Exam 11: Cash Flows and Other Topics in Capital Budgeting

If the cash flows of an accepted investment project are negatively correlated with the average cash flow of the firm's existing assets,then the company's total exposure to risk can decrease.

The initial outlay of a project may be reduced by the after-tax salvage value of replaced equipment.

Which of the following are included in the terminal cash flow?

Your company is considering the replacement of an old delivery van with a new one that is more efficient.The old van cost $40,000 when it was purchased 5 years ago.The old van is being depreciated using the simplified straight-line method over a useful life of 8 years.The old van could be sold today for $7,000.The new van has an invoice price of $80,000,and it will cost $6,000 to modify the van to carry the company's products.Cost savings from use of the new van are expected to be $28,000 per year for 5 years,at which time the van will be sold for its estimated salvage value of $18,000.The new van will be depreciated using the simplified straight-line method over its 5-year useful life.The company's tax rate is 35%.Working capital is expected to increase by $5,000 at the inception of the project,but this amount will be recaptured at the end of year five.What is the initial outlay required to fund this replacement project?

A project's contribution-to-firm risk does allow for diversification within the firm.

A small,family-owned corporation would be more likely to use the contribution-to-firm risk criteria rather than the systematic risk to evaluate capital budgeting projects.

A method for estimating a project's beta that attempts to identify publicly traded firms engage solely in the same business as the project is called the pure play method.

Increasing depreciation expense results in a decrease of the incremental after-tax free cash flow.

The simulation approach provides us with

Sunk costs are cash outflows that will occur regardless of the current accept/reject decision,and therefore should be excluded from the analysis.

Blackjack Inc.wants to replace a 9-year-old machine with a new machine that is more efficient.The old machine cost $70,000 when new and has a current book value of $15,000.Blackjack can sell the machine to a foreign buyer for $14,000.Blackjack's tax rate is 35%.The effect of the sale of the old machine on the initial outlay for the new machine is

Butler Automotive developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month.As more drivers bring in their vehicles,Butler expects to also do more oil changes and brake repairs.As a result,inventory levels of oil and brake parts must be increased by $5,000.Revenues from oil changes and brake jobs are expected to increase by $4,000 per month.An example of an increase in net working capital requirements from the new diagnostic testing procedure is the

Any increase in interest payments caused by a project should be counted in the incremental cash flows.

J.B.Corporation is considering the purchase of equipment that has an invoice price of $450,000.The equipment was recommended by a consulting firm that did an analysis for J.B.Corporation.J.B.paid the consulting firm $12,000 for its report.The cost of shipping and installation is $50,000.The equipment will be depreciated on a straight-line basis over its useful life of 10 years,assuming no salvage value.The equipment will replace existing assets that have a current book value of $100,000 and which could be sold for $150,000.Additional net working capital of $15,000 will be required to maintain the equipment and to support higher sales.J.B.'s marginal tax rate is 40%.Calculate the initial outlay required to fund this project.

Free cash flow calculations can be broken down into three parts: cash flows from operations,cash flows associated with working-capital requirements,and financing cash flows relating to interest and dividend payments.

Reducing the probability of bankruptcy is a benefit of diversification.

What method is used for calculation of the accounting beta?

Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

TRL,Inc.has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000.The present value of all benefits the center will produce in its lifetime are $19,000,000,so TRL should not build the convention center.

One method of accounting for systematic risk for a project involves identifying a publicly traded firm that is engaged in the same business as that project and using its required rate of return to evaluate the project.This method is referred to as