CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
68. DeVault Services recently hired you as a consultant to help with its capital budgeting process. The company 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 new 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?
10.0%
$65,000
33.3333%
$65,500
$25,000
35.0%
a.
$15,740
b.
$16,569
c.
$17,441
d.
$18,359
e.
$19,325
e
1
Difficulty: Moderate
INTE.GENE.16.85 – LO: 13-2
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
69. Kasper Film Co. is selling off some old equipment it no longer needs because its associated project has come to an
end. 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
b
1
1
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
70. McPherson Company must purchase a new milling machine. The purchase price is $50,000, including installation.
The machine has a tax life of 5 years, and it can be depreciated according to the following rates. 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
e.
$10,900
e
1
answer.
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
71. Weston Clothing Company is considering manufacturing a new style of shirt, 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 new 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 Weston’s 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 deprec. rate
33.333%
Sales revenues, each year for 3 years
$67,500
Annual operating costs (excl. deprec.)
$25,000
Tax rate
35.0%
a.
$3,636
b.
$3,828
c.
$4,019
d.
$4,220
e.
$4,431
b
1
Difficulty: Challenging
INTE.GENE.16.85 – LO: 13-2
United States – BUSPROG: Analytic
capital
United States – OH – Default City – TBA
Salvage value
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
72. Century Roofing is thinking of opening a new warehouse, 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 warehouse. 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 new 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.)
10.0%
$100,000
$65,000
33.333%
$123,000
$25,000
35%
a.
$10,521
b.
$11,075
c.
$11,658
d.
$12,271
e.
$12,885
d
1
Difficulty: Moderate
INTE.GENE.16.85 – LO: 13-2
United States – BUSPROG: Analytic
forecasting, and cash flows
United States – OH – Default City – TBA
Project NPV
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
73. Garden-Grow Products 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 some
additional 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 are constant in Years 1 to 3.)
10.0%
$75,000
$15,000
33.333%
$75,000
$25,000
35.0%
a.
$23,852
b.
$25,045
c.
$26,297
d.
$27,612
e.
$28,993
a
Investment in fixed assets
WACC = 10%
Investment in net working capital
Sales revenues
Operating income (EBIT)
Rate = 35%
After-tax EBIT
+ Depreciation
1
Difficulty: Challenging
INTE.GENE.16.85 – LO: 13-2
United States – BUSPROG: Analytic
forecasting, and cash flows
United States – OH – Default City – TBA
forecasting, and cash flows
United States – OH – Default City – TBA
Project NPV
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
74. Sheridan Films 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, some new 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 new working capital
$10,000
Straight-line deprec. rate
33.333%
Sales revenues, each year
$75,000
Operating costs (excl. deprec.), each year
$30,000
Expected pretax salvage value
$5,000
Tax rate
35.0%
a.
$20,762
b.
$21,854
c.
$23,005
d.
$24,155
e.
$25,363
c
Investment in fixed assets
WACC = 10%
Investment in net working capital
Sales revenues
Operating income (EBIT)
Rate = 35%
After-tax EBIT
Recovery of working capital
Salvage value, pre-tax
1
Difficulty: Challenging
INTE.GENE.16.85 – LO: 13-2
United States – BUSPROG: Analytic
Project NPV
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
75. Shultz Business Systems 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. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm
projects. What is the project’s expected NPV?
10.0%
$200,000
50,000
$25.00
$150,000
$20.20
33.333%
5.00%
40.0%
a.
$15,925
b.
$16,764
c.
$17,646
d.
$18,528
e.
$19,455
c
Investment cost
WACC = 10%
Price per unit
Units sold
Sales revenues
Rate = 40%
After-tax EBIT
1
Difficulty: Challenging
INTE.GENE.16.85 – LO: 13-2
United States – OH – Default City – TBA
Project NPV
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
76. Sylvester Media 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. This is just one of many projects for the firm, so any losses 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 adjustment is required. What is the difference in the
expected NPV if the inflation adjustment is made vs. if it is not made?
10.0%
$200,000
50,000
$25.00
$150,000
$20.20
33.333%
4.00%
35.0%
a.
$13,286
b.
$13,985
c.
$14,721
d.
$15,457
e.
$16,230
c
NPV with no adjustment
Investment cost
Inflation (set to 0%)
Price per unit
Units sold
Sales revenues
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
NPV including inflation
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
77. Spot-Free 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 new 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 decline?
(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 op. cost (excl. deprec.)
$10,000
Variable op. cost/unit (i.e., VC per car washed)
$5.375
Annual depreciation
$20,000
Tax rate
35.0%
Difficulty: Challenging
INTE.GENE.16.85 – LO: 13-2
United States – OH – Default City – TBA
NPV including inflation
TYPE: Multiple Choice: Problem
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
a.
$28,939
b.
$30,462
c.
$32,066
d.
$33,753
e.
$35,530
e
Base Case Calculations
Investment cost
WACC: 10%
Cars washed
Price per car
Variable cost/unit
Sales revenues
Operating income (EBIT)
Rate = 35%
After-tax EBIT
Base-Case NPV
Bad Case Calculations
Investment cost
Price per car
Variable cost/unit
Sales revenues
Operating income (EBIT)
After-tax EBIT
Bad-Case NPV
Decline in NPV
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS
78. Brandt 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?
a.
$55.08
b.
$57.98
c.
$61.03
d.
$64.08
e.
$67.29
1
CHAPTER 13—CASH FLOW ESTIMATION AND RISK ANALYSIS