Chapter 9
Scenario analysis:
helps determine the reasonable range of expectations for a project's anticipated outcome.
Sensitivity analysis:
helps identify the variable within a project that presents the greatest forecasting risk.
The operating cash flows of a project:
include erosion effects.
Assume a firm has positive net earnings. The operating cash flow of this firm:
increases when tax rates decrease.
The ability to delay an investment:
is valuable provided there are conditions under which the investment will have a positive net present value.
Contingency planning focuses on the:
managerial options implicit in a project.
The opportunities that a manager has to modify a project once it has started are called:
managerial options.
Ignoring the option to wait:
may underestimate the net present value of a project.
Which one of the following refers to a method of increasing the rate at which an asset is depreciated?
Accelerated cost recovery system
Miller Lite, Inc. is considering a new four-year expansion project that requires an initial fixed asset investment of $3.6 million. The fixed asset will be depreciated straight-line to zero over its four-year life, after which time it will be worthless. The project is estimated to generate $3.9 million in annual sales, with costs of $2.6 million. If the tax rate is 35 percent, what is the OCF for this project?
$1,160,000
An asset used in a three-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $5.4 million and will be sold for $1.2 million at the end of the project. If the tax rate is 35 percent, what is the aftertax salvage value of the asset?
$1,324,320
You are analyzing a project and have developed the following estimates: unit sales = 2,600, price per unit = $56, variable cost per unit = $39, fixed costs = $24,700. The depreciation is $15,800 a year and the tax rate is 35 percent. What effect would a decrease of $1 in the variable cost per unit have on the operating cash flow?
$1,690
Marshall's & Co. purchased a corner lot in Eglon City five years ago at a cost of $550,000. The lot was recently appraised at $605,000. At the time of the purchase, the company spent $42,000 to grade the lot and another $3,700 to build a small building on the lot to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1,160,000. What amount should be used as the initial cash flow for this building project?
$1,765,000
The Outpost currently sells short leather jackets for $349 each. The firm is considering selling long coats also. The coats would sell for $689 each and the company expects to sell 900 a year. If the firm decides to carry the long coat, management feels that the sales of the short jacket will decline from 1,420 to 1,265 units. Variable costs on the jacket are $210 and $445 on the long coat. The fixed costs for this project are $42,000, depreciation is $11,000 a year, and the tax rate is 33 percent. What is the projected operating cash flow for this project?
$108,187
Rock Haven has a proposed project that will generate sales of 1,680 units annually at a selling price of $22 each. The fixed costs are $12,700 and the variable costs per unit are $5.95. The project requires $28,000 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the four-year life of the project. The salvage value of the fixed assets is $6,900 and the tax rate is 34 percent. What is the operating cash flow for year 4?
$11,794
Six years ago, China Exporters paid cash for a new packaging machine that cost $287,000. Three years ago, the firm spent $3,900 on repairs and modifications to the machine. The machine is now fully depreciated and has just sat idly in a back corner of the shop for the past seven months. The estimated value of the machine today is $125,500. The firm is considering using this machine in a new project. If it does so, what value should be assigned to this machine and included in the initial costs of the new project?
$125,500
Consider an asset that costs $465,000 and is depreciated straight-line to zero over its six-year tax life. The asset is to be used in a four-year project; at the end of the project, the asset can be sold for $120,000. If the relevant tax rate is 35 percent, what is the aftertax cash flow from the sale of this asset?
$132,250
Outdoor Sports is considering adding a miniature golf course to its facility. The course would cost $138,000, would be depreciated on a straight-line basis over its five-year life, and would have a zero salvage value. The estimated income from the golfing fees would be $72,000 a year with $24,000 of that amount being variable cost. The fixed cost would be $11,600. In addition, the firm anticipates an additional $14,000 in revenue from its existing facilities if the golf course is added. The project will require $3,000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 12 percent and a tax rate of 34 percent?
