CH. 10 & CH.12 HW

The operating cash flow for a project should exclude which one of the following? A. taxes B. variable costs C. fixed costs D. interest expense E. depreciation tax shield

interest expense

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? A. salvage value B. wasted value C. sunk cost D. opportunity cost E. erosion

opportunity cost

Returns Year X Y 1 14 % 21 % 2 32 42 3 21 -7 4 -22 -21 5 23 50

(a) Calculate the arithmetic average return for X. (14+32+21-22+23)/5=13.60% (b) Calculate the arithmetic average return for Y. (21+42-7-21+50)/5 =17.00% (a) Calculate the variance for X. (Do not round intermediate calculations.) 0.043730 (b) Calculate the variance for Y. (Do not round intermediate calculations.) 0.093750 (a) Calculate the standard deviation for X. (Do not round intermediate calculations.) 20.91% (b) Calculate the standard deviation for Y. (Do not round intermediate calculations.) 30.62% The standard deviation is the square root of the variance, so the standard deviation of each stock is: σX = (0.043730)1/2 = 0.2091 or 20.91% σY = (0.093750)1/2 = 0.3062 or 30.62%

5) Champion Bakers uses specialized ovens to bake its bread. One oven costs $840,000 and lasts about 3 years before it needs to be replaced. The annual operating cost per oven is $10,000. What is the equivalent annual cost of an oven if the required rate of return is 8 percent? (Round your answer to whole dollars)

1) NPV = - 840,000 - 10,000 ( ( 1- 1/1.08^3)/.08) = -865,770.97 2) Equivalent annual cost EAC = Net present value of cash flow /Present value factor annuity 3 years,8% EAC = -865,770.97/ ( ( 1- 1/1.08^3)/.08) = -865,770.97 / 2.5771 EAC = - $335,948

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? A. -$41,311 B. -$7,820 C. $81,507 D. $98,441 E. $118,821

118,821

Edward's Manufactured Homes purchased some machinery 2 years ago for $52,000. The assets are classified as 5-year property for MACRS. The company is replacing this machinery today with newer machines that utilize the latest in technology. The old machines are being sold for $16,000 to a foreign firm for use in its production facility in South America. What is the aftertax salvage value from this sale if the tax rate is 34 percent? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a $15,651.84 b $24,960.00 c $16,000.00 d $18,043.23 e $19,046.40

Book value2 = $52,000 x (1 - 0.20 - 0.32) = $24,960 Tax on sale = ($16,000 - $24,960) x .34 =-$3,046.40 Aftertax cash flow = $16,000 + $3,046.40 = $19,046.40

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? A. EBIT + D B. EBIT - T C. NI + D D. (Sales - Costs) × (1 - D) × (1- T) E. (Sales - Costs) × (1 - T)

NI + D

The depreciation tax shield is best defined as the: A. amount of tax that is saved when an asset is purchased. B. tax that is avoided when an asset is sold as salvage. C. amount of tax that is due when an asset is sold. D. amount of tax that is saved because of the depreciation expense. E. amount by which the aftertax depreciation expense lowers net income.

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

Which one of the following is a project cash inflow? Ignore any tax effects. A. decrease in accounts payable B. increase in inventory C. decrease in accounts receivable D. depreciation expense based on MACRS E. equipment acquisition

decrease in accounts receivable

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? A. erosion effects B. taxes C. fixed expenses D. salaries E. depreciation expense

depreciation expense

Which one of the following is an example of a sunk cost? A. $1,500 of lost sales because an item was out of stock B. $1,200 paid to repair a machine last year C. $20,000 project that must be forfeited if another project is accepted D. $4,500 reduction in current shoe sales if a store commences selling sandals E. $1,800 increase in comic book sales if a store commences selling puzzles

$1,200 paid to repair a machine last year

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? A. $23,627.54 B. $28,070.26 C. $34,627.54 D. $39,070.26 E. $41,040.83

$28,070.26

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $4.5 million. The fixed asset falls into the 3-year MACRS class (MACRS Table) and will have a market value of $352,800 after 3 years. The project requires an initial investment in net working capital of $504,000. The project is estimated to generate $4,032,000 in annual sales, with costs of $1,612,800. The tax rate is 33 percent and the required return on the project is 14 percent. (Do not round your intermediate calculations.) (a) What is the project's year 0 net cash flow? (b) What is the project's year 1 net cash flow? (c) What is the project's year 2 net cash flow? (d) What is the project's year 3 net cash flow? (e) What is the NPV?

