Corporate Finance Chapter 10

Which one of the following is an example of a sunk cost?

$1,200 paid to repair a machine last year

You own a house that you rent for $1,100 a month. The maintenance expenses on the house average $200 a month. The house cost $219,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $239,000. If you sell the house you will incur $14,000 in real estate fees. The annual property taxes are $4,000. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

$225,000

A project will produce an operating cash flow of $14,600 a year for 8 years. The initial fixed asset investment in the project will be $48,900. The net aftertax salvage value is estimated at $11,000 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 12 percent?

$28,070.26

Bi-Lo Traders is considering a project that will produce sales of $28,000 and increase cash expenses by $17,500. If the project is implemented, taxes will increase by $3,000. The additional depreciation expense will be $1,600. An initial cash outlay of $1,400 is required for net working capital. What is the amount of the operating cash flow using the top-down approach?

$7,500 OCF = $28,000 - $17,500 - $3,000 = $7,500

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Which one of the following statements is correct concerning bid prices?

A firm can submit a bid that is higher than the computed bid price and still break even. C. A bid price ignores taxes.

Which one of the following statements is correct?

A project can create a positive operating cash flow without affecting sales.

Which one of the following is the depreciation method which allows accelerated write-offs of property under various lifetime classifications?

ACRS

When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I. differing productive lives II. differing manufacturers III. required replacement at end of economic life IV. differing initial cost

I and III

Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to the project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals.

I, II, III, and IV

The equivalent annual cost considers which of the following? I. required rate of return II. operating costs III. need for replacement IV. aftertax salvage value

I, II, III, and IV

The bid price always assumes which one of the following?

The net present value of the project is zero.

The depreciation tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense.

Which one of the following would make a project unacceptable?

an equivalent annual cost that exceeds that of an alternative project

Which one of the following will increase a bid price?

an increase in the required rate of return

Changes in the net working capital requirements:

can affect the cash flows of a project every year of the project's life.

The operating cash flow of a cost cutting project:

can be positive even though there are no sales.

Net working capital:

can create either a cash inflow or a cash outflow at time zero of a project.

Which one of the following is a project cash inflow? Ignore any tax effects.

decrease in accounts receivable

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:

incremental cash flows.

The operating cash flow for a project should exclude which one of the following?

interest expense

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

selling fewer hot dogs because hamburgers were added to the menu

Which one of the following costs was incurred in the past and cannot be recouped?

sunk

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

tax due on the salvage value of that asset

The equivalent annual cost method is useful in determining:

which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out

The net book value of equipment will:

decrease slower under straight-line depreciation than under MACRS.

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

stand-alone principle

The bottom-up approach to computing the operating cash flow applies only when:

the interest expense is equal to zero.

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You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the:

lowest equivalent annual cost.

The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following?

opportunity cost

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Three years ago, Knox Glass purchased a machine for a 3-year project. The machine is being depreciated straight-line to zero over a 5-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate)

Sale price + (Book value - Sale price) T

The bid price is:

the minimum price you should charge if you want to financially breakeven.

A company that utilizes the MACRS system of depreciation:

will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.

The Fluffy Feather sells customized handbags. Currently, it sells 18,000 handbags annually at an average price of $89 each. It is considering adding a lower-priced line of handbags that sell for $59 each. The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags?

$146,000 Sales = (7,000 $59) + (-3,000 $89) = $146,000

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the earnings before interest and taxes for the first year of this project?

$148,000 EBIT = $875,000 - $640,000 - ($522,000/6) = $148,000

The Card Shoppe needs to maintain 23 percent of its sales in net working capital. Currently, the shoppe is considering a 6-year project that will increase sales from its current level of $387,000 to $421,000 the first year and to $465,000 a year for the following 5 years of the project. What amount should be included in the project analysis for net working capital in year 6 of the project?

$17,940 NWC recovery = ($465,000 - $387,000) 0.23 = $17,940

You are working on a bid to build two city parks a year for the next three years. This project requires the purchase of $180,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the 3-year project life. The equipment can be sold at the end of the project for $34,000. You will also need $20,000 in net working capital for the duration of the project. The fixed costs will be $16,000 a year and the variable costs will be $168,000 per park. Your required rate of return is 15 percent and your tax rate is 34 percent. What is the minimal amount you should bid per park? (Round your answer to the nearest $100)

$217,600

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the amount of the aftertax salvage value of the equipment?

$31,850 Aftertax salvage value = $980,000 0.05 (1 - 0.35) = $31,850

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 16 percent?

$32,409.57

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the aftertax cash flow from the sale of the fixed assets at the end of this project?