$14,439
Your local athletic center is planning a $1.23 million expansion to its current facility. This cost will be depreciated on a straight-line basis over a 20-year period. The expanded area is expected to generate $524,000 in additional annual sales. Variable costs are 48 percent of sales, the annual fixed costs are $79,400, and the tax rate is 35 percent. What is the operating cash flow for the first year of this project?
$147,027
Travel America Coaches currently sells 15,000 motor homes per year at $94,000 each, and 1,500 luxury motor coaches per year at $159,000 each. The company wants to introduce a low-range camper to fill out its product line; it hopes to sell 6,000 of these campers per year at $14,500 each. An independent consultant has determined that if Travel Coaches introduces the new campers, it should boost the sales of its existing motor homes by 1,500 units per year, and reduce the sales of its luxury motor coaches by 450 units per year. What amount should be used as the annual sales figure when evaluating this project?
$156,450,000
Sun Lee's Furniture just purchased some fixed assets classified as 5-year property for MACRS. The assets cost $85,000. What is the amount of the depreciation expense for the third year?
$16,320
You are analyzing a project and have developed the following estimates. The depreciation is $3,200 a year and the tax rate is 34 percent. What is the best-case operating cash flow?
$17,423
A nine-year project is expected to generate annual revenues of $114,500, variable costs of $73,600, and fixed costs of $14,000. The annual depreciation is $3,500 and the tax rate is 34 percent. What is the annual operating cash flow?
$18,944
Hunter's Lodge purchased $578,000 of equipment four years ago. The equipment is seven-year MACRS property. The firm is selling this equipment today for $199,500. What is the aftertax cash flow from this sale if the tax rate is 35 percent? The MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
$192,873.52
The Blue Lagoon is considering a project with a five-year life. The project requires $110,000 of fixed assets that are classified as five-year property for MACRS. Variable costs equal 71 percent of sales, fixed costs are $9,600, and the tax rate is 35 percent. What is the operating cash flow for year 4 given the following sales estimates and MACRS depreciation allowance percentages?
$2,342
You are analyzing a project and have developed the following estimates. The depreciation is $14,800 a year and the tax rate is 35 percent. What is the base case operating cash flow?
$21,690
Hi-As-A-Kite is considering making and selling custom kites in two sizes. The small kites would be priced at $10 and the large kites would be $24. The variable cost per unit is $5 and $11, respectively. Jill, the owner, feels that she can sell 2,600 of the small kites and 1,700 of the large kites each year. The fixed costs would be only $2,100 a year and the tax rate is 34 percent. What is the annual operating cash flow if the annual depreciation expense is $900?
$22,086
A debt-free firm has net income of $228,400, taxes of $46,200, and depreciation of $21,300. What is the operating cash flow?
$249,700
The Tattle Teller has a printing press sitting idly in its back room. The press has no market value to another printer because the machine utilizes old technology. The firm could get $250 for the press as scrap metal. The press is six years old and originally cost $148,000. The current book value is $2,570. The president of the firm is considering a new project and feels he can use this press for that project. What value, if any, should be assigned to the press as an initial cost of the new project?
$250
A project will reduce costs by $34,000 but increase depreciation by $16,500. What is the operating cash flow of this project based on the tax shield approach if the tax rate is 40 percent?
$27,000
You are analyzing a project and have developed the following estimates. The depreciation is $7,600 a year and the tax rate is 34 percent. What is the worst-case operating cash flow?
$274
A project has annual depreciation of $16,200, costs of $87,100, and sales of $123,000. The applicable tax rate is 40 percent. What is the operating cash flow according to the tax shield approach?
$28,020
Cinram Machines has the following estimates for its new gear assembly project: price = $1,340 per unit; variable costs = $348 per unit; fixed costs = $5.1 million; quantity = 82,000 units. Suppose the company believes all of its estimates are accurate only to within ± 5 percent. What value should the company use for its total variable costs when performing its best-case scenario analysis?
$28,464,660
A firm is reviewing a project with labor cost of $7.40 per unit, raw materials cost of $23.65 a unit, and fixed costs of $17,000 a month. Sales are projected at 9,400 units over the 3-month life of the project. What are the total variable costs of the project?
