FIN 3200 CH10
Currently, GH Co. sells 42,600 handbags annually at an average price of $149 each. It is considering adding a lower-priced line of handbags that sell for $79 each. The firm estimates it can sell 21,000 of the lower-priced handbags but expects to sell 7,200 less of the higher-priced handbags by doing so. What is the amount of the annual sales that should be used when evaluating the addition of the lower-priced handbags? A) $586,200 B) $659,000 C) $6,933,600 D) $5,839,000 E) $780,200
A) $586,200 Sales = 21,000($79) − 7,200($149) Sales = $586,200
The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project is referred to as the project's: A) incremental cash flows. B) internal cash flows. C) external cash flows. D) erosion effects. E) financing cash flows.
A) incremental cash flows. Explanation: Incremental cash flows refers to how much the company will earn in excess (or less than) the companies cash flows without the project.
Pro forma financial statements can best be described as financial statements: A) expressed in a foreign currency. B) where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales. C) showing projected values for future time periods. D) expressed in real dollars, given a stated base year. E) where all accounts are expressed as a percentage of last year's values.
C) showing projected values for future time periods. A pro forma financial statement is a financial statement that is prepared as a guess of a financial statement over a specified future time period
Ausel's is considering a five-year project that will require $738,000 for new fixed assets that will be depreciated straight-line to a zero book value over five years. No bonus depreciation will be taken. At the end of the project, the fixed assets can be sold for 18 percent of their original cost. The project is expected to generate annual sales of $679,000 with costs of $321,000. The tax rate is 22 percent and the required rate of return is 15.2 percent. What is the amount of the aftertax salvage value? A) $105,165.60 B) $103,615.20 C) $104,409.20 D) $132,840.00 E) $118,406.90
B) $103,615.20 Aftertax salvage value = $738,000(.18)(1 − .22) Aftertax salvage value = $103,615.20
Dependable Motors just purchased some MACRS five-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for Years 1 to 3, respectively. Assume the firm opted to forego any bonus depreciation. Which one of the following will correctly give you the book value of this equipment at the end of Year 2? A) $216,000/(1 + .2 + .32) B) $216,000(1 − .2 − .32) C) $216,000(.20 + .32) D) [$216,000(1 − .20)](1 − .32) E) $216,000[(1 + .20)(1 + .32)]
B) $216,000(1 − .2 − .32) 216,000 is the initial cost for a project. The MACRS rates are future depreciation of the property. Then you can just plug those numbers into the equation of 1-Nt... times the initial cost then you can get the value of the equipment for any year.
PGH Inc. is considering a new seven-year expansion project with an initial fixed asset investment of $3.87 million. The fixed asset will be depreciated straight-line to zero over its seven-year tax life, after which time it will be worthless. No bonus depreciation will be taken. The project is estimated to generate $2,103,000 in annual sales, with costs of $1,065,000. The tax rate is 21 percent and the required return is 14.6 percent. What is the net present value of this project? A) $32,155.56 B) $71,841.16 C) $134,098.28 D) −$52,171.66 E) $95,008.04
B) $71,841.16 OCF = ($2,103,000 − 1,065,000)(1 − .21) + ($3,870,000/7)(.21) OCF = $936,120
Kelly's Corner Bakery purchased a lot in Oil City six years ago at a cost of $98,700. Today, that lot has a market value of $128,900. At the time of the purchase, the company spent $6,500 to level the lot and another $12,000 to install storm drains. The company now wants to build a new facility on the site at an estimated cost of $494,200. What amount should be used as the initial cash flow for this project? A) −$611,400 B) −$623,100 C) −$641,600 D) −$592,900 E) −$582,400
B) −$623,100 CF0 = −$128,900 − 494,200 CF0 = −$623,100
You are working on a bid to build two apartment buildings a year for the next three years. This project requires the purchase of $847,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. Ignore bonus depreciation. The equipment can be sold at the end of the project for $415,000. You will also need $165,000 in net working capital over the life of the project. The fixed costs will be $528,000 a year and the variable costs will be $1,640,000 per building. Your required rate of return is 16 percent for this project and your tax rate is 24 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building? A) $4,158,400 B) $4,489,500 C) $2,065,700 D) $2,780,600 E) $2,244,800
C) $2,065,700 OCF NPV = $847,000 + 165,000 − [$415,000(1 − .24) + $165,000]/1.163 OCF NPV = $704,228.05 $704,228.05 = OCF{[1 − (1/1.163)]/.16} OCF = $313,563.09 NI = $313,563.09 − $847,000/3 NI = $31,229.75 EBT = $31,229.75/(1 − .24) EBT = $41,091.78 Sales = $41,091.78 + $847,000/3 + $528,000 + $1,640,000(2) Sales = $4,131,425.11 Bid per building = $4,131,425.11/2 Bid per building = $2,065,713 When rounded to the nearest $100, the bid price is $2,065,700.
