Download Capital Budgeting: NPV, IRR, and Payback Period Exercises and Solutions and more Exams Advanced Education in PDF only on Docsity!
MGMT 446 STUDY GUIDE WITH
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Which of the following statements regarding investment in working capital is incorrect? - ANSWER Investment in working capital, unlike investment in plant and equipment, represents a positive cash flow.
What is the payback period for an investment with these cash flows: YR 0, -60,000; YR1, 10,000; YR 2, 20,000; YR 3, 15,000; YR 4, 20,000; YR 5, 15,000? - ANSWER 3.75 years
The modified accelerated cost recovery system (MACRS) allows an increase: - ANSWER in annual depreciation during earlier years.
You are evaluating a project for the Ultimate.....
What is the operating cash flow for the project in year 2? - ANSWER 97,
You are evaluating a project for the Ultimate..... - ANSWER Salvage value does not affect incremental cash flow until year 3.
Grady Precision Measurement has forecasted the following sales and costs for a new GPS system: annual sales of 48,000 units at $18 a unit, production costs at 37% of sales price, annual fixed costs for production at $180,000, and straight-line depreciation expense of $240,000 per year. The company tax rate is 35%. What is the annual operating cash flow of the new GPS system? Round your answer to the nearest dollar - ANSWER 320,
Which of the following is not accurate in depicting cash flows from operations? - ANSWER net profit + depreciation + tax paid
Your company is considering investing in a new system that will cost $160,000. In addition, it costs $40,000 to adapt the system to be compatible with existing IT infrastructure and operational. It is estimated that the system will increase sales/revenues by $150,000 annually for Years 1-6. Operating expenses, other than depreciation, are expected to be equal to 60 percent of sales in each year. - ANSWER 225,
What is the NPV of the following set of cash flows if the required return is 15%? - ANSWER 408.
Which of the following statements is most correct? - ANSWER If an asset to be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the new project were not undertaken, then the net rent that could be obtained should be charged as a cost to the project under consideration.
An investment opportunity, in year 3, is forecast to create revenue of $120,000, and cost of goods sold 40% of revenue. SG&A is expected to be $30,000. Depreciation will be $15,000. Tax rate is 40%. Working capital will increase by $10,000 during year 3. What is net cash flow projected for year 3?
Consider a project with an initial investment and positive future cash flows. As the discount rate is decreased the _____________. - ANSWER IRR remains constant while NPV increases
A firm generates sales of $250,000, depreciation expense of $50,000, taxable income of $50,000, and has a 35% tax rate. By how much does net cash flow deviate from net income? (assume the firm does not have any interest expenses.) - ANSWER 50,
what is operating CF for project in year 2? - ANSWER 9,
Company XYZ is evaluating a project....
Effect of 3,500 salvage value on year 2 CF? - ANSWER salvage value does not affect incremental cash flow until year 3
The Seattle Corporation has been presented with an investment opportunity that will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10 percent. What is the NPV for this investment? - ANSWER 51,
the truck's basic price is... If the cost of capital for this project is 10 percent. What is its NPV? - ANSWER -1,
the truck's basic price is... ....
What is the operating cash flow in year 1? - ANSWER 20,
the truck's basic price is...
What is the cash flow at year 0? - ANSWER -62,
Assume that the company sells the equipment after three years for $400, and the company's tax rate is 40 percent. What would be the tax consequences resulting from the sale of the equipment? - ANSWER the company would have to pay 44,000 in taxes
- Flynn, Inc. is considering a four-year project that has an initial outlay or cost of $80,000. The future cash inflows from its project are $40,000, $40,000, $30,000, and $30,000 for years 1, 2, 3 and 4, respectively. Flynn uses the internal rate of return method to evaluate projects. What is the
approximate IRR for this project? - ANSWER the IRR is about 28.88%
- Whenever a new product competes against a company's already existing products and reduces the sales of those products, ________ occur. - ANSWER negative side effects
An NPV of zero implies that an investment _____________ - ANSWER none of the above
- A firm is considering an investment in a project whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should - ANSWER increase the cost of capital used to evaluate the project to reflect the project's higher risk
- Normal projects C and D are mutually exclusive. Project C has a higher (positive) net present value if the cost of capital is less than 12 percent, whereas Project D has a higher (positive) net present value if the cost of capital exceeds 12 percent. Which of the following statements is most correct? - ANSWER All of the statements above are correct
- Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? - ANSWER all else equal, a project's NPV increases as the cost of capital declines
- A company is considering a new project. The company's CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial investment, the operating cash flows, and the salvage values) at the company's cost of capital. Which of the following factors should the CFO include when estimating the relevant cash flows? - ANSWER any opportunity costs associated with the project
the financial decision models. - ANSWER incremental
- If we know the __________ and the EBIT, we can estimate the taxes for a project for the year. - ANSWER tax rate
- Which is not a step in the estimation of after-tax cash flow at disposal? - ANSWER a. If book value is less than selling price: selling price + tax credit on loss.
- Anthony, Ltd. purchases a duplicating machine for $15,000. This machine qualifies as a five-year recovery asset under MACRS. The company has a tax rate of 33%. If the company sells the machine at the end of four years for $4,000, what is the cash flow from disposal? - ANSWER 3,535.
- The advantage of MACRS over straight-line depreciation is that you can write off more of your capital costs in the _________ year(s). - ANSWER earlier
A firm is considering purchasing two assets. Asset A will have a useful life of fifteen years and cost $3 million. It will have installation costs of $400,000, but no salvage or residual value. Asset B will have a useful life of six years and cost $1.3 million. It will have installation costs of $180,000 and a salvage or residual value of $300,000. - ANSWER Asset A has 30,000 more in depreciation per year
- Which of the statements below is true? - ANSWER a. An increase in working capital can be brought about by an increase in inventory or accounts receivable.