$291,870
Three years ago, Stock Tek purchased some five-year MACRS property for $67,400. Today, it is selling this property for $28,000. How much tax will the firm owe on this sale if the tax rate is 35 percent? The MACRS allowance percentages are as follows, commencing with year 1: 20.00, 32.00, 19.20, 11.52, 11.52, and 5.76 percent.
$3,006
An all-equity firm has net income of $28,300, depreciation of $7,500, and taxes of $2,050. What is the firm's operating cash flow?
$35,800
The Green Tomato purchased a parcel of land six years ago for $299,500. At that time, the firm invested $64,000 grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $28,000 a year. The Green Tomato is now considering building a hotel on the site as the rental lease is expiring. The current value of the land is $355,000. The firm has no loans or mortgages secured by the property. What value should be included in the initial cost of the hotel project for the use of this land?
$355,000
Burke's Corner currently sells blue jeans and T-shirts. Management is considering adding fleece tops to its inventory to provide a cooler weather option. The tops would sell for $49 each with expected sales of 3,600 tops annually. By adding the fleece tops, management feels the firm will sell an additional 220 pairs of jeans at $59 a pair and 350 fewer T-shirts at $18 each. The variable cost per unit is $36 on the jeans, $9 on the T-shirts, and $21 on the fleece tops. With the new item, the depreciation expense is $27,000 a year and the fixed costs are $62,000 annually. The tax rate is 34 percent. What is the project's operating cash flow?
$36,049
Western Steer purchased some three-year MACRS property three years ago. What is the current book value of this equipment if the original cost was $58,000? The MACRS allowance percentages are as follows, commencing with year 1: 33.33, 44.45, 14.81, and 7.41 percent.
$4,298
Fig Newton Industries is considering a project and has developed the following estimates: unit sales = 7,300, price per unit = $149, variable cost per unit = $91, fixed costs = $216,400. The depreciation is $94,700 a year and the tax rate is 40 percent. What effect would an increase of $1 in the selling price have on the operating cash flow?
$4,380
Custom Tailored Shirts is a specialty retailer offering T-shirts, sweatshirts, and caps. Its most recent annual sales consisted of $14,000 of T-shirts, $11,000 of sweatshirts, and $1,300 of caps. The company is adding polo shirts to the lineup and projects that this addition will result in sales next year of $14,000 of T-shirts, $8,000 of sweatshirts, $7,800 of Polo shirts, and $1,300 of caps. What sales amount should be used when evaluating the Polo shirt project?
$4,800
Ronnie's Custom Cars purchased some fixed assets two years ago for $80,000. The assets are classified as 5-year property for MACRS. Ronnie is considering selling these assets now so he can buy some newer fixed assets which utilize the latest in technology. Ronnie has been offered $42,000 for his old assets. What is the net cash flow from the salvage value if the tax rate is 34 percent?
$40,776.00
Green Woods sells specialty equipment for mountain climbers. Its sales for last year included $238,000 of tents and $411,000 of climbing gear. For next year, management has decided to sell specialty sleeping bags also. As a result of this change, sales projections for next year are $264,000 of tents, $426,000 of climbing gear, and $51,000 of sleeping bags. How much of next year's sales are derived from the side effects of adding the new product to its sales offerings?
$41,000
A cost-cutting project will decrease costs by $58,500 a year. The annual depreciation on the project's fixed assets will be $10,300 and the tax rate is 34 percent. What is the amount of the change in the firm's operating cash flow resulting from this project?
$42,112
Classic Cars is considering a project that requires $148,000 of fixed assets that are classified as five-year property for MACRS. What is the book value of these assets at the end of year 3? The MACRS allowance percentages are as follows, commencing with year 1: 20.00, 32.00, 19.20, 11.52, 11.52, and 5.76 percent.