A project will require $512,000 for fixed assets and $47,000 for net working capital. The fixed assets will be depreciated straight-line to a zero book value over the six-year life of the project. No bonus depreciation will be taken. At the end of the project, the fixed assets will be worthless. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $965,000 and costs of $508,000. The tax rate is 21 percent and the required rate of return is 14.7 percent. What is the amount of the annual operating cash flow? A) $283,633.33 B) $447,826.67 C) $378,950.00 D) $245,300.00 E) $198,300.00
C) $378,950.00 OCF = ($965,000 − 508,000)(1 − .21) + ($512,000/6)(.21) OCF = $378,950.00
Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? A) Providing both ketchup and mustard for customers' use B) Repairing the roof of the hot dog stand because of water damage C) Selling fewer hot dogs because hamburgers were added to the menu D) Offering french fries but not onion rings E) Losing sales due to bad weather
C) Selling fewer hot dogs because hamburgers were added to the menu Erosion is any unfavorable influence on a company's sales or assets in the longer term. So if the hot dog stand's sales went down because of a continual influence, that would be erosion. In this case, it is because hamburgers were added to the menu.
Frank's is a furniture store that is considering adding appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances? A) Moving furniture to provide floor space for the appliances B) Paying the rent for the store C) Selling furniture to appliance customers D) Having the current store manager oversee appliance sales E) Using the store's billing system for appliance sales
C) Selling furniture to appliance customers Since the question is asking about appliances, an incremental cashflow would be extra cash selling to customers who would usually buy appliances. So a customer who would usually buy appliances who buys furniture instead would be an incremental cashflow.
Net working capital: A) can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B) requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C) is rarely affected when a new product is introduced. D) can create either an initial cash inflow or outflow. E) is the only expenditure where at least a partial recovery can be made at the end of a project
D) can create either an initial cash inflow or outflow. Net working capital is current assets- current liabilities like cash and short-term debt that change when deciding a new project.
Gateway Communications is considering a project with an initial fixed asset cost of $2.168 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. Ignore bonus depreciation. At the end of the project the equipment will be sold for an estimated $495,000. The project will not directly produce any sales but will reduce operating costs by $634,000 a year. The tax rate is 21 percent. The project will require $128,000 of net working capital which will be recouped when the project ends. What is the net present value at the required rate of return of 14.3 percent? A) $668,019.24 B) $701,414.14 C) $652,108.10 D) $570,475.57 E) $657,345.35
E) $657,345.35 Explanation: Initial cash flow = −$2,168,000 − 128,000 Initial cash flow = −$2,296,000 OCF = $634,000(1 − .21) + ($2,168,000/10)(.21) OCF = $546,388 Final cash flow = $128,000 + $495,000(1 − .21) Final cash flow = $519,050 NPV = −$2,296,000 + $546,388{[1 − (1/1.14310)]/.143} + $519,050/1.14310 NPV = $657,345.35
GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? A) Opportunity B) Fixed C) Incremental D) Erosion E) Sunk
E) Sunk Explanation: The 1200 is gone regardless of what the company does moving forward. That is known as a sunk cost.
The bid price is the: A) price you must charge to break even at a zero discount rate. B) the aftertax contribution margin. C) the highest price you should charge if you want to win the bid. D) the only price you can bid if the project is to be profitable. E) the minimum price that will provide your target rate of return.
E) the minimum price that will provide your target rate of return The bid price you will pay is the one that will make you your acceptable rate of return.