Week 5 - Apply: Homework

Your company is considering a new project that will require $10,000 of new equipment at the start of the project. The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation. The cost of capital is 9 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.

$1,143.56

A new project would require an immediate increase in raw materials in the amount $17,000. The firm expects that accounts payable will automatically increase $7,000. How much must the firm expect its investment in net working capital to increase if they accept this project?

$10,000

Equipment was purchased for $100,000 plus $1,000 in freight charges. Installation costs were $500 and sales tax totaled $7,500. Hiring a special consultant to provide advice during the selection of the equipment cost $1,000. What is this asset's depreciable basis?

$109,000

Compute the NPV for Project X and accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Time: 0 1 2 3 4 5 Cash flow: −75 −75 0 100 75 50

$14.22

Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 10 percent.Project X Time 0 1 2 3 4 Cash Flow -$100,000 -$36,000 $200,000 $210,000 -$10,000

$183,507.96 Using a financial calculator: NPV = 183,507.96−100,000 CFO−36,000 CF1, 1 F1200,000 CF2, 2 F2210,000 CF3, 1 F3−10,000 CF4, 1 F410 I

Your company is considering a new project that will require $2,000,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $250,000 using straight-line depreciation. The cost of capital is 12 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.

$207,646

Equipment was purchased for $250,000 plus $500 in freight charges. Installation costs were $750 and sales tax totaled $18,750. Hiring a special consultant to provide advice during the selection of the equipment cost $500. What is this asset's depreciable basis?

$270,000

You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $13,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius, which will cost $23,000 to purchase and which will have OCF of −$550 annually throughout that vehicle's expected five-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 12 percent, what is the difference in the EAC of the two cars?

$317.88 Step 1: Using financial calculator: NPV of Scion = −15882.20; NPV of Prius = −24982.63.Step 2: Find EAC of each: EAC of Scion: I = 12, FV = 0, PV = −15,882.20, N = 3, PMT = EAC = −$6,612.54; EAC of Prius: I = 12, N = 5, PV = −24,982.63, FV = 0, PMT = EAC = −$6,930.42.Step 3: Difference = 317.88.

Compute the NPV statistic for Project U given the following cash flows if the appropriate cost of capital is 9 percent.Project U Time 0 1 2 3 4 5 Cash Flow -$1,000 $350 $1,480 -$520 $400 -$100

$383.63 Using a financial calculator: NPV = 383.63−1,000 CFO350 CF1, 1 F11,480 CF2, 2 F2−520 CF3, 1 F3400 CF4, 1 F4−100 CF5, 1 F59 I

Equipment was purchased for $45,000 plus $2,000 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis?

$49,500

Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 12 percent.Project X Time0 1 2 3 4 Cash Flow-$15,000 $6,000 $10,000 $12,000 -$1,000

$6,234.93 Explanation Using a financial calculator: NPV = 6,234.93−15,000 CFO6,000 CF1, 1 F110,000 CF2, 2 F212,000 CF3, 1 F3−1,000 CF4, 1 F412 I

Compute the NPV statistic for Project Y given the following cash flows if the appropriate cost of capital is 10 percent.Project Y Time0 1 2 3 4 5 Cash Flow-$50,000 $7,000 $20,000 $20,000 $20,000 $10,000

$7,788.34 Explanation Using a financial calculator: NPV = 7,788.34−50,000 CFO7,000 CF1, 1 F120,000 CF2, 3 F210,000 CF3, 1 F310 I

Suppose you sell a fixed asset for $90,000 when its book value is $95,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

$91,050

Suppose you sell a fixed asset for $112,000 when its book value is $112,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

*$0 (incorrect)

Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Time: 0 1 2 3 4 5 Cash flow: −75 −75 0 100 75 50

*0.1896, reject (incorrect)

A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as

*NPV (incorrect)

The benchmark for the profitability index (PI) is the

*zero or anything less than zero (incorrect)

Compute the NPV for Project X with the cash flows shown as follows if the appropriate cost of capital is 9 percent. Time 0 1 2 3 4 5 Cash Flow -$5,000 $1,000 $2,000 $2,000 $500 $500

-$175.66 Explanation Using the financial calculator: NPV = −175.66−5,000 CFO1,000 CF1, 1 F12,000 CF2, 2 F2500 CF3, 2 F39 I

How many possible IRRs could you find for the following set of cash flows? Time 0 1 2 3 4 Cash Flow -$15,000 $6,000 $10,000 $12,000 $1,000

1 Explanation Since there's only one change in sign, there can only be one IRR.

Compute the payback statistic for Project Y and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 11 percent and the maximum allowable payback is one year. Time: 0 1 2 3 4 5 Cash flow:−100 75 100 300 75 200

1.25 years, accept Explanation Time: 0 1 2 3 4 5 Cumulative Cash flow:−100 −25 75 375 450 650 1 + (25/100) = 1.25 years.

