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Exam 6: Making Capital Investment Decisions

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Question 31

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The increase you realize in buying power as a result of owning a bond is referred to as the _____ rate of return.

A) inflated
B) realized
C) nominal
D) real
E) risk-free

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

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Question 32

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A project's operating cash flow will increase when:

A) the depreciation expense increases.
B) the sales projections are lowered.
C) the interest expense is lowered.
D) the net working capital requirement increases.
E) the earnings before interest and taxes decreases.

F) B) and D)
G) None of the above

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Question 33

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Which of the following are examples of erosion? I. The loss of sales due to increased competition in the product market II. The loss of sales because your chief competitor just opened a store across the street from your store III. The loss of sales due to a new product which you recently introduced IV. The loss of sales due to a new product recently introduced by your competitor

Marshall's & Co. purchased a corner lot in Eglon City five years ago at a cost of $640,000. The lot was recently appraised at $810,000. At the time of the purchase,the company spent $50,000 to grade the lot and another $4,000 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 $1.2 million. What amount should be used as the initial cash flow for this building project?

Which one of the following will decrease net working capital of a firm?

Bruno's,Inc. is analyzing two machines to determine which one it should purchase. The company requires a 14% rate of return and uses straight-line depreciation to a zero book value. Machine A has a cost of $290,000,annual operating costs of $8,000,and a 3-year life. Machine B costs $180,000,has annual operating costs of $12,000,and has a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.)

Peter's Boats has sales of $760,000 and a profit margin of 5%. The annual depreciation expense is $80,000. What is the amount of the operating cash flow if the company has no long-term debt?

Margarite's Enterprises is considering a new project. The project will require $325,000 for new fixed assets,$160,000 for additional inventory and $35,000 for additional accounts receivable. Short-term debt is expected to increase by $100,000 and long-term debt is expected to increase by $300,000. The project has a 5-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 25% 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 $554,000 and costs of $430,000. The tax rate is 35% and the required rate of return is 15%. What is the cash flow recovery from net working capital at the end of this project?

You own a house that you rent for $1,200 a month. The maintenance expenses on the house average $200 a month. The house cost $89,000 when you purchased it several years ago. A recent appraisal on the house valued it at $210,000. The annual property taxes are $5,000. If you sell the house you will incur $20,000 in expenses. 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?

Walks Softly,Inc. sells customized shoes. Currently,it sells 10,000 pairs of shoes annually at an average price of $68 a pair. It is considering adding a lower-priced line of shoes which sell for $49 a pair. Walks Softly estimates it can sell 5,000 pairs of the lower-priced shoes but will sell 1,000 less pairs of the higher-priced shoes by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced shoes?

Your firm purchased a warehouse for $335,000 six years ago. Four years ago,repairs were made to the building which cost $60,000. The annual taxes on the property are $20,000. The warehouse has a current book value of $268,000 and a market value of $295,000. The warehouse is totally paid for and solely owned by your firm. If the company decides to assign this warehouse to a new project,what value,if any,should be included in the initial cash flow of the project for this building?

A project will produce operating cash flows of $45,000 a year for four years. During the life of the project,inventory will be lowered by $30,000 and accounts receivable will increase by $15,000. Accounts payable will decrease by $10,000. The project requires the purchase of equipment at an initial cost of $120,000. 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 $25,000 after-tax 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%?

A project will increase sales by $140,000 and cash expenses by $95,000. The project will cost $100,000 and be depreciated using the straight-line method to a zero book value over the 4-year life of the project. The company has a marginal tax rate of 34%. What is the value of the depreciation tax shield?

Louie's Leisure Products is considering a project which will require the purchase of $1.4 million in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. Annual sales from this project are estimated at $1.2 million. Net working capital equal to 20% of sales will be required to support the project. All of the net working capital will be recouped at the end of the project. The firm desires a minimal 14% rate of return on this project. The tax rate is 34%. What is the recovery amount attributable to net working capital at the end of the project?

Sunk costs include any cost that:

Matty's Place is considering the installation of a new computer system that will cut annual operating costs by $11,000. The system will cost $48,000 to purchase and install. This system is expected to have a 5-year life and will be depreciated to zero using straight-line depreciation. What is the amount of the earnings before interest and taxes for this project?

Your firm purchased a warehouse for $350,000 six years ago. Four years ago,repairs were made to the building which cost $60,000. The annual taxes on the property are $20,000. The warehouse has a current book value of $273,000 and a market value of $305,000. The warehouse is totally paid for and solely owned by your firm. If the company decides to assign this warehouse to a new project,what value,if any,should be included in the initial cash flow of the project for this building?

The bottom-up approach to computing the operating cash flow applies only when:

Explain the use of real and nominal discount rates in discounting cash flows. Which is used more often and why?

The top-down approach to computing the operating cash flow: