CASH FLOWS NET PRESENT VALUES

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Compute the NPV statistic for Project Y given the following cash flows if the appropriate cost of capital is 10 percent.Project Y Time0 1 2 3 4Cash Flow-$8,000 $3,350 $4,180 $1,520 $2,000

$1,008.03

An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4?

$11,093.76 Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76

An asset has a depreciable basis of $13,200 and qualifies as 3-year MACRS property. The MACRS percentages are: 16.67, 33.33, 33.33. and 16.67 percent for years 1 to 4, respectively. What is the year 3 ending book value?

$2,200.44 Reason: Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44

Your company is considering a new project that will require $2,000,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $250,000 using straight-line depreciation. The cost of capital is 12 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.

$207,646

A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4?

$3,080 Reason: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080

McGinty's purchased a new machine for $318,000, paid $19,000 in sales tax, and $7,500 in delivery charges. The firm paid $3,400 to have the machine calibrated once it was set in place. The machine requires $5,600 of annual maintenance. What is the depreciable basis of the machine?

$347,900 Reason: Depreciable basis = $318,000 + $19,000 + $7,500 + $3,400 = $347,900

Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed?

$38,000/(1 - 0.067) Reason: Adjusted CF0 = $38,000/(1 - 0.067)

You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $13,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $23,000 to purchase and which will have OCF of −$550 annually throughout that vehicle's expected five-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 16 percent, what is the difference in the EAC of the two cars?

$381.36

Compute the NPV for Project X with the cash flows shown as follows if the appropriate cost of capital is 9 percent. Time: 0 1 2 3 4 5 cash flow: -1000 -75 100 100 0 2000

$392.44

Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 12 percent. Time 0 1 2 3 4 Cash Flow -$15,000 6,000 10,000 12,000 -1,000

$6,234.93

$68,250

Suppose you sell a fixed asset for $75,000 when its book value is $80,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

$76,050

$76,050 After-tax Cash Flow = Salvage Value - (Salvage Value - Book Value) * Tax RateAfter-tax Cash Flow = $75,000 - ($75,000 - $80,000) * 0.21After-tax Cash Flow = $75,000 + $5,000 * 0.21After-tax Cash Flow = $75,000 + $1,050After-tax Cash Flow = $76,050

Suppose you sell a fixed asset for $10,000 when its book value is $2,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

$8,320

$880 Reason: Depreciation2 = ($15,400/5) - $2,200 = $880

What value should be used to discount the cash flow that occurs in time period N when computing a net present value?

(1 + i)N

A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero?

-$34,000 -$3,500 Reason: At time zero, there are cash outflows of $34,000 for equipment and $3,500 for NWC. At time zero, there are cash outflows of $34,000 for equipment and $3,500 for NWC.

Which of these project PI's indicate a reject decision? Select all that apply.

0 0.9

How many possible IRRs could you find for the following set of cash flows? Time0 1 2 3 4Cash Flow-$15,000 $6,000 $10,000 $12,000 $1,000

A new project would require an immediate increase in raw materials in the amount $17,000. The firm expects that accounts payable will automatically increase $7,000. How much must the firm expect its investment in net working capital to increase if they accept this project?

10,000 net working capital=(17000-7000)

Your company is considering a new project that will require $100,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $5,000 using straight-line depreciation. The cost of capital is 14 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.

10,406

Equipment was purchased for $100,000 plus $1,000 in freight charges. Installation costs were $500 and sales tax totaled $7,500. Hiring a special consultant to provide advice during the selection of the equipment cost $1,000. What is this asset's depreciable basis?

100,000 + 1,000 + 500 + 7,500 = 109,000

Suppose you sell a fixed asset for $99,000 when its book value is $129,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

105,300

105.300

Suppose you sell a fixed asset for $99,000 when its book value is $75,000. If your company's marginal tax rate is 39 percent, what is the gain or loss on the sale of the asset?

14,640 99,000-75,000 =24,000 24,000X39% = $9,360 24,000-9,360 = $14,640

Compute the IRR for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent. Time: 0 1 2 3 4 5 Cash flow: −1,000 −75 100 100 0 2,000

16.61 percent, accept

Compute the discounted payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years.

2.49 years, accept

A new project would require an immediate increase in raw materials in the amount of $1,000. The firm expects that accounts payable will automatically increase $800. How much must the firm expect its investment in net working capital to change if they accept this project?

200.00 =(1000-800)=$200

You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $13,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $23,000 to purchase and which will have OCF of −$550 annually throughout that vehicle's expected five-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 12 percent, what is the difference in the EAC of the two cars?

317.88

A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?

Over how many tax years will a 3-year asset be depreciated given the half-year convention?

4 years Reason: Given the half-year convention, a 3-year asset will be depreciated over 4 years.

Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent and the maximum allowable payback is four years. Time:012345Cash flow:−1,000−7510010002,000

4.4375 years, reject

A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7. The initial investment is $750. What is the payback for this investment?

4.88 years

A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4?

