FINA 320 - QUIZ 4

Project costs $100 and has cash flows of $40 per year for the next seven years. If the discount rate is 15%, what is the discounted payback period?

3.38 years

A new machine will cost $100,000 and generate after-tax cash inflows of $35,000 for 4 years. Find the discounted payback if the firm uses a 12% discount rate.

3.72

Assume that a firm takes on a project that requires an initial investment in year 0 of $20,000. Also assume that the project procedures cash inflows of $1,800 in all future years. If the required rate of return for this project is 6%, then what is the net present value?

$10,000

A new machine will cost $100,000 and generate after-tax cash inflows of $35,000 for 4 years. What is the payback period?

$100,000/$35,000 = 2.86 years

Your company has invested $5 million in R&D on self-driving car technology. What is the initial cash flow of the self-driving car manufacturing project at year 0?

$12 million cash outflow

What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

$16,082

What is the net effect on a firm's net working capital if a new project requires $30,000 increase in inventory, $10,000 increases in accounts receivable, $35,000 increase in machinery, and a $20,000 increase in accounts payable?

$20,000 increase in NWC $10,000 + $30,000 - $20,000 = $20,000

Your company is considering investing in a new system that will cost $160,000. What is the total cash outflow in year 0?

$225,000 Investment cash outflow = 160,000 + 40,000 = 200,000 Cash outflow due to change in NWV = 25,000 Total cash outflow in year 0 = 200,000 + 25,000 = 225,000

Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and a market value of $25,000. Ignoring taxes, what is the opportunity cost of this machine?

$25,000

Your company is considering investing in a new system that will cost $160,000. What is the after-tax salvage value at the end of year 5?

$28,608 Book value = (160,000 + 40,000)*(1-.20 - -.32 - .192 -.1152 -.1152) = 11,520 After tax salvage value = 40,000 - (40,000 - 11,520)*40% = 28,608

Western Inc. purchases a machine for $15,000. This machine qualifies as a five-year recovery asset under MACRS with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%. Western has a tax rate of 33%. If the machine is sold at the end of four years for $4,000, what is the after-tax cash flow from disposal?

$3,535.36 Year 1: $15,000(0.2000) = $3,000 Year 2: $15,000(0.3200) = $4,800 Year 3: $15,000(0.1920) = $2,880 Year 4: $15,000(0.1152) = $1,728 Accumulated Depreciation = $3,000 + $4,800 + $2,880 + $1,728 = $12,408 Book Value of machine = $15,000 - $12,408 = $2,592 Gain on disposal is $4,000 - $2,592 = $1,408 Tax rate = $1,408(0.33) = $464.64 After-Tax Cash Flow at disposal = $4,000 - $464.64 = $3,535.36

The BBM Corp. The net operating cash flow in year 5 from the production of Wuk is:

$3.5 million to 4.2 million

Depreciable assets were purchased for $70,000 five years ago. Accumulated depreciation is $37,000. The asset is sold for $40,000. If the company faces a 40% tax rate, how much total net after-cash will the sale of these assets generate?

$37,200 70,000 - 37,000 = 33,000 40,000 - ((40,000 - 33,000)* 40%) = 37,200

A firm generates sales of $250,000, depreciation expense of $50,000, taxable income of $50,000, and has a 35% tax rate. By how much does net cash flow deviate from net income?

$50,000

Your company is considering investing in a new system that will cost $160,00. What is the operation cash flow in year 3?

$51,360

Ultimate tennis total cash flow in year 0 (T=0)

$770,000

A firm purchased an asset that cost $1 million 3 years ago. In additional, the firm paid $100,000 in installation costs. The asset is classified as MACRS 3-year property class (MACRS depreciation schedule for 3-year property class is 33.33%, 44.45%, 14.81%, 7.41% for years 1, 2, 3, and 4 respectively). What is the book value today (at the end of year 3)?

$81,510

The profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12% is:

0.139 CF0 = -40,000 CF1 = 15,000 F1 = 4 I/Y = 12 NPV = 5560 PI = 5560/40000 = 0.139

Your assistant has estimated the cash flows of a new proposed 4-year project as follows. Somehow, he forgot to report cash flow in year 4. However, he did report that the project NPV is $0 at a discount rate of 10%. What is the IRR of the project?

10%

The business requires an investment of $100,000 of fixed assets (store furniture, computers, etc.), which will be depreciated in 8 years using straight line depreciation. You expect the fixed assets can be liquidated at half of its original value by the end of year 4. The tax rate if 35%. Please find the projected OCF.

100,000/8 = $12,500

What is the IRR of an investment that costs $18,500 and pays $5,250 a year for 5 years?

12.92%

What is the IRR of an investment that costs $18,500 and pays $5,250 for 5 years?

12.92%

Your company is considering taking on a new project that will cost $200,000. It is estimated that the system will increase sales/revenues by $150,000 annually for Years 1-6. Operating expenses, other than depreciation, are expected to be equal to 60 percent of sales in each year. The system will be depreciated on a MACRS basis over 5 years (depreciation rates are 20%, 32%, 19.2%, 11.52%, 11.52% and 5.76% for years 1 to 6 respectively) to a zero book value, but the expected salvage at Year 6 is $40,000. The firm will also be required to invest $25,000 in net working capital at Year 0, but will recapture this amount at Year 6. You may assume that the tax rate on ordinary income is 40 percent (record negative taxes as a positive cash flow). As you can calculate, the IRR for this project is 13.03%. If we assume that the firm's cost of capital for this project is 12 percent, then what is the NPV for this project?

13.03%

Your company is considering the installation of a new production system that will cost $150,000. It is estimated that the system will increase revenues by $65,000 annually for Years 1-4, followed by $50,000 annually for Years 5-7, although operating expenses other than depreciation will also increase by $15,000 per year for Years 1- 7. The system will be depreciated on a MACRS basis over 5 years (depreciation rates are 20%, 32%, 19.2%, 11.52%, 11.52% and 5.76% for years 1 to 6 respectively) to a zero book value. If we assume that the tax rate on ordinary income is 40 percent, and the firm's cost of capital for this project is 10 percent, then, as you can calculate, the NPV for this project is $27,161. What is the IRR for this project?

16.13%

An investment with a cost of $5,000 is expected to have cash inflows of $3,000 in year 1, an $4,000 in year 2. The internal rate of return (IRR) for this investment is closest to:

24% CF0 = -5,000 CF1 = 3,000 CF2 = 4,000 IRR = 24.33

Which of the following statements is most correct?

If an asset to be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the new project were not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration.

Which of the following statements is most correct?

If an asset to be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the new project were not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration.

Which of the following statements regarding making investment decisions using net present value (NPV) and internal rate of return (IRR) is least accurate?

If projects are mutually exclusive, one should always choose the project with the highest IRR

The value of a proposed capital budgeting project depends on the:

Incremental cash flows produced

Your company is faced with an investment project. The following information is associated with this project: 1 2 3 4 Year Net Income* $100,000 120,000 140,000 120,000 for 3-Yr. MACRS class 0.330.450.15 0.07*Assume no interest expense and a zero tax rate. Allowable Depreciation The project involves an initial investment of $300,000 in equipment that falls in the 3-year MACRS class and has an estimated salvage value (after-tax) of $45,000. In addition, the company expects an initial increase in net operating working capital of $25,000 that will be recovered in year 4. The cost of capital for the project is 14 percent. Determine the project's net present value.

Calculate depreciation for each year: Dep1 = ($300,000)(0.33) = $ 99,000 Dep2 = ($300,000)(0.45) = $135,000 Dep3 = ($300,000)(0.15) = $ 45,000 Dep4 = ($300,000)(0.07) = $ 21,000 Now calculate cash flows for each year: CF0 = -$300,000 - $25,000 = - $325,000 CF1 = $100,000 + $99,000 = $199,000 CF2 = $120,000 + $135,000 = $255,000 CF3 = $140,000 + $45,000 = $185,000 CF4 = $120,000 + $21,000 + $25,000 + $45,000 = $211,000 I = 14% Solve for NPV = $295,574.29

Financing costs for a capital project are

Captured in the project's required rate of return

Which of the following statements is false?

Cash Flow is an accounting measure of performance during the specified period of time

Your company is considering an expansion into a new product area. The company has collected the following information about the proposed product. The project has an anticipated economic life of 5 years. The company will have to purchase a new machine to produce the product. The machine has an up-front cost (T = 0) of $750,000. The machine will be depreciated on a straight-line basis over 5 years (that is, the company's depreciation expense will be $150,000 in each of the first five years (T = 1, 2, 3, 4, and 5). If the company goes ahead with the project, it will affect the company's net working capital. At the outset, T = 0, inventory will increase by $50,000 and accounts payable will increase by $30,000. At T = 5, the net working capital will be recovered. The project is expected to produce EBIT of $200,000 the first year (T = 1), $300,000 the second and third years (T = 2 and 3), $200,000 the fourth year (T = 4), and $150,000 the final year (T = 5). The company's tax rate is 40 percent. What is the total cash flow in year 0 (T=0)?

Cash outflow due to investment = $750,000Cash outflow due to change in net working capital = $30,000 +$50,000 = $80,000No cash in or outflow due to operationTotal cash out flow = $750,000 + $80,000 = $830,000

Which of the following statements regarding investment in working capital is incorrect?

Investment in working capital, unlike investment in plant and equipment, represents a positive cash flow

Normal projects C and D are mutually exclusive. Project C has a higher (positive) net present value if the discount rate is less than 12 percent, whereas Project D has a higher (positive) net present value if the discount rate exceeds 12%. Which of the following statements is most correct?