- ___________ involve(s) a cash flow that never occurs, but we need to add it as a cost or outflow of a new project. - ANSWER opportunity costs
- The revenue is $24,000, the cost of goods sold is $12,000, other expenses (from selling and administration) are $6,000, and depreciation is $2,000. What is the EBIT? - ANSWER 4,
- You are evaluating whether to retire your current computer modem product and
replace it with a new modem that incorporates new features. Which of the following - ANSWER a. $50,000 spent on research and development costs over time on the older modem.
- Your firm disposes of an asset which is worthless in the open market, but still has
remaining undepreciated book value. The tax benefit to the firm from the writeoff of - ANSWER the tax rate multiplied by the remaining book value
- Brock Florist Company sold its delivery truck (see previous problem) after three years of service. If MACRS was used for the depreciation schedule, what is the after-tax cash flow from the sale of the truck (continue to use a 30% tax rate) if - ANSWER 15,000= 13,005.
10,000= 9,505.
5,000= 6,005.
Compare the depreciation schedules from parts (a) and (b) before and after taxes using a 30% tax rate. What do you notice about the difference between these two methods? - ANSWER The difference is that the MACRS moves up the tax to the early depreciation years but the total tax is the same under both depreciations.
- Brock Florist Company buys a new delivery truck for $29,000. It is classified as a light-duty truck.
a. Calculate the depreciation schedule using a five-year life, straight-line depreciation, and the half-year convention for the first and last years. - ANSWER annual= 5,
first and last year= 2,
- Brock Florist Company buys a new delivery truck for $29,000. It is classified as a light-duty truck.
a. Calculate the depreciation schedule using a five-year life and MACRS depreciation. - ANSWER 1= 5,
2= 9,
3= 5,
4- 3,340.
5= 3,340.
6= 1,670.
- Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $450,000 is estimated to result in $150,000 in annual pretax cost savings. The press falls in the MACRS five year class, and it will have a salvage value at the end of the project of $90,000. The press also requires an initial investment in spare parts inventory of $18,000, along with an additional $3,000 in inventory for each succeeding year of the project. If the shop's tax rate is 35% and its discount rate is 14%, should Massey buy and install the machine press? - ANSWER NPV= 6,
- Bush Boomerang, Inc., is considering a new three year expansion project that requires an initial fixed asset investment of $2.1 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $1,900,000 in annual sales, with costs of $850,000. If the tax rate is 35%, what is the OCF for this project? - ANSWER ofc= .9275 million
- Flynn, Inc. is considering a four-year project that has an initial after-tax outlay or after-tax cost of $80,000 - ANSWER the IRR is about 28.
- Dweller, Inc. is considering a four-year project that has an initial after-tax outlay or after-tax cost of $80,000. - ANSWER a. Dweller accepts the project because the NPV is greater than $28,000.
- Which of the statements below is false? - ANSWER a. The discounted payback period method is the time it takes to recover the initial investment in future dollars.
- ___________ is at the heart of corporate finance because it is concerned with making the best choices about project selection. - ANSWER capital budgeting
- Which of the following statements is true? - ANSWER a. If the NPV of a project is positive, it should be accepted.
- A project whose NPV equals zero. - ANSWER a. has a discounted payback period that exactly matches the life of the project
- Project selection ambiguity can arise if one relies on IRR instead of NPV
when: - ANSWER project cash flows are not conventional
- Which of the following calculations ignores the impact of the time value of money?
I. payback
II. IRR
III. PI - ANSWER I only (payback)
- The discounted payback rule can be best stated as: - ANSWER a. An investment is acceptable if its discounted payback period is less than some prespecified number of years.
- Quark industries has four potential projects, all with an initial cost of $2,000,000. The capital budget for the year will allow Quark to accept only one of the four projects. Given the discount rate and the future cash flow of each project, determine which project Quark should accept. - ANSWER m- 106,181.9 accept
n- 333,790.77 accept
o- 197,126.53 accept
p- -219,413.98 reject
- Kong Petroleum, Inc. is trying to evaluate a generator project with the
- For the cash flows in the previous problem, what is the NPV at a discount rate of zero percent? What if the discount rate is 10%? If it is 20%? If it is 30%? - ANSWER 0- 2,
10- 1,277.
20- 386.
30- -283.
- What is the IRR of the following set of cash flows?
0- -4,
1- 1,
2- 2,
3- 2,900 - ANSWER 25.
- Given the cash flow of four projects - A, B, C, and D - and using the payback period decision model, which projects do you accept and which projects do you reject if you have a three-year cutoff period for recapturing the initial cash outflow? For payback period calculations, assume that the cash flow is equally distributed over the year. - ANSWER a= 2 1/2 years, accept
b= 3 1/20 years, reject
c= 3 years, accept
d= 4 years, reject
- Given the following four projects and their cash flows, calculate the discounted payback period with a 5% discount rate, 10% discount rate, and 20% discount rate. What do you notice about the payback period as the discount rate rises? Explain this relationship. - ANSWER Project A: DPP of 3 years (5%), 4 years (10%), 4 years (20%)
Project B: DPP of 4 years (5%), 4 years (10%), 5 years (20%)
Project C: DPP of 4 years (5%), 4 years (10%), 5 years (20%)
Project D: Never recovered (5%), never recovered (10%), never recovered (20%)
As discount rate rises, payback period increases.
