Exam 12: Estimating Cash Flows on Capital Budgeting Projects

You are evaluating a project for your company. You estimate the sales price to be $500 per unit and sales volume to be 2000 units in year 1; 3000 units in year 2; and 1500 units in year 3. The project has a three-year life. Variable costs amount to $300 per unit and fixed costs are $200,000 per year. The project requires an initial investment of $325,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $50,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 12 percent. What is the operating cash flow for the project in year 2?

Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.70. The flotation cost for equity is 6 percent, the flotation cost for debt is 3 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0?

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $50,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $10,000 estimated resale value, and falls under the MACRS five-year class life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $25,000 at the beginning of the project. What will the year 3 free cash flow for this project be?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in NWC (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the free cash flows for this project be?

Which of the following statements is correct?

Concerning incremental project cash flow, which of these is a cost one would never count as an expense of the project?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $75,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $13,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 21 percent. What will the operating cash flow for this project be during year 3?

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $250,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS seven-year class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 21 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 0 free cash flow for this project be?

Your firm needs a machine which costs $20,000, and requires $1,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 9 percent. What is the depreciation tax shield for this project in year 3?

You are evaluating a product for your company. You estimate the sales price of the product to be $200 per unit and sales volume to be 2,000 units in year 1; 5,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $75 per unit and fixed costs are $200,000 per year. The project requires an initial investment of $360,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $40,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 13 percent. What will the year 2 free cash flow for this project be?

Your firm needs a machine which costs $100,000, and requires $25,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 14 percent. What is the depreciation tax shield for this project in year 3?

ABC Engineering just bought a new machine. All of the following are examples of incremental cash flows EXCEPT

Due to rapid growth, a computer superstore is contemplating expanding by adding another location. Which of the following items should the financial officer NOT include in estimating the cash flow associated with this expansion?

Your firm needs a machine which costs $500,000, and requires $10,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 15 percent. What is the depreciation tax shield for this project in year 3?

Suppose you sell a fixed asset for $75,000 when its book value is $80,000. If your company's marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

You are evaluating a product for your company. You estimate the sales price of the product to be $50 per unit and sales volume to be 50,000 units in year 1; 75,000 units in year 2; and 10,000 units in year 3. The project has a three-year life. Variable costs amount to $15 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $275,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 9 percent. What will the year 2 free cash flow for this project be?

Your firm needs a machine which costs $90,000, and requires $30,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 21 percent and a discount rate of 13 percent. What is the depreciation tax shield for this project in year 5?

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $20,000 initially, and then $4,000 per year in maintenance costs. Machine B costs $25,000 initially, has a life of three years, and requires $3,500 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Using EAC which is the better machine for the firm? The discount rate is 14 percent and tax can be ignored.

With regard to depreciation, the time value of money concept tells us that

Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in installation, and another $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 21 percent and a discount rate of 12 percent. If the lathe can be sold for $7,000 at the end of year 3, what is the after-tax salvage value?