finchapter10

The bid price always assumes which one of the following?

The net present value of the project is 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?

The new machine will generate positive operating cash flows.

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 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.

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

The interest expense is equal to zero

The bid price is:

The minimum price that will provide your target rate of return

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 statements is correct concerning bid prices?

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

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

ACRS

Better Beverages purchased some fixed assets classified as five-year property for MACRS. The assets cost $108,000. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for years 1 to 6, respectively. What will the accumulated depreciation be at the end of year 4?

Accumulated depreciation = Cost (108,000) * Rates (.2 + .32 + .192 + .1152) = 89,337.60

A project will produce an operating cash flow of $31,200 a year for 7 years. The initial fixed asset investment in the project will be $204,900. The net aftertax salvage value is estimated at $62,000 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 11 percent?

CFo = -204,900 C01 = 31,200 --> etc through C06 C07 = 31,200 + 62,000

Corner Market is considering adding a new product line that is expected to increase annual sales by $418,000 and cash expenses by $337,000. The initial investment will require $237,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the five-year life of the project. The company has a marginal tax rate of 34 percent. What is the annual value of the depreciation tax shield?

Depreciation (237,000/5) * Taxes (.34) = Depreciation tax shield (16,116)

Kwik Dogs is considering the installation of a new computerized pressure cooker that will cut annual operating costs by $18,400. The system will cost $42,900 to purchase and install and will be depreciated to zero using straight-line depreciation over its four-year life. What is the amount of the earnings before interest and taxes for this project?

EBIT = Reduction in operating cost - Depreciation 18,400 - (42,900 / 4) = 7,675

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 (EAC)

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

Ignores noncash expenses.

Pro forma statements for a proposed project should generally do all of the following except:

Include interest expense

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 that 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 that has the:

Lowest equivalent annual cost.

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?

Net income + Depreciation

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

Opportunity cost

Three years ago, Knox Glass purchased a machine for a three-year project. The machine is being depreciated straight-line to zero over a five-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 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?

Sales = Increased revenue (7000 * 59) - Decreased revenue (3000 * 89) = 146,000

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 equivalent annual cost method is useful in determining:

Which one of two machines should be purchased when the machines are mutually exclusive, have different lives, and will be replaced at the end of their lives.

A company that utilizes the MACRS system of depreciation:

Will have a greater depreciation tax shield in year 2 than in year 1

Kelly's Corner Bakery purchased a lot in Oil City six years ago at a cost of $278,000. Today, that lot has a market value of $264,000. At the time of the purchase, the company spent $6,000 to level the lot and another $8,000 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1.03 million. What amount should be used as the initial cash flow for this project?

-$1,294,000 Estimated cost foregone + Market value

The Lunch Counter is expanding and expects operating cash flows of $32,500 a year for seven years as a result. This expansion requires $28,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $2,800 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 14 percent?

109,688.89

Dependable Motors just purchased some MACRS 5-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for years 1 to 3, respectively. Which one of the following will correctly give you the book value of this equipment at the end of year 2?

216,000 * (1 - .2 - .32)

P.A. Petroleum just purchased some equipment at a cost of $67,000. The equipment is classified as MACRS 5-year property. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for years 1 to 6, respectively. What is the proper methodology for computing the depreciation expense for year 2?

67,000 * .32

Which one of the following statements is correct?

A project can create a positive operating cash flows without affecting sales

You own some equipment that you purchased four years ago at a cost of $287,000. The equipment is five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, .0576, for years 1 to 6, respectively. You are considering selling the equipment today for $99,000. Which one of the following statements is correct if your tax rate is 35 percent?

Accum dep = 287,000 * (.2+.32+.192+.1152) = 237,406.40 Book value = 287,000 - 237,406.40 = 49,593.60 Sale price (99,000) - Book value (49,593.60) * .35 = 17,292.24 tax Net cash flows = 99,000 - 17,292.24 = 81,707.76 (after-tax salvage value)

Pre-Fab purchased some machinery two years ago for $337,600. These assets are classified as five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, .0576, for years 1 to 6, respectively. The company is currently replacing this equipment with newer models at a cost of $528,000. The old equipment is being sold for $149,000. What is the aftertax salvage value from this sale if the tax rate is 35 percent?

Accum dep = 337,600 * (.2+.32) = 175,552 Book value = 337,600 - 175,552 = 162048 Selling price (149,000) - Book value (162048) = -13048 Tax: -13048 * .35 = -4566.80 Selling price (149,000) - Tax (-4566.80) = 153,566.80

Pet Supply purchased some fixed assets two years ago at a cost of $43,800. It no longer needs these assets so it is going to sell them today for $32,500. The assets are classified as five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, .0576, for years 1 to 6, respectively. What is the net cash flow from this sale if the firm's tax rate is 35 percent?

Accum dep = Cost (43,800) * Rates (.2+.32) = 22,776 Cost (43,800) - Dep (22,776) = Book value (21,024) Sale price - Book value = 11,476 Taxes: (11,476 * .35) = 4016.60 Net cash flows: Sale price - Tax 32,500 - 4016.60 = 28,483.40

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 mutually exclusive 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

Gateway Communications is considering a project with an initial fixed asset cost of $2.872 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 $714,000 a year. The tax rate is 35 percent. The project will require $52,000 of inventory which will be recouped when the project ends. What is the net present value at the required rate of return of 13.6 percent?

Answer: Initial cash flow = -$2,872,000 - $52,000 = -$2,924,000 OCF = $714,000(1 - 0.35) + ($2,872,000/10)(0.35) = $564620 Final cash flow = $52,000 + $300,000 (1 - 0.35) = $247,000

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

Equivalent annual cost

You just purchased some equipment that is classified as five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for Years 1 to 6, respectively. The equipment cost $218,000. What will the book value of this equipment be at the end of three years should you decide to resell the equipment at that point in time?

