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Exam 10: Making Capital Investment Decisions

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Question 51

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A project will produce an operating cash flow of $14,600 a year for 7 years.The initial fixed asset investment in the project will be $48,900.The net aftertax salvage value is estimated at $12,000 and will be received during the last year of the project's life.What is the net present value of the project if the required rate of return is 12 percent?

A) $22,627.54
B) $23,159.04
C) $34,627.54
D) $39,070.26
E) $41,040.83

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

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Question 52

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Colors and More is considering replacing the equipment it uses to produce crayons.The equipment would cost $1.37 million,have a 12-year life,and lower manufacturing costs by an estimated $310,000 a year.The equipment will be depreciated using straight-line depreciation to a book value of zero.The required rate of return is 15 percent and the tax rate is 35 percent.What is the net income from this proposed project?

A) $18,508.75
B) $40,211.24
C) $66,441.67
D) $127,291.67
E) $136,709.48

F) C) and D)
G) All of the above

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Question 53

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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 amount of the earnings before interest and taxes for the first year of this project?

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

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?

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:

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

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?

Changes in the net working capital requirements:

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

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?

Chapman Machine Shop is considering a 4-year project to improve its production efficiency.Buying a new machine press for $576,000 is estimated to result in $192,000 in annual pretax cost savings.The press falls in the MACRS 5-year class,and it will have a salvage value at the end of the project of $84,000.The press also requires an initial investment in spare parts inventory of $24,000,along with an additional $3,600 in inventory for each succeeding year of the project.The inventory will return to its original level when the project ends.The shop's tax rate is 35 percent and its discount rate is 11 percent.Should the firm buy and install the machine press? Why or why not?

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?

What is the formula for the tax-shield approach to OCF? Explain the two key points the formula illustrates.

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?

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

Hollister & Hollister is considering a new project.The project will require $535,000 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 31 percent and the required rate of return is 14 percent.What is the amount of the aftertax cash flow from the sale of the fixed assets at the end of this project?

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

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?

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?