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Exam 10: Project Analysis and Evaluation

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Question 1

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Dexter Smith & Co.is replacing a machine simply because it has worn out.The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life.The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income.Given this, which one of the following statements is correct?

A) As a project, the new machine has a net present value equal to minus one times the machine's purchase price.
B) The new machine will have a zero rate of return.
C) The new machine will generate positive operating cash flows, at least in the first few years of its life.
D) The new machine will create a cash outflow when the firm disposes of it at the end of its life.
E) The new machine creates erosion effects.

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

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Question 2

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Eads Industrial Systems Company (EISC) is trying to decide between two different conveyor belt systems.System A costs $427,000, has a 6-year life, and requires $115,000 in pretax annual operating costs.System B costs $502,000, has an 8-year life, and requires $79,000 in pretax annual operating costs.Both systems are to be depreciated straight-line to zero over their lives and will have a zero salvage value.Whichever system is chosen, it will not be replaced when it wears out.The tax rate is 33 percent and the discount rate is 24 percent.Which system should the firm choose and why?

A) A; The net present value is $211,516.
B) A; The net present value is -$588,792.
C) A; The net present value is -$314,216.
D) B; The net present value is $308,222.
E) B: The net present value is -$612,240.

F) D) and E)
G) A) and B)

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Question 3

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Bruno's Lunch Counter is expanding and expects operating cash flows of $29,000 a year for 4 years as a result.This expansion requires $39,000 in new fixed assets.These assets will be worthless at the end of the project.In addition, the project requires $3,000 of net working capital throughout the life of the project.What is the net present value of this expansion project at a required rate of return of 15 percent?

Which one of the following statements is correct concerning bid prices?

You are working on a bid to build two apartment buildings a year for the next 5 years for a local college.This project requires the purchase of $750,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life.The equipment can be sold at the end of the project for $325,000.You will also need $140,000 in net working capital over the life of the project.The fixed costs will be $628,000 a year and the variable costs will be $1,298,000 per building.Your required rate of return is 14.5 percent for this project and your tax rate is 35 percent.What is the minimal amount, rounded to the nearest $100, you should bid per building?

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?

The operating cash flow for a project should exclude which one of the following?

The Pancake House has sales of $1,642,000, depreciation of $27,000, and net working capital of $218,000.The firm has a tax rate of 35 percent and a profit margin of 6 percent.The firm has no interest expense.What is the amount of the operating cash flow?

Which one of the following best describes the concept of erosion?

When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I.differing productive lives II.differing manufacturers III.required replacement at end of economic life IV.differing initial cost

Which one of the following is a project cash inflow? Ignore any tax effects.

You just purchased some equipment that is classified as 5-year property for MACRS.The equipment cost $147,000.What will the book value of this equipment be at the end of 4 years should you decide to resell the equipment at that point in time?

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?

G & L Plastic Molders 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?

Webster & Moore paid $148,000, in cash, for a piece of equipment 3 years ago.At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology.The company no longer uses this equipment in its current operations and has received an offer of $96,000 from a firm that would like to purchase it.Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used.When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?

Phone Home, Inc.is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million.The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless.The project is estimated to generate $2,208,000 in annual sales, with costs of $883,200.The tax rate is 32 percent and the required return on the project is 11 percent.What is the net present value for this project?

Net working capital:

Northern Railway is considering a project which will produce annual sales of $975,000 and increase cash expenses by $848,000.If the project is implemented, taxes will increase from $141,000 to $154,000 and depreciation will increase from $194,000 to $272,000.The company is debt-free.What is the amount of the operating cash flow using the top-down approach?

You own a house that you rent for $1,100 a month.The maintenance expenses on the house average $200 a month.The house cost $219,000 when you purchased it 4 years ago.A recent appraisal on the house valued it at $239,000.If you sell the house you will incur $14,000 in real estate fees.The annual property taxes are $4,000.You are deciding whether to sell the house or convert it for your own use as a professional office.What value should you place on this house when analyzing the option of using it as a professional office?

The equivalent annual cost method is useful in determining: