers Project L. How much
value will the firm gain or lose if Project L is selected over
Project S, i.e., what is the value of NPVL – NPVS?
a. $56.50
b. $62.15
c. $68.37
d. $75.21
e. $82.73
75. 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?
WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation rate per year 5.00%
Tax rate 40.0%
a. $15,925
b. $16,764
c. $17,646
d. $18,528
e. $19,455
Page 462 M/C Problems Chapter 12: Cash Flow and Risk
76. 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?
WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation 4.00%
Tax rate 40.0%
a. $12,018
b. $12,650
c. $13,316
d. $13,982
e. $14,681
77. 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.)
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 $75,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $23,852
b. $25,045
c. $26,297
d. $27,612
e. $28,993
Chapter 12: Cash Flow and Risk M/C Problems Page 463
78. 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?
WACC 10.0%
Net investment in fixed assets (depreciable basis) $70,000
Required net operating working capital $10,000
Straight-line depreciation rate 33.333%
Annual sales revenues $75,000
Annual operating costs (excl. depreciation) $30,000
Expected pre-tax salvage value $5,000
Tax rate 35.0%
a. $20,762
b. $21,854
c. $23,005
d. $24,155
e. $25,363
79. 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.)
WACC 10.0%
Net investment cost (depreciable basis) $60,000
Number of cars washed 2,800
Average price per car $25.00
Fixed oper. costs (excl. depreciation) $10,000
Variable oper. cost/unit (i.e., VC per car washed) $5.375
Annual depreciation $20,000
Tax rate 35.0%
a. –$28,939
b. –$30,462
c. –$32,066
d. –$33,753
e. –$35,530
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines.
Multiple Choice: Conceptual
80. Other things held constant, which of the following would increase the
NPV of a project being considered?
a. A shift from straight-line to MACRS depreciation.
b. Making the initial investment in the first year rather than spreading
it over the first three years.
c. An increase in the discount rate associated with the project.
d. An increase in required net operating working capital.
e. The project would decrease sales of another product line.
81. Which of the following statement completions is NOT CORRECT? For a
profitable firm, when MACRS accelerated depreciation is compared to
straight-line depreciation, MACRS accelerated allowances produce
a. Higher depreciation charges in the early years of an asset’s life.
b. Larger cash flows in the earlier years of an asset’s life.
c. Larger total undiscounted profits from the project over the project’s
life.
d. Smaller accounting profits in the early years, assuming the company
uses the same depreciation method for tax and book purposes.
e. Lower tax payments in the earlier years of an asset’s life.
CHAPTER 12
ANSWERS AND SOLUTIONS
