FIN 780 Ch. 8 practice problems

Cain's Tool & Die paid $397,000 in cash for a piece of equipment three years ago. Last year, the company spent $52,000 on equipment upgrades. The equipment is being depreciated using the straight-line method over seven years. The company no longer uses this equipment in its current operations and has received an offer of $125,000 from a firm that would like to purchase it. If the company should decide to use this equipment in an upcoming project, what cost, if any, should be assigned to the project for this equipment?

$125,000

Bhakta Group has spent $265,000 on research developing a new type of security system. For this system to now be manufactured, the firm will need to expand into an empty building that it currently owns. The firm was offered $442,000 last week for that building, but it has not responded to the offer yet. An additional $538,000 will be required for new equipment and building improvements. Labor and material costs are estimated at $85.20 per system. Interest expense on the loan needed to finance the production of this new system will be $22,000 a year. Which one of the following correctly identifies the sunk costs?

$265,000 for research

Walks Softly sells customized shoes. Currently, it sells 14,800 pairs of shoes annually at an average price of $79 a pair. The company is considering adding a lower-priced line of shoes that will sell for $59 a pair. The company estimates it can sell 4,800 pairs of the lower-priced shoes but will sell 1,900 less pairs of the higher-priced shoes by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced shoes?

1. 14,800 x 79 = 1,169,200 2. (14,800-1,900) x 79 = 1,019,100 3. 4,800 x 59 = 283,200 4. (1,019,100 + 283,200) - 1,169,200 5. 1,302,300 - 1,169,200 = $133,100

Which one of these statements related to MACRS depreciation is correct?

An asset will be depreciated faster using MACRS versus using the straight-line method.

Ernie's Electrical is evaluating a project that will increase sales by $48,000 and costs by $16,000. The project will initially cost $89,000 for fixed assets that will be depreciated straight-line to a zero book value over the 6-year life of the project. The applicable tax rate is 34 percent. What is the project's annual operating cash flow (OCF)?

Annual operating cash flow = (Sales-Cost-Depreciation)*(1-tax rate) + Depreciation Depreciation = $89,000/6 = $14,833.3333 Annual operating cash flow = ($48,000-$16,000-$14,833.33)*(1-0.34) + $14,833.33 $26,163.33

In project analysis, which one of these is a common assumption regarding net working capital?

At the end of a project, the net working capital will be returned to the level it was prior to the project.Correct

The initial cost of a machine is $727,000 with annual operating costs of $39,600. Each machine has a life of five years before it is replaced. Ignore taxes. What is the equivalent annual cost (EAC) of this machine if the required return is 16 percent?

CFs: 1. -CF0= 727,000 -CO1= 39,600 -FO1= 5 2. -(NPV) -I= 16 -CPT NPV -NPV = PV 3. -PV = -NPV -N= 5 -I/Y= 16 -FV= 0 -CPT PMT = $261,632.62

Which one of the following statements is correct?

Costs incurred prior to deciding whether to produce a new product are sunk costs.

Bloomfield's has some idle equipment that is debt-free and fully depreciated. If the company decides to use this equipment for a new project, what amount, if any, should be included for this equipment in the project's start-up costs?

Current market value of the equipment

Which one of these statements related to depreciation is correct for a firm with taxable income of $237,500 and aftertax income of $187,625?

Depreciation is a noncash expense that increases the firm's cash flows.

Bonilla Boats purchased a corner lot five years ago at a cost of $730,000. The lot was recently appraised at $680,000. At the time of the purchase, the company spent $25,000 to grade the lot and another $80,000 to pave the lot for customer parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.4 million. What amount should be used as the initial cash flow for this building project?

Initial Cash Flow = Cost of Building + lot recently appraised ( Oppourtunity Cost) Initial Cash Flow = $1,400,000 + $680,000 Initial Cash Flow = $2,080,000

DeCento's is analyzing two mutually exclusive machines to determine which one it should purchase. Whichever machine is purchased, it will be replaced at the end of its useful life. The company requires a return of 15 percent and uses straight-line depreciation to a zero book value over the life of the machine. Machine A has a cost of $386,000, annual operating costs of $29,000, and a life of four years. Machine B costs $257,000, has annual operating costs of $19,000, and a life of 3 years. The firm currently pays no taxes. Which machine should be purchased and why?

Machine B because it will save the company about $32,642 a year

Which one of the following is an example of an incremental cash flow for Project Epsilon?

Rental cost of some new machinery that will be acquired for Project Epsilon

Assume a machine costs $129,000 and lasts three years before it is replaced. The operating cost is $7,200 a year. Ignore taxes. What is the equivalent annual cost (EAC) if the required rate of return is 14 percent?

The equivalent cost of initial investment for 3 years = PV/(1-(1+r)^-n)/r = 129000/(1-(1+14%)^-3)/14% = 55564.36 The Equivalent annual cost = 55564.36 + 7200 = $62,764.36

The incremental cash flows of a project are best defined as

any change in a firm's cash flows resulting from the addition of the project including opportunity costs.

Sunk costs include any cost that

has previously been incurred and cannot be changed.

Project analysis is focused on __________ costs.

incremental

The cash flows of a project include the

incremental operating cash flow, as well as any changes in capital spending and net working capital.

Erosion can be best explained as the

loss of current sales due to a new project being implemented.

The most valuable investment given up if an alternative investment is chosen is referred to as a(n)

opportunity cost.

You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up, and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) __________ cost.

sunk