Chapter 6: Fina 5170

accounts receivable. inventory. accounts payable.

The components of working capital are:

cash flows

Which of the following should be discounted when determining the feasibility of a capital budgeting project(s)?

Interest expenses

______ incurred on debt financing are ignored when computing cash flows from a project.

typically firms must invest cash in short-term assets to produce finished goods.

One should consider net working capital (NWC) in project cash flows because

relevant

Opportunity costs are classified as ____ costs in project analysis.

raw materials inventory is purchased short-term credit obligations of the firm are paid down

A firm's net working capital changes when:

interest payments on debt incurred to finance the project.

For the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project except

$70,000 Reason: $150,000 - 80,000 = $70,000

If a firm's short-term assets are $150,000, its total assets are $320,000, and its short-term liabilities are $80,000, what is its net working capital?

Tax shield effect = ($100,000)(0.21) = $21,000.

If depreciation is $100,000 and the marginal tax rate is 21 percent, then the tax shield due to depreciation is

benefits lost due to taking on a particular project

Opportunity costs are ____.

Rental income likely to be lost by using a vacant building for an upcoming project

Which of the following is an example of an opportunity cost?

cash flows

Which of the following is given greater importance in capital budgeting problems in corporate finance?

Book value at the end of year 2 = (0.15 + 0.07) × $200,000 = $44,000. Year 1 cash flow: ($120,000 × (1 - 0.21)) + ($200,000 × 0.33 × 0.21) = $108,660. Year 2 cash flow: ($120,000 × (1 - 0.21)) + ($200,000 × 0.45 × 0.21) + $44,000 = $157,700. -$200,000 + ($108,660/1.12) + (($157,700)/(1.12^2)) = $22,735.

A project requires an initial investment of $200,000 and expects to produce a cash flow before taxes of $120,000 per year for two years (i.e., cash flows will occur at t = 1 and t = 2). The corporate tax rate is 21 percent. The assets will depreciate using the MACRS 3-year schedule: (t = 1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can use all applicable tax shields. The opportunity cost of capital is 12 percent. Assume that the asset can sell for book value at the end of the project. Calculate the NPV of the project (approximately).

sunk costs

Costs incurred as a result of past irrevocable decisions and irrelevant to future decisions are called

Annual depreciation = ($250,000 - $50,000)/5 = $40,000. Book value at the end of two years = $250,000 - $80,000 = $170,000.

Capital equipment costing $250,000 today has $50,000 salvage value at the end of five years. If the straight-line depreciation method is used, what is the book value of the equipment at the end of two years?

taxable income

Despite being a noncash expense, depreciation is important because it reduces _______________.

1.96% Reason: (1.04/1.02)-1 = 1.96%

If the nominal discount rate is 4 percent and the annual rate of inflation is 2 percent, what is the real discount rate?

decrease

If the tax rate decreases the value of the depreciation tax shield will ____.

increase

If the tax rate increases, the value of the depreciation tax shield will ____.

accepting a project

Incremental cash flows of a project are changes in a firm's cash flows that occur as a direct consequence of ____.

True

It is inappropriate to ignore all incidental effects that a project has on a firm's existing business.

either-or

Mutually exclusive projects are those that entail ______________ choices.

have already occurred and are not affected by accepting or rejecting a project

Sunk costs are costs that ____.

Depreciation for year 2 = ($600,000)(0.32) = $192,000.

Suppose that a project has a depreciable investment of $600,000 and falls under the following MACRS year 5 class depreciation schedule: year 1: 20 percent; year 2: 32 percent; year 3: 19.2 percent; year 4: 11.5 percent; year 5: 11.5 percent; and year 6: 5.8 percent. Calculate depreciation for year 2.

1 + nominal rate = (1 + real rate) (1 + inflation rate) = (1.03)(1.05) = (1.0815). Nominal rate = 0.0815 = 8.15%.

The real interest rate is 3 percent and the inflation rate is 5 percent. What is the nominal interest rate?

depreciation

The three most important components of working capital are all of the following except:

what adds the most to the firm's current value

Considering the goal of maximizing value, optimal timing for a project is:

lives

The computation of equivalent annual costs is useful when comparing projects with unequal _____.

Finding the terminal year cash flow Total year 4 CF = (1) Year 4 incremental CF + (2) Sales of asset + (3) Reversal of working capital Yearly Incremental Cash flow = NI + Depr Net Income = EBIT - Taxes = 106,000 - 42,400 = 63,600 = 63,600 + 20,000 = 83,600 Sales of equipment at Book value Book value = purchase price - accumulated depreciation Accumulated depreciation = 80,000 + 60,000 + 40,000 + 20,000 = 200,000 Book value = 300,000 - 200,000 = 100,000 There is no tax event because the equipment is sold at book value. Reversal of working capital = 18,000 Total year 4 CF = Yearly Cf + Sales of asset + Reversal of working capital = 83,600 + 100,000 + 18,000 = 201,600

The project requires an initial investment of $300,000 on equipment and is depreciated over 6 years. Working capital increased $18,000 at the beginning of the project and will be recovered in full at the end of year 4. The equipment will be sold at its book value at the end of year 4. The tax rate is 40%. 1 2 3 4 Revenues $120,000 $140,000 $160,000 $180,000 Cost of Goods Sold $ 36,000 $ 42,000 $ 48,000 $ 54,000 Depreciation $ 80,000 $ 60,000 $ 40,000 $ 20,000 EBIT $ 4,000 $ 38,000 $ 72,000 $106,000 What is the TOTAL net cash flow to the firm in year 4?

True

True or false: Corporate finance techniques emphasize the importance of cash flows rather than accounting income.

False

True or false: Discounting involves determining the future value of present cash flow.

False

True or false: Opportunity costs can be ignored when determining the financial feasibility of a project.

False

True or false: Sunk costs should be considered when deciding whether to accept or reject a project.

Project A, because it has higher EAC EAC(A) = 5,000/2.2832 = 2,189.88. (Accept the project with higher EAC.) EAC(B) = 6,500/3.35216 = 1,939.05. Using a financial calculator: EAC(A) = PV = 5,000; I = 15; FV = 0; & N = 3; Compute: PMT = -2,189.88. EAC(B) = PV = 6,500; I = 15; FV = 0; & N = 5; Compute: PMT = -1,939.05.

Two mutually exclusive projects have the following positive NPVs and project lives. Project: NPV: Life: Project A: $5,000: 3 Years Project B: $6,500: 5 Years If the cost of capital were 15 percent, which project would you accept?

Blank 1: opportunity Blank 2: cost

Using your personal savings as investment in your business has an_______ _________ because you are giving up the use of these funds for other investments or uses, such as a vacation or paying off a debt.

Short-term assets minus short-term liabilities

What is net working capital?

$600 Reason: Tax shield = $2,000 × .3 = $600

What is the depreciation tax shield if EBIT is $800, depreciation is $2,000, and the tax rate is 30 percent?

1+NominalInterestRate/1+InflationRate - 1

What is the equation for determining the real interest rate?

5.77% Reason: (1.10/1.04) - 1 = 5.77%

What is the real interest rate if the nominal annual interest rate is 10 percent and the annual inflation rate is 4 percent?

are not

When analyzing a project, sunk costs ____ incremental cash outflows.