Exam 11: Cash Flow and Risk

change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required.This situation is especially true for replacement projects.

Suppose Tapley Inc.uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects.Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?

Marshall-Miller & Company is considering the purchase of a new machine for $50,000, installed.The machine has a tax life of 5 years, and it can be depreciated according to the following rates.The firm expects to operate the machine for 4 years and then to sell it for $12,500.If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4?

Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation.This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held constant.

Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision--estimates of its effect would really just be guesses.In this case, the externality should be ignored--i.e., not considered at all--because if it were considered it would make the analysis appear more precise than it really is.

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?

a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.

Which of the following statements is CORRECT?

evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:

Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process.Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.

company is considering a proposed new plant that would increase productive capacity.Which of the following statements is CORRECT?

Florida Car Wash is considering a new project whose data are shown below. $\text { Currrent NPV }$ Year 0 1 2 3 Sales 70000 70000 70000 Less: VC 15050 15050 15050 Less: Dep 20000 20000 20000 Less: Fixed Cos: 10000 10000 10000 Profit Befor Tax 24950 24950 24950 Less: Tax 8732.5 8732.5 8732.5 Profit After Tax \ 16,217.50 16217.5 16217.5 Add Dep 20000 20000 20000 Cash Flow 36217.5 36217.5 36217.5 Investment (\ 60,000) Net Cash Flow (\ 60,000) 36217.5 36217.5 36217.5 PV Factor 1 0.9091 0.8264 0.7513 PV Factor (\ 60,000) \ 32,925 \ 29,931.82 \ 27,210.74 NVP \3 0,067.56 $\text { Project NPV }$ Year 0 1 2 3 Sales 42000 42000 42000 Less: VC 9030 9030 9030 Less: Dep 20000 20000 20000 Less: Fixed Cost 10000 10000 10000 Profit Befor Tax 2970 2970 2970 Less: Tax 1039.5 1039.5 1039.5 Profit After Tax \ 1,930.50 \ 1,930.50 \ 1,930.50 Add Dep 20000 20000 20000 Cash Flow 21930.5 21930.5 21930.5 Investment (\ 60,000) Net Cash Flow (\ 60,000) 21930.5 21930.5 21930.5 PV Factor 1 0.9091 0.8264 0.7513 PV Factor (\ 60,000) 19936.818 18124.38 16476.709 NPV (\ 5,462.09) The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3.No new working capital would be required.Revenues and other operating costs will be constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset profits in other units.If the number of cars washed declined by 40% from the expected level, by how much would the project's NPV decline? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)

Which of the following statements is CORRECT?

Langston Labs has an overall (composite)Which set of projects would maximize shareholder wealth?

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

Which of the following statements is CORRECT?

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.

two cardinal rules that financial analysts should follow to avoid capital budgeting errors are: (1) in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash flows should be considered when making accept/reject decisions.

Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below.The company owns the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office.The equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it would be worth nothing and thus it would have a zero salvage value.No new working capital would be required, and revenues and other operating costs would be constant over the project's 3-year life.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.) WACC 10.0% Opportunity cost $100,000 Net equipment cost (depreciable basis) $65,000 Straight-line depr. rate for equipment 33.333% Sales revenues, each year $141,000 Operating costs (excl. depr.), each year $25,000 Tax rate 35%