All of the statements above are correct.

A firm is considering purchasing two assets. Asset L will have a useful life of 20 years and cost $5 million; it will have installation costs of $1 million but no salvage or residual value. Asset S will have a useful life of 8 years and cost $2 million; it will have installation costs of $500,000 and a salvage or residual value of $400,000. Which asset will have a greater annual straight-line depreciation?

Annual depreciation for Asset A= (Asset Cost + Installation Cost - Salvage Value) / Useful Life = ($3 million + $0.4 million - 0) / 15 years = $226,666.67, or about $226,667 per year. Annual depreciation for Asset B= (Asset Cost + Installation Cost - Salvage Value) / Useful Life = ($1.3 million + $0.18 million - $0.3 million) / 6 years = $196,666.67, or about $196,667 per year.

Which of the following statements about the internal rate of return (IRR) for a project with the following cash flow pattern is CORRECT? Year 0: -$2,000 Year 1: $10,000 Year 2: -$10,000

It has 2 IRRs of approximately 38.2% and 261.8%

WOTFS about the internal rate of return for a project with the following: Year 0= -$2,000

It has two IRR's of approx 38.2% and 261.8%

Non-conventional Cash Flows: Suppose an investment will cost $90,000 initially and will generate the following cash flow: Year 1: $132,000 Year 2: $100,000 Year 3: -$150,000 The required rate of return is 15%. Should we accept/reject the project?

IRR = 10.11% NPV = 1,770 Based on NPV rule, accept the project. This is non-conventional because there is more than one IRR.

Consider a project with an initial investment and positive future cash flows. As the discount rate is decreased the ______.

IRR remains constant while the NPV increases

You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. a. What is EBIT for the project in the first year? b. What is the operating cash flow in year 2?

a. $20,000 EBIT = sales - cash expenses - depreciation EBIT Year 1 = 400,000 - 325,000 - 55,000 = 20,000 b. $97,075 Annual depreciation = 165,000/3 = 55,000 EBIT = 500,000 - 381,250 - 55,000 = 63,750 Tax = 63,750 * 34% = 21,675 OCF = 63.750 - 21,675 + 55,000 = 97,075

The Seattle Corporation has been presented with an investment opportunity that will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10 percent. a. What is the NPV for this investment? b. The packback period for this investment is closest to:

a. $51,138 Using cash flow keys, we enter: CF0= -150,000, CF1=30,000 F1=4 CF2=35,000 F2=5 CF3=40,000 I=10 Solve for NPV= 51,138. b. 4.86 years

In capital budgeting analysis, an increase in working capital can be shown as:

an outflow at the beginning and an equal inflow at the end of the project.

Pags Industrial Systems Company (PISC) is trying to decide between two different conveyor belt systems. System A costs $405,000, has a three-year life, and requires $105,000 in pretax annual operating costs. System B costs $450,000, has a five-year life, and requires $60,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. If the tax rate is 34% and the discount rate is 20%, which project should the firm choose?

Neither system is going to bring in any revenue. The system to be chosen should have a less negative System A: Annual depreciation = (Beginning value - Ending book value)/(# of years) = $405,000/3 = $135,000 NPVA = -$454,291.67 System B: Annual depreciation = (Beginning value - Ending book value)/(Number of years) = $450,000/5 = $90,000 NPVB = -$476,915.51 System A should be chosen, because it has the more positive NPV.

Your company is considering an expansion into a new product area. The company has collected the following information about the proposed product. The project has an anticipated economic life of 5 years. The company will have to purchase a new machine to produce the product. The machine has an up-front cost (T = 0) of $750,000. The machine will be depreciated on a straight-line basis over 5 years (that is, the company's depreciation expense will be $150,000 in each of the first five years (T = 1, 2, 3, 4, and 5). If the company goes ahead with the project, it will affect the company's net working capital. At the outset, T = 0, inventory will increase by $50,000 and accounts payable will increase by $30,000. At T = 5, the net working capital will be recovered. The project is expected to produce EBIT of $200,000 the first year (T = 1), $300,000 the second and third years (T = 2 and 3), $200,000 the fourth year (T = 4), and $150,000 the final year (T = 5). The company's tax rate is 40 percent.What is the operating cash flow in year 2 (T=2)?