5,000 × (1 - 0.35) $2,400 Reason: The book value of the equipment will be zero so the ATCF equals the market value times (1 - Tax rate), which is a cash inflow. The OCF and NWC recovery are also cash inflows for year 4. The NWC is recovered and is a year 4 cash inflow as are the OCF and the ATCF.

Compute the MIRR for Project Y and accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 12 percent. Time:012345Cash flow:−5,0001,0001,00002,0002,000

7.62 percent, reject

What is an incremental cash flow?

A cash flow that either increases or decreases when a new project is implemented Reason: This answer defines a variable cost. An incremental cash flow is any change in a cash flow resulting from the adoption of a new project. Reason: An incremental cash flow can be either an increase or a decrease in a cash flow. Reason: An incremental cash flow is a cash flow that changes when a new project is implemented. The project may or may not affect revenues.

A project has a 3-year life and annual sales projections of $120,000, $160,000 and $190,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 5 percent of the next year's sales. How is this requirement handled in project analysis? Select all that apply.

A cash outflow of [0.05 × ($160,000 - $120,000)] is recorded in year 1. A cash inflow of (0.05 × $190,000) occurs in year 3. A cash outflow of (0.05 × $120,000) is recorded at time zero.

Which of the following best describes the NPV profile?

A graph of a project's NPV as a function of possible capital costs.

What is a sunk cost?

A previously incurred cost that cannot be recovered

What does a positive net present value (NPV) represent?

A project more than covers all of its necessary costs

Which of the following statements is correct?

A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback.

Which one of these statements is correct?

A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.

Which one of these correctly states the accept rule for the payback statistic?

Accept any project that pays back within the maximum allowable period

What is the profitability index (PI) accept rule?

Accept when PI > or = 1

What is the accept decision rule for discounted payback (DPB)?

Accept when the DPB is equal to or less than the maximum allowable period

You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?

Accepting more than one project

The half-year convention is based on which of these assumptions?

All assets placed in service during a given period were placed in service at the mid-point of the period.

Which of these is a weakness of the payback method?

All cash flows after the payback period are ignored. The present value of the inflows is ignored.

How are non-normal cash flows modified for MIRR purposes?

All cash inflows are moved to the end of the project All cash outflows are moved to time zero.

Which of these requires modification so MIRR can be applied to non-normal cash flows?

All cash outflows that occur at any time other than time zero

Which of these is the best description of the substitution effect?

Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project

How is a complementary effect defined?

Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project Reason: A complementary effect is any increase in the current level of sales, costs, or necessary assets of a firm's existing operations that is caused by a new project.

Which one of these represents an opportunity cost?

Assigning a current employee to a new project

Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?

Borrowing rates

Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making?

Both assets may produce the same level of sales. Two assets can be used for the same purpose

Why is the IRR formula set equal to zero?

By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.

How is free cash flow defined?

Cash flow available for distribution to a firm's investors. Reason: Correct. Free cash flow is the cash that is available for distribution to the investors in the firm after the investments that are necessary to sustain the firm's ongoing operations are made. (See chapter 2.)

Which of these apply to the payback method?

Considers the total dollar cost of the initial investment Easy to compute

What does accelerated depreciation indicate?

Depreciation in the first half of an asset's life is greater.

How can the profitability index (PI) be defined?

Dollar return per dollar invested

Given a set of normal cash flows, which shape does the NPV profile have?

Downward-sloping

How is operating cash flow (OCF) defined?

EBIT (1 - Tax rate) + Depreciation Reason: OCF = EBIT (1 - Tax rate) + Depreciation

Rate-based decision statistics provide a rate of return based on which one of these?

Each $1 of investment

What type of return are firms seeking when considering a real asset project?

Economic profit

What is pro forma analysis?

Estimation of future project cash flows using only the relevant parts of the financial statements

Section 179 allows a business, with certain restrictions, to do which of the following?

Expense the asset immediately in the year of purchase.

Which of these correctly define free cash flow?

FCF = [EBIT(1 - Tax rate) + Depreciation] - [Change in gross fixed assets + Change in net operating working capital] FCF = OCF - Investment in operating capital

Concerning incremental project cash flow, which of these is a cost one would never count as an expense of the project?

Financing costs

What are the key differences between the free cash flows of a firm and those of a project?

Firm free cash flows are actual values while project free cash flows are estimates.

In pro forma analysis, what determines whether or not an account on the balance sheet or income statement is relevant to a project?

If the project causes an account value to change, then it is relevant. If the project causes an account value to change, then it is relevant.

What types of costs are included in an asset's depreciable basis?

Installation and testing costs Sales tax and freight charges Purchase price of the asset Reason: The depreciable basis includes the asset's cost, sales tax, freight, installation, and testing. The depreciable basis includes the asset's cost, sales tax, freight, installation, and testing. The depreciable basis includes the asset's cost, sales tax, freight, installation, and testing.

What is a financing cost?

Interest and dividends paid as a result of external financing

Which of these is a capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return?

Internal rate of return

Which one of these is a weakness of MIRR?

MIRR ignores project sizes.

A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as

MIRR.

