Exam 9: Fundamentals of Capital Budgeting

The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the capital cost allowance (CCA)tax shield.

Use the table for the question(s) below. -Panjandrum Industries,a manufacturer of industrial piping,is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems.It has made the above estimates of free cash flows resulting from such a decision.There are concerns of the sensitivity of this project to changes in the cost of capital.For approximately what cost of capital does this project break even?

The capital cost allowance (CCA)is only used for financial reporting purposes,and usually not for tax purposes.

Interest and other financing-related expenses are excluded when determining a project's unlevered net income.

Use the table for the question(s) below. -A company buys tracking software for its warehouse which,along with the computer system and ancillaries to run it,will cost $1.8 million.The new equipment and software falls under asset class 50 and has a capital cost allowance (CCA)rate of 55%.It is expected that the software will reduce inventory by $10.5 million at the end of the first year after it is installed,though there will be an annual cost of $120,000 per year to run the system.If the company's marginal tax rate is 40%,how will the purchase of this item change the company's free cash flows in the first year?

Use the information for the question(s) below. Food For Less (FFL), a grocery store, is considering offering one-hour photo developing in their store. The firm expects that sales from the new one-hour machine will be $150,000 per year. FFL currently offers overnight film processing with annual sales of $100,000. While many of the one-hour photo sales will be to new customers, FFL estimates that 60% of their current overnight photo customers will switch and use the one-hour service. -Joe pre-orders a non-refundable movie ticket.He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it.He goes to see it anyway,rationalizing that otherwise his money will have been wasted.Is Joe succumbing to the Sunk Cost Fallacy,and why?

The ultimate goal of capital budgeting is to determine the effect of a project on the firm's cash flows and the consequences of accepting or rejecting a project for the firm's value.

Use the table for the question(s) below. -A firm reports that in a certain year it had unlevered net income of $4.5 million,a capital cost allowance (CCA)deduction of $2.8 million,capital expenditures of $2.3 million,and net working capital decreased by $1.5 million.What is the firm's free cash flow for that year?

Use the table for the question(s) below. -Visby Rides,a livery car company,is considering buying some new luxury cars.After extensive research,they come up with the above estimates of free cash flow from this project.The cars belong to asset class 10 and have a capital cost allowance (CCA)rate of 30%.What is the net present value (NPV)of the project,given that the cost of capital is 10%,and the company faces a marginal tax rate of 25%?

Use the figure for the question(s) below. -The EBIT break even point can be calculated using which of the following formulas?

The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the the cost of manufacturing the knives,the selling price of the knives,the number of knives that will then be sold,and the project's net present value (NPV).Which of the following best describes what type of analysis the manager is performing?

Use the information for the question(s) below. Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $12 million during this year and the capital cost allowance will be another $3 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35%. -Assume that THSI's cost of capital for this project is 15%.The net present value (NPV)of this temporary housing project is closest to:

Use the information for the question(s) below. The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 10%. -The required net working capital in the first year for the Sisyphean Corporation's project is closest to:

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips.It will cost $6 million to buy the machine and $10,000 to have it delivered and installed.Building a clean room in the plant for the machine will cost an additional $3 million.The machine is expected to have a working life of six years.Which of these activities will be reported as an operating expense?

Which of the following formulas will correctly calculate Net Working Capital?

Use the information for the question(s) below. Food For Less (FFL), a grocery store, is considering offering one-hour photo developing in their store. The firm expects that sales from the new one-hour machine will be $150,000 per year. FFL currently offers overnight film processing with annual sales of $100,000. While many of the one-hour photo sales will be to new customers, FFL estimates that 60% of their current overnight photo customers will switch and use the one-hour service. -A bakery invests $30,000 in a light delivery truck.The truck belongs to asset class 10 and has a capital cost allowance (CCA)rate of 30%.If the company sold it immediately after the end of year 2 for $22,000,what would be the present value of the lost CCA tax shields,given a tax rate of 40% and a cost of capital of 8%?

Use the figure for the question(s) below. -The graph above shows the break-even analysis for the cost of making a certain good.Based on this chart,which of the following is true?

Use the table for the question(s) below. -A firm reports that in a certain year it had revenues of $4.5 million,costs of $1.2 million,a capital cost allowance (CCA)deduction of $2.8 million,capital expenditures of $2.3 million,and net working capital decreased by $1.5 million.If the firm's marginal corporate tax rate is 30%,what is the firm's free cash flow for that year?

Use the information for the question(s) below. The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine falls under asset class 43 and has a capital cost allowance (CCA) rate of 30%. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 10%. -The CCA tax shield for the Sisyphean Corporation's project in the first year is closest to: