Exam 12: Estimating Cash Flows on Capital Budgeting Projects

Your company is considering a new project that will require $2,000,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $250,000 using straight-line depreciation. The cost of capital is 12%, and the firm's tax rate is 39%. Estimate the present value of the tax benefits from depreciation.

Your company is considering the purchase of a new machine. The original cost of the old machine was $75,000; it is now 5 years old, and it has a current market value of $20,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $37,500 and an annual depreciation expense of $7,500. The old machine can be used for 6 more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $60,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $10,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 9 percent. Assume a 40 percent tax rate. What will the year 1 operating cash flow for this project be?

Which of the following statements is correct?

You are evaluating a project for your company. You estimate the sales price to be $25 per unit and sales volume to be 4,000 units in year 1; 7,000 units in year 2; and 1,000 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $10,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $1,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1?

Your company is considering a new project that will require $100,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $25,000 using straight-line depreciation. The cost of capital is 11%, and the firm's tax rate is 34%. Estimate the present value of the tax benefits from depreciation.

You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $25,000, has a six-year life, and has an annual OCF (after tax) of -$5,000 per year. The Keebler CookieMunster costs $40,000, has a seven-year life, and has an annual OCF (after tax) of -$500 per year. If your discount rate is 10 percent, what is each machine's EAC?

Everything held constant, would you rather depreciate a project with straight-line depreciation or with DDB?

A decrease in net working capital (NWC) is treated as a

Which of the following expenditures qualify for the Section 179 deduction?

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n) ________________.

Your company is considering a new project that will require $250,000 of new equipment at the start of the project. The equipment will have a depreciable life of 8 years and will be depreciated to a book value of $10,000 using straight-line depreciation. The cost of capital is 12%, and the firm's tax rate is 34%. Estimate the present value of the tax benefits from depreciation.

Your firm needs a machine which costs $500,000, and requires $10,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 35% and a discount rate of 15%. What is the depreciation tax shield for this project in year 3?

Will operating cash flow typically be larger or smaller than net income? Why?

You are evaluating a product for your company. You estimate the sales price of product to be $200 per unit and sales volume to be 2,000 units in year 1; 5,000 units in year 2; and 1,000 units in year 3. The project has a 3-year life. Variable costs amount to $75 per unit and fixed costs are $200,000 per year. The project requires an initial investment of $360,000 in assets which will be depreciated straight-line to zero over the 3-year project life. The actual market value of these assets at the end of year 3 is expected to be $40,000. NWC requirements at the beginning of each year will be approximately 20% of the projected sales during the coming year. The tax rate is 34% and the required return on the project is 13%. What will the year 2 free cash flow for this project be?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $250,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $50,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $80,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What will the operating cash flow for this project be during year 3?

Your firm needs a machine which costs $60,000, and requires $15,000 in maintenance for each year of its 5-year life. After 5 years, this machine will be replaced. The machine falls into the MACRS 5-year class life category. Assume a tax rate of 35% and a discount rate of 10%. If this machine can be sold for $8,000 at the end of year 5, what is the after-tax salvage value?

You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $300 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 units in year 3. The project has a 3-year life. Variable costs amount to $200 per unit and fixed costs are $50,000 per year. The project requires an initial investment of $150,000 in assets which will be depreciated straight-line to zero over the 3-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 10% of the projected sales during the coming year. The tax rate is 30% and the required return on the project is 10%. What will the free cash flow for this project be in year 2?

Suppose you sell a fixed asset for $90,000 when its book value is $95,000. If your company's marginal tax rate is 40%, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

Your firm needs a computerized machine tool lathe which costs $50,000 and another $12,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 30% and a discount rate of 12%. If the lathe can be sold for $6,000 at the end of year 3, what is the after-tax salvage value?

In a cost-cutting proposal, what might cause you to sometimes have a negative EBIT?