$42,624
A project has an initial requirement of $261,000 for fixed assets and $27,000 for net working capital. The fixed assets will be depreciated to a zero book value over the four-year life of the project and have an estimated salvage value of $78,000. All of the net working capital will be recouped at the end of the project. The annual operating cash flow is $96,200 and the discount rate is 13 percent. What is the project's net present value if the tax rate is 35 percent?
$45,799
You are analyzing a project and have developed the following estimates. The depreciation is $52,000 a year and the tax rate is 34 percent. What is the worst-case operating cash flow?
$48,106
We are evaluating a project that costs $1.68 million, has a five-year life, and has no salvage value. Assume depreciation is straight-line to zero over the life of the project. Sales are projected at 82,000 units per year. Price per unit is $43.29, variable cost per unit is $22.18, and fixed costs are $623,000 per year. The tax rate is 34 percent, and we require a 10 percent return on this project. What is the sensitivity of NPV to a 100-unit change in the sales figure?
$5,281.55
What is the year 2 depreciation on equipment costing $166,000 if it is classified as five-year property for MACRS purposes? The MACRS allowance percentages are as follows, commencing with year 1: 20.00, 32.00, 19.20, 11.52, 11.52, and 5.76 percent.
$53,120
A project has an annual operating cash flow of $45,000. Initially, this four-year project required $3,800 in net working capital, which is recoverable when the project ends. The firm also spent $21,500 on equipment to start the project. This equipment will have a book value of $4,300 at the end of year 4. What is the cash flow for year 4 of the project if the equipment can be sold for $5,400 and the tax rate is 34 percent?
$53,826
Phil's Dinor purchased some new equipment two years ago for $89,500. Today, it is selling this equipment for $67,000. What is the aftertax cash flow from this sale if the tax rate is 35 percent? The MACRS allowance percentages are as follows, commencing with year 1: 20.00, 32.00, 19.20, 11.52, 11.52, and 5.76 percent.
$58,586
You are analyzing a project and have developed the following estimates. The depreciation is $19,800 a year and the tax rate is 34 percent. What is the best-case operating cash flow?
$60,456
A project requires $360,000 of equipment that is classified as seven-year property. What is the depreciation expense in year 3 given the following MACRS depreciation allowances, starting with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent?
$62,964
British Motor Works is reviewing its current accounts to determine how a proposed project might affect the account balances. The firm estimates the project will initially require $67,000 in additional current assets and $32,000 in additional current liabilities. The firm also estimates the project will require an additional $7,000 a year in current assets for each one of the four years of the project. How much net working capital will the firm recoup at the end of the project assuming that all net working capital can be recaptured?
$63,000
You are analyzing a project and have developed the following estimates: unit sales = 3,100, price per unit = $215, variable cost per unit = $115, fixed costs = $164,000. The depreciation is $59,000 a year and the tax rate is 35 percent. What effect would the sale of one more unit have on the operating cash flow?
$65.00
Consider a three-year project with the following information: initial fixed asset investment = $770,000; straight-line depreciation to zero over the three-year life; zero salvage value; price = $34.99; variable costs = $23.16; fixed costs = $245,000; quantity sold = 94,500 units; tax rate = 40 percent. How sensitive is OCF to an increase of one unit in the quantity sold?
$7.10
You are analyzing a project and have developed the following estimates: unit sales = 1,320, price per unit = $79, variable cost per unit = $43, fixed costs = $24,900. The depreciation is $11,300 a year and the tax rate is 40 percent. What effect would an increase of $1 in the selling price have on the operating cash flow?
$792
Better Chocolates has a new project that requires $975,000 of equipment. What is the depreciation in year 6 of this project if the equipment is classified as seven-year property for MACRS purposes? The MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
$86,970
A project is expected to create operating cash flows of $24,000 a year for three years. The initial cost of the fixed assets is $50,000. These assets will be worthless at the end of the project. An additional $2,500 of net working capital will be required throughout the life of the project. What is the project's net present value if the required rate of return is 10 percent?
$9,062.73
A project has sales of $462,000, costs of $274,000, depreciation of $26,000, interest expense of $3,400, and a tax rate of 35 percent. What is the value of the depreciation tax shield?