What is the definition of net present value (NPV)?

NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.

Which one of these is a correct formula for OCF, assuming there is no interest expense?

Net income + Depreciation Reason: OCF = Net income + Depreciation

Which of the following is a technique for evaluating capital projects that tells how long it will take a firm to earn back the money invested in a project?

Net present value

The profitability index (PI) is most closely associated with which other decision method?

Net present value (NPV)

Which one of these capital budgeting techniques is preferred for most projects?

Net present value (NPV)

Which of these are strengths of the MIRR process?

Non-normal cash flows can be converted into normal cash flows. The reinvestment rate assumption is more reasonable than in the IRR process.

What does the term "mutually exclusive projects" imply?

Only one of the two or more projects can be accepted.

A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?

PB > 2.5 years

Which of these is a capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows?

Profitability index

Free cash flows for which one of the following are affected by estimation error?

Project free cash flows only

Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply.

Purchase price of the equipment Shipping costs to have the equipment delivered Installation and initial testing costs

You are considering two mutually exclusive projects, A and B. Which of these options do you have?

Reject both A and B Accept A, reject B Accept B, reject A

What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?

Reject the project

Which one of these is the IRR benchmark?

Required rate of return

How do Section 179 deductions aid small businesses?

Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase

Which of these are financing costs?

Stock dividend Bond interest

How can a sunk cost be recovered?

Sunk costs cannot be recovered. Reason: By definition, a sunk cost is a cost that has been incurred and cannot be recovered.

Which one of these represents a limit placed on Section 179 deductions?

Taxable income from the active conduct of the firm

In the NPV formula, what does CF0 represent?

The cash flow at time zero, or the project start-up costs

How can you determine if a cash flow is incremental to a project?

The cash flow will disappear when the project ceases. The cash flow changes only when a new project is implemented. The cash flow occurs only if a new project is implemented.

What is the double-declining balance (DDB) method of depreciation?

The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value.

What does the net present value (NPV) of a project represent?

The expected increase in wealth from accepting a project

Why are a firm's target capital structure values used in computing the average flotation cost?

The firm will issue securities in these percentages over the long term.

What is the internal rate of return (IRR)?

The implicit expected geometric average of a project's rate of return

Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal.

The interest rate that causes the NPV to equal zero. The interest rate that causes NPV to equal (-1)(Cash flow at time 0)

Which one of these best describes the NPV profile given non-normal cash flows?

The profile will switch from downward-sloping to upward-sloping at least once.

How can the IRR benchmark best be described?

The rate required by investors to compensate for a project's level of risk

Which of the following statements is correct?

The reinvestment rates of NPV and MIRR are the same.

What is the discounted payback method designed to compute?

The time period required to return the initial investment plus interest

Which one of these is a weakness of the payback method?

The time value of money is ignored.

Why do firms purchase real assets in the form of capital equipment?

To create value for their customers

A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.

To the left of and above the x-axis intersection point

For most projects, net present value is the generally preferred method for making capital budgeting decisions.

True Reason: NPV is the preferred method for most capital budgeting decisions.

Explain the disadvantage of the net present value (NPV) method.

Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.

Which of these represent opportunity costs?

Using a current employee who is about to be laid off to run a project on a day by day basis Using a piece of company equipment that has been sitting idle for two years in a new project Building a new building on a vacant lot owned by the firm Reason: The cost savings that would be realized if the employee were laid off represents an opportunity cost of the new project. If the equipment cannot be used elsewhere, then the opportunity cost equals the current market value of the equipment. The value of the vacant lot in its next best use is an opportunity cost.

All of the following can be included in the depreciable basis of an asset EXCEPT

Variable costs

When is a cash flow not discounted when using the discounted payback method for project analysis?

When the cash flow occurs at time zero

Which one of these is a key assumption in situations where EAC is used as the decision method?

Whenever the chosen asset wears out, it will be replaced with an identical asset.

Which one of these is an advantage of the net present value (NPV) method?

Which one of these represents a time zero project cash flow?

We accept projects with a positive NPV because it means that

all of the options.

Effects that arise from a new product or service that increase sales of the firm's existing products or services are referred to as

complementary effects.

Which one of these is the primary advantage of the payback method?

easy compute

All of the following are incremental cash flows attributable to the project EXCEPT

financing cost

All of the following are strengths of NPV EXCEPT

it uses a conservative reinvestment rate assumption.

All of the following are strengths of payback EXCEPT

none of these

Which of the following is a technique for evaluating capital projects that is particularly useful when firms face time constraints in repaying investors?

payback

The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as

pro forma analysis.

Accelerated depreciation allows firms to

receive more of the dollars of depreciation earlier in the asset's life.

When looking at which of these types of projects, one must consider any cash flows that arise from surrendering old equipment before the end of its useful life?

replacement

AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n)

sunk cost.

We accept projects with a positive NPV because it means that

we have recovered all our costs.

3. As new capital budgeting projects arise, we must estimate

when such projects will require cash flows.

If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct?

CASH FLOWS NET PRESENT VALUES

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