OCF = EBIT + Depreciation - TaxOCF = 300,000 + 150,000 - EBIT*Tax Rate OCF = 450,000 - 300,000 * 40% = 330,000

Your company is considering an expansion into a new product area. The company has collected the following information about the proposed product. The project has an anticipated economic life of 5 years. The company will have to purchase a new machine to produce the product. The machine has an up-front cost (T = 0) of $750,000. The machine will be depreciated on a straight-line basis over 5 years (that is, the company's depreciation expense will be $150,000 in each of the first five years (T = 1, 2, 3, 4, and 5). If the company goes ahead with the project, it will affect the company's net working capital. At the outset, T = 0, inventory will increase by $50,000 and accounts payable will increase by $30,000. At T = 5, the net working capital will be recovered. The project is expected to produce EBIT of $200,000 the first year (T = 1), $300,000 the second and third years (T = 2 and 3), $200,000 the fourth year (T = 4), and $150,000 the final year (T = 5). The company's tax rate is 40 percent. What is the total cash flow in year 5 (T=0)?

Operating cash flow in year 5 = EBIT + Depreciation - Tax Operating cash flow in year 5 = $150,000 + $150,000 - $150,000*40% = $240,000 Cash flow due to changes in net working capital = $30,000 +50,000 =$80,000 No salvage value or cash flow due to investmentTotal cash flow in year 5 = $240,000 + $80,000 = $320,000 = 260,000?

Allied, Inc. is considering Project A and Project B, which are two mutually exclusive. Project A is an eight- year project that has an initial outlay or cost of $180,000, its future cash inflows for years 1 through 8 are $38,000. Project B is also an 8 year project that has an initial outlay or cost of $160,000 . Its future cash inflows for years 1 through 8 are the same at $34,500. The appropriate discount rate for both project is 7.5%. Which project should Allied accept?

Project A because it has a higher NPV

The financial manager at Johnson & Smith estimates that its required rate of return is 11%. Which of the following independent projects should Johnson & Smith accept?

Project C requires an up-front expenditure of $600,000 and generates a positive internal rate of return of 12.0%

A firm is evaluating two mutually exclusive projects of the same risk class, Project X and Project Y. Both have the same initial cash outlay and both have positive NPVs. Which of the following is a sufficient reason to choose Project X over Project Y?

Project Y has a lower profitability index than Project X

Allocations of overhead should not affect a project's incremental cash flows unless the:

Project actually increased overhead expenses

New projects or products can have a side effect on the firm as well as a direct effect. Which of the following appears to be a side effect of launching a new product?

Sales of a similar product of your firm's will decline

Ashlyn Lutz makes the following statements to her supervisor, Paul Ulring, regarding the basic principles of capital budgeting: Statement 1: The timing of expected cash flows is crucial for determining the profitability of a capital budgeting project. Statement 2: Capital budgeting decisions should be based on the after-tax net income produced by the capital project. Which of the following regarding Lutz's statements is most accurate?

Statement 1 Correct Statement 2 Incorrect

For a project with conventional cash flows, if Pl is greater than 1, then:

The NPV is greater than zero

Which of the statements below is true?

The graphic plot of project NPV against discount rate is called the NPV profile

Which of the following statements is true? a. The graphic plot of project NPV against discount rate is called the NPV profile b. NPV profile is always downward sloping, i.e., NPV decreases with higher discount rate c. At the intercept point of the NPV profile with the horizontal axis, the project IRR is zero d. All of the above e. None of the above

The graphic plot of project NPV against discount rate rate is called NPV profile

MACRS Schedule for assets with five-year life. Format: Year, MACRS Percent

Year 1, 20% Year 2, 32% Year 3, 19.20% Year 4, 11.52% Year 5, 11.52% Year 6, 5.76%

Simpson, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax cost of $48,000. The respective future cash inflows from its project for years 1, 2,3 4, and 5 are: $15,000, $25,000, $35,000, $45,000, and -$70,000. The appropriate discount rate for this project is 9%. Should Simpson accept the project?

Yes because the NPV is positive

If a project is expected to increase inventory by $17,000, increase accounts payable by $10,000, and decrease accounts receivable by $1,000, what effect does working capital have during the life of the project?

cash outflow of $6,000

Which of the following would not be expected to affect the decision of whether to undertake an investment?

cost of feasibility study done for the project

One of the basic principles of capital budgeting is that:

decisions are based on cash flows, not accounting income.

Sunk Costs are ______ in estimating an investment's cash flow, since sunk costs are______.

ignored, not recoverable

The MACRS allows an increase

in annual depreciation during earlier years

The modified accelerated cost recovery system (MACRS) allows an increase:

in annual depreciation during earlier years

Which of the following is not accurate in depicting cash flows from operations?

net profit + depreciation + tax paid

Which of the following changes would be likely to increase the NPV of a project? a. increasing the firms opportunity cost of capital b. permitting a net increase in working capital c. spreading the total cash inflows over a longer interval d. increasing the projects estimated expenses e. none of the above

none of the above

The accelerated depreciation of capital investments in MACRS depreciation provides a taxable expense that reduces taxed at a faster rate than with straight-line depreciation. Therefore, according to _________ concepts, we can surmise that lower tax expenses in the earlier years and higher tax expenses in the later years are better than a steady tax expense each year.

time-value of money