Finance Chapter 10

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

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

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

1,200 paid to repair a machine last year

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

ACRS

A project will require $543,000 for fixed assets, $218,000 for inventory, and $42,000 for accounts receivable. Short-term debt is expected to increase by $165,000. The project has a six-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. The project is expected to generate annual sales of $905,000 with costs of $730,000. The tax rate is 35 percent and the required rate of return is 14 percent. What is the project's cash flow at Time 0? Selected Answer: Incorrect A. -$536,000 Answers: A. -$536,000 Correct B. -$638,000 C. -$720,000 D. -$779,000 E. -$944,000

Correct B. -$638,000

Which one of the following is a project cash inflow? Ignore any tax effects. Selected Answer: Incorrect B. Increase in inventory. Answers: A. Decrease in accounts payable. B. Increase in inventory. Correct C. Decrease in accounts receivable. D. Depreciation expense based on MACRS. E. Equipment acquisition.

Correct C. Decrease in accounts receivable.

The depreciation tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense

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

Which one of the following will increase a bid price

can increase in the required rate of return

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

decrease in accounts receivable

The net book value of equipment will:

decrease slower under straight-line depreciation than under MACRS

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.

Morris Motors just purchased some MACRS 5-year property at a cost of $216,000. Which one of the following will correctly give you the book value of this equipment at the end of year 2?

$216,000 × (1 - 0.20 - 0.32)

Keyser Petroleum just purchased some equipment at a cost of $67,000. What is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5-year property for MACRS

$67,000 × 0.32

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

the interest expense is equal to zero

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 five-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? Selected Answer: Incorrect E. The new machine creates erosion effects. Answers: A. As a project, the new machine has a net present value equal to minus one times the machine's purchase price. B. The new machine will have a zero rate of return. Correct C. The new machine will generate positive operating cash flows. D. The new machine will create a cash outflow when the firm disposes of it at the end of its life. E. The new machine creates erosion effects.

Correct C. The new machine will generate positive operating cash flows.

Incorrect Your firm is contemplating the purchase of a new $1,049,000 computer-based order entry system. The system will be depreciated straight-line to zero over its three-year life. It will be worth $156,300 at the end of that time. You will save $423,500 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 three-year project? Selected Answer: Incorrect A. 11.78 percent Answers: A. 11.78 percent B. 13.49 percent C. 18.21 percent Correct D. 12.74 percent E. 13.58 percent

Correct D. 12.74 percent

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 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

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

Net working capital:

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

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

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

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

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

incremental

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

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

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 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

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