Exam 11: Cash Flows and Other Topics in Capital Budgeting

A bakery company is considering one capital budgeting project involving the replacement of a sophisticated brick oven,and another capital budgeting project involving research and development into synthetic food substitutes.Which of the following statements is MOST correct concerning the risk-adjusted discount rate(s)for the projects?

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

AFB Systems is considering a new marketing campaign that will require the addition of a new computer programmer and new software.The programmer will occupy an office in AFB's current building and will be paid $8,000 per month.The software license costs $1,000 per month.The rent for the building is $4,000 per month.AFB's computer system is always on,so running the new software will not change the current monthly electric bill of $900.The incremental expenses for the new marketing campaign are

Additional investment in working capital,even if it may be recovered at the end of a project,must be included in capital budgeting analysis because of the time value of money.

The use of risk-adjusted discount rates is based on the concept that investors require a higher rate of return for more risky projects.

A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

The initial outlay for a new project is an example of an opportunity cost.

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 tax effect of selling the old machine?

A weakness in the capital budgeting process is the funds for an investment proposal obtained by issuing bonds,and the respective interest payments,are not considered in the capital budgeting process.

Proceeds from the issuance of new debt and principal payments upon maturity of debt used to finance a project should be included in the calculation of the project's after-tax cash flows.

In measuring cash flows,we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.

When terminating a project for capital budgeting purposes,the working capital outlay required at the initiation of the project will

For companies in competitive markets,the evolution and introduction of new products may serve more to preserve market share than to expand it.

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 incremental free cash flow for year one?

Accounting profits,adjusted for taxes and differences in accounting methods,provide the best measure of relevant cash flows for capital budgeting purposes.

If an old asset is sold for its depreciated,or book,value,then no taxes result and there is no tax effect from the sale.

Which of the following is NOT an acceptable method of measuring risk for capital budgeting purposes?

An asset with an original cost of $100,000 and a current book value of $20,000 is sold for $50,000 as part of a capital budgeting project.The company has a tax rate of 30%.This transaction will have what impact on the project's initial outlay?

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from ACME Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the incremental free cash flow for the first year of the project?

A local restaurant owner is considering expanding into another rural area.The expansion project will be financed through a line of credit with City Bank.The administrative costs of obtaining the line of credit are $500,and the interest payments are expected to be $1,000 per month.The new restaurant will occupy an existing building that can be rented for $2,500 per month.The incremental cash flows for the new restaurant include