Chapter 9
Capital Budgeting and Cash Flow Analysis
CHAPTER 9
CAPITAL BUDGETING AND
CASH FLOW ANALYSIS
ANSWERS TO QUESTIONS:
1. a. Personnel managers — the value of insurance programs and pension plans can be
b. Research and development staffs — investments in new product research and product
c. Advertising executives — advertising campaigns normally generate benefits (increased sales)
2. Mutually exclusive projects — the acceptance of one precludes the acceptance of another,
Independent projects — the acceptance of one project neither precludes the acceptance of
Contingent projects — the acceptance of one project requires ( is contingent upon) the
3. Capital rationing is normally not consistent with shareholder wealth maximization, because
4. The primary types of investment projects are projects generated by growth opportunities,
5. The objective of capital budgeting analysis is to estimate the total change in the firm’s cash
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
6. The factors that should be considered when estimating a project’s net investment include the
7. Although depreciation itself is a noncash charge, it has the effect of reducing taxable net
8. If the old asset is sold for its book value there are no tax consequences. If the asset is sold
for less than book value, the difference may be charged as a loss against ordinary income. If
9. Interest charges are considered in the discounting process of capital budgeting analysis.
10. An asset expansion project requires a firm to invest funds in additional assets in order to
increase sales or reduce costs. Asset expansion projects frequently require a significant,
Asset replacement investments involve the retiring of one asset and the replacement of that asset
11. The opportunity cost concept is considered in the capital budgeting process primarily
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
SOLUTIONS TO PROBLEMS:
1. a. After tax operating cash ow (assuming straight-line
depreciation):
Revenues $200.0 MM
Total operating expenses $130.0 MM
After tax operating cash ow (assuming accelerated
depreciation):
Revenues $200.0 MM
Total operating expenses $130.0 MM
b. The income statement reported to the stockholders will be the
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
same as the cash ow statement shown in part (a) above under the
straight-line depreciation assumption, except that the income statement
2. Annual depreciation amount = Installed cost / Number of years
over which the asset is depreciated
3. a. Projects A,B D,E, and G should be adopted because they offer
b. A capital budgeting funds constraint could eliminate some of the less
c. If these projects di1ered with respect to risk, the expected project
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
b. Annual depreciation = $102,500/8
c. Year Depreciation
1 $14,647
2 25,102
5. Net investment = $100,000 (There are no tax consequences
assumed to be associated with this purchase.)
Annual net cash ow:
6. a.
Year Cash Outlay PVIF0.12,t Present Value of Cash Outlays
0 $4,000,000
$4,000,000
1 2,000,000
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
7. Net investment: $1,200,000
Net cash ows: (in thousands of dollars)
Years R -O -Dep OEBT –T OEAT NCF
8. Net investment calculation:
Installed cost
Plus: Net working capital increase
Less: Proceeds from sale of old assets -250,000
Plus: Tax on sale of machine 1
Plus: Tax on sale of machine 2
Net Investment $402,000
9. a. Sale for $15,000:
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
of the old machine for $15,000 (book value) has no tax
consequences.
b. Sale for $5,000:
c. Sale for $26,000:
d. Sale for $32,000:
Recapture of depreciation: $30,000 – $15,000 = $15,000
10. a. Calculation of net investment:
Installed cost of new computer $160,000
b. Net cash ows:
Depreciation computed on basis of installed cost ($160,000).
Year R -O -Dep OEBT –T OEAT NCF
9-.
Chapter 9
Capital Budgeting and Cash Flow Analysis
9-.