$9,100
Rocky Top, Inc. purchased some welding equipment six years ago at a cost of $579,000. Today, the company is selling this equipment for $110,000. The tax rate is 35 percent. What is the aftertax cash flow from this sale? The MACRS allowance percentages are as follows, commencing with year 1: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
$98,635 $58,586
Lakeside Winery is considering expanding its winemaking operations. The expansion will require new equipment costing $649,000 that would be depreciated on a straight-line basis to a zero balance over the four-year life of the project. The estimated salvage value is $187,000. The project requires $38,000 initially for net working capital, all of which will be recouped at the end of the project. The projected operating cash flow is $198,500 a year. What is the net present value of this project if the relevant discount rate is 14 percent and the tax rate is 35 percent?
-$14,162
The Sausage Hut is looking at a new sausage system with an installed cost of $438,000. This cost will be depreciated straight-line to zero over the project's four-year life, at the end of which the sausage system can be scrapped for $69,000. The sausage system will save the firm $129,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000, which will be recouped at project end. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project?
-$18,870
Mind Blowers, Inc. has a new project in mind that will increase accounts receivable by $28,000, decrease accounts payable by $6,000, increase fixed assets by $36,000, and decrease inventory by $11,000. What is the amount the firm should use as the initial cash flow attributable to net working capital when it analyzes this project?
-$23,000
A new project you are considering is expected to generate an operating cash flow of $45,620 and will initially free up $22,000 in net working capital. Purchases of fixed assets costing $68,800 will be required to start up the project. What is the total cash flow for this project at time zero?
-$46,800
Jim's Hardware is adding a new product line to its sales lineup. Initially, the firm will stock $41,000 of the new inventory, which will be purchased on 30 days' credit from a supplier. The firm will also invest $6,000 in accounts receivable and $4,000 in equipment. What amount should be included in the initial project costs for net working capital?
-$6,000
Mike's Fish Market is implementing a project that will initially increase accounts payable by $4,600, increase inventory by $4,800, and decrease accounts receivable by $800. All net working capital will be recouped when the project terminates. What is the cash flow related to the net working capital for the last year of the project?
-$600
Your firm is contemplating the purchase of a new $674,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $58,000 at that time. You will save $185,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $29,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 34 percent, what is the IRR for this project?
13.01 percent
Which one of the following statements is correct when a firm faces hard rationing?
The firm does not have funds to finance any new projects.
Industrial Services is analyzing a proposed investment that would initially require $538,000 of new equipment. This equipment would be depreciated on a straight-line basis to a zero balance over the four-year life of the project. The estimated salvage value is $187,000. The project requires $39,000 initially for net working capital, all of which will be recouped at the end of the project. The projected operating cash flow is $194,900 a year. What is the internal rate of return on this project if the relevant tax rate is 34 percent?
20.49 percent
The Golf Range is considering adding an additional driving range to its facility. The range would cost $76,000, would be depreciated on a straight-line basis over its seven-year life, and would have a zero salvage value. The anticipated income from the project is $34,000 a year with $14,400 of that amount being variable cost. The fixed cost would be $16,200. The firm believes that it will earn an additional $13,000 a year from its current operations should the driving range be added. The project will require $2,000 of net working capital, which is recoverable at the end of the project. What is the internal rate of return on this project at a tax rate of 34 percent?
7.53 percent
A project has an initial requirement of $698,700 for fixed assets and $61,000 for net working capital. The fixed assets will be depreciated to a zero book value over the four-year life of the project and will be worthless at the end of the project. All of the net working capital will be recouped after four years. The expected annual operating cash flow is $218,000. What is the project's internal rate of return if the tax rate is 35 percent?
8.41 percent
Kyle Electric has three positive net present value opportunities. Unfortunately, the firm has not been able to find financing for any of these projects. Which one of the following terms best describes the firm's situation?
