Exam 11: Cash Flows and Other Topics in Capital Budgeting

In a replacement decision,the initial outlay is equal to the cost of the new asset less the reduction in depreciation from elimination of the old asset.

According to the CAPM,systematic risk is the only relevant risk for capital budgeting purposes.

Which of the following statements about project standing alone risk is true?

The risk-adjusted discount rate method implicitly assumes that distant cash flows have the same risk as near cash flows.

Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run.The industrial size oven will cost $1,200,000.The oven will be depreciated on a straight-line basis over its six-year useful life.The old oven cost the company $800,000 just four years ago.The old oven is being depreciated on a straight-line basis over its expected ten-year useful life.(That is,the old oven is expected to last six more years if it is not replaced now.)Due to changes in fuel costs,the old oven may only be sold today for $100,000.The new oven will allow the company to expand,increasing sales by $300,000 per year.Expenses will also decrease by $50,000 per year due to the more energy efficient design of the new oven.Premium Pie Company is in the 40% marginal tax bracket and has a required rate of return of 10%. a.Calculate the net present value and internal rate of return of replacing the existing machine b.Explain the impact on NPV of the following: i.Required rate of return increases ii.Operating costs of new machine are increased iii.Existing machine sold for less

Bill and Mary own a small chain of high fashion boutiques that represent almost 100% of their net worth.When considering capital budgeting projects for their boutiques,the appropriate measure of risk is

Using simulation provides the financial manager with a probability distribution of an investment's net present value or internal rate of return.

Terminal cash flows are always positive because they result from the shutting down of a project with the sale of any assets with remaining value.

The calculation of incremental free cash flows over a project's life should include

Operating cash flow is equal to the change in EBIT less the change in interest expense,less the change in taxes,plus the change in depreciation.

Salvage value would most likely NOT be considered by

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 a synergistic effect from the new diagnostic testing procedure is the

If a project uses an asset the corporation already owns,the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets.

Trinitron,Inc.purchased a new molding machine for $85,000.The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets.Trinitron must maintain a supply of special lubricating oil just in case the machine breaks down.The company purchased a supply of oil for $4,000.The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years.What will depreciation expense be during the first year?

If an old asset is sold for less than its book value,the resulting loss will save the company taxes,hence lowering the cost of the project.

Increases in working capital needs should be included as part of the initial outlay of a project,but decreases in working capital for a project should not be considered because they are not guaranteed.

Give an example of an option to expand a project.Why might this be of value?

A new machine can be purchased for $1,200,000.It will cost $35,000 to ship and $15,000 to modify the machine.A $12,000 recently completed feasibility study indicated that the firm can employ an existing factory owned by the firm,which would have otherwise been sold for $180,000.The firm will borrow $750,000 to finance the acquisition.Total interest expense for 5-years is expected to approximate $350,000.What is the investment cost of the machine for capital budgeting purposes?

Which of the following should be included in the initial outlay?

Which of the following is the most relevant measure of risk for capital budgeting purposes?