3: Chapter 10
Identify which of these are the relevant cash flows when considering a capital budgeting project.
lost rent from retail facility remodeling expenses for new store increase in inventory expected salvage value of manufacturing equipment
^^^^^What is the operating cash flow @ t=2?
3,212,500
What are the after tax proceeds from the sale of the factory (i.e., ATSV)?
4,500,000
What types of analyses do the BNSF strategic studies team conduct?
discounted cash flow sensitivity
What types of projects does the BNSF strategic studies team evaluate?
discretionary
What is the total cash flow at t=10?
10,712,500
Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?
a decrease in a fixed cost
If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:
deemphasizing that variable as a critical factor.
A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $100 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's IRR? % terms to 2 decimal places and without the % sign.
15.95%
According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?
increase bank executive turnover
An analysis that breaks the NPV calculation into its component assumptions and shows how the NPV varies as one of the underlying assumptions is changed is called: A) scenario analysis. B) IRR analysis. C) accounting break-even analysis. D) sensitivity analysis.
D
Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as
-a balancing act that requires careful evaluation of the costs and benefits of each project -a means to ensure regulatory compliance
Grill Master Johnnys is thinking about purchasing a new, energy-efficient grill. The grill will cost $53,000.00 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $11,750.00. The grill will have no effect on revenues but will save Johnny's $23,500.00 per year in energy expenses. The tax rate is 40%. The 3-year MACRS schedule; Year Depr % 1 33.33 2 44.45 3 14.81 4 7.41 What is the total cash flow in year 3?
25,860.64
Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features; • The firm just spent $300,000 for a marketing study to determine consumer demand (@ t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600,000. • The project has an initial cost of $20,000,000 (excluding land, hint: the land is not subject to depreciation). • If the project is undertaken, at t = 0 the company will need to increase its inventories by $3,500,000, accounts receivable by $1,500,000, and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project's life (t = 10). • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years. (i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • At t = 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits (i.e. negative taxes). What is the operating cash flow @ t=1?
3,212,500
Suppose the capital budget in the lecture example worksheet in was $100,000. What is the NPV of the best project(s)? "Capital Rationing" worksheet.
45000
A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $81,854,519 now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's NPV?
81,854,519 - 20,000,000 / (1+0.11)^1 + 80,000,000 / (1+0.11)^2 + 90,000,000 / (1+0.11)^3 = -81,854,519 - 18018018.018 + 64929794.6594 + 65,807,224.3169 = 30,864,481.95
Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet demand for a new line of solar charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features; • The firm just spent $300,000 for marketing study to determine consumer demand (@ t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600,000. • The project has an initial cost of $24,992,526 (excluding land, hint: land is not subject to depreciation). • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years. (i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • At t = 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits (i.e. negative taxes) .0 What is the project's outflow at t=0?
=initial cost + land market value = 24,992,526 + 2,600,000 = 27,592,526
An exploration of the effect on NPV of changing multiple project parameters is called: A) scenario analysis. B) IRR analysis. C) accounting break-even analysis. D) sensitivity analysis.
A
The value of currently unused warehouse space that will be used as part of a new capital budgeting project is: A) an opportunity cost. B) irrelevant to the investment decision. C) an overhead expense. D) a sunk cost
A
You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an investment of $40,000 in new equipment. This equipment will be depreciated straight line over five years. If your firm's marginal corporate tax rate is 21%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation? A) $1680 B) $14,000 C) $5200 D) $26,000
A 40,000/5=8000 8000 x .21 =1680
Revenues generated by a new fad product are forecast as follows: Year Revenues 1 $52,387 2 40,000 3 20,000 4 10,000 Thereafter 0 Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $40,000 in plant and equipment that will be depreciated using the straight-line method over 5 years. The firm recently spent $2,000 on a study to estimate the revenues of the new product. The tax rate is 20%. What is the operating cash flow in year 1? Answer to nearest whole dollar amount.
Annual Depreciation = Cost of Investment / Life = 40,000 / 5= $8,000 Year 1 Revenue = $52,387 Year 1 Expenses = $52,387 x 50% = $26,193.5 Year 1 EBITDA = Revenue - Expenses = 52,387 - 26,193.5 = $26,193.5 Year 1 Operating Cash Flow = EBITDA x (1 - Tax Rate) + Depreciation x Tax Rate = 26,193.5 x (1 - 0.2) + 8,000 x 0.2 = $22,554.8
A corporation is contemplating an expansion project. The CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the corporation's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?
Any opportunity costs associated with the project.
Which of the following costs would you consider when making a capital budgeting decision? A) Sunk cost B) Opportunity cost C) Interest expense D) Fixed overhead cost
B
Which of the following statements is FALSE? A) Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project. B) Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis. C) Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation. D) When computing the incremental earnings of an investment decision, we should include all changes between the firm's earnings with the project versus without the project.
B
The difference between scenario analysis and sensitivity analysis is that: A) scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV. B) only sensitivity analysis allows us to change our estimated inputs of our NPV analysis. C) only scenario analysis considers the effect on NPV of changing multiple project parameters. D) only scenario analysis breaks the NPV calculation into its component assumptions.
C
When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions, due to the need to calculate ________ cash inflows. A) conventional B) opportunity C) incremental D) sunk
C
What is the net effect on a firm's working capital if a new project requires: $48,182 increase in inventory, $45,033 increase in accounts receivable, $35,000.00 increase in machinery, and a $45,985 increase in accounts payable? Round to nearest dollar amount.
Change in Net Working Capital = Increase in Inventory + Increase in Accounts Receivable - Increase in Accounts Payable = 47,230
Money that has been or will be paid regardless of the decision whether or not to proceed with the project is: A) cannibalization. B) considered as part of the initial investment in the project. C) an opportunity cost. D) a sunk cost.
D
You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an increase in inventory of $8000, an increase in accounts payable of $2500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is: A) $45,500. B) $10,500. C) $6500. D) $5500.
D 8000-2500 =5500
Which of the following statements is FALSE? A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our NPV analysis for the project. B) To compute the NPV for a project, you need to estimate the incremental cash flows and choose a discount rate. C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty. D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
D Explanation: When we are UNCERTAIN regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
Which of the following statements is FALSE? A) We can use scenario analysis to evaluate alternative pricing strategies for our project. B) Scenario analysis considers the effect on NPV of changing multiple project parameters. C) The difference between the IRR of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision. D) Scenario analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each one of the underlying assumptions change.
D Scenario analysis shows how the NPV varies as MULTIPLE underlying assumptions change.
What is the equivalent annual cost for a project that requires a $50,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?
Present value of cash outflows = CF0 + Annual Cash outflow * PVAF (10%, 1-4 years) = 50,000 + 10,000 * 3.16986544634 = 81698.65 equivalent annual cost = Present value of cash outflows / PVAF (10%, 1-4 years) = 81698.65 / 3.16986544634 = 25773.54
What is the amount of the operating cash flow for a firm with $371,416 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?
Profit before taxes- taxes= net income + depreciation 371,416- (371,416*35%){129,995.6}= 241,420.4 +100,000 =$341,420.4