Compute the IRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Time: 0 1 2 3 4 5 Cash flow: −75 −750 100 75 50

13.26 percent, accept Explanation −75 CFO−75 CF1, 1 F10 CF2, 1 F2100 CF3, 1 F375 CF4, 1 F450 CF5, 1 F5

Compute the MIRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. Time: 0 1 2 3 4 5 Cash flow: −175 75 0 100 75 50

15.73 percent, accept

Compute the IRR for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent. Time: 0 1 2 3 4 5 Cash flow: −1,000 −75 100 100 0 2,000

16.61 percent, accept

How many possible IRRs could you find for the following set of cash flows? Time 0 1 2 3 4 Cash Flow -$201,000 -$37,350 $460,180 $217,020 -$5,000

2 Explanation Since there are two changes in sign, there could potentially be as many as two IRRs.

Compute the discounted payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years. Time: 0 1 2 3 4 5 Cash flow: −1,000 500 480 400 300 150

2.98 years, accept Explanation Time: 0 1 2 3 Disc'd Cash flow: −1,000 454.55 396.69 300.53 Cumulative Cash flow:−1,000 −545.45 −148.76 151.77 2 + 148.76/300.53 = 2.49.

Compute the payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable payback is five years. Time: 0 1 2 3 4 5 Cash flow:−75 −75 0 100 75 50

3.67 years, accept

Compute the discounted payback statistic for Project Y and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 12 percent and the maximum allowable discounted payback is three years. Time: 0 1 2 3 4 5 Cash flow: −5,000 500 2,000 3,000 1,500 500

3.86 years, reject Explanation Time: 0 1 2 3 4 Disc'd Cash flow: −5,000 446.43 1,594.39 2,135.34 953.28 Cumulative Cash flow:−5,000 −4,553.57 −2,959.18 −823.84 129.44 3 + 823.84/953.28 = 3.86.

To correctly project cash flows, we need to consider all of the factors EXCEPT

All of these choices are correct

Concerning incremental project cash flow, which of these is a cost one would never count as an expense of the project?

Financing costs

Which of these is a capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return?

Internal rate of return

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as

NPV

Which of these is a capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows?

Net present value

Which of these is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements?

Pro forma analysis

When looking at which of these types of projects, one must consider any cash flows that arise from surrendering old equipment before the end of its useful life?

Replacement projects

Which statement is true regarding cost-cutting proposals?

The main benefits come only from changes in costs

Compute the MIRR statistic for Project I and note whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 15 percent.Project I Time 0 1 2 3 4 5 Cash Flow -$1,000 $400 $300 $200 $300 $50

The project's MIRR is 12.67 percent and the project should be rejected.

A disadvantage of the payback statistic is that

all of these choices are correct

The net present value decision technique uses a statistic denominated in

currency

An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the ___________________.

depreciable basis

All of the following are incremental cash flows attributable to the project EXCEPT

financing costs

A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications that has a monthly cost of $50 per month. This is an example of

incremental cash flow

All of the following are strengths of NPV EXCEPT

managers have a preference for using a statistic that is in percent instead of dollars.

All of the following are strengths of payback EXCEPT

none of the options

A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as

profitability index

Effects that arise from a new product or service that decrease sales of the firm's existing products or services are referred to as

substitutionary effects

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n)

sunk cost

With regard to depreciation, the time value of money concept tells us that

taking the depreciation expense sooner is always better

The MIRR statistic is different from the IRR statistic in that

the MIRR assumes that the cash inflows can be reinvested at the cost of capital

All of the following can be included in the depreciable basis of an asset EXCEPT

variable costs

As new capital budgeting projects arise, we must estimate

when such projects will require cash flows