1) Yr1 Dep: 4.5 million x 0 .3333= 1,499,850 Yr2 Dep : 4.5 million x 0.4485 = 2,018,250 Yr3 Dep: 4.5 million x 0.1481 = 666,450 Accumulated Dep Total: 3 yr = 4,184,550 2) BV at end of 3 yr is 4,500,000 - 4,184,550 = 315,450 3) Aftertax salvage value = 352,800 + (315,450-352,800) (0.33) = 352,800 - 12,325.50 = 340,474.50 4) OCF tax shield approach = (sale - cost)(1- T.33) + ( depreciation ) *(0.33) OCF 0: -4,500,000 - 504,000 = -5,004,000 OCF 1 =(4,032,000 - 1,612,800)x0.67 +1,499,850 x 0.33 = 2,419,200x 0.67 +494,950.50= 2,115,814.50 OCF 2: =(4,032,000 - 1,612,800)x 0.67 + 2,018,250 x 0.33 = 1,620.864 + 666,0222.50 = 2,286,886.50 OCF 3: =(4,032,000 - 1,612,800)x 0.67 + 666,450 x 0.33 +340,474.50+504,000 = 2,685,267 5) NPV use calculator = $424,141.27

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? A. $1,432,155 B. $1,433,059 C. $1,434,098 D. $1,434,217 E. $1,435,008

1,433,059

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? A. 11.78 percent B. 13.49 percent C. 18.21 percent D. 21.65 percent E. 23.58 percent

21.65

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? A. $17,150 B. $31,850 C. $118,800 D. $237,600 E. $343,000

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? A. $18,477.29 B. $21,033.33 C. $28,288.70 D. $29,416.08 E. $32,409.57

32,409.57

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? A. $31,800 B. $32,600 C. $33,300 D. $34,100 E. $34,600

34,600

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? A. $35,496 B. $68,904 C. $104,400 D. $287,615 E. $344,520

68,904

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? A. $714,056 B. $733,970 C. $741,335 D. $742,208 E. $744,595

733,970

13) Your firm is contemplating the purchase of a new $772,800 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $69,000 at the end of that time. You will save $303,600 before taxes per year in order processing costs and you will be able to reduce working capital by $70,270 (this is a one-time reduction). Required : If the tax rate is 30%, what is the IRR for this project? (Do not round your intermediate calculations.)

Annual depreciation charge = $772,800/5 Annual depreciation charge = $154,560 Aftertax salvage value = $69,000(1 - 0.3) Aftertax salvage value = $48,300 Using the tax shield approach, the OCF is: OCF = $303,600(1 - 0.3) + 0.3($154,560) OCF = 212,520+ 46,368= $258,888 Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project. The IRR of the project is: NPV = 0 = -$772,800 + 70,270 + $258,888(PVIFAIRR%,5) + [($48,300 - 70,270) / (1+IRR)5] IRR = 24.05%

1) The Beach House has sales of $790,000 and a profit margin of 6 percent. The annual depreciation expense is $80,000. What is the amount of the operating cash flow if the company has no long-term debt?

Bottom-Up OCF= NI+Depre = (790,000x 0.06) + 80,000= $127,400

10) The equivalent annual cost method is useful in determining:

C. 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.

Kelly's Corner Bakery purchased a lot in Oil City five years ago at a cost of $560,000. Today, that lot has a market value of $850,000. At the time of the purchase, the company spent $42,000 to level the lot and another $4,600 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1,100,000. What amount should be used as the initial cash flow for this project? a $-1,100,000 b $-1,660,000 c $-1,950,000 d $-1,702,000 e $-1,992,000

CF0 = -$850,000 - $1,100,000 = -$1,950,000

8) 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-erosion 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

D. II, III, and IV only

Bernie's Beverages purchased some fixed assets classified as 5-year property for MACRS. The assets cost $26,000. What will the accumulated depreciation be at the end of year three? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% a $2,995 b $13,520 c $21,918 d $5,200 e $18,512

Depreciation = $26,000 x (0.20 + 0.32 + 0.192) = $18,512

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 A. I and II only B. I and IV only C. II and IV only D. I, II, and IV only E. I, II, III, and IV

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 A. I and II only B. III and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV

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 a. I and III only b I, II, III, and IV c. I, II, and III only d II and IV only e. II, III, and IV only

II, III, and IV only

You own some equipment that you purchased 4 years ago at a cost of $216,000. The equipment is 5-year property for MACRS. You are considering selling the equipment today for $75,500. Which one of the following statements is correct if your tax rate is 35 percent?