Capital rationing
The managers of H.R Construction are considering remodeling plans for an old building the firm currently owns. The building was purchased eight years ago for $689,000. Over the past eight years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $898,000. The firm is considering remodeling the building into a conference centre and sandwich bar at an estimated cost of $1.7 million. The estimated present value of the future income from this centre is $2.9 million. Which one of the following defines the opportunity cost of the remodeling project?
Current market value of the building
Which one of the following will increase the operating cash flow as computed using the tax shield approach?
Decrease in fixed costs
Nu Tek is comprised of four separate operating divisions. For this year, the firm has decided to allocate capital funds using a soft rationing approach. Which one of the following applies to this situation?
Divisions managers will vie with each other for additional capital allocations.
Which one of the following terms is most commonly used to describe the cash flows of a new project that are simply an offset of reduced cash flows for a current project?
Erosion
Isabella is considering three mutually exclusive options for the additional space she just added to her specialty women's store. The cost of the expansion was $127,000. She can use this additional space to add a fabric and quilting section, add an exclusive gifts department, or expand into imported decorator items for the home. She estimates the present value of these options at $114,000 for fabric and quilting, $163,000 for exclusive gifts, and $138,000 for decorator items. Which option(s), if any, should Isabella accept?
Exclusive gifts only
The Blackwell Group is unable to obtain financing for any new projects under any circumstances. Which term best applies to this situation?
Hard rationing
Which of the following are cash inflows from net working capital? I. Increase in accounts payable II. Increase in inventory III. Decrease in accounts receivable IV. Decrease in fixed assets
I and III only
Which of the following have the potential to increase the net present value of a proposed investment? I. Ability to immediately shut down a project should the project become unprofitable II. Ability to wait until the economy improves before making the investment III. Option to place the investment on hold until a more favorable discount rate becomes available IV. Option to increase production beyond that initially projected
I, II, III, and IV
Which of the following should be included when compiling pro forma statements for a proposed investment? I. Forecasted sales II. Start-up costs III. Aftertax salvage value of any assets sold IV. Anticipated changes in net working capital
I, II, III, and IV
Steve owns a store that caters primarily to men and their hobbies. He is contemplating greatly expanding the hunting and fishing section of the store. If he does this, he expects his fishing and hunting sales will increase, his camping gear sales will increase, and his model train sales will decrease. Which of the following should Steve include in his revenue projection for the expansion project? I. Increase in fishing and hunting sales II. Increase in camping gear sales III. Decrease in model train sales
I, II, and III
Lake City Plastics currently produces plastic plates and silverware. The company is considering expanding its product offerings to include plastic serving trays. Which of the following are cash flows relevant to the new product? I. Molds needed to form the serving trays II. Projected increase in plate and silverware sales if the trays are produced III. A portion of the production manager's current annual salary of $75,000 IV. Raw materials used in the production of the serving trays
I, II, and IV only
The Shoe Box is considering adding a new line of winter footwear to its product lineup. Which of the following are relevant cash flows for this project? I. Decreased revenue from products currently being offered if this new footwear is added to the lineup II. Revenue from the new line of footwear III. Money spent to date looking for a new product line to add to the store's offerings IV. Cost of new counters to display the new line of footwear
I, II, and IV only
Which of the following should be included in the analysis of a proposed investment? I. Erosion effects II. Opportunity costs III. Sunk costs IV. Side effects
I, II, and IV only
Lakeside Rides is adding a new roller coaster to its amusement park. The firm expects this addition to increase its overall ticket sales and increase attendance at its park. In particular, the firm expects to sell more tickets for its current roller coaster and experience extremely high demand for its new coaster. Sales for its boat ride are expected to decline but food and beverage sales are expected to increase significantly. Which of the following are considered side effects associated with the new roller coaster? I. Ticket sales for the new roller coaster II. Change in ticket sales for the existing coaster III. Change in ticket sales for the boat ride IV. Change in food and beverage sales
II, III, and IV only
Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following?
Incremental cash flows
Which one of the following is a correct value to use if you are conducting a best-case scenario analysis?
Lowest expected value for fixed costs
Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of eight years.