$68,904 Aftertax salvage value = $522,000 0.20 (1 - 0.34) = $68,904

Mason Farms purchased a building for $729,000 eight years ago. Six years ago, repairs were made to the building which cost $136,000. The annual taxes on the property are $11,000. The building has a current market value of $825,000 and a current book value of $494,000. The building is totally paid for and solely owned by the firm. If the company decides to use this building for a new project, what value, if any, should be included in the initial cash flow of the project for this building?

$825,000

Webster & Moore paid $139,000, in cash, for a piece of equipment 3 years ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $89,000 from a firm that would like to purchase it. Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?

$89,000

Kelly's Corner Bakery purchased a lot in Oil City 6 years ago at a cost of $280,000. Today, that lot has a market value of $340,000. At the time of the purchase, the company spent $15,000 to level the lot and another $20,000 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1.47 million. What amount should be used as the initial cash flow for this project?

-$1,810,000 CF0 = -$340,000 - $1,470,000 = -$1,810,000

Sailcloth & More currently produces boat sails and is considering expanding its operations to include awnings for homes and travel trailers. The company owns land beside its current manufacturing facility that could be used for the expansion. The company bought this land 5 years ago at a cost of $319,000. At the time of purchase, the company paid $24,000 to level out the land so it would be suitable for future use. Today, the land is valued at $295,000. The company currently has some unused equipment that it currently owns valued at $38,000. This equipment could be used for producing awnings if $12,000 is spent for equipment modifications. Other equipment costing $490,000 will also be required. What is the amount of the initial cash flow for this expansion project?

-$835,000 CF0 = -$295,000 - $38,000 - $12,000 - $490,000 = -$835,000

Phone Home, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with costs of $883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project?

$1,433,059 OCF = ($2,208,000 - $883,200)(1 - 0.32) + ($2,484,000/5)(0.32) = $1,059,840

Nelson Mfg. owns a manufacturing facility that is currently sitting idle. The facility is located on a piece of land that originally cost $159,000. The facility itself cost $1,460,000 to build. As of now, the book value of the land and the facility are $159,000 and $458,000, respectively. The firm owes no debt on either the land or the facility at the present time. The firm received a bid of $1,500,000 for the land and facility last week. The firm's management rejected this bid even though they were told that it is a reasonable offer in today's market. If the firm was to consider using this land and facility in a new project, what cost, if any, should it include in the project analysis?

$1,500,000

You are working on a bid to build two apartment buildings a year for the next 5 years for a local college. This project requires the purchase of $750,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. The equipment can be sold at the end of the project for $325,000. You will also need $140,000 in net working capital over the life of the project. The fixed costs will be $628,000 a year and the variable costs will be $1,298,000 per building. Your required rate of return is 14.5 percent for this project and your tax rate is 35 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building?

$1,733,000

The Beach House has sales of $784,000 and a profit margin of 11 percent. The annual depreciation expense is $14,000. What is the amount of the operating cash flow if the company has no long-term debt?

$100,240 OCF = ($784,000 0.11) + $14,000 = $100,240

Northern Railway is considering a project which will produce annual sales of $975,000 and increase cash expenses by $859,000. If the project is implemented, taxes will increase from $141,000 to $154,000 and depreciation will increase from $194,000 to $272,000. The company is debt-free. What is the amount of the operating cash flow using the top-down approach?

$103,000 OCF = $975,000 - $859,000 - ($154,000 - $141,000) = $103,000

A proposed expansion project is expected to increase sales of JL Ticker's Store by $35,000 and increase cash expenses by $21,000. The project will cost $24,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The store has a marginal tax rate of 30 percent. What is the operating cash flow of the project using the tax shield approach?

$11,600 OCF = ($35,000 - $21,000) (1 - 0.30) + ($24,000/4) (0.30) = $11,600

Dog Up! Franks is looking at a new sausage system with an installed cost of $397,800. This cost will be depreciated straight-line to zero over the project's 7-year life, at the end of which the sausage system can be scrapped for $61,200. The sausage system will save the firm $122,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $28,560. All of the net working capital will be recovered at the end of the project. The tax rate is 33 percent and the discount rate is 9 percent. What is the net present value of this project?

$118,821 OCF = $122,400(1 - 0.33) + ($397,800/7)(0.33) = $100,761.43

Colors and More is considering replacing the equipment it uses to produce crayons. The equipment would cost $1.37 million, have a 12-year life, and lower manufacturing costs by an estimated $304,000 a year. The equipment will be depreciated using straight-line depreciation to a book value of zero. The required rate of return is 15 percent and the tax rate is 35 percent. What is the net income from this proposed project?