Book value = Remaining tax: Cost (218,000) * Remaining rates (.1152 + .1152 + .0576) = 62,784

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 an initial cash inflow or outflow.

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 $1,390,000 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 $1,700,000 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?

Cost of keeping = market price 1,700,000

The equivalent annual cost considers all of the following except the:

Costs of research conducted to identify equipment choices.

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

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

Overland Trucking just purchased some fixed assets that are classified as three-year property for MACRS. The MACRS rates are .3333, .4445, .1481, and .0741 for years 1 to 4, respectively. What is the amount of the depreciation expense in year 3 if the initial cost is $387,950?

Depreciation expense = Cost (387,950) * Year's rate (.1481) = 57,455.40

Assume you are considering two mutually exclusive machines and need to select one for a cost-cutting project. Which one of these sets of characteristics best indicates the use of the equivalent annual cost method of analysis?

Differing lives and planned replacement at end of life.

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 $310,000 a year. The equipment will be depreciated over 12 years 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 annual operating cash flow?

EBIT = 310,000 - (1,370,000/12) = 195,833.33 - Taxes 195,833.33 * .35 = 68,541.67 = 127,291.66 + Depreciation = 241,458.33 OFC

Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs and 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

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 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

Mason Farms purchased a building for $689,000 eight years ago. Six years ago, repairs costing $136,000 were made to the building. The annual taxes on the property are $11,000. The building has a current market value of $840,000 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?

Initial cash flow = Market price (what someone would pay to purchase it) 840,000

Webster & Moore paid $148,000, in cash, for equipment three 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 $96,000 from a firm that would like to purchase it. The firm is debating whether to sell the equipment or to expand its operations so that the equipment can be used. The equipment, including the updates, has a book value of $44,500. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?

Initial cost of project = Opportunity cost 96,000

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0?

Initial investment of inventory to support the project (and initial NWC)

High Breeze currently produces boat sails and is considering expanding into awnings for homes and travel trailers. The company owns land that could be used for the expansion. This land was purchased at a cost of $319,000 and is valued today at $395,000. The company 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 $138,000 will also be required. What is the amount of the initial cash flow for this expansion project?

Market value (395,000) + Other costs (38,000 + 12,000 + 138,000) = 583,000

Which one of the following should not be included in the analysis of a new product?

Money already spent for research and development of the new product.

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?

Reduction in class A sales: (300-225 * 12,000) + Reduction in class C sales: (450 - 200 * 6000) = 2,400,000

Jefferson & Sons is evaluating a project that will increase annual sales by $145,000 and annual cash 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 four-year life of the project. The applicable tax rate is 32 percent. What is the operating cash flow for this project?

Sales (145,000) - Costs (94,000) = 51,000 - Depreciation (110,000 /4 = 27500) = 23,500 - Taxes (23,500 * .32 = 7520) = 15980 + Depreciation (27500) = 43480 as OCF

Houston's is considering a project that will produce incremental annual sales of $234,000 and increase cash expenses by $148,000. If the project is implemented, taxes will increase from $31,000 to $34,000, and depreciation will increase from $41,000 to $46,000. The company is debt-free. What is the amount of the operating cash flow using the top-down approach?

Sales (234,000) - Costs (148,000) - Tax (3,000) = 83,000 *You can add depreciation then subtract, but tax is already given so there is essentially no point in including it.

A project has projected sales of $26,000, cash expenses of $18,500, depreciation of $1,730, taxes of $1,400, and an initial cash requirement of $2,200 for working capital. What is the amount of the operating cash flow using the top-down approach?

Sales (26,000) - Costs (18,500) - Tax (1,400) = 6,100

A proposed expansion project is expected to increase sales of JJ's Store by $58,000 and increase cash expenses by $36,100. The project will require $36,900 of fixed assets that will be depreciated using straight-line depreciation to a zero book value over the three-year life of the project. The store has a marginal tax rate of 35 percent. What is the operating cash flow of the project using the tax shield approach?

Sales (58,000) - Costs (36,100) = 21,900 - Depreciation (36,900 / 3 = 12,300) = 9600 - Tax (9600 *.35 = 3360) = 6240 + Depreciation (12,300) = 18,540

Marie's Fashions is considering a project that will require $41,000 in net working capital and $64,000 in fixed assets. The project is expected to produce annual sales of $62,000 with associated cash costs of $41,000. The project has a three-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 34 percent. What is the operating cash flow for this project?

Sales (62,000) - Costs (41,000) = 21,000 - Depreciation (64,000 / 3 = 21,333.33 = -333.33 - Taxes (-333.33 * .34 = 113.33) = -220 + Depreciation (21,333.33) = 21,113.33

Webster's has sales of $649,000 and a profit margin of 7.2 percent. The annual depreciation expense is $102,600. What is the amount of the operating cash flow if the company has no long-term debt?

Sales (649,000) * Profit margin (.072) = Net income (46,728) + Depreciation (102,600) = 149,328 OCF

Hot and Cold has annual sales of $982,000, annual depreciation of $127,000, and net working capital of $243,000. The tax rate is 34 percent and the profit margin is 6 percent. The firm has no interest expense. What is the amount of the operating cash flow?

Sales (982,000) * Profit margin (.06) = 58,920 + Depreciation (127,000) = 185,920 OCF

Frank's is a furniture store that is considering adding appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances?

Selling furniture to appliance customers

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 maintenance expenses on a rental house you own average $200 a month. The house cost $219,000 when you purchased it four 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?

Value = Market price (239,000) - Savings (14,000) = 225,000