Money spent last month repairing a damaged front fender
Boyertown Industrial Tools is considering a three-year project to improve its production efficiency. Buying a new machine press for $611,000 is estimated to result in $193,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $162,000. The press also requires an initial investment in spare parts inventory of $19,000, along with an additional $2,000 in inventory for each succeeding year of the project. If the tax rate is 35 percent and the discount rate is 12 percent, should the company buy and install the machine press? Why or why not?
No; the NPV is -$74,945
Which one of the following terms refers to the best option that was foregone when a particular investment is selected?
Opportunity cost
Turner Industries started a new project three months ago. Sales arising from this project are exceeding all expectations. Given this, which one of the following is management most apt to implement?
Option to expand
Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value. What type of analysis is Mark conducting?
Sensitivity analysis
Marcos Enterprises has three separate divisions. The firm allocates each division $1.5 million per year for capital purchases. Which one of the following terms applies to this allocation process?
Soft rationing
Which one of the following principles refers to the assumption that a project will be evaluated based on its incremental cash flows?
Stand-alone principle
Which one of the following refers to the option to expand into related businesses in the future?
Strategic option
A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost?
Sunk
Weston Steel purchased a new coal furnace six years ago at a cost of $2.2 million. Last year, the government changed the emission requirements and this furnace cannot meet those standards. Thus, Weston can no longer use the furnace, nor has it been able to locate anyone willing to purchase the furnace. Given the current situation, the furnace is best described as which type of cost?
Sunk
The Corner Market has decided to expand its retail store by building on a vacant lot it currently owns. This lot was purchased four years ago at a cost of $299,000, which the firm paid in cash. To date, the firm has spent another $38,000 on land improvements, all of which was also paid in cash. Today, the lot has a market value of $329,000. What value should be included in the analysis of the expansion project for the cost of the land?
The current market value of the land
Bruce Moneybags owns several restaurants and hotels near a local interstate. One restaurant, Beef and More, needs modernized. He is trying to decide whether to accept an offer and sell Beef and More as is for the offer price of $1.1 million or renovate the restaurant himself. The projected renovation cost is $1.3 million. The restaurant would need to be shut down completely during the renovation which would cause a net operating cash flow loss of $210,000 in today's dollars. The estimated present value of the cash inflows from the renovated restaurant are $3.2 million. When analyzing the renovation project, what opportunity cost, if any, should be included for the current restaurant? Assume the restaurant is totally paid for and any future costs will be paid in cash.
The opportunity cost is the value of the current offer to buy the restaurant.
Scenario analysis asks questions such as:
What is the best outcome that should reasonably be expected?
A proposed project will increase a firm's accounts payables. This increase is generally:
a cash inflow at time zero and a cash outflow at the end of the project.
Forecasting risk is best defined as:
estimation risk.
Firm A uses straight-line depreciation. Firm B uses MACRS depreciation. Both firms bought $60,000 worth of equipment last year. Both firms are in the 35 percent tax bracket. The operating cash flows for each firm are identical except for the depreciation effects. Given this, you know the:
operating cash flow of Firm A is less than that of Firm B for year 2.
A pro forma financial statement is a financial statement that:
projects future years' operations.
Scenario analysis is best described as the determination of the:
reasonable range of project outcomes.
The tax shield approach to computing the operating cash flow, given a tax-paying firm:
recognizes that depreciation creates a cash inflow.
The net working capital invested in a project is generally:
recouped at the end of the project.
Jamie is analyzing the estimated net present value of a project under various what if scenarios. The type of analysis that Jamie is doing is best described as:
scenario analysis.
The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation:
tax shield.
Thornley Machines is considering a 3-year project with an initial cost of $870,000. The project will not directly produce any sales but will reduce operating costs by $440,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $93,000. The tax rate is 34 percent. The project will require $23,000 in extra inventory for spare parts and accessories. Should this project be implemented if Thornley's requires a rate of return of 11 percent? Why or why not?
yes; The NPV is $119,302.95