$123,391.67 Net income = [$304,000 - ($1,370,000/12)] [1 - 0.35] = $123,391.67

The Pancake House has sales of $1,642,000, depreciation of $27,000, and net working capital of $218,000. The firm has a tax rate of 35 percent and a profit margin of 6 percent. The firm has no interest expense. What is the amount of the operating cash flow?

$125,520 OCF = ($1,642,000 0.06) + $27,000 = $125,520

Kwik 'n Hot Dogs is considering the installation of a new computerized pressure cooker that will cut annual operating costs by $23,000. The system will cost $39,900 to purchase and install. This system is expected to have a 4-year life and will be depreciated to zero using straight-line depreciation. What is the amount of the earnings before interest and taxes for this project?

$13,025 Earnings before interest and taxes = $23,000 - ($39,900/4) = $13,025

Heer Enterprises needs someone to supply it with 225,000 cartons of machine screws per year to support its manufacturing needs over the next 7 years, and you've decided to bid on the contract. It will cost you $1,170,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. You estimate that in 7 years, this equipment can be salvaged for $75,000. Your fixed production costs will be $360,000 per year, and your variable production costs should be $12.75 per carton. You also need an initial investment in net working capital of $112,500, all of which will be recovered when the project ends. Your tax rate is 32 percent and you require a 13 percent return on your investment. What bid price per carton should you submit?

$15.79

Marie's Fashions is considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated costs of $57,000. The project has a 5-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 30 percent. What is the operating cash flow for this project?

$17,820 OCF = ($75,000 - $57,000)(1 - 0.30) + ($87,000/5)(0.30) = $17,820

Cool Comfort currently sells 300 Class A spas, 450 Class C spas, and 200 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does it can sell 375 of them. However, if the new spa is added, Class A sales are expected to decline to 225 units while the Class C sales are expected to decline to 200. The sales of the deluxe model will not be affected. Class A spas sell for an average of $12,000 each. Class C spas are priced at $6,000 and the deluxe model sells for $17,000 each. The new mid-range spa will sell for $8,000. What is the value of the erosion?

$2,400,000 Erosion = [(300 - 225) $12,000] + [(450 - 200) $6,000] = $2,400,000

Phone Home, Inc. is considering a new 6-year expansion project that requires an initial fixed asset investment of $5.994 million. The fixed asset will be depreciated straight-line to zero over its 6-year tax life, after which time it will be worthless. The project is estimated to generate $5,328,000 in annual sales, with costs of $2,131,200. The tax rate is 31 percent. What is the operating cash flow for this project?

$2,515,482 OCF = (5,328,000 - $2,131,200)(1 - 0.31) + ($5,994,000/6)(0.31) = $2,515,482

Winnebagel Corp. currently sells 28,200 motor homes per year at $42,300 each, and 11,280 luxury motor coaches per year at $79,900 each. The company wants to introduce a new portable camper to fill out its product line. It hopes to sell 19,740 of these campers per year at $11,280 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 4,700 units per year, and reduce the sales of its motor coaches by 1,222 units per year. What is the amount that should be used as the annual sales figure when evaluating this project?

$323,839,400 Sales = (19,740 $11,280) + (4,700 $42,300) + (-1,222 $79,900) = $323,839,400

Consider an asset that costs $176,000 and is depreciated straight-line to zero over its 11-year tax life. The asset is to be used in a 7-year project; at the end of the project, the asset can be sold for $22,000. The relevant tax rate is 30 percent. What is the aftertax cash flow from the sale of this asset?

$34,600 Book value at end of year 7 = $176,000 4/11 = $64,000 Aftertax salvage value = $22,000 + [($64,000 - $22,000) .30] = $34,600

Jefferson & Sons is evaluating a project that will increase annual sales by $138,000 and annual costs by $94,000. The project will initially require $110,000 in fixed assets that will be depreciated straight-line to a zero book value over the 4-year life of the project. The applicable tax rate is 32 percent. What is the operating cash flow for this project?

$38,720 OCF = ($138,000 - $94,000)(1 - 0.32) + ($110,000/4)(0.32) = $38,720

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the value of the depreciation tax shield in year 4 of the project?

$49,000 Depreciation tax shield = $980,000/7 0.35 = $49,000

The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $238,000 and cash expenses by $184,000. The initial investment will require $96,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield?

$5,120 Depreciation tax shield = ($96,000/6) 0.32 = $5,120

Phone Home, Inc. is considering a new 4-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset will be depreciated straight-line to zero over its 4-year tax life, after which time it will have a market value of $231,000. The project requires an initial investment in net working capital of $330,000, all of which will be recovered at the end of the project. The project is estimated to generate $2,640,000 in annual sales, with costs of $1,056,000. The tax rate is 31 percent and the required return for the project is 15 percent. What is the net present value for this project?

