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Exam 10: Making Capital Investment Decisions

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Question 1

Multiple Choice

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The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following?

A) salvage value
B) wasted value
C) sunk cost
D) opportunity cost
E) erosion

F) C) and D)
G) C) and E)

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Question 2

Multiple Choice

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All of the following are related to a proposed project.Which of these should be included in the cash flow at time zero? I.purchase of $1,400 of parts inventory needed to support the project II.loan of $125,000 used to finance the project III.depreciation tax shield of $1,100 IV.$6,500 of equipment needed to commence the project

A) I and II only
B) I and IV only
C) II and IV only
D) I,II,and IV only
E) I,II,III,and IV

F) B) and D)
G) C) and D)

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B

Question 3

Multiple Choice

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Pro forma statements for a proposed project should: I.be compiled on a stand-alone basis. II.include all the incremental cash flows related to the project. III.generally exclude interest expense. IV.include all project-related fixed asset acquisitions and disposals.

-In a single sentence,explain how you can determine which cash flows should be included in the analysis of a project.

-Phone Home,Inc.is considering a new 4-year expansion project that requires an initial fixed asset investment of $3 million.The fixed asset will be depreciated straight-line to zero over its 4-year tax life,after which time it will have a market value of $225,000.The project requires an initial investment in net working capital of $330,000,all of which will be recovered at the end of the project.The project is estimated to generate $2,640,000 in annual sales,with costs of $1,056,000.The tax rate is 33 percent and the required return for the project is 15 percent.What is the net present value for this project?

The Card Shoppe needs to maintain 20 percent of its sales in net working capital.Currently,the shoppe is considering a 6-year project that will increase sales from its current level of $379,000 to $421,000 the first year and to $465,000 a year for the following 5 years of the project.What amount should be included in the project analysis for net working capital in year 6 of the project?

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

Decreasing which one of the following will increase the acceptability of a project?

-Your firm is contemplating the purchase of a new $1,628,000 computer-based order entry system.The system will be depreciated straight-line to zero over its 5-year life.It will be worth $156,300 at the end of that time.You will save $642,500 before taxes per year in order processing costs and you will be able to reduce working capital by $115,764 (this is a one-time reduction) .The net working capital will return to its original level when the project ends.The tax rate is 35 percent.What is the internal rate of return for this project?

-Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years.At the beginning of the project,inventory will decrease by $16,000,accounts receivables will increase by $21,000,and accounts payable will increase by $15,000.All net working capital will be recovered at the end of the project.The initial cost of the molding machine is $249,000.The equipment will be depreciated straight-line to a zero book value over the life of the project.The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow.At the end of the project,net working capital will return to its normal level.What is the net present value of this project given a required return of 14.5 percent?

Which one of the following will increase a bid price?

-Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers.Each one of these machines costs $1,480,000 to purchase plus an additional $52,000 a year to operate.The machines have a 6-year life after which they are worthless.What is the equivalent annual cost of one these machines if the required return is 16 percent?

Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project.At the end of the project the equipment will be sold for an estimated $300,000.The project will not directly produce any sales but will reduce operating costs by $725,000 a year.The tax rate is 35 percent.The project will require $45,000 of inventory which will be recouped when the project ends.Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not?

Hollister & Hollister is considering a new project.The project will require $522,000 for new fixed assets,$218,000 for additional inventory,and $39,000 for additional accounts receivable.Short-term debt is expected to increase by $165,000.The project has a 6-year life.The fixed assets will be depreciated straight-line to a zero book value over the life of the project.At the end of the project,the fixed assets can be sold for 20 percent of their original cost.The net working capital returns to its original level at the end of the project.The project is expected to generate annual sales of $875,000 and costs of $640,000.The tax rate is 34 percent and the required rate of return is 14 percent.What is the cash flow recovery from net working capital at the end of this project?

Home Furnishings Express is expanding its product offerings to reach a wider range of customers.The expansion project includes increasing the floor inventory by $430,000 and increasing its debt to suppliers by 70 percent of that amount.The company will also spend $450,000 for a building contractor to expand the size of its showroom.As part of the expansion plan,the company will be offering credit to its customers and thus expects accounts receivable to rise by $90,000.For the project analysis,what amount should be used as the initial cash flow for net working capital?

Three years ago,Knox Glass purchased a machine for a 3-year project.The machine is being depreciated straight-line to zero over a 5-year period.Today,the project ended and the machine was sold.Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate)

Mason Farms purchased a building for $689,000 eight years ago.Six years ago,repairs were made to the building which cost $136,000.The annual taxes on the property are $11,000.The building has a current market value of $840,000 and a current book value of $494,000.The building is totally paid for and solely owned by the firm.If the company decides to use this building for a new project,what value,if any,should be included in the initial cash flow of the project for this building?

Hollister & Hollister is considering a new project.The project will require $543,000 for new fixed assets,$218,000 for additional inventory,and $42,000 for additional accounts receivable.Short-term debt is expected to increase by $165,000.The project has a 6-year life.The fixed assets will be depreciated straight-line to a zero book value over the life of the project.At the end of the project,the fixed assets can be sold for 20 percent of their original cost.The net working capital returns to its original level at the end of the project.The project is expected to generate annual sales of $875,000 with costs of $640,000.The tax rate is 34 percent and the required rate of return is 13 percent.What is the project's cash flow at time zero?

You own some equipment that you purchased 4 years ago at a cost of $225,000.The equipment is 5-year property for MACRS.You are considering selling the equipment today for $87,000.Which one of the following statements is correct if your tax rate is 35 percent?

Assume a firm sets its bid price for a project at the minimum level as computed using the discounted cash flow method.Given this,what do you know about the net present value and the internal rate of return on the project as bid?