Exam 11: Cash Flow and Risk

Thomson Media is considering some new equipment whose data are shown below.The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down.Also, some new working capital would be required, but it would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's NPV? WACC 10.0\% Net investment in fixed assets (depreciable basis) \ 70,000 Required net operating working capital \ 10,000 Straight-line depreciation rate 33.333\% Annual sales revenues \ 57,000 Annual operating costs (excl. depreciation) \ 30,000 Expected pre-tax salvage value \ 5,000 Tax rate 35.0\%

Foley Systems is considering a new investment whose data are shown below.The equipment would be depreciated on a straight-line basis over the project's 3-year life, would have a zero salvage value, and would require some additional working capital that would be recovered at the end of the project's life.Revenues and other operating costs are expected to be constant over the project's life.What is the project's NPV? (Hint: Cash flows are constant in Years 1 to 3.) WACC 10.0% Net investment in fixed assets (basis) $75,000 Required net operating working capital $15,000 Straight-line depreciation rate 33.333% Annual sales revenues $75,000 Annual operating costs (excl. depreciation) $25,000 Tax rate 35.0%

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.

Which of the following statements is CORRECT?

Which of the following rules is CORRECT for capital budgeting analysis?

is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop.This is why subjective judgment is often used for such projects along with discounted cash flow analysis.

debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Dalrymple Inc.is considering production of a new product.In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?

cash flows that can be classified as incremental to a particular project--i.e., results directly from the decision to undertake the project--should be reflected in the capital budgeting analysis.

Which of the following statements is CORRECT?

Clemson Software is considering a new project whose data are shown below.The required equipment has a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's Year 1 cash flow? Equipment cost (depreciable basis) $65,000 Straight-line depreciation rate 33.333% Sales revenues, each year $60,000 Operating costs (excl. depr.) $25,000 Tax rate 35.0%