Ch 12
How is the gain or loss on a sale of equipment determined?
Market value - Book value
A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent?
-$99,416.45 NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45
Which of these illustrates a complementary effect? Select all that apply.
A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products A new product increases the sales of one of the firm's existing products
Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply.
Both assets may produce the same level of sales. Two assets can be used for the same purpose
Which one of these is a feature of MACRS depreciation?
Depreciation commences with an accelerated method and later switches to a straight-line method.
What does accelerated depreciation indicate?
Depreciation in the first half of an asset's life is greater than half of the assets value.
An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed?
N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT
What is the definition of net working capital?
Net working capital is the difference between a firm's current assets and current liabilities.
A cost-cutting project is least apt to affect which one of these?
Revenue
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.
What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply.
Selling the project's equipment Scrapping equipment that has a positive book value but no market value Trading in the project's equipment on new equipment for other projects
Which one of these explains the after-tax cash flow formula for the sale of an asset?
The cash flow equals the book value plus the after-tax value of any gain or loss on the sale.
How can you determine if a cash flow is incremental to a project? Select all that apply.
The cash flow occurs only if a new project is implemented. The cash flow changes only when a new project is implemented. The cash flow will disappear when the project ceases.
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.
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.
Net working capital is a measure of a firm's ability to pay its bills for the next year.
True
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.
The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF?
$1,646 OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646
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 Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76
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? Select all that apply.
$5,000 × (1 - 0.35) $2,400
Values for the first year of a project are projected as: Sales = $1,800, Depreciation = $300, Fixed costs = $450, Variable costs = $620, Tax rate = 34 percent. What is the OCF?
$583.80 OCF = ($1,800 - $620 - $450 - $300)(1 - 0.34) + $300 = $583.30
In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4?
$7,185 OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185
A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention.
($28,000 + $2,000 - $5,000)/6
A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed?
($28,000 - $5,000)/5
Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention.
(Depreciable basis - Ending book value)/Life of asset
A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent?
-$22,933.01 NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01
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? Select all that apply.
-$3,500 -$34,000
Over how many tax years will a 3-year asset be depreciated given the half-year convention?
4 years
What is an incremental cash flow?
A cash flow that either increases or decreases when a new project is implemented
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 × $120,000) is recorded at time zero. A cash inflow of (0.05 × $190,000) occurs in year 3. A cash outflow of [0.05 × ($160,000 - $120,000)] is recorded in year 1.
Which of these illustrates a complementary effect? Select all that apply.
A new product increases the sales of one of the firm's existing products A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products
What is a sunk cost?
A previously incurred cost than cannot be recovered
How is bond interest included in the analysis of a new project?
Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC
New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent?
Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34)
What is the first step in the process of adjusting the initial investment for flotation costs?
Compute the weighted average flotation cost using the target capital weights
Which one of these is an example of the substitution effect?
Current employee costs are lowered due to the automation processes implemented by a new project
A machine has an initial cost of $32,000 and annual after-tax net expenses of $2,600. The life of the machine is three years, after which the machine will be worthless. The discount rate is 13 percent. How is the sum of the present values (NPV) of the machine's cash flows calculated?
NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133
Which one of these is a correct formula for OCF, assuming there is no interest expense?
Net income + Depreciation
What typifies a cost-cutting project?
No revenue is generated by the project.
In essence, the EAC process makes a decision based on which one of these?
Perpetuity payment amount
Free cash flows for which one of the following are affected by estimation error?
Project free cash flows only
Which one of these represents a time zero project cash flow
Purchase of new equipment to start a project
Which one of these represents a time zero project cash flow?
Purchase of new equipment to start a project
What types of costs are included in an asset's depreciable basis? Select all that apply.
Purchase price of the asset Installation and testing costs Sales tax and freight charges
Which of these are financing costs? Select all that apply.
Stock dividend Bond interest
How can a sunk cost be recovered?
Sunk costs cannot be recovered.
Which one of these represents a limit placed on Section 179 deductions?
Taxable income from the active conduct of the firm
Why would a firm prefer to use MACRS rather than straight-line depreciation for tax purposes?
The tax deduction from depreciation is greater in the early years.
How can straight-line depreciation be defined? Ignore the half-year convention.
Total amount to be depreciated spread evenly over an asset's life
Which of these represent opportunity costs? Select all that apply.
Using a current employee who is about to be laid off to run a project on a day by day basis Building a new building on a vacant lot owned by the firm Using a piece of company equipment that has been sitting idle for two years in a new project
What is a financing cost?
Interest and dividends paid as a result of external financing
In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4?
$13,100 OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100
A project requires $15,000 of net working capital throughout its 5-year life. How is this requirement handled in project analysis? Select all that apply.
$15,000 is a cash inflow in year 5. $15,000 is a cash outflow at time zero.
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 Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44
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 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)
An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent?
ATCF = $138 + ($96 - $138)(1 - 0.35)
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 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
Which one of these represents an opportunity cost?
Assigning a current employee to a new project
How is operating cash flow (OCF) defined?
EBIT (1 - Tax rate) + Depreciation
How are the dividends paid on stock included in the analysis of a new project?
Financing costs, such as dividends, are considered in the component costs of capital when a project's WACC is calculated.
What is the second step of the EAC process?
Find the annuity payment that has the same present value as the sum of the present values of a project's cash flows
What is the first step in the EAC process?
Find the sum of the present values of the cash flows for one iteration of each project
What are the key differences between the free cash flows of a firm and those of a project? Select all that apply.
Firm free cash flows are actual values while project free cash flows are estimates.
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.
Installation and initial testing costs Shipping costs to have the equipment delivered Purchase price of the equipment
Which of these correctly apply to MACRS depreciation? Select all that apply.
MACRS uses DDB for 3- to 10-year property and then switches to SL when SL produces a higher depreciation value. All of the MACRS percentages found in the IRS tables are applied to an asset's initial depreciable basis. MACRS tables are provided by the IRS.
Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable?
Which asset will produce the least negative EAC?
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?
Zero
What two conditions must exist for equipment to have no effect on a project's final cash flows? Select two. Assume there are no disposal costs.
Zero market value Zero book value