Rate from yr 1-yr4 : 0.20 + 0.32 + 0.192 + 0.1152 Accumulated depreciation yr4 = $216,000 × (0.20 + 0.32 + 0.192 + 0.1152) = $178,675.20 Book Value4 = $216,000 - $178,675.20 = $37,324.80 Taxable gain on sale = $75,500 - $37,324.80 = $38,175.20 Tax due = $38,175.20 × 0.35 = $13,361.32 Aftertax salvage value = $75,500 - $13,361.32 = $62,138.68

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) A. Sale price + (Sales price - Book value) × T B. Sale price + (Sales price - Book value) × (1 - T) C. Sale price + (Book value - Sale price) × T D. Sale price + (Book value - Sale price) × (1 - T) E. Sale price × (1 - T)

Sale price + (Book value - Sale price) × T

2) A proposed new project has projected sales of $183,600, costs of $92,880, and depreciation of $6,480. The tax rate is 32 percent. Calculate operating cash flow using the four different approaches.

Sales $183,600.00 Cost $92,880.00 Depreciation $6,480.00 EBIT: $84,240.00 Tax 32% $26,956.80 Net Income: $57,283.20 a.The common calculation Approach OCF= EBIT + Depr-Tax = 84,240+6,480-26,956.80= 63,763.20 b. Bottom-Up Approach OCF= NI + Depre = 57,283.20+6480=63,763.20 c.Top-Down Approach OCF= sales- cost - taxes = 183,600-92,880-26,956.80 =63,763.20 d. The tax-shield approach is: OCF = (Sales - Costs)(1 - tC) + tCDepreciation OCF = ($183,600 - 92,880)(1 - 0.32) + 0.32(6,480) OCF = $63,763.20 e. And the bottom-up approach is: OCF = Net income + Depreciation OCF = $57,283.20 + 6,480 OCF = $63,763.20

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

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

9) Jefferson & Sons is evaluating a project that will increase annual sales by $80,000 and annual costs by $40,000. The project will initially require $140,000 in fixed assets that will be depreciated straight-line to a zero book value over the 10 years life of the project. The applicable tax rate is 34 percent. What is the operating cash flow for this project?

The tax-shield approach is: OCF = (Sales - Costs)(1 - tC) + tCDepreciation = (80,000-40,000) (1- 0.34) + (140,000/10) *(0.34) = 26,400 + 14,000x 0.34=26,400+4760 OCF= $31,160

Changes in the net working capital requirements: A. can affect the cash flows of a project every year of the project's life. B. only affect the initial cash flows of a project. C. only affect the cash flow at time zero and the final year of a project. D. are generally excluded from project analysis due to their irrelevance to the total project. E. reflect only the changes in the current asset accounts.

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

The operating cash flow of a cost cutting project: A. is equal to the depreciation tax shield. B. is equal to zero because there is no incremental sales. C. can only be analyzed by projecting the sales and costs for a firm's entire operations. D. includes any changes that occur in the current accounts. E. can be positive even though there are no sales.

can be positive even though there are no sales

Net working capital: A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project.

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

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? A. yearly incremental costs B. sunk costs C. opportunity costs D. erosion cost E. equivalent annual cost

equivalent annual cost

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? A. storing supplies in the same space currently used for materials storage B. utilizing the basket manager to oversee wreath production C. hiring additional employees to handle the increased workload should the firm accept the wreath project D. researching the market to determine if wreath sales might be profitable before deciding to proceed E. planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt

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: A. ignores noncash expenses. B. applies only if a project increases sales. C. applies only to cost cutting projects. D. is equal to sales - costs - taxes + depreciation. E. is used solely to compute a bid price.

ignores noncash expense

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? A. opportunity B. fixed C. incremental D. erosion E. sunk

sunk

Which one of the following costs was incurred in the past and cannot be recouped? A. incremental B. side C. sunk D. opportunity E. erosion

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? A. depreciation tax shield B. tax due on the salvage value of that asset C. current year's operating cash flow D. change in net working capital E. MACRS depreciation for the current year

tax due on the salvage value of that asset

The bottom-up approach to computing the operating cash flow applies only when: A. both the depreciation expense and the interest expense are equal to zero. B. the interest expense is equal to zero. C. the project is a cost-cutting project. D. no fixed assets are required for a project. E. both taxes and the interest expense are equal to zero.

the interest expense is equal to zero.

A company that utilizes the MACRS system of depreciation: A. will have equal depreciation costs each year of an asset's life. B. 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. C. can depreciate the cost of land, if it so desires. D. will expense less than the entire cost of an asset. E. cannot expense any of the cost of a new asset during the first year of the asset's life.

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 operating cash flow of a cost cutting project: can only be analyzed by projecting the sales and costs for a firm's entire operations. includes any changes that occur in the current accounts. is equal to zero because there is no incremental sales. is equal to the depreciation tax shield. ✓ can be positive even though there are no sales.

✓ can be positive even though there are no sales.