Finance Chapter 12

Hobart Industries is trying to estimate its first-year operating cash flow (at t = 1) for a proposed project. The financial staff has collected the following information: The company faces a 40% tax rate. What is the project's operating cash flow for the first year (t = 1)?

$1,260,000 (2)

Given the following, what is the project's standard deviation? The Carlisle Corporation is considering a proposed project for its capital budget. The company estimates that the project's NPV is $5 million. This estimate assumes that the economy and market conditions will be average over the next few years. The company's CFO, however, forecasts that there is only a 40% chance that the economy will be average. Recognizing this uncertainty, she has also performed the following scenario analysis:

$10.04 (6)

The capital budgeting director of National Products Inc. is evaluating a new 3-year project that would decrease operating costs by $30,000 per year without affecting revenues. The project's cost is $50,000. The project will be depreciated using the MACRS method over its 3-year class life. The applicable MACRS depreciation rates are 33%, 45%, 15%, and 7%. It will have a zero salvage valueafter 3 years. The marginal tax rate of National Products is 35%, and the project's cost of capital is 12%. What is the project's NPV?

$11,010 (5)

Franklin Corporation is considering an expansion project. The necessary equipment could be purchased for $15 million and shipping and installation costs are another $500,000. The project will also require an initial $2 million investment in net operating working capital. If the company's tax rate is 40%, what is the project's initial investment outlay (in millions)?

$17.5 (12)

Your firm has a marginal tax rate of 40% and a cost of capital of 14%. You are performing a capital budgeting analysis on a new project that will cost $500,000. The project is expected to have a useful life of 10 years, although its MACRS class life is only 5 years. The applicable MACRS depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The project is expected to increase the firm's net income by $61,257 per year and to have a salvage value of $35,000 at the end of 10 years. What is the project's NPV?

$177,902

Given the following, what is the project's expected NPV (in millions)? The Carlisle Corporation is considering a proposed project for its capital budget. The company estimates that the project's NPV is $5 million. This estimate assumes that the economy and market conditions will be average over the next few years. The company's CFO, however, forecasts that there is only a 40% chance that the economy will be average. Recognizing this uncertainty, she has also performed the following scenario analysis:

0.85 (3)

What is the project's coefficient of variation given the following? The Carlisle Corporation is considering a proposed project for its capital budget. The company estimates that the project's NPV is $5 million. This estimate assumes that the economy and market conditions will be average over the next few years. The company's CFO, however, forecasts that there is only a 40% chance that the economy will be average. Recognizing this uncertainty, she has also performed the following scenario analysis:

11.81 (8)

Of the following new product expansion situations, only one would not result in incremental cash flows so it should not be included in the capital budgeting analysis. Which situation is it?

A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected (9)

Each of the following is a valid assessment of the replacement chain and equivalent annual annuity methods EXCEPT:

Engineers prefer to use both methods in case they yield conflicting results.

In general, the value of land currently owned by a firm is irrelevant to a capital budgeting decision because the cost of that property is a sunk cost.

False (15)

Which of the following statements about capital budgeting is CORRECT?

If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration. (1)

Global Spice Co. is considering a new project, but all methods for assessing risk indicate that the project's risk is greater than the risk of the firm's average project. In evaluating this project, it would be reasonable for Global Spice's management to do which of the following?

Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk. (16)

In capital budgeting decisions, corporate risk will be of least interest to:

Institutional investors. (10)

A company's new project evaluation should include all of the following EXCEPT:

Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. (9)

To assess the risk of two potential projects, X and Y, Green Plastics Inc. estimated the beta of each project versus the company's other assets. Green Plastics also estimated the beta of each project against the stock market. Together with a thorough scenario and simulation analyses, the company's research revealed the following: Which of the following statements is CORRECT?

Project X has more market risk than Project Y. (14)

Which of the following statements about sensitivity analysis and simulation analysis is CORRECT?

Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables. (4)

The CFO of Rambler Retail Concepts is considering a new project, so she plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life. (9)

Which of the following is a valid assessment of the replacement chain and equivalent annual annuity methods?

The equivalent annual annuity method is easier to implement.

The traditional NPV analysis may yield faulty results when a company chooses between two projects that have significantly different lives, are mutually exclusive, and _____.

can be repeated (7)

The _____ method of comparing projects with unequal lives calculates the NPV of each project over its stated life and then finds the constant annual cash flow that this NPV would provide over the project's initial life.

equivalent annual annuity

Calculating beta risk via a pure-play approach is rare because _____.

pure-play proxies do not exist for most projects

Managers generally evaluate within-firm and beta risk _____.

qualitatively because the relevant data do not exist for new projects (13)

The _____ method of comparing projects with unequal lives assumes that each project can be repeated as many times as necessary to reach a common life.

replacement chain