$733,970 OCF = ($2,640,000 - $1,056,000)(1 - 0.31) + ($3,000,000/4)(0.31) = $1,325,460

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the recovery amount attributable to net working capital at the end of the project?

$84,000 NWC recapture = $420,000 0.20 = $84,000

Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, inventory will decrease by $16,000, accounts receivables will increase by $21,000, and accounts payable will increase by $15,000. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.5 percent?

$84,049.74 CF0 = -$249,000 + $16,000 - $21,000 + $15,000 = -$239,000 C07 = $73,000 + $48,000 - $16,000 + $21,000 - $15,000 = $111,000

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the cash flow recovery from net working capital at the end of this project?

$92,000 Net working capital recovery = $218,000 + $39,000 - $165,000 = $92,000

A 4-year project has an initial asset investment of $306,600, and initial net working capital investment of $29,200, and an annual operating cash flow of -$46,720. The fixed asset is fully depreciated over the life of the project and has no salvage value. The net working capital will be recovered when the project ends. The required return is 15 percent. What is the project's equivalent annual cost, or EAC?

-$158,491

Home Furnishings Express is expanding its product offerings to reach a wider range of customers. The expansion project includes increasing the floor inventory by $430,000 and increasing its debt to suppliers by 70 percent of that amount. The company will also spend $450,000 for a building contractor to expand the size of its showroom. As part of the expansion plan, the company will be offering credit to its customers and thus expects accounts receivable to rise by $90,000. For the project analysis, what amount should be used as the initial cash flow for net working capital?

-$219,000 NWC requirement = -$430,000 + (0.70 $430,000) - $90,000 = -$219,000

Champion Bakers uses specialized ovens to bake its bread. One oven costs $689,000 and lasts about 4 years before it needs to be replaced. The annual operating cost per over is $41,000. What is the equivalent annual cost of an oven if the required rate of return is 13 percent?

-$272,638

Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,480,000 to purchase plus an additional $49,000 a year to operate. The machines have a 6-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16 percent?

-$450,657

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 with costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the project's cash flow at time zero?

-$614,000 Initial cash flow = -$522,000 - $218,000 - $39,000 + $165,000 = -$614,000

The Buck Store is considering a project that will require additional inventory of $216,000 and will increase accounts payable by $181,000. Accounts receivable are currently $525,000 and are expected to increase by 9 percent if this project is accepted. What is the project's initial cash flow for net working capital?

-$82,250 NWC requirement = -$216,000 + $181,000 - ($525,000 0.09) = - $82,250

Your firm is contemplating the purchase of a new $1,628,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $158,400 at the end of that time. You will save $633,600 before taxes per year in order processing costs and you will be able to reduce working capital by $115,764 (this is a one-time reduction). The net working capital will return to its original level when the project ends. The tax rate is 35 percent. What is the internal rate of return for this project?

21.65 percent OCF = $663,600(1 - 0.35) + ($1,628,000/5)(0.35) = $525,800

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The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

incremental

Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $26,300, and a 4-year life. Machine B costs $1,127,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Precision Tool should purchase Machine _____ because it lowers the firm's annual cost by approximately _______ as compared to the other machine.

A; $16,965.

All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero? I. purchase of $1,400 of parts inventory needed to support the project II. loan of $125,000 used to finance the project III. depreciation tax shield of $1,100 IV. $6,500 of equipment needed to commence the project

I and IV only

Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary

I, II, and IV only

Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product

II, III, and IV only

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero?

NI + D

Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income. Given this, which one of the following statements is correct?

The new machine will generate positive operating cash flows, at least in the first few years of its life.

Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not?

Yes; The NPV is $466,940.57 Initial cash flow = -$2,460,000 - $45,000 = -$2,505,000 OCF = $725,000(1 - 0.35) + ($2,460,000/10)(0.35) = $557,350 Final cash flow = $45,000 + $300,000 (1 - 0.35) = $240,000

Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow?

depreciation expense

Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision?

equivalent annual cost

Decreasing which one of the following will increase the acceptability of a project?

equivalent annual cost

The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?

equivalent annual cost

Which one of the following best describes pro forma financial statements?

financial statements showing projected values for future time periods

Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

hiring additional employees to handle the increased workload should the firm accept the wreath project

The top-down approach to computing the operating cash flow:

ignores noncash expenses.

G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?

sunk

Which one of the following best describes the concept of erosion?

the cash flows of a new project that come at the expense of a firm's existing cash flows